Title 26—Internal Revenue--Volume 22

§ 1.1502-22 Consolidated capital gain and loss.

(a) Capital gain. The determinations under section 1222, including capital gain net income, net long-term capital gain, and net capital gain, with respect to members during consolidated return years are not made separately. Instead, consolidated amounts are determined for the group as a whole. The consolidated capital gain net income for any consolidated return year is determined by reference to—

(1) The aggregate gains and losses of members from sales or exchanges of capital assets for the year (other than gains and losses to which section 1231 applies);

(2) The consolidated net section 1231 gain for the year (determined under § 1.1502-23); and

(3) The net capital loss carryovers or carrybacks to the year.

(b) Net capital loss carryovers and carrybacks—(1) In general. The determinations under section 1222, including net capital loss and net short-term capital loss, with respect to members during consolidated return years are not made separately. Instead, consolidated amounts are determined for the group as a whole. Losses included in the consolidated net capital loss may be carried to consolidated return years, and, after apportionment, may be carried to separate return years. The net capital loss carryovers and carrybacks consist of—

(i) Any consolidated net capital losses of the group; and

(ii) Any net capital losses of the members arising in separate return years.

(2) Carryovers and carrybacks generally. The net capital loss carryovers and carrybacks to a taxable year are determined under the principles of section 1212 and this section. Thus, losses permitted to be absorbed in a consolidated return year generally are absorbed in the order of the taxable years in which they were sustained, and losses carried from taxable years ending on the same date, and which are available to offset consolidated capital gain net income, generally are absorbed on a pro rata basis. Additional rules provided under the Internal Revenue Code or regulations also apply, as well as the SRLY limitation under paragraph (c) of this section. See, e.g., section 382(l)(2)(B).

(3) Carryovers and carrybacks of consolidated net capital losses to separate return years. If any consolidated net capital loss that is attributable to a member may be carried to a separate return year under the principles of § 1.1502-21(b)(2), the amount of the consolidated net capital loss that is attributable to the member is apportioned and carried to the separate return year (apportioned loss).

(4) Special rules—(i) Short years in connection with transactions to which section 381(a) applies. If a member distributes or transfers assets to a corporation that is a member immediately after the distribution or transfer in a transaction to which section 381(a) applies, the transaction does not cause the distributor or transferor to have a short year within the consolidated return year of the group in which the transaction occurred that is counted as a separate year for purposes of determining the years to which a net capital loss may be carried.

(ii) Special status losses. [Reserved]

(c) Limitations on net capital loss carryovers and carrybacks from separate return limitation years. The aggregate of the net capital losses of a member arising (or treated as arising) in SRLYs that are included in the determination of consolidated capital gain net income for all consolidated return years of the group under paragraph (a) of this section may not exceed the aggregate of the consolidated capital gain net income for all consolidated return years of the group determined by reference to only the member's items of gain and loss from capital assets as defined in section 1221 and trade or business assets defined in section 1231(b), including the member's losses actually absorbed by the group in the taxable year (whether or not absorbed by the member). The principles of § 1.1502-21(c) (including the SRLY subgroup principles under § 1.1502-21(c)(2)) apply with appropriate adjustments for purposes of applying this paragraph (c).

(d) [Reserved]

(e) Consolidated net capital loss. Any excess of losses over gains, as determined under paragraph (a) of this section (without regard to any carryovers or carrybacks), is also referred to as the consolidated net capital loss.

(f) Predecessors and successors. For purposes of this section, the principles of § 1.1502-21(f) apply with appropriate adjustments.

(g) Overlap with section 383—(1) General rule. The limitation provided in paragraph (c) of this section does not apply to net capital loss carryovers ((other than a hypothetical carryover like those described in § 1.1502-21(c)(1)(i)(D) and a carryover like those described in § 1.1502-21(c)(1)(ii)) when the application of paragraph (c) of this section results in an overlap with the application of section 383. For a similar rule applying in the case of net capital loss carryovers like those described in §§ 1.1502-21(c)(1)(i)(D) and (c)(1)(ii), see § 1.1502-15(g).

(2) Definitions—(i) Generally. For purposes of this paragraph (g), the definitions and nomenclature contained in sections 382 and 383, the regulations thereunder, and §§ 1.1502-90 through 1.1502-99 apply.

(ii) Overlap. (A) An overlap of the application of paragraph (c) of this section and the application of section 383 with respect to a net capital loss carryover occurs if a corporation becomes a member of the consolidated group (the SRLY event) within six months of the change date of an ownership change giving rise to a section 382 limitation with respect to that carryover (the section 383 event).

(B) If an overlap described in paragraph (g)(2)(ii)(A) of this section occurs with respect to net capital loss carryovers of a corporation whose SRLY event occurs within the six month period beginning on the date of a section 383 event, then an overlap is treated as also occurring with respect to that corporation's net capital loss carryover that arises within the period beginning with the section 383 event and ending with the SRLY event.

(C) For special rules in the event that there is a SRLY subgroup and/or a loss subgroup as defined in § 1.1502-91(d)(1) with respect to a carryover, see paragraph (g)(4) of this section.

(3) Operating rules—(i) Section 383 event before SRLY event. If a SRLY event occurs on the same date as a section 383 event or within the six month period beginning on the date of the section 383 event, paragraph (g)(1) of this section applies beginning with the tax year that includes the SRLY event.

(ii) SRLY event before section 383 event. If a section 383 event occurs within the period beginning the day after the SRLY event and ending six months after the SRLY event, paragraph (g)(1) of this section applies starting with the first tax year that begins after the section 383 event.

(4) Subgroup rules. In general, in the case of a net capital loss carryover for which there is a SRLY subgroup and a loss subgroup (as defined in § 1.1502-91(d)(1)), the principles of this paragraph (g) apply to the SRLY subgroup, and not separately to its members. However, paragraph (g)(1) of this section applies—

(i) With respect to a carryover described in paragraph (g)(2)(ii)(A) of this section only if—

(A) All members of the SRLY subgroup with respect to that carryover are also included in a loss subgroup with respect to that carryover; and

(B) All members of a loss subgroup with respect to that carryover are also members of a SRLY subgroup with respect to that carryover; and

(ii) With respect to a carryover described in paragraph (g)(2)(ii)(B) of this section only if all members of the SRLY subgroup for that carryover are also members of a SRLY subgroup that has net capital loss carryovers described in paragraph (g)(2)(ii)(A) of this section that are subject to the overlap rule of paragraph (g)(1) of this section.

(h) Effective date—(1) In general. This section generally applies to taxable years for which the due date (without extensions) of the consolidated return is after June 25, 1999. However—

(i) In the event that paragraph (g)(1) of this section does not apply to a particular net capital loss carryover in the current group, then solely for purposes of applying paragraph (c) of this section to determine a limitation with respect to that carryover and with respect to which the SRLY register (consolidated taxable income determined by reference to only the member's or subgroup's items of income, gain, deduction, or loss) began in a taxable year for which the due date of the return was on or before June 25, 1999, the principles of § 1.1502-21(c)(2) shall be applied without regard to the phrase “or for a carryover that was subject to the overlap rule described in paragraph (g) of this section or § 1.1502-15(g) with respect to another group (the former group)”; and

(ii) For purposes of paragraph (g) of this section, only an ownership change to which section 383, as amended by the Tax Reform Act of 1986, applies and which results in a section 382 limitation shall constitute a section 383 event.

(2) Prior periods. For certain taxable years ending on or before June 25, 1999, see § 1.1502-22T in effect prior to June 25, 1999, as contained in 26 CFR part 1 revised April 1, 1999, as applicable.

[T.D. 8823, 64 FR 36114, July 2, 1999, as amended by T.D. 10018, 89 FR 106868, Dec. 30, 2024]

§ 1.1502-23 Consolidated net section 1231 gain or loss.

(a) In general. Net section 1231 gains and losses of members arising during consolidated return years are not determined separately. Instead, the consolidated net section 1231 gain or loss is determined under this section for the group as a whole.

(b) Example. The following example illustrates the provisions of this section:

Example. Use of SRLY registers with net gains and net losses under section 1231. (i) In Year 1, T sustains a $20 net capital loss. At the beginning of Year 2, T becomes a member of the P group. T's capital loss carryover from Year 1 is subject to SRLY limits under § 1.1502-22(c). The members of the P group contribute the following to the consolidated taxable income for Year 2 (computed without regard to T's net capital loss carryover under § 1.1502-22):

P | T

Year 1 (SRLY)

Ordinary

Capital | (20)

Year 2

Ordinary | 10 | 20

Capital | 70 | 0

§ 1231 | (60) | 30

(ii) Under section 1231, if the section 1231 losses for any taxable year exceed the section 1231 gains for such taxable year, such gains and losses are treated as ordinary gains or losses. Because the P group's section 1231 losses, $(60), exceed the section 1231 gains, $30, the P group's net loss is treated as an ordinary loss. T's net section 1231 gain has the same character as the P group's consolidated net section 1231 loss, so T's $30 of section 1231 income is treated as ordinary income for purposes of applying § 1.1502-22(c). Under § 1.1502-22(c), the group's consolidated net capital gain determined by reference only to T's items is $0. None of T's capital loss carryover from Year 1 may be taken into account in Year 2.

(d) Effective date—(1) In general. This section applies to gains and losses arising in the determination of consolidated net section 1231 gain or loss for taxable years for which the due date (without extensions) of the consolidated return is after June 25, 1999.

(2) Application to prior periods. See § 1.1502-21(h)(3) for rules applicable to groups that applied the rules of this section to consolidated return years ending on or after January 29, 1991, and beginning before January 1, 1997.

[T.D. 8823, 64 FR 36115, July 2, 1999; 64 FR 41784, Aug. 2, 1999]

§ 1.1502-24 Consolidated charitable contributions deduction.

(a) Determination of amount of consolidated charitable contributions deduction. The deduction allowed by section 170 for the taxable year shall be the lesser of:

(1) The aggregate deductions of the members of the group allowable under section 170 (determined without regard to section 170(b)(2)), plus the consolidated charitable contribution carryovers to such year, or

(2) The percentage limitation on the total charitable contribution deduction provided in section 170(b)(2)(A) applied to adjusted consolidated income as determined under paragraph (c) of this section.

(b) Carryover of excess charitable contributions. The consolidated charitable contribution carryovers to any consolidated return year shall consist of any excess consolidated charitable contributions of the group, plus any excess charitable contributions of members of the group arising in separate return years of such members, which may be carried over to the taxable year under the principles of section 170(b) (2) and (3). However, such consolidated carryovers shall not include any excess charitable contributions apportioned to a corporation for a separate return year pursuant to paragraph (e) of § 1.1502-79.

(c) Adjusted consolidated taxable income. For purposes of this section, the adjusted consolidated taxable income of the group for any consolidated return year is the consolidated taxable income computed without regard to this section, section 243(a)(2) and (3), and § 1.1502-26, and without regard to any consolidated net operating or net capital loss carrybacks to such year.

[T.D. 6894, 31 FR 11794, Sept. 8, 1966; as amended by T.D. 10018, 89 FR 106868, Dec. 30, 2024]

§ 1.1502-26 Consolidated dividends received deduction.

(a) In general. The consolidated dividends received deduction for the taxable year is the lesser of—

(1) The aggregate of the deduction of the members of the group allowable under sections 243(a)(1), 245(a) and (b), and 250 (computed without regard to the limitations provided in section 246(b)), or

(2) The aggregate amount described in section 246(b), determined by substituting, wherever it appears—

(i) The term consolidated taxable income for taxable income,

(ii) The term consolidated net operating loss for net operating loss, and

(iii) The term consolidated net capital loss for capital loss.

(b) Intercompany dividends. The deduction determined under paragraph (a) of this section is determined without taking into account intercompany dividends to the extent that, under § 1.1502-13(f)(2), they are not included in gross income. See § 1.1502-13 for additional rules relating to intercompany dividends.

(1) Example 1. (i) Corporations P, S, and S-1 filed a consolidated return for the calendar year 2023 showing consolidated taxable income of $100,000 (determined without regard to the consolidated net operating loss deduction, and the consolidated dividends received deduction). These corporations received dividends during such year from less than 20-percent owned domestic corporations as follows:

Table 1 to Paragraph (c)(1)(i)

Corporation | Dividends

P | $6,000

S | 10,000

S-1 | 34,000

Total | 50,000

(ii) The dividends received deduction allowable to each member under section 243(a)(1) (computed without regard to the limitation in section 246(b)) is as follows: P has $3,000 (50 percent of $6,000), S has $5,000 (50 percent of $10,000), and S-1 has $17,000 (50 percent of $34,000), or a total of $25,000. Since $25,000 is less than $50,000 (50 percent of $100,000), the consolidated dividends received deduction is $25,000.

(2) Example 2. Assume the same facts as in paragraph (c)(1)(i) of this section (Example 1), except that consolidated taxable income (computed without regard to the consolidated net operating loss deduction and the consolidated dividends received deduction) was $40,000. The aggregate of the dividends received deductions, $42,500, computed without regard to section 246(b), results in a consolidated net operating loss of $2,500. See section 172(d)(5). Therefore, paragraph (a)(2) of this section does not apply and the consolidated dividends received deduction is $42,500.

[T.D. 6894, 31 FR 11794, Sept. 8, 1966, as amended by T.D. 7631, 44 FR 40497, July 11, 1979; T.D. 8597, 60 FR 36710, July 18, 1995; T.D. 8677, 61 FR 33323, June 27, 1996; T.D. 8823, 64 FR 36099, July 2, 1999; T.D. 10018, 89 FR 106868, Dec. 30, 2024]

§ 1.1502-28 Consolidated section 108.

(a) In general. This section sets forth rules for the application of section 108(a) and the reduction of tax attributes pursuant to section 108(b) when a member of the group realizes discharge of indebtedness income that is excluded from gross income under section 108(a) (excluded COD income).

(1) Application of section 108(a). Section 108(a)(1)(A) and (B) is applied separately to each member that realizes excluded COD income. Therefore, the limitation of section 108(a)(3) on the amount of discharge of indebtedness income that is treated as excluded COD income is determined based on the assets (including stock and securities of other members) and liabilities (including liabilities to other members) of only the member that realizes excluded COD income.

(2) Reduction of tax attributes attributable to the debtor—(i) In general. With respect to a member that realizes excluded COD income in a taxable year, the tax attributes attributable to that member (and its direct and indirect subsidiaries to the extent required by section 1017(b)(3)(D) and paragraph (a)(3) of this section), including basis of assets and losses and credits arising in separate return limitation years, shall be reduced as provided in sections 108 and 1017 and this section. Basis of subsidiary stock, however, shall not be reduced below zero pursuant to paragraph (a)(2) of this section (including when subsidiary stock is treated as depreciable property under section 1017(b)(3)(D) when there is an election under section 108(b)(5)).

(ii) Consolidated tax attributes attributable to a member. For purposes of this section, the amount of a consolidated tax attribute (e.g., a consolidated net operating loss) that is attributable to a member shall be determined pursuant to the principles of § 1.1502-21(b)(2)(iv). In addition, if the member is a member of a separate return limitation year subgroup, the amount of a tax attribute that arose in a separate return limitation year that is attributable to that member shall also be determined pursuant to the principles of § 1.1502-21(b)(2)(iv).

(3) Look-through rules—(i) Priority of section 1017(b)(3)(D). If a member treats stock of a subsidiary as depreciable property pursuant to section 1017(b)(3)(D), the basis of the depreciable property of such subsidiary shall be reduced pursuant to section 1017(b)(3)(D) prior to the application of paragraph (a)(3)(ii) of this section.

(ii) Application of additional look-through rule. If the basis of stock of a corporation (the lower-tier member) that is owned by another corporation (the higher-tier member) is reduced pursuant to sections 108 and 1017 and paragraph (a)(2) of this section (but not as a result of treating subsidiary stock as depreciable property pursuant to section 1017(b)(3)(D)), and both of such corporations are members of the same consolidated group on the last day of the higher-tier member's taxable year that includes the date on which the excluded COD income is realized or the first day of the higher-tier member's taxable year that follows the taxable year that includes the date on which the excluded COD income is realized, solely for purposes of sections 108 and 1017 and this section other than paragraphs (a)(4) and (b)(1) of this section, the lower-tier member shall be treated as realizing excluded COD income on the last day of the taxable year of the higher-tier member that includes the date on which the higher-tier member realized the excluded COD income. The amount of such excluded COD income shall be the amount of such basis reduction. Accordingly, the tax attributes attributable to such lower-tier member shall be reduced as provided in sections 108 and 1017 and this section. To the extent that the excluded COD income realized by the lower-tier member pursuant to this paragraph (a)(3) does not reduce a tax attribute attributable to the lower-tier member, such excluded COD income shall not be applied to reduce tax attributes attributable to any member under paragraph (a)(4) of this section and shall not cause an excess loss account to be taken into account under § 1.1502-19(b)(1) and (c)(1)(iii)(B).

(4) Reduction of certain tax attributes attributable to other members. To the extent that, pursuant to paragraph (a)(2) of this section, the excluded COD income is not applied to reduce the tax attributes attributable to the member that realizes the excluded COD income, after the application of paragraph (a)(3) of this section, such amount shall be applied to reduce the remaining consolidated tax attributes of the group, other than consolidated tax attributes to which a SRLY limitation applies, as provided in section 108 and this section. Such amount also shall be applied to reduce the tax attributes attributable to members that arose (or are treated as arising) in a separate return limitation year to the extent that the member that realizes excluded COD income is a member of the separate return limitation year subgroup with respect to such attribute if a SRLY limitation applies to the use of such attribute. In addition, such amount shall be applied to reduce the tax attributes attributable to members that arose in a separate return year or that arose (or are treated as arising) in a separate return limitation year if no SRLY limitation applies to the use of such attribute. The reduction of each tax attribute pursuant to the three preceding sentences shall be made in the order prescribed in section 108(b)(2) and pursuant to the principles of § 1.1502-21(b)(1). Except as otherwise provided in this paragraph (a)(4), a tax attribute that arose in a separate return year or that arose (or is treated as arising) in a separate return limitation year is not subject to reduction pursuant to this paragraph (a)(4). Basis in assets is not subject to reduction pursuant to this paragraph (a)(4). Finally, to the extent that the realization of excluded COD income by a member pursuant to paragraph (a)(3) does not reduce a tax attribute attributable to such lower-tier member, such excess shall not be applied to reduce tax attributes attributable to any member pursuant to this paragraph (a)(4).

(b) Special rules—(1) Multiple debtor members—(i) Reduction of tax attributes attributable to debtor members prior to reduction of consolidated tax attributes. If in a single taxable year multiple members realize excluded COD income, paragraphs (a)(2) and (3) of this section shall apply with respect to the excluded COD income of each such member before the application of paragraph (a)(4) of this section.

(ii) Reduction of higher-tier debtor's tax attributes. If in a single taxable year multiple members realize excluded COD income and one such member is a higher-tier member of another such member, paragraphs (a)(2) and (3) of this section shall be applied with respect to the excluded COD income of the higher-tier member before such paragraphs are applied to the excluded COD income of the other such member. In applying the rules of paragraph (a)(2) and (3) of this section with respect to the excluded COD income of the higher-tier member, the liabilities that give rise to the excluded COD income of the other such member shall not be treated as discharged for purposes of computing the limitation on basis reduction under section 1017(b)(2). A member (the first member) is a higher-tier member of another member (the second member) if the first member is the common parent or investment adjustments under § 1.1502-32 with respect to the stock of the second member would affect investment adjustments with respect to the stock of the first member.

(iii) Reduction of additional tax attributes. If more than one member realizes excluded COD income that has not been applied to reduce a tax attribute attributable to such member (the remaining COD amount) and the remaining tax attributes available for reduction under paragraph (a)(4) of this section are less than the aggregate of the remaining COD amounts, after the application of paragraph (a)(2) of this section, each such member's remaining COD amount shall be applied on a pro rata basis (based on the relative remaining COD amounts), pursuant to paragraph (a)(4) of this section, to reduce such remaining available tax attributes.

(iv) Ownership of lower-tier member by multiple higher-tier members. If stock of a corporation is held by more than one higher-tier member of the group and more than one such higher-tier member reduces its basis in such stock, then under paragraph (a)(3) of this section the excluded COD income resulting from the stock basis reductions shall be applied on a pro rata basis (based on the amount of excluded COD income caused by each basis reduction) to reduce the attributes of the corporation.

(v) Ownership of lower-tier member by multiple higher-tier members in multiple groups. If a corporation is a member of one group (the first group) on the last day of the first group's higher-tier member's taxable year that includes the date on which that higher-tier member realizes excluded COD income and is a member of another group (the second group) on the following day and the first group's higher-tier member and the second group's higher-tier member both reduce their basis in the stock of such corporation pursuant to sections 108 and 1017 and this section, paragraph (a)(3) of this section shall first be applied in respect of the excluded COD income that results from the reduction of the basis of the corporation's stock owned by the first group's higher-tier member and then shall be applied in respect of the excluded COD income that results from the reduction of the basis of the corporation's stock owned by the second group's higher-tier member.

(2) Election under section 108(b)(5)—(i) Availability of election. The group may make the election described in section 108(b)(5) for any member that realizes excluded COD income. The election is made separately for each member. Therefore, an election may be made for one member that realizes excluded COD income (either actually or pursuant to paragraph (a)(3) of this section) while another election, or no election, may be made for another member that realizes excluded COD income (either actually or pursuant to paragraph (a)(3) of this section). See § 1.108-4 for rules relating to the procedure for making an election under section 108(b)(5).

(ii) Treatment of shares with an excess loss account. For purposes of applying section 108(b)(5)(B), the basis of stock of a subsidiary that has an excess loss account shall be treated as zero.

(3) Application of section 1017—(i) Timing of basis reduction. Basis of property shall be subject to reduction pursuant to the rules of sections 108 and 1017 and this section after the determination of the tax imposed by chapter 1 of the Internal Revenue Code for the taxable year during which the member realizes excluded COD income and any prior years and coincident with the reduction of other attributes pursuant to section 108 and this section. However, only the basis of property held as of the beginning of the taxable year following the taxable year during which the excluded COD income is realized is subject to reduction pursuant to sections 108 and 1017 and this section.

(ii) Limitation of section 1017(b)(2). The limitation of section 1017(b)(2) on the reduction in basis of property shall be applied by reference to the aggregate of the basis of the property held by the member that realizes excluded COD income, not the aggregate of the basis of the property held by all of the members of the group, and the liabilities of such member, not the aggregate liabilities of all of the members of the group.

(iii) Treatment of shares with an excess loss account. For purposes of applying section 1017(b)(2) and § 1.1017-1, the basis of stock of a subsidiary that has an excess loss account shall be treated as zero.

(4) Application of section 1245. Notwithstanding section 1017(d)(1)(B), a reduction of the basis of subsidiary stock is treated as a deduction allowed for depreciation only to the extent that the amount by which the basis of the subsidiary stock is reduced exceeds the total amount of the attributes attributable to such subsidiary that are reduced pursuant to the subsidiary's consent under section 1017(b)(3)(D) or as a result of the application of paragraph (a)(3)(ii) of this section.

(5) Reduction of basis of intercompany obligations and former intercompany obligations—(i) Intercompany obligations that cease to be intercompany obligations. If excluded COD income is realized in a consolidated return year in which an intercompany obligation becomes an obligation that is not an intercompany obligation because the debtor or creditor becomes a nonmember, or because the assets of the debtor or the creditor are acquired by a nonmember in a transaction to which section 381 applies, then the basis of such intercompany obligation (or new obligation if the intercompany obligation is deemed reissued under § 1.1502-13(g)(3)) is available for reduction in respect of such excluded COD income pursuant to sections 108 and 1017 and this section.

(ii) Intercompany obligations. The reduction of the basis of an intercompany obligation pursuant to sections 108 and 1017 and this section shall not result in the satisfaction and reissuance of the obligation under § 1.1502-13(g). Therefore, any income or gain (or reduction of loss or deduction) attributable to a reduction of the basis of an intercompany obligation will be taken into account when § 1.1502-13(g)(3) applies to such obligation. Furthermore, § 1.1502-13(c)(6)(i) (regarding the treatment of intercompany items if corresponding items are excluded or nondeductible) will not apply to exclude any amount of income or gain attributable to a reduction of the basis of an intercompany obligation pursuant to sections 108 and 1017 and this section. See § 1.1502-13(g)(3)(i)(A)(1) and (g)(4)(i)(A).

(6) Taking into account excess loss account—(i) Determination of inclusion. The determination of whether any portion of an excess loss account in a share of stock of a subsidiary that realizes excluded COD income is required to be taken into account as a result of the application of § 1.1502-19(c)(1)(iii)(B) is made after the determination of the tax imposed by chapter 1 of the Internal Revenue Code for the year during which the member realizes excluded COD income (without regard to whether any portion of an excess loss account in a share of stock of the subsidiary is required to be taken into account) and any prior years, after the reduction of tax attributes pursuant to sections 108 and 1017 and this section, and after the adjustment of the basis of the share of stock of the subsidiary pursuant to § 1.1502-32 to reflect the amount of the subsidiary's deductions and losses that are absorbed in the computation of taxable income (or loss) for the year of the disposition and any prior years, and the excluded COD income applied to reduce attributes and the attributes reduced in respect thereof. See § 1.1502-11(c) for special rules related to the computation of tax that apply when an excess loss account is required to be taken into account.

(ii) Timing of inclusion. To the extent an excess loss account in a share of stock of a subsidiary that realizes excluded COD income is required to be taken into account as a result of the application of § 1.1502-19(c)(1)(iii)(B), such amount shall be included on the group's tax return for the taxable year that includes the date on which the subsidiary realizes such excluded COD income.

(7) Dispositions of stock. See § 1.1502-11(c) for limitations on the reduction of tax attributes when a member disposes of stock of another member (including dispositions that result from the application of § 1.1502-19(c)(1)(iii)(B)) during a taxable year in which any member realizes excluded COD income.

(8) Departure of member. If the taxable year of a member (the departing member) during which such member realizes excluded COD income ends on or prior to the last day of the consolidated return year and, on the first day of the taxable year of such member that follows the taxable year during which such member realizes excluded COD income, such member is not a member of the group and does not have a successor member (within the meaning of paragraph (b)(10) of this section), all tax attributes listed in section 108(b)(2) that remain after the determination of the tax imposed that belong to members of the group (including the departing member and subsidiaries of the departing member) shall be subject to reduction as provided in section 108 and the regulations promulgated thereunder (including § 1.108-7(c), if applicable) and this section.

(9) Intragroup reorganization—(i) In general. If the taxable year of a member during which such member realizes excluded COD income ends prior to the last day of the consolidated return year and, on the first day that follows the taxable year of such member during which such member realizes excluded COD income, such member has a successor member, for purposes of applying the rules of sections 108 and 1017 and this section, notwithstanding § 1.108-7, the successor member shall be treated as the member that realized the excluded COD income. Thus, all attributes attributable to the successor member listed in section 108(b)(2) (including attributes that were attributable to the successor member prior to the date such member became a successor member) are available for reduction under paragraph (a)(2) of this section.

(ii) Group structure change. If a member that realizes excluded COD income acquires the assets of the common parent of the consolidated group in a transaction to which section 381(a) applies and succeeds such common parent under the principles of § 1.1502-75(d)(2) as the common parent of the consolidated group, the member's attributes that remain after the determination of tax for the group for the consolidated return year during which the excluded COD income is realized (and any prior years) (including attributes that were attributable to the former common parent prior to the date of the transaction to which section 381(a) applies) shall be available for reduction under paragraph (a)(2) of this section.

(10) Definition of successor member. A successor member means a person to which the member that realizes excluded COD income (or a successor member) transfers its assets in a transaction to which section 381(a) applies if such transferee is a member of the group immediately after the transaction.

(11) Non-application of next day rule. For purposes of applying the rules of sections 108 and 1017 and this section, the next day rule of § 1.1502-76(b)(1)(ii)(B) shall not apply to treat a member's excluded COD income as realized at the beginning of the day following the day on which such member's status as a member changes.

(c) Examples. The principles of paragraphs (a) and (b) of this section are illustrated by the following examples. Unless otherwise indicated, no election under section 108(b)(5) has been made and the taxable year of all consolidated groups is the calendar year. The examples are as follows:

Example 1. (i) Facts. P is the common parent of a consolidated group that includes subsidiary S1. P owns 80 percent of the stock of S1. In Year 1, the P group sustained a $250 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $125 was attributable to P and $125 was attributable to S1. On Day 1 of Year 2, P acquired 100 percent of the stock of S2, and S2 joined the P group. As of the beginning of Year 2, S2 had a $50 net operating loss carryover from Year 1, a separate return limitation year. In Year 2, the P group sustained a $200 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $90 was attributable to P, $70 was attributable to S1, and $40 was attributable to S2. In Year 3, S2 realized $200 of excluded COD income from the discharge of non-intercompany indebtedness. In that same year, the P group sustained a $50 consolidated net operating loss, of which $40 was attributable to S1 and $10 was attributable to S2 under the principles of § 1.1502-21(b)(2)(iv). As of the beginning of Year 4, S2 had Asset A with a fair market value of $10. After the computation of tax imposed for Year 3 and before the application of sections 108 and 1017 and this section, Asset A had a basis of $40 and S2 had no liabilities.

(ii) Analysis—(A) Reduction of tax attributes attributable to debtor. Pursuant to paragraph (a)(2) of this section, the tax attributes attributable to S2 must first be reduced to take into account its excluded COD income in the amount of $200.

(1) Reduction of net operating losses. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating loss and the net operating loss carryovers attributable to S2 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is reduced by $10, the portion of the consolidated net operating loss attributable to S2, to $40. Then, again pursuant to section 108(b)(4)(B), S2's net operating loss carryover of $50 from its separate return limitation year is reduced to $0. Finally, the consolidated net operating loss carryover from Year 2 is reduced by $40, the portion of that consolidated net operating loss carryover attributable to S2, to $160.

(2) Reduction of basis. Following the reduction of the net operating loss and the net operating loss carryovers attributable to S2, S2 reduces its basis in its assets pursuant to section 1017 and § 1.1017-1. Accordingly, S2 reduces its basis in Asset A by $40, from $40 to $0.

(B) Reduction of remaining consolidated tax attributes. The remaining $60 of excluded COD income then reduces consolidated tax attributes pursuant to paragraph (a)(4) of this section. In particular, the remaining $40 consolidated net operating loss for Year 3 is reduced to $0. Then, the consolidated net operating loss carryover from Year 1 is reduced by $20 from $250 to $230. Pursuant to paragraph (a)(4) of this section, a pro rata amount of the consolidated net operating loss carryover from Year 1 that is attributable to each of P and S1 is treated as reduced. Therefore, $10 of the consolidated net operating loss carryover from Year 1 that is attributable to each of P and S1 is treated as reduced.

Example 2. (i) Facts. P is the common parent of a consolidated group that includes subsidiaries S1 and S2. P owns 100 percent of the stock of S1 and S1 owns 100 percent of the stock of S2. None of P, S1, or S2 has a separate return limitation year. In Year 1, the P group sustained a $50 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $10 was attributable to P, $20 was attributable to S1, and $20 was attributable to S2. In Year 2, the P group sustained a $70 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $30 was attributable to P, $30 was attributable to S1, and $10 was attributable to S2. In Year 3, S1 realized $170 of excluded COD income from the discharge of non-intercompany indebtedness. In that same year, the P group sustained a $50 consolidated net operating loss, of which $10 was attributable to S1 and $40 was attributable to S2 under the principles of § 1.1502-21(b)(2)(iv). As of the beginning of Year 4, S1's sole asset was the stock of S2, and S2 had Asset A with a $10 value. After the computation of tax imposed for Year 3 and before the application of sections 108 and 1017 and this section, S1 had an $80 basis in the S2 stock, Asset A had a basis of $0, and neither S1 nor S2 had any liabilities.

(ii) Analysis—(A) Reduction of tax attributes attributable to debtor. Pursuant to paragraph (a)(2) of this section, the tax attributes attributable to S1 must first be reduced to take into account its excluded COD income in the amount of $170.

(1) Reduction of net operating losses. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating loss and the net operating loss carryovers attributable to S1 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is reduced by $10, the portion of the consolidated net operating loss for Year 3 attributable to S1, to $40. Then, the consolidated net operating loss carryover from Year 1 is reduced by $20, the portion of that consolidated net operating loss carryover attributable to S1, to $30, and the consolidated net operating loss carryover from Year 2 is reduced by $30, the portion of that consolidated net operating loss carryover attributable to S1, to $40.

(2) Reduction of basis. Following the reduction of the net operating loss and the net operating loss carryovers attributable to S1, S1 reduces its basis in its assets pursuant to section 1017 and § 1.1017-1. Accordingly, S1 reduces its basis in the stock of S2 by $80, from $80 to $0.

(3) Tiering down of stock basis reduction. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S2 is treated as realizing $80 of excluded COD income. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and net operating loss carryovers attributable to S2 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is reduced by an additional $40, the portion of the consolidated net operating loss for Year 3 attributable to S2, to $0. Then, the consolidated net operating loss carryover from Year 1 is reduced by $20, the portion of that consolidated net operating loss carryover attributable to S2, to $10. Then, the consolidated net operating loss carryover from Year 2 is reduced by $10, the portion of that consolidated net operating loss carryover attributable to S2, to $30. S2's remaining $10 of excluded COD income does not reduce consolidated tax attributes attributable to P or S1 under paragraph (a)(4) of this section.

(B) Reduction of remaining consolidated tax attributes. Finally, pursuant to paragraph (a)(4) of this section, S1's remaining $30 of excluded COD income reduces the remaining consolidated tax attributes. In particular, the remaining $10 consolidated net operating loss carryover from Year 1 is reduced by $10 to $0, and the remaining $30 consolidated net operating loss carryover from Year 2 is reduced by $20 to $10.

Example 3. (i) Facts. P is the common parent of a consolidated group that includes subsidiaries S1, S2, and S3. P owns 100 percent of the stock of S1, S1 owns 100 percent of the stock of S2, and S2 owns 100 percent of the stock of S3. None of P, S1, S2, or S3 had a separate return limitation year prior to Year 1. In Year 1, the P group sustained a $150 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $50 was attributable to S2, and $100 was attributable to S3. In Year 2, the P group sustained a $50 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $40 was attributable to S1 and $10 was attributable to S2. In Year 3, S1 realized $170 of excluded COD income from the discharge of non-intercompany indebtedness. In that same year, the P group sustained a $50 consolidated net operating loss, of which $10 was attributable to S1, $20 was attributable to S2, and $20 was attributable to S3 under the principles of § 1.1502-21(b)(2)(iv). At the beginning of Year 4, S1's only asset was the stock of S2, and S2's only asset was the stock of S3 with a value of $10. After the computation of tax imposed for Year 3 and before the application of sections 108 and 1017 and this section, S1's stock of S2 had a basis of $120 and S2's stock of S3 had a basis of $180. In addition, none of S1, S2, and S3 had any liabilities.

(1) Reduction of net operating losses. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating loss and the net operating loss carryovers attributable to S1 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is reduced by $10, the portion of the consolidated net operating loss attributable to S1, to $40. Then, the consolidated net operating loss carryover from Year 2 is reduced by $40, the portion of that consolidated net operating loss carryover attributable to S1, to $10.

(B) Tiering down of stock basis reduction to S2. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S2 is treated as realizing $120 of excluded COD income. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and net operating loss carryovers attributable to S2 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is further reduced by $20, the portion of the consolidated net operating loss attributable to S2, to $20. Then, the consolidated net operating loss carryover from Year 1 is reduced by $50, the portion of that consolidated net operating loss carryover attributable to S2, to $100. Then, the consolidated net operating loss carryover from Year 2 is further reduced by $10, the portion of that consolidated net operating loss carryover attributable to S2, to $0. Following the reduction of the net operating loss and the net operating loss carryovers attributable to S2, S2 reduces its basis in its assets pursuant to section 1017 and § 1.1017-1. Accordingly, S2 reduces its basis in its S3 stock by $40 to $140.

(C) Tiering down of stock basis reduction to S3. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S3 is treated as realizing $40 of excluded COD income. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and the net operating loss carryovers attributable to S3 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is further reduced by $20, the portion of the consolidated net operating loss attributable to S3, to $0. Then, the consolidated net operating loss carryover from Year 1 is reduced by $20, the lesser of the portion of that consolidated net operating loss carryover attributable to S3 and the remaining excluded COD income, to $80.

Example 4. (i) Facts. P is the common parent of a consolidated group that includes subsidiaries S1, S2, and S3. P owns 100 percent of the stock of each of S1 and S2. Each of S1 and S2 owns stock of S3 that represents 50 percent of the value of the stock of S3. None of P, S1, S2, or S3 had a separate return limitation year prior to Year 1. In Year 1, the P group sustained a $160 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $10 was attributable to P, $50 was attributable to S2, and $100 was attributable to S3. In Year 2, the P group sustained a $110 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $40 was attributable to S1 and $70 was attributable to S2. In Year 3, S1 realized $200 of excluded COD income from the discharge of non-intercompany indebtedness, and S2 realized $270 of excluded COD income from the discharge of non-intercompany indebtedness. In that same year, the P group sustained a $50 consolidated net operating loss, of which $10 was attributable to S1, $20 was attributable to S2, and $20 was attributable to S3 under the principles of § 1.1502-21(b)(2)(iv). At the beginning of Year 4, S3 had one asset with a value of $10. After the computation of tax imposed for Year 3 and before the application of sections 108 and 1017 and this section, S1's basis in its S3 stock was $60, S2's basis in its S3 stock was $120, and S3's asset had a basis of $200. In addition, none of S1, S2, and S3 had any liabilities.

(ii) Analysis—(A) Reduction of tax attributes attributable to debtors. Pursuant to paragraph (b)(1)(i) of this section, the tax attributes attributable to each of S1 and S2 are reduced pursuant to paragraph (a)(2) of this section. Then, pursuant to paragraph (a)(3) of this section, the tax attributes attributable to S3 are reduced so as to reflect a reduction of S1's and S2's basis in the stock of S3. Then, paragraph (a)(4) is applied to reduce additional tax attributes.

(1) Reduction of net operating losses generally. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating losses and the net operating loss carryovers attributable to S1 and S2 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B).

(2) Reduction of net operating losses attributable to S1. The consolidated net operating loss for Year 3 is reduced by $10, the portion of the consolidated net operating loss attributable to S1, to $40. Then, the consolidated net operating loss carryover from Year 2 is reduced by $40, the portion of that consolidated net operating loss carryover attributable to S1, to $70.

(3) Reduction of net operating losses attributable to S2. The consolidated net operating loss for Year 3 is also reduced by $20, the portion of the consolidated net operating loss attributable to S2, to $20. Then, the consolidated net operating loss carryover from Year 1 is reduced by $50, the portion of that consolidated net operating loss carryover attributable to S2, to $110. Then, the consolidated net operating loss carryover from Year 2 is reduced by $70, the portion of that consolidated net operating loss carryover attributable to S2, to $0.

(4) Reduction of basis. Following the reduction of the net operating losses and the net operating loss carryovers attributable to S1 and S2, S1 and S2 must reduce their basis in their assets pursuant to section 1017 and § 1.1017-1. Accordingly, S1 reduces its basis in the stock of S3 by $60, from $60 to $0, and S2 reduces its basis in the stock of S3 by $120, from $120 to $0.

(B) Tiering down of basis reduction. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S3 is treated as realizing $180 of excluded COD income. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and the net operating loss carryovers attributable to S3 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 3 is further reduced by $20, the portion of the consolidated net operating loss attributable to S3, to $0. Then, the consolidated net operating loss carryover from Year 1 is reduced by $100, the portion of that consolidated net operating loss carryover attributable to S3, to $10. Following the reduction of the net operating loss and the net operating loss carryover attributable to S3, S3 reduces its basis in its asset pursuant to section 1017 and § 1.1017-1. Accordingly, S3 reduces its basis in its asset by $60, from $200 to $140.

(C) Reduction of remaining consolidated tax attributes. Finally, pursuant to paragraph (a)(4) of this section, the remaining $90 of S1's excluded COD income and the remaining $10 of S2's excluded COD income reduce the remaining consolidated tax attributes. In particular, the remaining $10 consolidated net operating loss carryover from Year 1 is reduced by $10 to $0. Because that amount is less than the aggregate amount of remaining excluded COD income, such income is applied on a pro rata basis to reduce the remaining consolidated tax attributes. Accordingly, $9 of S1's remaining excluded COD income and $1 of S2's remaining excluded COD income is applied to reduce the remaining consolidated net operating loss carryover from Year 1. Consequently, of S1's excluded COD income of $200, only $119 is applied to reduce tax attributes, and, of S2's excluded COD income of $270, only $261 is applied to reduce tax attributes.

Example 5. (i) Facts. P is the common parent of a consolidated group that includes subsidiaries S1, S2, and S3. P owns 100 percent of the stock of S1 and S2, and S1 owns 100 percent of the stock of S3. None of P, S1, S2, or S3 has a separate return limitation year prior to Year 1. In Year 1, the P group sustained a $90 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $10 was attributable to P, $15 was attributable to S1, $20 was attributable to S2, and $45 was attributable to S3. On January 1 of Year 2, P realized $140 of excluded COD income from the discharge of non-intercompany indebtedness. On December 31 of Year 2, S1 issued stock representing 50 percent of the vote and value of its outstanding stock to a person that was not a member of the group. As a result of the issuance of stock, S1 and S3 ceased to be members of the P group. For the consolidated return year of Year 2, the P group sustained a $60 consolidated net operating loss, of which $5 was attributable to S1, $40 was attributable to S2, and $15 was attributable to S3 under the principles of § 1.1502-21(b)(2)(iv). As of the beginning of Year 3, P's only assets were the stock of S1 and S2, S1's sole asset was the stock of S3, S2 had Asset A with a value of $10, and S3 had Asset B with a value of $10. After the computation of tax imposed for Year 2 and before the application of sections 108 and 1017 and this section, P had a $80 basis in the S1 stock and a $50 basis in the S2 stock, S1 had a $80 basis in the S3 stock, and Asset A and B each had a basis of $10. In addition, none of P, S1, S2, and S3 had any liabilities.

(ii) Analysis. Pursuant to paragraph (a)(2) of this section, the tax attributes attributable to P must first be reduced to take into account its excluded COD income in the amount of $140.

(A) Reduction of net operating losses. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating loss and the net operating loss carryover attributable to P under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss carryover from Year 1 is reduced by $10, the portion of that consolidated net operating loss carryover attributable to P, to $80.

(B) Reduction of basis. Following the reduction of the net operating loss and the net operating loss carryover attributable to P, P reduces its basis in its assets pursuant to section 1017 and § 1.1017-1. Accordingly, P reduces its basis in the stock of S1 by $80, from $80 to $0, and its basis in the stock of S2 by $50, from $50 to $0.

(C) Tiering down of stock basis reduction to S1. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S1 is treated as realizing $80 of excluded COD income, despite the fact that it ceases to be a member of the group at the end of the day on December 31 of Year 2. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and net operating loss carryovers attributable to S1 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 2 is reduced by $5, the portion of the consolidated net operating loss for Year 2 attributable to S1, to $55. Then, the consolidated net operating loss carryover from Year 1 is reduced by an additional $15, the portion of that consolidated net operating loss carryover attributable to S1, to $65. Following the reduction of the net operating loss and the net operating loss carryover attributable to S1, S1 reduces its basis in its assets pursuant to section 1017 and § 1.1017-1. Accordingly, S1 reduces its basis in the stock of S3 by $60, from $80 to $20.

(D) Tiering down of stock basis reduction to S2. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S2 is treated as realizing $50 of excluded COD income. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and net operating loss carryovers attributable to S2 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 2 is reduced by an additional $40, the portion of the consolidated net operating loss for Year 2 attributable to S2, to $15. Then, the consolidated net operating loss carryover from Year 1 is reduced by an additional $10, a portion of the consolidated net operating loss carryover attributable to S2, to $55.

(E) Tiering down of stock basis reduction to S3. Pursuant to paragraph (a)(3) of this section, for purposes of sections 108 and 1017 and this section, S3 is treated as realizing $60 of excluded COD income (by reason of S1's reduction in its basis of its S3 stock). Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, therefore, the net operating loss and net operating loss carryovers attributable to S3 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 2 is reduced by an additional $15, the portion of the consolidated net operating loss for Year 2 attributable to S3, to $0. Then, the consolidated net operating loss carryover from Year 1 is reduced by an additional $45, the portion of that consolidated net operating loss carryover attributable to S3, to $10.

Example 6. (i) Facts. P1 is the common parent of a consolidated group that includes subsidiaries S1, S2, and S3. P1 owns 100 percent of the stock of S1 and S2. S1 owns 100 percent of the stock of S3. None of P1, S1, S2, or S3 has a separate return limitation year prior to Year 1. In Year 1, the P1 group sustained a $120 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $40 was attributable to P1, $35 was attributable to S1, $30 was attributable to S2, and $15 was attributable to S3. On January 1 of Year 2, S3 realized $65 of excluded COD income from the discharge of non-intercompany indebtedness. On June 30 of Year 2, S3 issued stock representing 80 percent of the vote and value of its outstanding stock to P2, the common parent of another group. As a result of the issuance of stock, S3 ceased to be a member of the P1 group and became a member of the P2 group. For the consolidated return year of Year 2, the P1 group sustained a $50 consolidated net operating loss, of which $5 was attributable to S1, $40 was attributable to S2, and $5 was attributable to S3 under the principles of § 1.1502-21(b)(2)(iv). As of the beginning of its taxable year beginning on July 1 of Year 2, S3's sole asset was Asset A with a $10 value. After the computation of tax imposed for Year 2 on the P1 group and before the application of sections 108 and 1017 and this section and the computation of tax imposed for Year 2 on the P2 group, Asset A had a basis of $0. In addition, S3 had no liabilities. On January 1 of Year 3, P1 sold all of its stock of S1.

(ii) Analysis—(A) Reduction of tax attributes attributable to debtor. Pursuant to paragraph (a)(2) of this section, the tax attributes attributable to S3 must first be reduced to take into account its excluded COD income in the amount of $65. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating loss and the net operating loss carryover attributable to S3 under the principles of § 1.1502-21(b)(2)(iv) are reduced in the order prescribed by section 108(b)(4)(B). Accordingly, the consolidated net operating loss for Year 2 is reduced by $5, the portion of the consolidated net operating loss for Year 2 attributable to S3, to $45. Then, the consolidated net operating loss carryover from Year 1 is reduced by $15, the portion of that consolidated net operating loss carryover attributable to S3, to $105.

(B) Reduction of remaining consolidated tax attributes. Pursuant to paragraphs (a)(4) and (b)(8) of this section, S3's remaining $45 of excluded COD income reduces the remaining consolidated tax attributes in the P1 group. In particular, the remaining $45 consolidated net operating loss for Year 2 is reduced by an additional $45 to $0.

(C) Basis Adjustments. For purposes of computing P1's gain or loss on the sale of the S1 stock in Year 3, P1's basis in its S1 stock will reflect a net positive adjustment of $40, which is the excess of the amount of S3's excluded COD income that is applied to reduce attributes ($65) over the reduction of S1's and S3's attributes in respect of such excluded COD income ($25).

Example 7. (i) Facts. P is the common parent of a consolidated group that includes subsidiaries S1 and S2. P owns 100 percent of the stock of S1, and S1 owns 100 percent of the stock of S2. None of P, S1, or S2 has a separate return limitation year prior to Year 1. In Year 1, the P group sustained a $50 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $10 was attributable to P, $20 was attributable to S1, and $20 was attributable to S2. On January 1 of Year 2, S1 realized $55 of excluded COD income from the discharge of non-intercompany indebtedness. On June 30 of Year 2, P transferred all of its assets to S1 in a transaction to which section 381(a) applied. As a result of that transaction, pursuant to § 1.1502-75(d)(2)(ii), S1 succeeded P as the common parent of the group. Pursuant to § 1.1502-75(d)(2)(iii), S1's taxable year closed on the date of the acquisition. However, P's taxable year did not close. On the consolidated return for Year 2, the group sustained a $50 consolidated net operating loss. Under the principles of § 1.1502-21(b)(2)(iv), of that amount, $10 was attributable to S1 for its taxable year that ended on June 30, $15 was attributable to S1 as the successor of P, and $25 was attributable to S2.

(ii) Analysis. Pursuant to paragraph (a)(2) of this section, the tax attributes attributable to S1 must first be reduced to take into account its excluded COD income in the amount of $55. For this purpose, S1's attributes that remain after the determination of tax for the group for Year 2 are subject to reduction. Pursuant to section 108(b)(2)(A) and paragraph (a) of this section, the net operating loss and the net operating loss carryover attributable to S1 under the principles of § 1.1502-21(b)(2)(iv) are reduced. Accordingly, the consolidated net operating loss for Year 2 is reduced by $25, the portion of the consolidated net operating loss for Year 2 attributable to S1, to $25. Then, the consolidated net operating loss carryover from Year 1 is reduced by $30, the portion of that consolidated net operating loss carryover attributable to S1 (which includes the portion attributable to P), to $20.

(d) Effective dates. This section applies to discharges of indebtedness that occur after March 21, 2005. Groups, however, may apply this section in whole, but not in part, to discharges of indebtedness that occur on or before March 21, 2005, and after August 29, 2003. For discharges of indebtedness occurring on or before March 21, 2005, and after August 29, 2003, with respect to which a group chooses not to apply this section, see § 1.1502-28T as contained in 26 CFR part 1 revised as of April 1, 2004. Furthermore, groups may apply paragraph (b)(4) of this section to discharges of indebtedness that occur on or before August 29, 2003, in cases in which section 1017(b)(3)(D) was applied. Paragraph (b)(5)(i) of this section and the last sentence of paragraph (b)(5)(ii) of this section applies to transactions occurring in consolidated return years beginning on or after December 24, 2008.

[T.D. 9192, 70 FR 14404, Mar. 22, 2005, as amended by T.D. 9442, 73 FR 79334, Dec. 29, 2008]

14 Basis, Stock Ownership, and Earnings and Profits Rules

§ 1.1502-30 Stock basis after certain triangular reorganizations.

(a) Scope. This section provides rules for determining the basis of the stock of an acquiring corporation as a result of a triangular reorganization. The definitions and nomenclature contained in § 1.358-6 apply to this section.

(b) General rules—(1) Forward triangular merger, triangular C reorganization, or triangular B reorganization. P adjusts its basis in the stock of S as a result of a forward triangular merger, triangular C reorganization, or triangular B reorganization under § 1.358-6(c) and (d), except that § 1.358-6 (c)(1)(ii) and (d)(2) do not apply. Instead, P adjusts such basis by taking into account the full amount of—

(i) T liabilities assumed by S or the amount of liabilities to which the T assets acquired by S are subject, and

(ii) The fair market value of any consideration not provided by P pursuant to the plan of reorganization.

(2) Reverse triangular merger. If P adjusts its basis in the T stock acquired as a result of a reverse triangular merger under § 1.358-6 (c)(2)(i) and (d), § 1.358-6 (c)(1)(ii) and (d)(2) do not apply. Instead, P adjusts such basis by taking into account the full amount of—

(i) T liabilities deemed assumed by S or the amount of liabilities to which the T assets deemed acquired by S are subject, and

(ii) The fair market value of any consideration not provided by P pursuant to the plan of reorganization.

(3) Excess loss accounts. Negative adjustments under this section may exceed P's basis in its S or T stock. The resulting negative amount is P's excess loss account in its S or T stock. See § 1.1502-19 for rules treating excess loss accounts as negative basis, and treating references to stock basis as including references to excess loss accounts.

(4) Application of other rules of law. If a transaction otherwise subject to this section is also a group structure change subject to § 1.1502-31, the provisions of § 1.1502-31 and not this section apply to determine stock basis. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. See § 1.1502-80(d) for the non-application of section 357(c) to P.

(5) Examples. The rules of this paragraph (b) are illustrated by the following examples. For purposes of these examples, P, S, and T are domestic corporations, P and S file consolidated returns, P owns all of the only class of S stock, the P stock exchanged in the transaction satisfies the requirements of the applicable triangular reorganization provisions, the facts set forth the only corporate activity, and tax liabilities are disregarded.

Example 1. Liabilities. (a) Facts. T has assets with an aggregate basis of $60 and fair market value of $100. T's assets are subject to $70 of liabilities. Pursuant to a plan, P forms S with $5 of cash (which S retains), and T merges into S. In the merger, the T shareholders receive P stock worth $30 in exchange for their T stock. The transaction is a reorganization to which sections 368 (a)(1)(A) and (a)(2)(D) apply.

(b) Basis adjustment. Under § 1.358-6, P adjusts its $5 basis in the S stock as if P had acquired the T assets with a carryover basis under section 362 and transferred these assets to S in a transaction in which P determines its basis in the S stock under section 358. Under the rules of this section, the limitation described in § 1.358-6(c)(1)(ii) does not apply. Thus, P adjusts its basis in the S stock by -$10 (the aggregate adjusted basis of T's assets decreased by the amount of liabilities to which the T assets are subject). Consequently, as a result of the reorganization, P has an excess loss account of $5 in its S stock.

Example 2. Consideration not provided by P. (a) Facts. T has assets with an aggregate basis of $10 and fair market value of $100 and no liabilities. S is an operating company with substantial assets that has been in existence for several years. P has a $5 basis in its S stock. Pursuant to a plan, T merges into S and the T shareholders receive $70 of P stock provided by P pursuant to the plan of reorganization and $30 of cash provided by S in exchange for their T stock. The transaction is a reorganization to which sections 368 (a)(1)(A) and (a)(2)(D) apply.

(b) Basis adjustment. Under § 1.358-6, P adjusts its $5 basis in the S stock as if P had acquired the T assets with a carryover basis under section 362 and transferred these assets to S in a transaction in which P determines its basis in the S stock under section 358. Under the rules of this section, the limitation described in § 1.358-6(d)(2) does not apply. Thus, P adjusts its basis in the S stock by -$20 (the aggregate adjusted basis of T's assets decreased by the fair market value of the consideration provided by S). As a result of the reorganization, P has an excess loss account of $15 in its S stock.

(c) Appreciated asset. The facts are the same as in paragraph (a) of this Example 2, except that in the reorganization S provides an asset with a $20 adjusted basis and $30 fair market value instead of $30 cash. The basis is adjusted in the same manner as in paragraph (b) of this Example 2. In addition, because S recognizes a $10 gain from the asset under section 1001, P's basis in its S stock is increased under § 1.1502-32(b) by S's $10 gain. Consequently, as a result of the reorganization, P has an excess loss account of $5 in its S stock. (The results would be the same if the appreciated asset provided by S was P stock with respect to which S recognized gain. See § 1.1032-2(c)).

Example 3. Reverse triangular merger. (a) Facts. T has assets with an aggregate basis of $60 and fair market value of $100. T's assets are subject to $70 of liabilities. P owns all of the only class of S stock. P has a $5 basis in its S stock. Pursuant to a plan, S merges into T with T surviving. In the merger, the T shareholders exchange their T stock for $2 cash from P and $28 worth of P stock provided by P pursuant to the plan. The transaction is a reorganization to which sections 368 (a)(1)(A) and (a)(2)(E) apply.

(b) Basis adjustment. Under § 1.358-6, P's basis in the T stock acquired equals its $5 basis in its S stock immediately before the transaction adjusted by the $60 basis in the T assets deemed transferred, and the $70 of liabilities to which the T assets are subject. Under the rules of this section, the limitation described in § 1.358-6(c)(1)(ii) does not apply. Consequently, P has an excess loss account of $5 in its T stock as a result of the transaction.

(c) Effective/applicability date. This section applies to reorganizations occurring on or after December 21, 1995. However, paragraph (b)(4) of this section applies to reorganizations occurring on or after September 17, 2008.

[T.D. 8648, 60 FR 66082, Dec. 21, 1995, as amended by T.D. 9424, 73 FR 53949, Sept. 17, 2008]

§ 1.1502-31 Stock basis after a group structure change.

(a) In general—(1) Overview. If one corporation (P) succeeds another corporation (T) under the principles of § 1.1502-75(d) (2) or (3) as the common parent of a consolidated group in a group structure change, the basis of members in the stock of the former common parent (or the stock of a successor) is adjusted or determined under this section. See § 1.1502-33(f)(1) for the definition of group structure change. For example, if P owns all of the stock of another corporation (S), and T merges into S in a group structure change that is a reorganization described in section 368(a)(2)(D) in which P becomes the common parent of the T group, P's basis in S's stock must be adjusted to reflect the change in S's assets and liabilities. The rules of this section coordinate with the earnings and profits adjustments required under § 1.1502-33(f)(1), generally conforming the results of transactions in which the T group continues under § 1.1502-75 with P as the common parent. By preserving in P the relationship between T's earnings and profits and asset basis, these adjustments limit possible distortions under section 1502 (e.g., in the deconsolidation rules for earnings and profits under § 1.1502-33(e), and the continued filing requirements under § 1.1502-75(a)). This section applies whether or not T continues to exist after the group structure change.

(2) Application of other rules of law. If a transaction subject to this section is also a triangular reorganization otherwise subject to § 1.1502-30, the provisions of this section and not those of § 1.1502-30 apply to determine stock basis. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments.

(b) General rules. Except as otherwise provided in this section—

(1) Asset acquisitions. If a corporation acquires the former common parent's assets (and any liabilities assumed or to which the assets are subject) in a group structure change, the basis of members in the stock of the acquiring corporation is adjusted immediately after the group structure change to reflect the acquiring corporation's allocable share of the former common parent's net asset basis as determined under paragraph (c) of this section. For example, if S acquires all of T's assets in a group structure change that is a reorganization described in section 368(a)(2)(D), P's basis in S's stock is adjusted to reflect T's net asset basis. If P owned some of T's stock before the group structure change, the results would be the same because P's basis in the T stock is not taken into account in determining P's basis in S's stock. If T's net asset basis is a negative amount, it reduces P's basis in S's stock and, if the reduction exceeds P's basis in S's stock, the excess is P's excess loss account in S's stock. See § 1.1502-19 for rules treating P's excess loss account as negative basis, and treating a reference to P's basis in S's stock as including an excess loss account.

(2) Stock acquisitions. If a corporation acquires stock of the former common parent in a group structure change, the basis of the members in the former common parent's stock immediately after the group structure change (including any stock of the former common parent owned before the group structure change) that is, or would otherwise be, transferred basis property is redetermined in accordance with the results for an asset acquisition described in paragraph (b)(1) of this section. For example, if all of T's stock is contributed to P in a group structure change to which section 351 applies, P's basis in T's stock is T's net asset basis, rather than the amount determined under section 362. Similarly, if S merges into T in a group structure change described in section 368(a)(2)(E) and P acquires all of the T stock, P's basis in T's stock is the basis that P would have in S's stock under paragraph (b)(1) of this section if T had merged into S in a group structure change described in section 368(a)(2)(D).

(c) Net asset basis. The former common parent's net asset basis is the basis it would have in the stock of a newly formed subsidiary, if—

(1) The former common parent transferred its assets (and any liabilities assumed or to which the assets are subject) to the subsidiary in a transaction to which section 351 applies;

(2) The former common parent and the subsidiary were members of the same consolidated group (see § 1.1502-80(d) for the non-application of section 357(c) to the transfer); and

(3) The asset basis taken into account is each asset's basis immediately after the group structure change (e.g., taking into account any income or gain recognized in the group structure change and reflected in the asset's basis).

(d) Additional adjustments. In addition to the adjustments in paragraph (b) of this section, the following adjustments are made:

(1) Consideration not provided by P. The basis is reduced to reflect the fair market value of any consideration not provided by the member. For example, if S acquires T's assets in a group structure change described in section 368(a)(2)(D), and S provides an appreciated asset (e.g., stock of P) as partial consideration in the transaction, P's basis in S's stock is reduced by the fair market value of the asset.

(2) Allocable share—(i) Asset acquisitions. If a corporation receives less than all of the former common parent's assets and liabilities in the group structure change, the former common parent's net asset basis taken into account under paragraph (b)(1) of this section is adjusted accordingly.

(ii) Stock acquisitions. If less than all of the former common parent's stock is subject to the redetermination described in paragraph (b)(2) of this section, the percentage of the former common parent's net asset basis taken into account in the redetermination equals the percentage (by fair market value) of the former common parent's stock subject to the redetermination. For example, if P owns less than all of the former common parent's stock immediately after the group structure change and such stock would otherwise be transferred basis property, only an allocable part of the basis determined under this section is reflected in the shares owned by P (and the amount allocable to shares owned by nonmembers has no effect on the basis of their shares). Alternatively, if P acquired 10 percent of the former common parent's stock in a transaction in which the stock basis was determined by P's cost, and P later acquires the remaining 90 percent of the former common parent's stock in a separate transaction that is described in paragraph (b)(2) of this section, P retains its cost basis in its original stock and the basis of P's newly acquired shares reflects only an allocable part of the former common parent's net asset basis.

(3) Allocation among shares of stock. The basis determined under this section is allocated among shares under the principles of section 358. For example, if P owns multiple classes of the former common parent's stock immediately after the group structure change, only an allocable part of the basis determined under this section is reflected in the basis of each share. See § 1.1502-19(d), for special allocations with respect to excess loss accounts.

(4) Higher-tier members. To the extent that the former common parent is owned by members other than the new common parent, the basis of members in the stock of all subsidiaries owning, directly or indirectly, in whole or in part, an interest in the former common parent's assets or liabilities is adjusted in accordance with the principles of this section. The adjustments are applied in the order of the tiers, from the lowest to the highest.

(e) Waiver of loss carryovers of former common parent—(1) General rule. An irrevocable election may be made to treat all or any portion of a loss carryover attributable to the common parent as expiring for all Federal income tax purposes immediately before the group structure change. Thus, if the loss carryover is treated as expiring under the election, it will not result in a negative adjustment to the basis of P's stock under § 1.1502-32(b).

(2) Election. The election described in paragraph (e)(1) of this section must be made in a separate statement entitled, “ELECTION TO TREAT LOSS CARRYOVER AS EXPIRING UNDER § 1.1502-31(e).” The election must be filed by including the statement on or with the consolidated group's income tax return for the year that includes the group structure change. The statement must identify the amount of each loss carryover deemed to expire (or the amount of each loss carryover deemed not to expire, with any balance of any loss carryovers being deemed to expire).

(f) Predecessors and successors. For purposes of this section, any reference to a corporation includes a reference to a successor or predecessor as the context may require. See § 1.1502-32(f) for definitions of predecessor and successor.

(g) Examples. For purposes of the examples in this section, unless otherwise stated, all corporations have only one class of stock outstanding, the tax year of all persons is the calendar year, all persons use the accrual method of accounting, the facts set forth the only corporate activity, all transactions are between unrelated persons, and tax liabilities are disregarded. The principles of this section are illustrated by the following examples:

Example 1. Forward triangular merger. (i) Facts. P is the common parent of one group and T is the common parent of another. T has assets with an aggregate basis of $60 and fair market value of $100 and no liabilities. T's shareholders have an aggregate basis of $50 in T's stock. In Year 1, pursuant to a plan, P forms S and T merges into S with the T shareholders receiving $100 of P stock in exchange for their T stock. The transaction is a reorganization described in section 368(a)(2)(D). The transaction is also a reverse acquisition under § 1.1502-75(d)(3) because the T shareholders, as a result of owning T's stock, own more than 50% of the value of P's stock immediately after the transaction. Thus, the transaction is a group structure change under § 1.1502-33(f)(1), and P's earnings and profits are adjusted to reflect T's earnings and profits immediately before T ceases to be the common parent of the T group.

(ii) Analysis. Under paragraph (b)(1) of this section, P's basis in S's stock is adjusted to reflect T's net asset basis. Under paragraph (c) of this section, T's net asset basis is $60, the basis T would have in the stock of a subsidiary under section 358 if T had transferred all of its assets and liabilities to the subsidiary in a transaction to which section 351 applies. Thus, P has a $60 basis in S's stock.

(iii) Pre-existing S. The facts are the same as in paragraph (i) of this Example 1, except that P has owned the stock of S for several years and P has a $50 basis in the S stock before the merger with T. Under paragraph (b)(1) of this section, P's $50 basis in S's stock is adjusted to reflect T's net asset basis. Thus, P's basis in S's stock is $110 ($50 plus $60).

(iv) Excess loss account included in former common parent's net asset basis. The facts are the same as in paragraph (i) of this Example 1, except that T has two assets, an operating asset with an $80 basis and $90 fair market value, and stock of a subsidiary with a $20 excess loss account and $10 fair market value. Under paragraph (c) of this section, T's net asset basis is $60 ($80 minus $20). See sections 351 and 358, and § 1.1502-19. Consequently, P has a $60 basis in S's stock. Under section 362 and § 1.1502-19, S has an $80 basis in the operating asset and a $20 excess loss account in the stock of the subsidiary.

(v) Liabilities in excess of basis. The facts are the same as in paragraph (i) of this Example 1, except that T's assets have a fair market value of $170 (and $60 basis) and are subject to $70 of liabilities. Under paragraph (c) of this section, T's net asset basis is negative $10 ($60 minus $70). See sections 351 and 358, and §§ 1.1502-19 and 1.1502-80(d). Thus, P has a $10 excess loss account in S's stock. Under section 362, S has a $60 basis in its assets (which are subject to $70 of liabilities). (Under paragraph (a)(2) of this section, because the liabilities are taken into account in determining net asset basis under paragraph (c) of this section, the liabilities are not also taken into account as consideration not provided by P under paragraph (d)(1) of this section.)

(vi) Consideration provided by S. The facts are the same as in paragraph (i) of this Example 1, except that P forms S with a $100 contribution at the beginning of Year 1, and during Year 6, pursuant to a plan, S purchases $100 of P stock and T merges into S with the T shareholders receiving P stock in exchange for their T stock. Under paragraph (b)(1) of this section, P's $100 basis in S's stock is increased by $60 to reflect T's net asset basis. Under paragraph (d)(1) of this section, P's basis in S's stock is decreased by $100 (the fair market value of the P stock) because the P stock purchased by S and used in the transaction is consideration not provided by P.

(vii) Appreciated asset provided by S. The facts are the same as in paragraph (i) of this Example 1, except that P has owned the stock of S for several years, and the shareholders of T receive $60 of P stock and an asset of S with a $30 adjusted basis and $40 fair market value. S recognizes a $10 gain from the asset under section 1001. Under paragraph (b)(1) of this section, P's basis in S's stock is increased by $60 to reflect T's net asset basis. Under paragraph (d)(1) of this section, P's basis in S's stock is decreased by $40 (the fair market value of the asset provided by S). In addition, P's basis in S's stock is increased under § 1.1502-32(b) by S's $10 gain.

(viii) Depreciated asset provided by S. The facts are the same as in paragraph (i) of this Example 1, except that P has owned the stock of S for several years, and the shareholders of T receive $60 of P stock and an asset of S with a $50 adjusted basis and $40 fair market value. S recognizes a $10 loss from the asset under section 1001. Under paragraph (b)(1) of this section, P's basis in S's stock is increased by $60 to reflect T's net asset basis. Under paragraph (d)(1) of this section, P's basis in S's stock is decreased by $40 (the fair market value of the asset provided by S). In addition, S's $10 loss is taken into account under § 1.1502-32(b) in determining P's basis adjustments under that section.

Example 2. Stock acquisition. (i) Facts. P is the common parent of one group and T is the common parent of another. T has assets with an aggregate basis of $60 and fair market value of $100 and no liabilities. T's shareholders have an aggregate basis of $50 in T's stock. Pursuant to a plan, P forms S and S acquires all of T's stock in exchange for P stock in a transaction described in section 368(a)(1)(B). The transaction is also a reverse acquisition under § 1.1502-75(d)(3). Thus, the transaction is a group structure change under § 1.1502-33(f)(1), and the earnings and profits of P and S are adjusted to reflect T's earnings and profits immediately before T ceases to be the common parent of the T group.

(ii) Analysis. Under paragraph (d)(4) of this section, although S is not the new common parent of the T group, adjustments must be made to S's basis in T's stock in accordance with the principles of this section. Although S's basis in T's stock would ordinarily be determined under section 362 by reference to the basis of T's shareholders in T's stock immediately before the group structure change, under the principles of paragraph (b)(2) of this section, S's basis in T's stock is determined by reference to T's net asset basis. Thus, S's basis in T's stock is $60.

(iii) Higher-tier adjustments. Under paragraph (d)(4) of this section, P's basis in S's stock is increased by $60 (to be consistent with the adjustment to S's basis in T's stock).

(iv) Cross ownership. The facts are the same as in paragraph (i) of this Example 2, except S purchased 10% of T's stock from an unrelated person for cash. In an unrelated transaction, S acquires the remaining 90% of T's stock in exchange for P stock. S's basis in the initial 10% of T's stock is not redetermined under this section. However, S's basis in the additional 90% of T's stock is redetermined under this section. S's basis in that stock is adjusted to $54 (90% of T's net asset basis).

(v) Allocable share. The facts are the same as in paragraph (i) of this Example 2, except that P owns only 90% of S's stock immediately after the group structure change. S's basis in T's stock is the same as in paragraph (ii) of this Example 2. Under paragraph (d)(2) of this section, P's basis in its S stock is increased by $54 (90% of S's $60 adjustment).

Example 3. Taxable stock acquisition. (i) Facts. P is the common parent of one group and T is the common parent of another. T has assets with an aggregate basis of $60 and fair market value of $100 and no liabilities. T's shareholders have an aggregate basis of $50 in T's stock. Pursuant to a plan, P acquires all of T's stock in exchange for $70 of P's stock and $30 in a transaction that is a group structure change under § 1.1502-33(f)(1). P's acquired T stock is not transferred basis property. (Because of P's use of cash, the acquisition is not a transaction described in section 368(a)(1)(B).)

(ii) Analysis. The rules of this section do not apply to determine P's basis in T's stock. Therefore, P's basis in T's stock is $100.

(h) Effective/applicability dates—(1) General rule. This section applies to group structure changes that occur after April 26, 2004. However, a group may apply this section to group structure changes that occurred on or before April 26, 2004, and in consolidated return years beginning on or after January 1, 1995. In addition, paragraph (a)(2) of this section applies to group structure changes that occurred on or after September 17, 2008. Paragraph (e)(2) of this section applies to any original consolidated Federal income tax return due (without extensions) after June 14, 2007. For original consolidated Federal income tax returns due (without extensions) after May 30, 2006, and on or before June 14, 2007, see § 1.1502-31T as contained in 26 CFR part 1 in effect on April 1, 2007. For original consolidated Federal income tax returns due (without extensions) on or before May 30, 2006, see § 1.1502-31 as contained in 26 CFR part 1 in effect on April 1, 2006.

(2) Prior law. For group structure changes that occur on or before April 26, 2004, and in consolidated return years beginning on or after January 1, 1995, with respect to which the group does not elect to apply the provisions of this section, see § 1.1502-31 as contained in the 26 CFR part 1 edition revised as of April 1, 2003. For group structure changes that occur in consolidated return years beginning before January 1, 1995, see § 1.1502-31T as contained in the 26 CFR part 1 edition revised as of April 1, 1994.

[T.D. 8560, 59 FR 41683, Aug. 15, 1994, as amended by T.D. 9122, 69 FR 22400, Apr. 26, 2004; T.D. 9264, 71 FR 30602, May 30, 2006; T.D. 9329, 72 FR 32804, June 14, 2007; T.D. 9424, 73 FR 53949, Sept. 17, 2008]

§ 1.1502-32 Investment adjustments.

(a) In general—(1) Purpose. This section provides rules for adjusting the basis of the stock of a subsidiary (S) owned by another member (M). These rules modify the determination of M's basis in S's stock under applicable rules of law by adjusting M's basis to reflect S's distributions and S's items of income, gain, deduction, and loss taken into account for the period that S is a member of the consolidated group. The purpose of the adjustments is to treat M and S as a single entity so that consolidated taxable income reflects the group's income. For example, if M forms S with a $100 contribution, and S takes into account $10 of income, M's $100 basis in S's stock under section 358 is increased by $10 under this section to prevent S's income from being taken into account a second time on M's disposition of S's stock. Comparable adjustments are made for tax-exempt income and noncapital, nondeductible expenses that S takes into account, to preserve their treatment under the Internal Revenue Code.

(2) Application of other rules of law, duplicative adjustments. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. The rules of this section are in addition to other rules of law. See, e.g., section 358 (basis determinations for distributees), section 1016 (adjustments to basis), § 1.1502-11(b) (limitations on the use of losses), § 1.1502-19 (treatment of excess loss accounts), § 1.1502-31 (basis after a group structure change), and § 1.1502-35 (additional rules relating to stock loss, including losses attributable to worthlessness and certain dispositions not followed by a separate return year). M's basis in S's stock must not be adjusted under this section and other rules of law in a manner that has the effect of duplicating an adjustment.

(3) Overview—(i) In general. The amount of the stock basis adjustments and their timing are determined under paragraph (b) of this section. Under paragraph (c) of this section, the amount of the adjustment is allocated among the shares of S's stock. Paragraphs (d) through (g) of this section provide definitions, an anti-avoidance rule, successor rules, and recordkeeping requirements.

(ii) Excess loss account. Negative adjustments under this section may exceed M's basis in S's stock. The resulting negative amount is M's excess loss account in S's stock. See § 1.1502-19 for rules treating excess loss accounts as negative basis, and treating references to stock basis as including references to excess loss accounts.

(iii) Tiering up of adjustments. The adjustments to S's stock under this section are taken into account in determining adjustments to higher-tier stock. The adjustments are applied in the order of the tiers, from the lowest to the highest. For example, if M is also a subsidiary, M's adjustment to S's stock is taken into account in determining the adjustments to stock of M owned by other members.

(b) Stock basis adjustments—(1) Timing of adjustments—(i) In general. Adjustments under this section are made as of the close of each consolidated return year, and as of any other time (an interim adjustment) if a determination at that time is necessary to determine a tax liability of any person. For example, adjustments are made as of M's sale of S's stock in order to measure M's gain or loss from the sale, and if M's interest in S's stock is not uniform throughout the year (e.g., because M disposes of a portion of its S stock, or S issues additional shares to another person), the adjustments under this section are made by taking into account the varying interests. An interim adjustment may be necessary even if tax liability is not affected until a later time. For example, if M sells only 50% of S's stock and S becomes a nonmember, adjustments must be made for the retained stock as of the disposition (whether or not M has an excess loss account in that stock). Similarly, if S liquidates during a consolidated return year, adjustments must be made as of the liquidation (even if the liquidation is tax free under section 332).

(ii) Special rule for discharge of indebtedness income. Adjustments under this section resulting from the realization of discharge of indebtedness income of a member that is excluded from gross income under section 108(a) (excluded COD income) and from the reduction of attributes in respect thereof pursuant to sections 108 and 1017 and § 1.1502-28 (including reductions in the basis of property) when a member (the departing member) ceases to be a member of the group on or prior to the last day of the consolidated return year that includes the date the excluded COD income is realized are made immediately after the determination of tax for the group for the taxable year during which the excluded COD income is realized (and any prior years) and are effective immediately before the beginning of the taxable year of the departing member following the taxable year during which the excluded COD income is realized. Such adjustments when a corporation (the new member) is not a member of the group on the last day of the consolidated return year that includes the date the excluded COD income is realized but is a member of the group at the beginning of the following consolidated return year are also made immediately after the determination of tax for the group for the taxable year during which the excluded COD income is realized (and any prior years) and are effective immediately before the beginning of the taxable year of the new member following the taxable year during which the excluded COD income is realized. If the new member was a member of another group immediately before it became a member of the group, such adjustments are treated as occurring immediately after it ceases to be a member of the prior group.

(iii) Allocation of items. If § 1.1502-76(b) applies to S for purposes of an adjustment before the close of the group's consolidated return year, the amount of the adjustment is determined under that section. If § 1.1502-76(b) does not apply to the interim adjustment, the adjustment is determined under the principles of § 1.1502-76(b), consistently applied, and ratable allocation under the principles of § 1.1502-76(b)(2)(ii) or (iii) may be used without filing an election under § 1.1502-76(b)(2). The principles would apply, for example, if M becomes a nonmember but S remains a member.

(2) Amount of adjustments. M's basis in S's stock is increased by positive adjustments and decreased by negative adjustments under this paragraph (b)(2). The amount of the adjustment, determined as of the time of the adjustment, is the net amount of S's—

(i) Taxable income or loss;

(ii) Tax-exempt income;

(iii) Noncapital, nondeductible expenses; and

(iv) Distributions with respect to S's stock.

(3) Operating rules. For purposes of determining M's adjustments to the basis of S's stock under paragraph (b)(2) of this section—

(i) Taxable income or loss. S's taxable income or loss is consolidated taxable income (or loss) determined by including only S's items of income, gain, deduction, and loss taken into account in determining consolidated taxable income (or loss), treating S's deductions and losses as taken into account to the extent they are absorbed by S or any other member. For this purpose:

(A) To the extent that S's deduction or loss is absorbed in the year it arises or is carried forward and absorbed in a subsequent year (e.g., under section 172, 465, or 1212), the deduction or loss is taken into account under paragraph (b)(2) of this section in the year in which it is absorbed.

(B) To the extent that S's deduction or loss is carried back and absorbed in a prior year (whether consolidated or separate), the deduction or loss is taken into account under paragraph (b)(2) of this section in the year in which it arises and not in the year in which it is absorbed.

(ii) Tax-exempt income—(A) In general. S's tax-exempt income is its income and gain which is taken into account but permanently excluded from its gross income under applicable law, and which increases, directly or indirectly, the basis of its assets (or an equivalent amount). For example, S's dividend income to which § 1.1502-13(f)(2)(ii) applies, and its interest excluded from gross income under section 103, are treated as tax-exempt income. However, S's income not recognized under section 1031 is not treated as tax- exempt income because the corresponding basis adjustments under section 1031(d) prevent S's nonrecognition from being permanent. Similarly, S's tax-exempt income does not include gain not recognized under section 332 from the liquidation of a lower-tier subsidiary, or not recognized under section 118 or section 351 from a transfer of assets to S.

(B) Equivalent deductions. To the extent that S's taxable income or gain is permanently offset by a deduction or loss that does not reduce, directly or indirectly, the basis of S's assets (or an equivalent amount), the income or gain is treated as tax-exempt income and is taken into account under paragraph (b)(3)(ii)(A) of this section. In addition, the income and the offsetting item are taken into account under paragraph (b)(3)(i) of this section. For example, if S receives a $100 dividend with respect to which a $70 dividends received deduction is allowed under section 243, $70 of the dividend is treated as tax-exempt income. Accordingly, M's basis in S's stock increases by $100 because the $100 dividend and $70 deduction are taken into account under paragraph (b)(3)(i) of this section (resulting in $30 of the increase), and $70 of the dividend is also taken into account under paragraph (b)(3)(ii)(A) of this section as tax-exempt income (resulting in $70 of the increase). (See paragraph (b)(3)(iii) of this section if there is a corresponding negative adjustment under section 1059.) Similarly, income from mineral properties is treated as tax-exempt income to the extent it is offset by deductions for depletion in excess of the basis of the property.

(C) Discharge of indebtedness income—(1) In general. Excluded COD income is treated as tax-exempt income only to the extent the discharge is applied to reduce tax attributes attributable to any member of the group under section 108, section 1017 or § 1.1502-28. However, if S is treated as realizing excluded COD income pursuant to § 1.1502-28(a)(3), S shall not be treated as realizing excluded COD income for purposes of the preceding sentence.

(2) Expired loss carryovers. If the amount of the discharge exceeds the amount of the attribute reduction under sections 108 and 1017, and § 1.1502-28, the excess nevertheless is treated as applied to reduce tax attributes to the extent a loss carryover attributable to S expired without tax benefit, the expiration was taken into account as a noncapital, nondeductible expense under paragraph (b)(3)(iii) of this section, and the loss carryover would have been reduced had it not expired.

(D) Basis shifts. An increase in the basis of S's assets (or an equivalent as described in paragraph (b)(3)(iv)(B) of this section) is treated as tax-exempt income to the extent that the increase is not otherwise taken into account in determining stock basis, it corresponds to a negative adjustment that is taken into account by the group under this paragraph (b) (or incurred by the common parent), and it has the effect (viewing the group in the aggregate) of a permanent recovery of the reduction. For example, S's basis increase under section 50(c)(2) is treated as tax-exempt income to the extent the preceding basis reduction under section 50(c)(1) is reflected in the basis of a member's stock. On the other hand, if S increases the basis of an asset as the result of an accounting method change, and the related positive section 481(a) adjustment is taken into account over time, the basis increase is not treated as tax-exempt income.

(E) [Reserved]

(iii) Noncapital, nondeductible expenses—(A) In general. S's noncapital, nondeductible expenses are its deductions and losses that are taken into account but permanently disallowed or eliminated under applicable law in determining its taxable income or loss, and that decrease, directly or indirectly, the basis of its assets (or an equivalent amount). For example, S's Federal taxes described in section 275 and loss not recognized under section 311(a) are noncapital, nondeductible expenses. Similarly, if a loss carryover (e.g., under section 172 or 1212) attributable to S expires or is reduced under section 108(b) and § 1.1502-28, it becomes a noncapital, nondeductible expense at the close of the last tax year to which it may be carried. However, when a tax attribute attributable to S is reduced as required pursuant to § 1.1502-28(a)(3), the reduction of the tax attribute is not treated as a noncapital, nondeductible expense of S. Finally, if S sells and repurchases a security subject to section 1091, the disallowed loss is not a noncapital, nondeductible expense because the corresponding basis adjustments under section 1091(d) prevent the disallowance from being permanent.

(B) Nondeductible basis recovery. Any other decrease in the basis of S's assets (or an equivalent as described in paragraph (b)(3)(iv)(B) of this section) may be a noncapital, nondeductible expense to the extent that the decrease is not otherwise taken into account in determining stock basis and is permanently eliminated for purposes of determining S's taxable income or loss. Whether a decrease is so treated is determined by taking into account both the purposes of the Code or regulatory provision resulting in the decrease and the purposes of this section. For example, S's noncapital, nondeductible expenses include any basis reduction under section 50(c)(1), section 1017, section 1059, § 1.1502-35(b) or (f)(2). Also included as a noncapital, nondeductible expense is the amount of any gross-up for taxes paid by another taxpayer that S is treated as having paid (e.g., income included under section 78, or the portion of an undistributed capital gain dividend that is treated as tax deemed to have been paid by a shareholder under section 852(b)(3)(D)(ii), whether or not any corresponding amount is claimed as a tax credit). In contrast, a decrease generally is not a noncapital, nondeductible expense if it results because S redeems stock in a transaction to which section 302(a) applies, S receives assets in a liquidation to which section 332 applies and its basis in the assets is less than its basis in the stock canceled, or S distributes the stock of a subsidiary in a distribution to which section 355 applies.

(iv) Special rules for tax-exempt income and noncapital, nondeductible expenses. For purposes of paragraphs (b)(3)(ii) and (iii) of this section:

(A) Treatment as permanent. An amount is permanently excluded from gross income, or permanently disallowed or eliminated, if it is so treated by S even though another person may take a corresponding amount into account. For example, if S sells property to a nonmember at a loss that is disallowed under section 267(a), S's loss is a noncapital, nondeductible expense even though under section 267(d) the nonmember may treat a corresponding amount of gain as not recognized. (If the nonmember is a subsidiary in another consolidated group, its gain not recognized under section 267(d) is tax-exempt income under paragraph (b)(3)(ii)(A) of this section.)

(B) Amounts equivalent to basis and adjustments to basis. Amounts equivalent to basis include the amount of money, the amount of a loss carryover, and the amount of an adjustment to gain or loss under section 475(a) for securities described in section 475(a)(2). An equivalent to a basis increase includes a decrease in an excess loss account, and an equivalent to a basis decrease includes the denial of basis for taxable income.

(C) Timing. An amount is taken into account in the year in which it would be taken into account under paragraph (b)(3)(i) of this section if it were subject to Federal income taxation.

(D) Tax sharing agreements. Taxes are taken into account by applying the principles of section 1552 and the percentage method under § 1.1502-33(d)(3) (and by assuming a 100% allocation of any decreased tax liability). The treatment of amounts allocated under this paragraph (b)(3)(iv)(D) is analogous to the treatment of allocations under § 1.1552-1(b)(2). For example, if one member owes a payment to a second member, the first member is treated as indebted to the second member. The right to receive payment is treated as a positive adjustment under paragraph (b)(3)(ii) of this section, and the obligation to make payment is treated as a negative adjustment under paragraph (b)(3)(iii) of this section. If the obligation is not paid, the amount not paid generally is treated as a distribution, contribution, or both, depending on the relationship between the members.

(v) Distributions. Distributions taken into account under paragraph (b)(2) of this section are distributions with respect to S's stock to which section 301 applies and all other distributions treated as dividends (e.g., under section 356(a)(2)). See § 1.1502-13(f)(2)(iv) for taking into account distributions to which section 301 applies (but not other distributions treated as dividends) under the entitlement rule.

(4) Waiver of loss carryovers from separate return limitation years—(i) General rule. If S has a loss carryover from a separate return limitation year when it becomes a member of a consolidated group, the group may make an irrevocable election to treat all or any portion of the loss carryover as expiring for all Federal income tax purposes immediately before S becomes a member of the consolidated group (deemed expiration). If S was a member of another group immediately before it became a member of the consolidated group, the expiration is also treated as occurring immediately after it ceases to be a member of the prior group.

(ii) Stock basis adjustments from a waiver—(A) Qualifying transactions. If S becomes a member of the consolidated group in a qualifying cost basis transaction and an election under this paragraph (b)(4) is made, the noncapital, nondeductible expense resulting from the deemed expiration does not result in a corresponding stock basis adjustment for any member under this section. A qualifying cost basis transaction is the purchase (i.e., a transaction in which basis is determined under section 1012) by members of the acquiring consolidated group (while they are members) in a 12-month period of an amount of S's stock satisfying the requirements of section 1504(a)(2).

(B) Nonqualifying transactions. If S becomes a member of the consolidated group other than in a qualifying cost basis transaction and an election under this paragraph (b)(4) is made, the basis of its stock that is owned by members immediately after it becomes a member is subject to reduction under the principles of this section to reflect the deemed expiration. The reduction occurs immediately before S becomes a member, but after it ceases to be a member of any prior group, and it therefore does not result in a corresponding stock basis adjustment for any higher-tier member of the transferring or acquiring consolidated group. Any basis reduction under this paragraph (b)(4)(ii)(B) is taken into account in making determinations of basis under the Code with respect to S's stock (e.g., a determination under section 362 because the stock is acquired in a transaction described in section 368(a)(1)(B)), but it does not result in corresponding stock basis adjustments under this section for any higher-tier member. If the basis reduction exceeds the basis of S's stock, the excess is treated as an excess loss account to which the members owning S's stock succeed.

(C) Higher-tier corporations. If S becomes a member of the consolidated group as a result, in whole or in part, of a higher-tier corporation becoming a member (whether or not in a qualifying cost basis transaction), additional adjustments are required. The highest-tier corporation (T) whose becoming a member resulted in S becoming a member, and T's chain of lower-tier corporations that includes S, are subject to the adjustment. The deemed expiration of S's loss carryover that results in a negative adjustment for the first higher-tier corporation is treated as an expiring loss carryover of that higher-tier corporation for purposes of applying paragraph (b)(4)(ii)(B) of this section to that corporation. For example, if M purchases all of the stock of T, T owns all of the stock of T1, T1 owns all of the stock of S, S becomes a member as a result of T becoming a member, and the election under this paragraph (b)(4) is made, the basis of the S stock is reduced and the reduction tiers up to T1, T1 treats the negative adjustment to its basis in S's stock as an expiring loss carryover of T1, and T then adjusts its basis in T1's stock. In addition, if T becomes a member of the acquiring group in a transaction other than a qualifying cost basis transaction, the amount that tiers up to T also reduces the basis of its stock under paragraph (b)(4)(ii)(B) of this section (but the amount does not tier up to higher-tier members).

(iii) Net asset basis limitation. Basis reduced under this paragraph (b)(4) is restored before S becomes a member (and before the basis of S's stock is taken into account in determining basis under the Code) to the extent necessary to conform a share's basis to its allocable portion of net asset basis. In the case of higher-tier corporations under paragraph (b)(4)(ii)(C) of this section, the restoration does not tier up but is instead applied separately to each higher-tier corporation. For purposes of determining each corporation's net asset basis (including the basis of stock in lower-tier corporations), the restoration is applied in the order of tiers, from the lowest to the highest. For purposes of the restoration:

(A) A member's net asset basis is the positive or negative difference between the adjusted basis of its assets (and the amount of any of its loss carryovers that are not deemed to expire) and its liabilities. Appropriate adjustments must be made, for example, to disregard liabilities that subsequently will give rise to deductions (e.g., liabilities to which section 461(h) applies).

(B) Within a class of stock, each share has the same allocable portion of net asset basis. If there is more than one class of common stock, the net asset basis is allocated to each class by taking into account the terms of each class and all other facts and circumstances relating to the overall economic arrangement.

(iv) Election. The election described in paragraph (b)(4) of this section must be made in a separate statement entitled, “ELECTION TO TREAT LOSS CARRYOVER OF [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF S] AS EXPIRING UNDER § 1.1502-32(b)(4).” The election must be filed by including a statement on or with the consolidated group's income tax return for the year S becomes a member. A separate statement must be made for each member whose loss carryover is deemed to expire. The statement must identify the amount of each loss carryover deemed to expire (or the amount of each loss carryover deemed not to expire, with any balance of any loss carryovers being deemed to expire) and the basis of any stock reduced as a result of the deemed expiration.

(v) Special rule for loss carryovers of a subsidiary acquired in a transaction for which an election under § 1.1502-20(i)(2) is made. See paragraph (b)(4)(v) of this section as contained in 26 CFR part 1 revised as of April 1, 2005.

(vi) Special rules in the case of certain transactions subject to § 1.1502-35. If a member of a consolidated group transfers stock of a subsidiary and such stock has a basis that exceeds its value immediately before such transfer or a subsidiary is deconsolidated and any stock of such subsidiary owned by members of the group immediately before such deconsolidation has a basis that exceeds its value, all members of the group are subject to the provisions of § 1.1502-35(b), which generally require a redetermination of members' basis in all shares of subsidiary stock.

(vii) Special rules for amending waiver of loss carryovers from separate return limitation year relating to the acquisition of a subsidiary in a transaction subject to § 1.1502-20. See paragraph (b)(4)(vii) of this section as contained in 26 CFR part 1 revised as of April 1, 2005.

(5) Examples—(i) In general. For purposes of the examples in this section, unless otherwise stated, M owns all of the only class of S's stock, the stock is owned for the entire year, S owns no stock of lower-tier members, the tax year of all persons is the calendar year, all persons use the accrual method of accounting, the facts set forth the only corporate activity, preferred stock is described in section 1504(a)(4), all transactions are between unrelated persons, and tax liabilities are disregarded.

(ii) Stock basis adjustments. The principles of this paragraph (b) are illustrated by the following examples.

(A) Example 1. Taxable income—(1) Current taxable income. For Year 1, the M group has $100 of taxable income when determined by including only S's items of income, gain, deduction, and loss taken into account. Under paragraph (b)(1) of this section, M's basis in S's stock is adjusted under this section as of the close of Year 1. Under paragraph (b)(2) of this section, M's basis in S's stock is increased by the amount of the M group's taxable income determined by including only S's items taken into account. Thus, M's basis in S's stock is increased by $100 as of the close of Year 1.

(2) Intercompany gain that is not taken into account. The facts are the same as in paragraph (b)(5)(ii)(A)(1) of this section (Example 1), except that S also sells property to another member at a $25 gain in Year 1, the gain is deferred under § 1.1502-13 and taken into account in Year 3, and M sells 10% of S's stock to nonmembers in Year 2. Under paragraph (b)(3)(i) of this section, S's deferred gain is not additional taxable income for Year 1 or 2 because it is not taken into account in determining the M group's consolidated taxable income for either of those years. The deferred gain is not tax-exempt income under paragraph (b)(3)(ii) of this section because it is not permanently excluded from S's gross income. The deferred gain does not result in a basis adjustment until Year 3, when it is taken into account in determining the M group's consolidated taxable income. Consequently, M's basis in the S shares sold is not increased to reflect S's gain from the intercompany sale of the property. In Year 3, the deferred gain is taken into account, but the amount allocable to the shares sold by M does not increase their basis because these shares are held by nonmembers.

(3) Intercompany gain taken into account. The facts are the same as in paragraph (b)(5)(ii)(A)(2) of this section (Example 1), except that M sells all of S's stock in Year 2 (rather than only 10%). Under § 1.1502-13, S takes the $25 gain into account immediately before S becomes a nonmember. Thus, M's basis in S's stock is increased to reflect S's gain from the intercompany sale of the property.

(B) Example 2. Tax loss—(1) Current absorption. For Year 2, the M group has a $50 consolidated net operating loss when determined by taking into account only S's items of income, gain, deduction, and loss. S's loss is absorbed by the M group in Year 2, offsetting M's income for that year. Under paragraph (b)(3)(i)(A) of this section, because S's loss is absorbed in the year it arises, M has a $50 negative adjustment with respect to S's stock. Under paragraph (b)(2) of this section, M reduces its basis in S's stock by $50. Under paragraph (a)(3)(ii) of this section, if the decrease exceeds M's basis in S's stock, the excess is M's excess loss account in S's stock.

(2) Interim determination from stock sale. The facts are the same as in paragraph (b)(5)(ii)(B)(1) of this section (Example 2), except that S's Year 2 loss arises in the first half of the calendar year, M sells 50% of S's stock on July 1 of Year 2, and M's income for Year 2 does not arise until after the sale of S's stock. M's income for Year 2 (exclusive of the sale of S's stock) is offset by S's loss, even though the income arises after the stock sale, and no loss remains to be apportioned to S. See §§ 1.1502-11 and 1.1502-21(b). Under paragraph (b)(3)(i)(A) of this section, because S's $50 loss is absorbed in the year it arises, it reduces M's basis in the S shares sold by $25 immediately before the stock sale. Because S becomes a nonmember, the loss also reduces M's basis in the retained S shares by $25 immediately before S becomes a nonmember.

(3) Loss carryback. The facts are the same as in paragraph (b)(5)(ii)(B)(1) of this section (Example 2), except that M has no income or loss for Year 2, S's $50 loss is carried back and absorbed by the M group in Year 1 (offsetting the income of M or S), and the M group receives a $17 tax refund in Year 2 that is paid to S. Under paragraph (b)(3)(i)(B) of this section, because the $50 loss is carried back and absorbed in Year 1, it is treated as a tax loss for Year 2 (the year in which it arises). Under paragraph (b)(3)(ii) of this section, the refund is treated as tax-exempt income of S. Under paragraph (b)(3)(iv)(C) of this section, the tax-exempt income is taken into account in Year 2 because that is the year it would be taken into account under S's method of accounting if it were subject to Federal income taxation. Thus, under paragraph (b)(2) of this section, M reduces its basis in S's stock by $33 as of the close of Year 2 (the $50 tax loss, less the $17 tax refund).

(4) Loss carryforward. The facts are the same as in paragraph (b)(5)(ii)(B)(1) of this section (Example 2), except that M has no income or loss for Year 2, and S's loss is carried forward and absorbed by the M group in Year 3 (offsetting the income of M or S). Under paragraph (b)(3)(i)(A) of this section, the loss is not treated as a tax loss under paragraph (b)(2) of this section until Year 3.

(C) Example 3. Tax-exempt income and noncapital, nondeductible expenses—(1) Facts. For Year 1, the M group has $500 of consolidated taxable income. However, the M group has a $100 consolidated net operating loss when determined by including only S's items of income, gain, deduction, and loss taken into account. Also for Year 1, S has $80 of interest income that is permanently excluded from gross income under section 103, and S incurs $60 of related expense for which a deduction is permanently disallowed under section 265.

(2) Analysis. Under paragraph (b)(3)(i)(A) of this section, S has a $100 tax loss for Year 1. Under paragraph (b)(3)(ii)(A) of this section, S has $80 of tax-exempt income. Under paragraph (b)(3)(iii)(A) of this section, S has $60 of noncapital, nondeductible expense. Under paragraph (b)(3)(iv)(C) of this section, the tax-exempt income and noncapital, nondeductible expense are taken into account in Year 1 because that is the year they would be taken into account under S's method of accounting if they were subject to Federal income taxation. Thus, under paragraph (b) of this section, M reduces its basis in S's stock as of the close of Year 1 by an $80 net amount (the $100 tax loss, less $80 of tax-exempt income, plus $60 of noncapital, nondeductible expenses).

(D) Example 4. Discharge of indebtedness—(1) Facts. M forms S on January 1 of Year 1 and S borrows $200. During Year 1, S's assets decline in value and the M group has a $100 consolidated net operating loss. Of that amount, $10 is attributable to M and $90 is attributable to S under the principles of § 1.1502-21(b)(2)(iv). None of the loss is absorbed by the group in Year 1, and S is discharged from $100 of indebtedness at the close of Year 1. M has a $0 basis in the S stock. M and S have no attributes other than the consolidated net operating loss. Under section 108(a), S's $100 of discharge of indebtedness income is excluded from gross income because of insolvency. Under section 108(b) and § 1.1502-28, the consolidated net operating loss is reduced to $0.

(2) Analysis. Under paragraph (b)(3)(iii)(A) of this section, the reduction of $90 of the consolidated net operating loss attributable to S is treated as a noncapital, nondeductible expense in Year 1 because that loss is permanently disallowed by section 108(b) and § 1.1502-28. Under paragraph (b)(3)(ii)(C)(1) of this section, all $100 of S's discharge of indebtedness income is treated as tax-exempt income in Year 1 because the discharge results in a $100 reduction to the consolidated net operating loss. Consequently, the loss and the cancellation of the indebtedness result in a net positive $10 adjustment to M's basis in its S stock.

(3) Insufficient attributes. The facts are the same as in paragraph (b)(5)(ii)(D)(1) of this section (Example 4), except that S is discharged from $120 of indebtedness at the close of Year 1. Under section 108(a), S's $120 of discharge of indebtedness income is excluded from gross income because of insolvency. Under section 108(b) and § 1.1502-28, the consolidated net operating loss is reduced by $100 to $0 after the determination of tax for Year 1. Under paragraph (b)(3)(iii)(A) of this section, the reduction of $90 of the consolidated net operating loss attributable to S is treated as a noncapital, nondeductible expense. Under paragraph (b)(3)(ii)(C)(1) of this section, only $100 of the discharge is treated as tax-exempt income because only that amount is applied to reduce tax attributes. The remaining $20 of discharge of indebtedness income excluded from gross income under section 108(a) has no effect on M's basis in S's stock.

(4) Purchase price adjustment. Assume instead that S buys land in Year 1 in exchange for S's $100 purchase money note (bearing interest at a market rate of interest in excess of the applicable Federal rate, and providing for a principal payment at the end of Year 10), and the seller agrees with S in Year 4 to discharge $60 of the note as a purchase price adjustment to which section 108(e)(5) applies. S has no discharge of indebtedness income that is treated as tax-exempt income under paragraph (b)(3)(ii) of this section. In addition, the $60 purchase price adjustment is not a noncapital, nondeductible expense under paragraph (b)(3)(iii) of this section. A purchase price adjustment is not equivalent to a discharge of indebtedness that is offset by a deduction or loss. Consequently, the purchase price adjustment results in no net adjustment to M's basis in S's stock under paragraph (b) of this section.

(E) Example 5. Distributions—(1) Amounts declared and distributed. For Year 1, the M group has $120 of consolidated taxable income when determined by including only S's items of income, gain, deduction, and loss taken into account. S declares and makes a $10 dividend distribution to M at the close of Year 1. Under paragraph (b) of this section, M increases its basis in S's stock as of the close of Year 1 by a $110 net amount ($120 of taxable income, less a $10 distribution).

(2) Distributions in later years. The facts are the same as in paragraph (b)(5)(ii)(E)(1) of this section (Example 5), except that S does not declare and distribute the $10 until Year 2. Under paragraph (b) of this section, M increases its basis in S's stock by $120 as of the close of Year 1, and decreases its basis by $10 as of the close of Year 2. (If M were also a subsidiary, the basis of its stock would also be increased in Year 1 to reflect M's $120 adjustment to basis of S's stock; the basis of M's stock would not be changed as a result of S's distribution in Year 2, because M's $10 of tax-exempt dividend income under paragraph (b)(3)(ii) of this section would be offset by the $10 negative adjustment to M's basis in S's stock for the distribution.)

(3) Amounts declared but not distributed. The facts are the same as in paragraph (b)(5)(ii)(E)(1) of this section (Example 5), except that, during December of Year 1, S declares (and M becomes entitled to) another $70 dividend distribution with respect to its stock, but M does not receive the distribution until after it sells all of S's stock at the close of Year 1. Under § 1.1502-13(f)(2)(iv), S is treated as making a $70 distribution to M at the time M becomes entitled to the distribution. (If S is distributing an appreciated asset, its gain under section 311 is also taken into account under paragraph (b)(3)(i) of this section at the time M becomes entitled to the distribution.) Consequently, under paragraph (b) of this section, M increases its basis in S's stock as of the close of Year 1 by only a $40 net amount ($120 of taxable income, less two distributions totaling $80). Any further adjustments after S ceases to be a member and the $70 distribution is made would be duplicative, because the stock basis has already been adjusted for the distribution. Accordingly, the distribution will not result in further adjustments or gain, even if the distribution is a payment to which section 301(c)(2) or (3) applies.

(F) Example 6. Reorganization with boot—(1) Facts. M owns all the stock of S and T. M owns ten shares of the same class of common stock of S and ten shares of the same class of common stock of T. The fair market value of each share of S stock is $10 and the fair market value of each share of T stock is $10. On January 1 of Year 1, M has a $5 basis in each of its ten shares of S stock and a $10 basis in each of its ten shares of T stock. S and T have no items of income, gain, deduction, or loss for Year 1. S and T each have substantial earnings and profits. At the close of Year 1, T merges into S in a reorganization described in section 368(a)(1)(A) (and in section 368(a)(1)(D)). M receives no additional S stock, but does receive $10 which is treated as received by M in a separate transaction occurring immediately after the merger of T into S.

(2) Analysis. The merger of T into S is a transaction to which § 1.1502-13(f)(3) applies. Under §§ 1.1502-13(f)(3) and 1.358-2(a)(2)(iii), M is deemed to receive ten additional shares of S stock with a total fair market value of $100 (the fair market value of the T stock surrendered by M). Under § 1.358-2(a)(2)(i), M will have a basis of $10 in each share of S stock deemed received in the reorganization. Under § 1.358-2(a)(2)(iii), M is deemed to surrender all twenty shares of its S stock in a recapitalization under section 368(a)(1)(E) in exchange for the ten shares of S stock, the number of shares of S stock held by M immediately after the transaction. Thus, under § 1.358-2(a)(2)(i), M has five shares of S stock each with a basis of $10 and five shares of S stock each with a basis of $20. The $10 M received is treated as a dividend distribution under section 301 and, under paragraph (b)(3)(v) of this section, the $10 is a distribution to which paragraph (b)(2)(iv) of this section applies. Accordingly, M's total basis in the S stock is decreased by the $10 distribution.

(G) Example 7. Tiering up of basis adjustments. M owns all of S's stock, and S owns all of T's stock. For Year 1, the M group has $100 of consolidated taxable income when determined by including only T's items of income, gain, deduction, and loss taken into account, and $50 of consolidated taxable income when determined by including only S's items taken into account. S increases its basis in T's stock by $100 under paragraph (b) of this section. Under paragraph (a)(3) of this section, this $100 basis adjustment is taken into account in determining M's adjustments to its basis in S's stock. Thus, M increases its basis in S's stock by $150 under paragraph (b) of this section.

(H) Example 8. Allocation of items—(1) Acquisition in mid-year. M is the common parent of a consolidated group, and S is an unaffiliated corporation filing separate returns on a calendar-year basis. M acquires all of S's stock and S becomes a member of the M group on July 1 of Year 1. For the entire calendar Year 1, S has $100 of ordinary income and under § 1.1502-76(b) $60 is allocated to the period from January 1 to June 30 and $40 to the period from July 1 to December 31. Under paragraph (b) of this section, M increases its basis in S's stock by $40.

(2) Sale in mid-year. The facts are the same as in paragraph (b)(5)(ii)(H)(1) of this section (Example 8), except that S is a member of the M group at the beginning of Year 1 but ceases to be a member on June 30 as a result of M's sale of S's stock. Under paragraph (b) of this section, M increases its basis in S's stock by $60 immediately before the stock sale. (M's basis increase would be the same if S became a nonmember because S issued additional shares to nonmembers.)

(3) Absorption of loss carryovers. Assume instead that S is a member of the M group at the beginning of Year 1 but ceases to be a member on June 30 as a result of M's sale of S's stock, and a $100 consolidated net operating loss attributable to S is carried over by the M group to Year 1. The consolidated net operating loss may be apportioned to S for its first separate return year only to the extent not absorbed by the M group during Year 1. Under paragraph (b)(3)(i) of this section, if the loss is absorbed by the M group in Year 1, whether the offsetting income arises before or after M's sale of S's stock, the absorption of the loss carryover is included in the determination of S's taxable income or loss for Year 1. Thus, M's basis in S's stock is adjusted under paragraph (b) of this section to reflect any absorption of the loss by the M group.

(I) Example 9. Gross-ups—(1) Facts. M owns all of the stock of S, and S owns all of the stock of T, a newly formed controlled foreign corporation that is not a passive foreign investment company. In Year 1, T has $100 of subpart F income and pays $34 of foreign income tax, leaving T with $66 of earnings and profits. The M group has $100 of consolidated taxable income when determined by taking into account only S's items (the inclusion under section 951(a), taking into account the section 78 gross-up). As a result of the section 951(a) inclusion, S increases its basis in T's stock by $66 under section 961(a).

(2) Analysis. Under paragraph (b)(3)(i) of this section, S has $100 of taxable income. Under paragraph (b)(3)(iii)(B) of this section, the $34 gross-up for taxes paid by T that S is treated as having paid is a noncapital, nondeductible expense (whether or not any corresponding amount is claimed by the M group as a tax credit). Thus, M increases its basis in S's stock under paragraph (b) of this section by the net adjustment of $66.

(3) Subsequent distribution. The facts are the same as in paragraph (b)(5)(ii)(I)(1) of this section (Example 9), except that T distributes its $66 of earnings and profits in Year 2. The $66 distribution received by S is excluded from S's income under section 959(a) because the distribution represents earnings and profits attributable to amounts that were included in S's income under section 951(a) for Year 1. In addition, S's basis in T's stock is decreased by $66 under section 961(b). The excluded distribution is not tax-exempt income under paragraph (b)(3)(ii) of this section because of the corresponding reduction to S's basis in T's stock. Consequently, M's basis in S's stock is not adjusted under paragraph (b) of this section for Year 2.

(J) Example 10. Recapture of tax-exempt items—(1) Facts. S is a life insurance company. For Year 1, the M group has $200 of consolidated taxable income, determined by including only S's items of income, gain, deduction, and loss taken into account (including a $300 small company deduction under section 806). In addition, S has $100 of tax-exempt interest income, $60 of which is S's company share. The remaining $40 of tax-exempt income is the policyholders' share that reduces S's deduction for increase in reserves.

(2) Tax-exempt items generally. Under paragraph (b)(3)(i) of this section, S has $200 of taxable income for Year 1. Also for Year 1, S has $100 of tax-exempt income under paragraph (b)(3)(ii)(A) of this section, and another $300 is treated as tax-exempt income under paragraph (b)(3)(ii)(B) of this section because of the deduction under section 806. Under paragraph (b)(3)(iii) of this section, S has $40 of noncapital, nondeductible expenses for Year 1 because S's deduction under section 807 for its increase in reserves has been permanently reduced by the $40 policyholders' share of the tax-exempt interest income. Thus, M increases its basis in S's stock by $560 under paragraph (b) of this section.

(3) Recapture. Assume instead that S is a property and casualty company and, for Year 1, S accrues $100 of estimated salvage recoverable under section 832. Of this amount, $87 (87% of $100) is excluded from gross income because of the “fresh start” provisions of Sec. 11305(c) of Public Law 101-508 (the Omnibus Budget Reconciliation Act of 1990). Thus, S has $87 of tax-exempt income under paragraph (b)(3)(ii)(A) of this section that increases M's basis in S's stock for Year 1. (S also has $13 of taxable income over the period of inclusion under section 481.) In Year 5, S determines that the $100 salvage recoverable was overestimated by $30 and deducts $30 for the reduction of the salvage recoverable. However, S has $26.10 (87% of $30) of taxable income in Year 5 due to the partial recapture of its fresh start. Because S has no basis corresponding to this income, S is treated under paragraph (b)(3)(iii)(B) of this section as having a $26.10 noncapital, nondeductible expense in Year 5. This treatment is necessary to reflect the elimination of the erroneous fresh start in S's stock basis and causes a decrease in M's basis in S's stock by $30 for Year 5 (a $3.90 taxable loss and a $26.10 special adjustment).

(c) Allocation of adjustments among shares of stock—(1) In general—(i) Distributions. The adjustment that is described in paragraph (b)(2)(iv) of this section (negative adjustments for distributions) is allocated to the shares of S stock to which the distribution relates.

(ii) Special rules applicable in the case of certain loss transfers of subsidiary stock—(A) Losses reattributed pursuant to an election under § 1.1502-36(d)(6)—(1) General rule. If a member transfers loss shares of S stock and the common parent elects under § 1.1502-36(d)(6) to reattribute all or a portion of S's attributes, S's resulting noncapital, nondeductible expense is allocated to all loss shares of S stock transferred by members in the transaction. The expense is allocated among those S shares in proportion to the loss in the shares. The tier-up of that expense is included in the remaining adjustment (see paragraph (c)(1)(iii) of this section).

(2) Reattribution of attributes of a subsidiary that is lower-tier to S. If a member transfers loss shares of S stock and the common parent elects under § 1.1502-36(d)(6) to reattribute attributes of a subsidiary (S2) that is lower-tier to S, S2's resulting noncapital, nondeductible expense is allocated among S2 shares held by members as of the transaction, other than those transferred in the transaction and with respect to which gain or loss was recognized (recognition transfer), in a manner that permits the full amount of the expense to tier up and be applied to the bases of the loss shares of S stock transferred by members in the transaction. The expense is allocated among those S2 shares with positive basis in a manner that, first, reduces the bases of S2's preferred shares to equalize and then eliminate loss and, second, reduces the bases of S2's common shares in a manner that reduces disparity among the bases of those common shares to the greatest extent possible. The noncapital, nondeductible expense applied to the S2 shares tiers up and is applied to the stock of any subsidiaries that are lower-tier to S (middle-tier subsidiaries) in a manner that will permit the full amount of this expense to be applied to reduce the bases of the loss shares of S stock transferred by members in the transaction. Similar to the allocation among the S2 shares, the tier-up of this expense is allocated among the middle-tier subsidiary shares held by members as of the transaction, other than those transferred in a recognition transfer, in a manner that permits the full amount of the expense to tier up and be applied to the bases of the loss shares of S stock transferred by members in the transaction. The tier-up of this expense is allocated among those middle-tier subsidiary shares with positive basis in a manner that, first, reduces the bases of the middle-tier subsidiary's preferred shares to equalize and then eliminate loss and, second, reduces the bases of the middle-tier subsidiary's common shares in a manner that reduces disparity among the bases of those common shares to the greatest extent possible. The tier-up of this expense is allocated to the loss shares of S stock transferred by members in the transaction in the same manner as provided in paragraph (c)(1)(ii)(A)(1) of this section, and thereafter the tier-up of that expense is included in the remaining adjustment (see paragraph (c)(1)(iii) of this section).

(3) Example. The following example illustrates the rules of this paragraph (c)(1)(ii)(A).

Example.Assume P owns M1, P and M1 own M2, M2 owns S, M1 and S own S1, and M1 and S1 own S2. If S sells a portion of the S1 shares at a gain and M2 sells all of the S stock at a net loss (after adjusting the basis for the gain recognized by S on the sale of the S1 shares), and P elects under § 1.1502-36(d)(6) to reattribute attributes of S2, the resulting noncapital, nondeductible expense is allocated entirely to the S2 shares held by S1 with positive basis in a manner that reduces the disparity in those bases to the greatest extent possible. The tier-up of this amount is allocated entirely to the S1 shares held by S (excluding the S1 shares sold) with positive basis in a manner that reduces the disparity in those bases to the greatest extent possible. The tier-up of this amount is allocated to the loss shares of S stock sold by M2 in proportion to the loss in those shares. The tier-up of this amount is then included in the remaining adjustment and tiers up from M2 to M1 and P, and from M1 to P under the general rules of this section.

(B) Tier-up of reallocated investment adjustments subject to prior use limitation. If the reallocation of an investment adjustment under § 1.1502-36(b)(2) is subject to the prior use limitation in § 1.1502-36(b)(2)(iii)(B)(2), no amount of the tier-up of such reallocated investment adjustment shall be allocated to any share whose prior use resulted in the application of the limitation. Thereafter, the tier-up of this amount is included in the remaining adjustment (see paragraph (c)(1)(iii) of this section).

(iii) Remaining adjustment. The remaining adjustment is the adjustment that consists of the items described in paragraphs (b)(2)(i) through (b)(2)(iii) of this section (adjustments for taxable income or loss, tax-exempt income, and noncapital, nondeductible expenses), including adjustments to lower-tier stock basis that tier up under paragraph (a)(3)(iii) of this section, but only to the extent not specially allocated under paragraph (c)(1)(ii) of this section. The remaining adjustment is allocated among the shares of S stock as provided in paragraphs (c)(2) through (c)(4) of this section. If the remaining adjustment is positive, it is allocated first to any preferred stock as provided in paragraph (c)(3) of this section, and then to the common stock as provided in paragraph (c)(2) of this section. If the remaining adjustment is negative, it is allocated only to common stock as provided in paragraph (c)(2) of this section.

(iv) Nonmember shares. No adjustment under this section that is allocated to a share for the period it is owned by a nonmember affects the basis of the share.

(v) Cross-references. See paragraph (c)(4) of this section for the reallocation of adjustments, and paragraph (d) of this section for definitions. See § 1.1502-19(d) for special allocations of basis determined or adjusted under the Internal Revenue Code (Code) with respect to excess loss accounts.

(2) Common stock—(i) Allocation within a class. The remaining adjustment described in paragraph (c)(1)(iii) of this section that is allocable to a class of common stock is generally allocated equally to each share within the class. However, if a member has an excess loss account in a share of a class of common stock at the time a positive remaining adjustment is to be allocated, the portion of the positive remaining adjustment allocable to the member with respect to the class is allocated first to equalize and then eliminate that member's excess loss accounts. It is then allocated equally among the members' shares in that class. Similarly, the portion of any negative remaining adjustment allocable to the member with respect to the class is allocated equally to the member's shares with positive bases, eliminating all positive basis in shares of the class before creating or increasing any excess loss accounts. After positive basis is eliminated, any remaining portion of the negative remaining adjustment is allocated to equalize the member's excess loss accounts in the shares of that class to the greatest extent possible. Distributions and any adjustments or determinations under the Internal Revenue Code (for example, under section 358, including any modifications under § 1.1502-19(d)) are taken into account before the allocation is made under this paragraph (c)(2)(i).

(ii) Allocation among classes—(A) General rule. If S has more than one class of common stock, the extent to which the remaining adjustment described in paragraph (c)(1)(iii) of this section is allocated to each class is determined, based on consistently applied assumptions, by taking into account the terms of each class and all other facts and circumstances relating to the overall economic arrangement. The allocation generally must reflect the manner in which the classes participate in the economic benefit or burden (if any) corresponding to the items of income, gain, deduction, or loss allocated. In determining participation, any differences in voting rights are not taken into account, and the following factors are among those to be considered—

(1) The interest of each share in economic profits and losses (if different from the interest in taxable income);

(2) The interest of each share in cash flow and other non-liquidating distributions; and

(3) The interest of each share in distributions in liquidation.

(B) Distributions and Code adjustments. Distributions and any adjustments or determinations under the Internal Revenue Code are taken into account before the allocation is made under this paragraph (c)(2)(ii).

(3) Preferred stock. If the remaining adjustment described in paragraph (c)(1)(iii) of this section is positive, it is allocated to preferred stock to the extent required (when aggregated with prior allocations to the preferred stock during the period that S is a member of the consolidated group) to reflect distributions described in section 301 (and all other distributions treated as dividends) to which the preferred stock becomes entitled, and arrearages arising, during the period that S is a member of the consolidated group. For this purpose, the preferred stock is treated as entitled to a distribution no later than the time the distribution is taken into account under the Internal Revenue Code (e.g., under section 305). If the amount of distributions and arrearages exceeds the positive amount (when aggregated with prior allocations), the positive amount is first allocated among classes of preferred stock to reflect their relative priorities, and the amount allocated to each class is then allocated pro rata within the class. An allocation to a share with respect to arrearages and distributions for the period the share is owned by a nonmember is not reflected in the basis of the share under paragraph (b) of this section. However, if M and S cease to be members of one consolidated group and remain affiliated as members of another consolidated group, M's ownership of S's stock during consolidated return years of the prior group is treated for this purpose as ownership by a member to the extent that the adjustments during the prior consolidated return years are still reflected in the basis of the preferred stock.

(4) Cumulative redetermination—(i) General rule. A member's basis in each share of S preferred and common stock must be redetermined whenever necessary to determine the tax liability of any person. See paragraph (b)(1) of this section. The redetermination is made by reallocating S's adjustments described in paragraphs (c)(1)(ii)(B) (specially allocated adjustments for tier-up of reallocated investment adjustments subject to prior use limitation) and (c)(1)(iii) (remaining adjustments) of this section for each consolidated return year (or other applicable period) of the group by taking into account all of the facts and circumstances affecting allocations under this paragraph (c) as of the redetermination date with respect to all of the S shares. For this purpose:

(A) Amounts may be reallocated from one class of S's stock to another class, but not from one share of a class to another share of the same class.

(B) If there is a change in the equity structure of S (e.g., as the result of S's issuance, redemption, or recapitalization of shares), a cumulative redetermination is made for the period before the change. If a reallocation is required by another redetermination after a change, amounts arising after the change are reallocated before amounts arising before the change.

(C) If S becomes a nonmember as a result of a change in its equity structure, any reallocation is made only among the shares of S's stock immediately before the change. For example, if S issues stock to a nonmember creditor in exchange for its debt, and the exchange results in S becoming a nonmember, any reallocation is only among the shares of S's stock immediately before the exchange.

(D) Any reallocation is treated for all purposes after it is made (including subsequent redeterminations) as the original allocation of an amount under this paragraph (c), but the reallocation does not affect any prior period.

(ii) Prior use of allocations. An amount may not be reallocated under paragraph (c)(4)(i) of this section to the extent that the amount has been used before the reallocation. For this purpose, an amount has been used to the extent it has been taken into account, directly or indirectly, by any member in determining income, gain, deduction, or loss, or in determining the basis of any property that is not subject to this section (e.g., stock of a corporation that has become a nonmember). For example, if M sells a share of S stock, an amount previously allocated to the share cannot be reallocated to another share of S stock, but an amount allocated to another share of S stock can still be reallocated to the sold share because the reallocated amount has not been taken into account; however, any adjustment reallocated to the sold share may effectively be eliminated, because the reallocation was not in effect when the share was previously sold and M's gain or loss from the sale is not redetermined. If, however, M sells the share of S stock to another member, the amount is not used until M's gain or loss is taken into account under § 1.1502-13.

(5) Examples. The principles of this paragraph (c) are illustrated by the following examples.

Example 1. Ownership of less than all the stock. (a) Facts. M owns 80% of S's only class of stock with an $800 basis. For Year 1, S has $100 of taxable income.

(b) Analysis. Under paragraph (c)(1) of this section, the $100 positive adjustment under paragraph (b) of this section for S's taxable income is allocated among the shares of S's stock, including shares owned by nonmembers. Under paragraph (c)(2)(i) of this section, the adjustment is allocated equally to each share of S's stock. Thus, M increases its basis in S's stock under paragraph (b) of this section as of the close of Year 1 by $80. (The basis of the 20% of S's stock owned by nonmembers is not adjusted under this section.)

(c) Varying interest. The facts are the same as in paragraph (a) of this Example 1, except that M buys the remaining 20% of S's stock at the close of business on June 30 of Year 1 for $208. Under paragraph (b)(1) of this section and the principles of § 1.1502-76(b), S's $100 of taxable income is allocable $40 to the period from January 1 to June 30 and $60 to the period from July 1 to December 31. Thus, for the period ending June 30, M is treated as having a $32 adjustment with respect to the S stock that M has owned since January 1 (80% of $40) and, under paragraph (c)(2)(i) of this section, the adjustment is allocated equally among those shares. For the period ending December 31, M is treated as having a $60 adjustment (100% of $60) that is also allocated equally among M's shares of S's stock owned after June 30. M's basis in the shares owned as of the beginning of the year therefore increases by $80 (the sum of 80% of $40 and 80% of $60), from $800 to $880, and M's basis in the shares purchased on June 30 increases by $12 (20% of $60), from $208 to $220. Thus, M's aggregate basis in S's stock as of the end of Year 1 is $1,100.

(d) Tax liability. The facts are the same as in paragraph (a) of this Example 1, except that M pays S's $34 share of the group's consolidated tax liability resulting from S's taxable income, and S does not reimburse M. S's $100 of taxable income results in a positive adjustment under paragraph (b)(3)(i) of this section, and S's $34 of tax liability results in a negative adjustment under paragraph (b)(3)(iv)(D) of this section and the principles of section 1552. Because S does not make any payment in recognition of the additional tax liability, by analogy to the treatment under § 1.1552-1(b)(2), S is treated as having made a $34 payment that is described in paragraph (b)(3)(iii) of this section (noncapital, nondeductible expenses) and as having received an equal amount from M as a capital contribution. Thus, M increases its basis in its S stock by $52.80 (80% of the $100 of taxable income, less 80% of the $34 tax payment). In addition, M increases its basis in S's stock by $34 under the Internal Revenue Code and paragraph (a)(2) of this section to reflect the capital contribution. In the aggregate, M increases its basis in S's stock by $86.80. (If, as in paragraph (c) of this Example 1, M buys the remaining 20% of S's stock at the close of business on June 30, M increases its basis in S's stock by another $7.90 for the additional 20% interest in S's income after June 30 ($60 multiplied by 20%, less 20% of the $20.40 tax payment on $60); the $34 capital contribution by M is reflected in all of its S shares (not just the original 80%), and M's aggregate basis adjustment under this section is $94.70 ($86.80 plus $7.90).)

Example 2. Preferred stock. (a) Facts. M owns all of S's common stock with an $800 basis, and nonmembers own all of S's preferred stock. The preferred stock was issued for $200, has a $20 annual, cumulative preference as to dividends, and has an initial liquidation preference of $200. For Year 1, S has $50 of taxable income and no distributions are declared or made.

(b) Analysis of arrearages. Under paragraphs (c) (1) and (3) of this section, $20 of the $50 positive adjustment under paragraph (b) of this section is allocated first to the preferred stock to reflect the dividend arrearage arising in Year 1. The remaining $30 of the positive adjustment is allocated to the common stock, increasing M's basis from $800 to $830 as of the close of Year 1. (The basis of the preferred stock owned by nonmembers is not adjusted under this section.)

(c) Current distribution. The facts are the same as in paragraph (a) of this Example 2, except that S declares and makes a $20 distribution with respect to the preferred stock during Year 1 in satisfaction of its preference. The results are the same as in paragraph (b) of this Example 2.

(d) Varying interest. The facts are the same as in paragraph (a) of this Example 2, except that S has no income or loss for Years 1 and 2, M purchases all of S's preferred stock at the beginning of Year 3 for $240, and S has $70 of taxable income for Year 3. Under paragraph (c)(3) of this section, $60 of the $70 positive adjustment under paragraph (b) of this section is allocated to the preferred stock to reflect the dividends arrearages for Years 1 through 3, but only the $20 for Year 3 is reflected in the basis of the preferred stock under paragraph (b) of this section. (The remaining $40 is not reflected because the preferred stock was owned by nonmembers during Years 1 and 2.) Thus, M increases its basis in S's preferred stock from $240 to $260, and its basis in S's common stock from $800 to $810, as of the close of Year 3. (If M had acquired all of S's preferred stock in a transaction to which section 351 applies, and M's initial basis in S's preferred stock was $200 under section 362, M's basis in S's preferred stock would increase from $200 to $220.)

(e) Varying interest with current distributions. The facts are the same as in paragraph (d) of this Example 2, except that S declares and makes a $20 distribution with respect to the preferred stock in each of Years 1 and 2 in satisfaction of its preference, and M purchases all of S's preferred stock at the beginning of Year 3 for $200. Under paragraph (c)(3) of this section, $40 of the $70 positive adjustment under paragraph (b) of this section is allocated to the preferred stock to reflect the distributions in Years 1 and 2, and $20 of the $70 is allocated to the preferred stock to reflect the arrearage for Year 3. However, as in paragraph (d) of this Example 2, only the $20 attributable to Year 3 is reflected in the basis of the preferred stock under paragraph (b) of this section. Thus, M increases its basis in S's preferred stock from $200 to $220, and M increases its basis in S's common stock from $800 to $810.

Example 3. Cumulative redetermination. (a) Facts. M owns all of S's common and preferred stock. The preferred stock has a $100 annual, cumulative preference as to dividends. For Year 1, S has $200 of taxable income, the first $100 of which is allocated to the preferred stock and the remaining $100 of which is allocated to the common stock. For Year 2, S has no adjustment under paragraph (b) of this section, and M sells all of S's common stock at the close of Year 2.

(b) Analysis. Under paragraph (c)(4) of this section, M's basis in S's common stock must be redetermined as of the sale of the stock. The redetermination is made by reallocating the $200 positive adjustment under paragraph (b) of this section for Year 1 by taking into account all of the facts and circumstances affecting allocations as of the sale. Thus, the $200 positive adjustment for Year 1 is reallocated entirely to the preferred stock to reflect the dividend arrearages for Years 1 and 2. The reallocation away from the common stock reflects the fact that, because of the additional amount of arrearage in Year 2, the common stock is not entitled to any part of the $200 of taxable income from Year 1. Thus, the common stock has no positive or negative adjustment, and the preferred stock has a $200 positive adjustment. These reallocations are treated as the original allocations for Years 1 and 2. (The results for the common stock would be the same if the common and preferred stock were not owned by the same member, or the preferred stock were owned by nonmembers.)

(c) Preferred stock issued after adjustment arises. The facts are the same as in paragraph (a) of this Example 3, except that S does not issue its preferred stock until the beginning of Year 2, S has no further adjustment under paragraph (b) of this section for Years 2 and 3, and M sells S's common stock at the close of Year 3. Under paragraphs (c) (1) and (2) of this section, the $200 positive adjustment for Year 1 is initially allocated entirely to the common stock. Under paragraph (c)(4) of this section, the $200 adjustment is reallocated to the preferred stock to reflect the arrearages for Years 2 and 3. Thus, the common stock has no positive or negative adjustment.

(d) Common stock issued after adjustment arises. The facts are the same as in paragraph (a) of this Example 3, except that S has no preferred stock, S issues additional common stock of the same class at the beginning of Year 2, S has no further adjustment under paragraph (b) of this section in Years 2 and 3, and M sells its S common stock at the close of Year 3. Under paragraphs (c) (1) and (2) of this section, the $200 positive adjustment for Year 1 is initially allocated entirely to the original common stock. Under paragraph (c)(4)(i)(A) of this section, the $200 adjustment is not reallocated among the original common stock and the additional stock. Unlike the preferred stock in paragraph (c) of this Example 3, the additional common stock is of the same class as the original stock, and there is no reallocation between shares of the same class.

(e) Positive and negative adjustments. The facts are the same as in paragraph (a) of this Example 3, except that S has a $200 loss for Year 2 that results in a negative adjustment to the common stock before any redetermination. For purposes of the basis redetermination under paragraph (c)(4) of this section, the Year 1 and 2 adjustments under paragraph (b) of this section are not netted. Thus, as in paragraph (b) of this Example 3, the redetermination is made by reallocating the $200 positive adjustment for Year 1 entirely to the preferred stock. The $200 negative adjustment for Year 2 is allocated entirely to the common stock. Consequently, the preferred stock has a $200 positive cumulative adjustment, and the common stock has a $200 negative cumulative adjustment. (The results would be the same if there were no other adjustments described in paragraph (b) of this section, M sells S's common stock at the close of Year 3 rather than Year 2, and an additional $100 arrearage arises in Year 3; only adjustments under paragraph (b) of this section may be reallocated, and there is no additional adjustment for Year 3.)

(f) Current distributions. The facts are the same as in paragraph (a) of this Example 3, except that, during Year 1, S declares and makes a distribution to M of $100 as a dividend on the preferred stock and $100 as a dividend on the common stock. The taxable income and distributions result in no Year 1 adjustment under paragraph (b) of this section for either the common or preferred stock. For example, if T merges into S, S is treated, as the context may require, as a successor to T and as becoming a member of the group. However, as in paragraph (b) of this Example 3, the redetermination under paragraph (c)(4) of this section is made by reallocating a $200 positive adjustment for Year 1 (S's net adjustment described in paragraph (b) of this section, determined without taking distributions into account) to the preferred stock. Consequently, the preferred stock has a $100 positive cumulative adjustment ($200 of taxable income, less a $100 distribution with respect to the preferred stock) and the common stock has a $100 negative cumulative adjustment (for the distribution).

(g) Convertible preferred stock. The facts are the same as in paragraph (a) of this Example 3, except that the preferred stock is convertible into common stock that is identical to the common stock already outstanding, the holders of the preferred stock convert the stock at the close of Year 2, and no stock is sold until the close of Year 5. Under paragraph (c)(4) of this section, the $200 positive adjustment for Year 1 is reallocated entirely to the preferred stock immediately before the conversion. The newly issued common stock is treated as a second class of S common stock, and adjustments under paragraph (b) of this section are allocated between the original and the new common stock under paragraph (c)(2)(ii) of this section. Although the preferred stock is converted to common stock, the $200 adjustment to the preferred stock is not subsequently reallocated between the original and the new common stock. Because the original and the new stock are equivalent, adjustments under paragraph (b) of this section for subsequent periods are allocated equally to each share.

(h) Prior use of allocations. The facts are the same as in paragraph (a) of this Example 3, except that M sells 10% of S's common stock at the close of Year 1, and the remaining 90% at the close of Year 2. M's basis in the common stock sold in Year 1 reflects $10 of the adjustment allocated to the common stock for Year 1. Under paragraph (c)(4)(ii) of this section, because $10 of the Year 1 adjustment was used in determining M's gain or loss, only $90 is reallocated to the preferred stock, and $10 remains allocated to the common stock sold.

(i) Lower-tier members. The facts are the same as in paragraph (a) of this Example 3, except that M owns only S's common stock, and M is also a subsidiary. If there is a redetermination under paragraph (c)(4) of this section by a member owning M's stock, a redetermination with respect to S's stock must be made first, and the effect of that redetermination on M's adjustments is taken into account under paragraph (b) of this section. However, as in paragraph (h) of this Example 3, to the extent an amount of the initial adjustments with respect to S's common stock have already been tiered up and used by a member owning M's stock, that amount remains with S's common stock (and the higher-tier member using the adjustment with respect to M's stock), and may not be reallocated to S's preferred stock.

Example 4. Allocation to preferred stock between groups. (a) Facts. M owns all of S's only class of stock, and S owns all of T's common and preferred stock. The preferred stock has a $100 annual, cumulative preference as to dividends. For Year 1, T has $200 of taxable income, the first $100 of which is allocated to the preferred stock and the remaining $100 of which is allocated to the common stock, and S has no adjustments other than the amounts tiered up from T. S and T have no adjustments under paragraph (b) of this section for Years 2 and 3. X, the common parent of another consolidated group, purchases all of S's stock at the close of Year 3, and S and T become members of the X group. For Year 4, T has $200 of taxable income, and S has no adjustments other than the amounts tiered up from T.

(b) Analysis for Years 1 through 3. Under paragraph (c)(4) of this section, the allocation of S's adjustments under paragraph (b) of this section (determined without taking distributions into account) must be redetermined as of the time M sells S's stock. As a result of this redetermination, T's common stock has no positive or negative adjustment and the preferred stock has a $200 positive adjustment.

(c) Analysis for Year 4. Under paragraph (c)(3) of this section, the allocation of T's $200 positive adjustment in Year 4 to T's preferred stock with respect to arrearages is made by taking into account the consolidated return years of both the M group and the X group. Thus, the allocation of the $200 positive adjustment for Year 4 to T's preferred stock is not treated as an allocation for a period for which the preferred stock is owned by a nonmember. Thus, the $200 adjustment is reflected in S's basis in T's preferred stock under paragraph (b) of this section.

(d) Definitions. For purposes of this section—

(1) Class. The shares of a member having the same material terms (without taking into account voting rights) are treated as a single class of stock.

(2) Preferred stock. Preferred stock is stock that is limited and preferred as to dividends and has a liquidation preference. A class of stock that is not described in section 1504(a)(4), however, is not treated as preferred stock for purposes of paragraph (c) of this section if members own less than 80% of each class of common stock (determined without taking this paragraph (d)(2) into account).

(3) Common stock. Common stock is stock that is not preferred stock.

(4) Becoming a nonmember. A member is treated as becoming a nonmember if it has a separate return year (including another group's consolidated return year). For example, S may become a nonmember if it issues additional stock to nonmembers, but S does not become a nonmember as a result of its complete liquidation.

(e) Anti-avoidance rule—(1) General rule. If any person acts with a principal purpose contrary to the purposes of this section, to avoid the effect of the rules of this section or apply the rules of this section to avoid the effect of any other provision of the consolidated return regulations, adjustments must be made as necessary to carry out the purposes of this section.

(2) Examples. The principles of this paragraph (e) are illustrated by the following examples.

Example 1. Preferred stock treated as common stock. (a) Facts. S has 100 shares of common stock and 100 shares of preferred stock described in section 1504(a)(4). M owns 80 shares of S's common stock and all of S's preferred stock. The shareholders expect that S will have negative adjustments under paragraph (b) of this section for Years 1 and 2 (all of which will be allocable to S's common stock), the negative adjustments will have no significant effect on the value of S's stock, and S will have offsetting positive adjustments thereafter. When the preferred stock was issued, M intended to cause S to recapitalize the preferred stock into additional common stock at the end of Year 2 in a transaction described in section 368(a)(1)(E). M's temporary ownership of the preferred stock is with a principal purpose to limit M's basis reductions under paragraph (b) of this section to 80% of the anticipated negative adjustments. The recapitalization is intended to cause significantly more than 80% of the anticipated positive adjustments to increase M's basis in S's stock because of M's increased ownership of S's common stock immediately after the recapitalization.

(b) Analysis. S has established a transitory capital structure with a principal purpose to enhance M's basis in S's stock under this section. Under paragraph (e)(1) of this section, all of S's common and preferred stock is treated as a single class of common stock in Years 1 and 2 for purposes of this section. Thus, S's items are allocated under the principles of paragraph (c)(2)(ii) of this section, and M decreases its basis in both the common and preferred stock accordingly.

Example 2. Contribution of appreciated property. (a) Facts. M owns all of the stock of S and T, and S and T each own 50% of the stock of U. M's S stock has a $150 basis and $200 value, and M's T stock has a $200 basis and $200 value. With a principal purpose to eliminate M's gain from an anticipated sale of S's stock, T contributes to U an asset with a $100 value and $0 basis, and S contributes $100 cash. U sells T's asset and recognizes a $100 gain that results in a $100 positive adjustment under paragraph (b) of this section.

(b) Analysis. Under paragraph (c)(2) of this section, U's adjustment ordinarily would be allocated equally to each share of U's stock. If so allocated, M's basis in S's stock would increase from $150 to $200 and M would recognize no gain from the sale of S's stock for $200. Under paragraph (e)(1) of this section, however, because T transferred an appreciated asset to U with a principal purpose to shift a portion of the stock basis increase from M's stock in T to M's stock in S, the allocation of the $100 positive adjustment under paragraph (c) of this section between the shares of U's stock must take into account the contribution. Consequently, all $100 of the positive adjustment is allocated to the U stock owned by T, rather than $50 to the U stock owned by S and $50 to the U stock owned by T. M's basis in S's stock remains $150, and its basis in T's stock increases to $300. Thus, M recognizes a $50 gain from its sale of S's stock for $200.

Example 3. Reorganizations. (a) Facts. M forms S with an $800 contribution, $200 of which is in exchange for S's preferred stock described in section 1504(a)(4) and the balance of which is for S's common stock. For Years 1 through 3, S has a total of $160 of ordinary income, $60 of which is distributed with respect to the preferred stock in satisfaction of its $20 annual preference as to dividends. Under this section, M's basis in S's preferred stock is unchanged, and its basis in S's common stock is increased from $600 to $700. To reduce its gain from an anticipated sale of S's preferred stock, M forms T at the close of Year 3 with a contribution of all of S's stock in exchange for corresponding common and preferred stock of T in a transaction to which section 351 applies. At the time of the contribution, the fair market value of the common stock is $700 and the fair market value of the preferred stock is $300 (due to a decrease in prevailing market interest rates). M subsequently sells T's preferred stock for $300.

(b) Analysis. Under section 358(b), M ordinarily has a $630 basis in T's common stock (70% of the $900 aggregate stock basis) and a $270 basis in T's preferred stock (30% of the $900 aggregate stock basis). However, because M transferred S's stock to T with a principal purpose to shift the allocation of basis adjustments under this section, adjustments are made under paragraph (e)(1) of this section to preserve the allocation under this section. Thus, M has a $700 basis in T's common stock and a $200 basis in T's preferred stock. Consequently, M recognizes a $100 gain from the sale of T's preferred stock.

Example 4. Post-deconsolidation basis adjustments. (a) Facts. For Year 1, the M group has $40 of taxable income when determined by including only S's items of income, gain, deduction, and loss taken into account, and M increases its basis in S's stock by $40 under paragraph (b) of this section. M anticipates that S will have a $40 ordinary loss for Year 2 that will be carried back and offset S's income in Year 1 and result in a $40 reduction to M's basis in S's stock for Year 2 under paragraph (b) of this section. With a principal purpose to avoid the reduction, M causes S to issue voting preferred stock that results in S becoming a nonmember at the beginning of Year 2. As anticipated, S has a $40 loss for Year 2, which is carried back to Year 1 and offsets S's income from Year 1.

(b) Analysis. Under paragraph (e)(1) of this section, because M caused S to become a nonmember with a principal purpose to absorb S's loss but avoid the corresponding negative adjustment under this section, and M bears a substantial portion of the loss because of its continued ownership of S common stock, the basis of M's common stock in S is decreased by $40 for Year 2. (If M has less than a $40 basis in the retained S stock, M must recognize income for Year 2 to the extent of the excess.) Section 1504(a)(3) limits the ability of S to subsequently rejoin the M group's consolidated return.

(c) Carryback to pre-consolidation year. The facts are the same as in paragraph (a) of this Example 4, except that M anticipates that S's loss will be carried back and absorbed in a separate return year of S before Year 1 (rather than to the M group's consolidated return for Year 1). Although M causes S to become a nonmember with a principal purpose to avoid the negative adjustment under this section, and M bears a substantial portion of the loss because of its continued ownership of S common stock, both S's income and loss are taken into account under the separate return rules. Consequently, no one has acted with a principal purpose contrary to the purposes of this section, and no adjustments are necessary to carry out the purposes of this section.

Example 5. Pre-consolidation basis adjustments. (a) Facts. M forms S with a $100 contribution, and S becomes a member of the M affiliated group which does not file consolidated returns. For Years 1 through 3, S earns $300. M anticipates that it will elect under section 1501 for the M group to begin filing consolidated returns in Year 5. In anticipation of filing consolidated returns, and to avoid the negative stock basis adjustment that would result under paragraph (b) of this section from distributing S's earnings after Year 5, M causes S to distribute $300 during Year 4 as a qualifying dividend within the meaning of section 243(b). There is no plan or intention to recontribute the funds to S after the distribution.

(b) Analysis. Although S's distribution of $300 is with a principal purpose to avoid a corresponding negative adjustment under this section, the $300 was both earned and distributed entirely under the separate return rules. Consequently, M and S have not acted with a principal purpose contrary to the purposes of this section, and no adjustments are necessary to carry out the purposes of this section.

(f) Predecessors and successors. For purposes of this section, any reference to a corporation or to a share of stock includes a reference to a successor or predecessor as the context may require. A corporation is a successor if the basis of its assets is determined, directly or indirectly, in whole or in part, by reference to the basis of another corporation (the predecessor). For example, if T merges into S, S is treated, as the context may require, as a successor to T and as becoming a member of the group. A share is a successor if its basis is determined, directly or indirectly, in whole or in part, by reference to the basis of another share (the predecessor).

(g) Recordkeeping. Adjustments under this section must be reflected annually on permanent records (including work papers). See also section 6001, requiring records to be maintained. The group must be able to identify from these permanent records the amount and allocation of adjustments, including the nature of any tax-exempt income and noncapital, nondeductible expenses, so as to permit the application of the rules of this section for each year.

(h) Effective/applicability date—(1) General rule. Except as provided in paragraph (h)(8) of this section, this section applies with respect to determinations of the basis of the stock of a subsidiary (e.g., for determining gain or loss from a disposition of stock), in consolidated return years beginning on or after January 1, 1995. If this section applies, basis must be determined or redetermined as if this section were in effect for all years (including, for example, the consolidated return years of another consolidated group to the extent adjustments from those years are still reflected). For example, if the portion of a consolidated net operating loss carryover attributable to S expired in 1990 and is treated as a noncapital, nondeductible expense under paragraph (b) of this section, it is taken into account in tax years beginning on or after January 1, 1995 as a negative adjustment for 1990. Any such determination or redetermination does not, however, affect any prior period. Thus, the negative adjustment for S's noncapital, nondeductible expense is not taken into account for tax years beginning before January 1, 1995.

(2) Dispositions of stock before effective date—(i) In general. If M disposes of stock of S in a consolidated return year beginning before January 1, 1995, the amount of M's income, gain, deduction, or loss, and the basis reflected in that amount, are not redetermined under this section.

(ii) Lower-tier members. Although M disposes of S's stock in a tax year beginning before January 1, 1995, S's determinations or adjustments with respect to the stock of a lower-tier member with which it continues to file a consolidated return are redetermined in accordance with the rules of this section (even if they were previously taken into account by M and reflected in income, gain, deduction, or loss from the disposition of S's stock). For example, assume that M owns all of S's stock, S owns all of T's stock, and T owns all of U's stock. If S sells 80% of T's stock in a tax year beginning before January 1, 1995 (the effective date), the amount of S's income, gain, deduction, or loss from the sale, and the stock basis adjustments reflected in that amount, are not redetermined if M sells S's stock after the effective date. If S sells the remaining 20% of T's stock after the effective date, S's stock basis adjustments with respect to that T stock are also not redetermined because T became a nonmember before the effective date. However, if T and U continue to file a consolidated return with each other and T sells U's stock after the effective date, T's stock basis adjustments with respect to U's stock are redetermined (even though some of those adjustments may have been taken into account by S in its prior sale of T's stock before the effective date).

(iii) Deferred amounts. For purposes of this paragraph (h)(2), a disposition does not include a transaction to which § 1.1502-13, § 1.1502-13T, § 1.1502-14, or § 1.1502-14T applies. Instead, the transaction is deemed to occur as the income, gain, deduction, or loss (if any) is taken into account.

(3) Distributions—(i) Deemed dividend elections. If there is a deemed distribution and recontribution pursuant to § 1.1502-32(f)(2) as contained in the 26 CFR part 1 edition revised as of April 1, 1994 in a consolidated return year beginning before January 1, 1995, the deemed distribution and recontribution under the election are treated as an actual distribution by S and recontribution by M as provided under the election.

(ii) Affiliated earnings and profits. This section does not apply to reduce the basis in S's stock as a result of a distribution of earnings and profits accumulated in separate return years, if the distribution is made in a consolidated return year beginning before January 1, 1995, and the distribution does not cause a negative adjustment under the investment adjustment rules in effect at the time of the distribution. See paragraph (h)(5) of this section for the rules in effect with respect to the distribution.

(4) Expiring loss carryovers. If S became a member of a consolidated group in a consolidated return year beginning before January 1, 1995, and S had a loss carryover from a separate return limitation year at that time, the group does not treat any expiration of the loss carryover (even if in a tax year beginning on or after January 1, 1995) as a noncapital, nondeductible expense resulting in a negative adjustment under this section. If S becomes a member of a consolidated group in a consolidated return year beginning on or after January 1, 1995, and S has a loss carryover from a separate return limitation year at that time, adjustments with respect to the expiration are determined under this section.

(5) Continuing basis reductions for certain deconsolidated subsidiaries. If a subsidiary ceases to be a member of a group in a consolidated return year beginning before January 1, 1995, and its basis was subject to reduction under § 1.1502-32T or § 1.1502-32(g) as contained in the 26 CFR part 1 edition revised as of April 1, 1994, its basis remains subject to reduction under those principles. For example, if S ceased to be a member in 1990, and M's basis in any retained S stock was subject to a basis reduction account, the basis remains subject to reduction. Similarly, if an election could be made to apply § 1.1502-32T instead of § 1.1502-32(g), the election remains available. However, §§ 1.1502-32T and 1.1502-32(g) do not apply as a result of a subsidiary ceasing to be a member in tax years beginning on or after January 1, 1995.

(6) Loss suspended under § 1.1502-35(c) or disallowed under § 1.1502-35(g)(3)(iii). Paragraphs (a)(2), (b)(3)(iii)(C) and (D), and (b)(4)(vi) of this section are applicable on and after March 10, 2006.

(7) Rules related to discharge of indebtedness income excluded from gross income. Paragraphs (b)(1)(ii), (b)(3)(ii)(C)(1), (b)(3)(iii)(A), and (b)(5)(ii), Example 4, paragraphs (a), (b), and (c) of this section apply with respect to determinations of the basis of the stock of a subsidiary in consolidated return years the original return for which is due (without regard to extensions) after March 21, 2005. However, groups may apply those provisions with respect to determinations of the basis of the stock of a subsidiary in consolidated return years the original return for which is due (without regard to extensions) on or before March 21, 2005, and after August 29, 2003.

(8) Determination of stock basis in reorganization with boot. Paragraph (b)(5)(ii)(F) of this section (Example 6) applies only with respect to determinations of the basis of the stock of a subsidiary on or after January 23, 2006.

(9) Allocations of investment adjustments, including adjustments attributable to certain loss transfers; certain conforming amendments. Paragraphs (a)(2), (b)(3)(ii)(C)(2), (c)(1), (c)(2)(i), (c)(2)(ii)(A), (c)(3), and (c)(4)(i) of this section are applicable for determinations of the basis of stock of a subsidiary on or after September 17, 2008.

(i) [Reserved]. For further guidance, see § 1.1502-32T(i) through (j)(1).

(10) Election to treat loss carryover as expiring. Paragraph (b)(4)(iv) of this section applies to any original consolidated Federal income tax return due (without extensions) after June 14, 2007. For original consolidated Federal income tax returns due (without extensions) after May 30, 2006, and on or before June 14, 2007, see § 1.1502-32T as contained in 26 CFR part 1 in effect on April 1, 2007.

[T.D. 8560, 59 FR 41685, Aug. 15, 1994]

Editorial Note:For Federal Register citations affecting § 1.1502-32, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.1502-33 Earnings and profits.

(a) In general—(1) Purpose. This section provides rules for adjusting the earnings and profits of a subsidiary (S) and any member (P) owning S's stock. These rules modify the determination of P's earnings and profits under applicable rules of law, including section 312, by adjusting P's earnings and profits to reflect S's earnings and profits for the period that S is a member of the consolidated group. The purpose for modifying the determination of earnings and profits is to treat P and S as a single entity by reflecting the earnings and profits of lower-tier members in the earnings and profits of higher-tier members and consolidating the group's earnings and profits in the common parent. References in this section to earnings and profits include deficits in earnings and profits.

(2) Application of other rules of law, duplicative adjustments. See § 1.1502-80(a) regarding the general applicability of other rules of law and a limitation on duplicative adjustments. The rules of this section are in addition to other rules of law. For example, the allowance for depreciation is determined in accordance with section 312(k). P's earnings and profits must not be adjusted under this section and other rules of law in a manner that has the effect of duplicating an adjustment. For example, if S's earnings and profits are reflected in P's earnings and profits under paragraph (b) of this section, and S transfers its assets to P in a liquidation to which section 332 applies, S's earnings and profits that P succeeds to under section 381 must be adjusted to prevent duplication.

(b) Tiering up earnings and profits—(1) General rule. P's earnings and profits are adjusted under this section to reflect changes in S's earnings and profits in accordance with the applicable principles of § 1.1502-32, consistently applied, and an adjustment to P's earnings and profits for a tax year under this paragraph (b)(1) is treated as earnings and profits of P for the tax year in which the adjustment arises. Under these principles, for example, the adjustments are made as of the close of each consolidated return year, and as of any other time if a determination at that time is necessary to determine the earnings and profits of any person. Similarly, S's earnings and profits are allocated under the principles of § 1.1502-32(c), and the adjustments are applied in the order of the tiers, from the lowest to the highest. However, modifications to the principles include:

(i) The amount of P's adjustment is determined by reference to S's earnings and profits, rather than S's taxable and tax-exempt items (and therefore, for example, the deferral of a negative adjustment for S's unabsorbed losses does not apply).

(ii) The tax sharing rules under paragraph (d) of this section apply rather than those of § 1.1502-32(b)(3)(iv)(D).

(2) Affiliated earnings and profits. The reduction in S's earnings and profits under section 312 from a distribution of earnings and profits accumulated in separate return years of S that are not separate return limitation years does not tier up to P's earnings and profits. Thus, the increase in P's earnings and profits under section 312 from receipt of the distribution is not offset by a corresponding reduction.

(3) Examples—(i) In general. For purposes of the examples in this section, unless otherwise stated, P owns all of the only class of S's stock, the stock is owned for the entire year, S owns no stock of lower-tier members, the tax year of all persons is the calendar year, all persons use the accrual method of accounting, the facts set forth the only corporate activity, preferred stock is described in section 1504(a)(4), all transactions are between unrelated persons, and tax liabilities are disregarded.

(ii) Tiering up earnings and profits. The principles of this paragraph (b) are illustrated by the following examples.

Example 1. Tier-up and distribution of earnings and profits. (a) Facts. P forms S in Year 1 with a $100 contribution. S has $100 of earnings and profits for Year 1 and no earnings and profits for Year 2. During Year 2, S declares and distributes a $50 dividend to P.

(b) Analysis. Under paragraph (b)(1) of this section, S's $100 of earnings and profits for Year 1 increases P's earnings and profits for Year 1. P has no additional earnings and profits for Year 2 as a result of the $50 distribution in Year 2, because there is a $50 increase in P's earnings and profits as a result of the receipt of the dividend and a corresponding $50 decrease in S's earnings and profits under section 312(a) that is reflected in P's earnings and profits under paragraph (b)(1) of this section.

(c) Distribution of current earnings and profits. The facts are the same as in paragraph (a) of this Example 1, except that S distributes the $50 dividend at the end of Year 1 rather than during Year 2. Under paragraph (b)(1) of this section, P's earnings and profits are increased by $100 (S's $50 of undistributed earnings and profits, plus P's receipt of the $50 distribution). Thus, S's earnings and profits increase by $50 and P's earnings and profits increase by $100.

(d) Affiliated earnings and profits. The facts are the same as in paragraph (a) of this Example 1, except that P and S do not begin filing consolidated returns until Year 2. Because P and S file separate returns for Year 1, P's basis in S's stock remains $100 under § 1.1502-32 and this section, S has $100 of earnings and profits, and none of S's earnings and profits is reflected in P's earnings and profits under paragraph (b) of this section. S's distribution in Year 2 ordinarily would reduce S's earnings and profits but not increase P's earnings and profits. (P's $50 of earnings and profits from the dividend would be offset by S's $50 reduction in earnings and profits that tiers up under paragraph (b) of this section.) However, under paragraph (b)(2) of this section, the negative adjustment for S's distribution to P does not apply. Thus, S's distribution reduces its earnings and profits by $50 but increases P's earnings and profits by $50. (If S's earnings and profits had been accumulated in a separate return limitation year, paragraph (b)(2) of this section would not apply and the distribution would reduce S's earnings and profits but not increase P's earnings and profits.)

(e) Earnings and profits deficit. Assume instead that after P forms S in Year 1 with a $100 contribution, S borrows additional funds and has a $150 deficit in earnings and profits for Year 1. The corresponding loss for tax purposes is not absorbed in Year 1, and is included in the group's consolidated net operating loss carried forward to Year 2. Under paragraph (b)(1) of this section, however, S's $150 deficit in earnings and profits decreases P's earnings and profits for Year 1 by $150. (Absorption of the loss in a later tax year has no effect on the earnings and profits of P and S.)

Example 2. Section 355 distribution. (a) Facts. P owns all of S's stock and S owns all of T's stock. For Year 1, T has $100 of earnings and profits. Under paragraph (b)(1) of this section, the earnings and profits of T tier up to S and to P. S and P have no other earnings and profits for Year 1. S distributes T's stock to P at the end of Year 1 in a distribution to which section 355 applies.

(b) Analysis. Because S's distribution of T's stock is a distribution to which section 355 applies, the applicable principles of § 1.1502-32(b)(2)(iv) do not require P's earnings and profits to be adjusted by reason of the distribution. In addition, although S's earnings and profits may be reduced under section 312(h) as a result of the distribution, the applicable principles of § 1.1502-32(b)(3)(iii) do not require P's earnings and profits to be adjusted to reflect this reduction in S's earnings and profits.

Example 3. Allocating earnings and profits among shares.P owns 80% of S's stock throughout Year 1. For Year 1, S has $100 of earnings and profits. Under paragraph (b)(1) of this section, $80 of S's earnings and profits is allocated to P based on P's ownership of S's stock. Accordingly, $80 of S's earnings and profits for Year 1 is reflected in P's earnings and profits for Year 1.

(1) Stock of members. For purposes of determining P's earnings and profits from the disposition of S's stock, P's basis in S's stock is adjusted to reflect S's earnings and profits determined under paragraph (b) of this section, rather than under § 1.1502-32. For example, P's basis in S's stock is increased by positive earnings and profits and decreased by deficits in earnings and profits. Similarly, P's basis in S's stock is not reduced for distributions to which paragraph (b)(2) of this section applies (affiliated earnings and profits). P may have an excess loss account in S's stock for earnings and profits purposes (whether or not there is an excess loss account under § 1.1502-32), and the excess loss account is determined, adjusted, and taken into account in accordance with the principles of §§ 1.1502-19 and 1.1502-32.

(2) Intercompany transactions. Intercompany items and corresponding items are not reflected in earnings and profits before they are taken into account under § 1.1502-13. See § 1.1502-13 for the applicable rules and definitions.

(3) Example. The principles of this paragraph (c) are illustrated by the following example.

Example. Adjustments to stock basis. (a) Facts. P forms S in Year 1 with a $100 contribution. For Year 1, S has $75 of taxable income and $100 of earnings and profits. For Year 2, S has no taxable income or earnings and profits, and S declares and distributes a $50 dividend to P. P sells all of S's stock for $150 at the end of Year 2.

(b) Analysis. Under paragraph (c)(1) of this section, P's basis in S's stock for earnings and profits purposes immediately before the sale is $150 (the $100 initial basis, plus S's $100 of earnings and profits for Year 1, minus the $50 distribution of earnings and profits in Year 2). Thus, P recognizes no gain or loss from the sale of S's stock for earnings and profits purposes.

(c) Earnings and profits deficit. Assume instead that S has a $100 tax loss and earnings and profits deficit for Year 1. The tax loss is not absorbed in Year 1 and is included in the group's consolidated net operating loss carried forward to Year 2. Under paragraph (b) of this section, S's $100 deficit in earnings and profits decreases P's earnings and profits for Year 1. Under paragraph (c) of this section, P decreases its basis in S's stock for purposes of determining earnings and profits from $100 to $0. (If S had borrowed an additional $50 that it also lost in Year 1, P would have decreased its earnings and profits for Year 1 by the additional $50, and P would have had a $50 excess loss account in S's stock for earnings and profits purposes, which would be taken into account in determining P's earnings and profits from its sale of S's stock.)

(d) Affiliated earnings and profits. Assume instead that P and S do not begin filing consolidated returns until Year 2. Under paragraph (b) of this section, the negative adjustment under § 1.1502-32(b) for distributions does not apply to S's distribution of earnings and profits accumulated in a separate return year that is a not separate return limitation year. Thus, P's basis in S's stock for earnings and profits purposes remains $100, and P has $50 of earnings and profits from the sale of S's stock.

(d) Federal income tax liability—(1) In general—(i) Extension of tax allocations. Section 1552 allocates the tax liability of a consolidated group among its members for purposes of determining the amounts by which their earnings and profits are reduced for taxes. Section 1552 does not reflect the absorption by one member of another member's tax attributes (e.g., losses, deductions and credits). For example, if P's $100 of income is offset by S's $100 of deductions, consolidated tax liability is $0 and no amount is allocated under section 1552. However, the group may elect under this paragraph (d) to allocate additional amounts to reflect the absorption by one member of the tax attributes of another member. Permissible methods are set forth in paragraphs (d)(2) through (4) of this section, and election procedures are provided in paragraph (d)(5) of this section. Allocations under this paragraph (d) must be reflected annually on permanent records (including work papers). Any computations of separate return tax liability are subject to the principles of section 1561.

(ii) Effect of extended tax allocations. The amounts allocated under this paragraph (d) are treated as allocations of tax liability for purposes of § 1.1552-1(b)(2). For example, if P's taxable income is offset by S's loss, and tax liability is allocated under the percentage method of paragraph (d)(3) of this section, P's earnings and profits are reduced as if its income were subject to tax, P is treated as liable to S for the amount of the tax, and corresponding adjustments are made to S's earnings and profits. If the liability of one member to another is not paid, the amount not paid generally is treated as a distribution, contribution, or both, depending on the relationship between the members.

(2) Wait-and-see method. The wait-and-see method under this paragraph (d)(2) is derived from Securities and Exchange Commission procedures. In the year that a member's tax attribute is absorbed, the group's consolidated tax liability is allocated in accordance with the group's method under section 1552. When, in effect, the member with the tax attribute could have absorbed the attribute on a separate return basis in a later year, a portion of the group's consolidated tax liability for the later year that is otherwise allocated to members under section 1552 is reallocated. The reallocation takes into account all consolidated return years to which this paragraph (d) applies (the computation period), and is determined by comparing the tax allocated to a member during the computation period with the member's tax liability determined as if it had filed separate returns during the computation period.

(i) Cap on allocation under section 1552. A member's allocation under section 1552 for a tax year may not exceed the excess, if any, of—

(A) The total of the tax liabilities of the member for the computation period (including the current year), determined as if the member had filed separate returns; over

(B) The total amount allocated to the member under section 1552 and this paragraph (d) for the computation period (except the current year).

(ii) Reallocation of capped amounts. To the extent that the amount allocated to a member under section 1552 exceeds the limitation under paragraph (d)(2)(i) of this section, the excess is allocated among the remaining members in proportion to (but not to exceed the amount of) each member's excess, if any, of—

(A) The total of the tax liabilities of the member for the computation period (including the current year), determined as if the member had filed separate returns; over

(B) The total amount allocated to the member under section 1552 and this paragraph (d) for the computation period (including for the current year only the amount allocated under section 1552).

(iii) Reallocation of excess capped amounts. If the reductions under paragraph (d)(2)(i) of this section exceed the amounts allocable under paragraph (d)(2)(ii) of this section, the excess is allocated among the members in accordance with the group's method under section 1552 without taking this paragraph (d)(2) into account.

(3) Percentage method. The percentage method under this paragraph (d)(3) allocates tax liability based on the absorption of tax attributes, without taking into account the ability of any member to subsequently absorb its own tax attributes. The allocation under this method is in addition to the allocation under section 1552.

(i) Decreased earnings and profits. A member's allocation under section 1552 for any year is increased, thereby decreasing its earnings and profits, by a fixed percentage (not to exceed 100%) of the excess, if any, of—

(A) The member's separate return tax liability for the consolidated return year as determined under § 1.1552-1(a)(2)(ii); over

(B) The amount allocated to the member under section 1552.

(ii) Increased earnings and profits. An amount equal to the total decrease in earnings and profits under paragraph (d)(3)(i) of this section (including amounts allocated as a result of a carryback) increases the earnings and profits of the members whose attributes are absorbed, and is allocated among them in a manner that reasonably reflects the absorption of the tax attributes.

(4) Additional methods. The absorption by one member of the tax attributes of another member may be reflected under any other method approved in writing by the Commissioner.

(5) Election of allocation method—(i) In general. Tax liability may be allocated under this paragraph (d) only if an election is filed with the group's first return. The election must—

(A) Be made in a separate statement entitled “ELECTION TO ALLOCATE TAX LIABILITY UNDER § 1.1502-33(d)”;

(B) State the allocation method elected under § 1.1502-33(d) and under section 1552;

(D) If a method is permitted under paragraph (d)(4) of this section, provide the date and control number of the private letter ruling issued by the Internal Revenue Service approving such method.

(ii) Consent—(A) Electing or changing methods. An election for a later year, or an election to change methods, may be made only with the written consent of the Commissioner.

(B) Prior law elections. An election in effect for the last tax year beginning before January 1, 1995, remains in effect under this section. However, a group may elect to conform its earnings and profits computations to the method described in § 1.1502-32(b)(3)(iv)(D) (the percentage method, using a 100% allocation), whether or not it has previously made an election for earnings and profits purposes. If a conforming election is made, the group must make all adjustments necessary to prevent amounts from being duplicated or omitted. The conforming election is made by attaching a statement entitled “ELECTION TO CONFORM TAX ALLOCATIONS UNDER §§ 1.1502-32 and 1.1502-33(d)” to the consolidated group's return for its first tax year beginning on or after January 1, 1995. The statement must be signed by the common parent, and must specify whether the method is conformed only for years beginning on or after January 1, 1995 or as if the method were in effect for all prior years. The statement must also describe the adjustments made by reason of the change (e.g., to reflect prior use of earnings and profits).

(6) Examples. The principles of this paragraph (d) are illustrated by the following examples.

Example 1. Wait-and-see method. (a) Facts. P owns all of the stock of S1 and S2. The P group uses the wait-and-see method of allocation under paragraph (d)(2) of this section in conjunction with § 1.1552-1(a)(1). For Year 1, each member's taxable income, both for purposes of § 1.1552-1(a)(1) and redetermined as if the member had filed separate returns, is as follows: P $0, S1 $2,000, and S2 ($1,000). Thus, the P group's consolidated tax liability for Year 1 is $340 (assuming a 34% tax rate).

(b) Analysis. Under § 1.1552-1(a)(1)(i), the tax liability of the P group is allocated among the members in accordance with the portion of the consolidated taxable income attributable to each member having taxable income. Thus, all of the P group's $340 consolidated tax liability is allocated to S1. As a result, S1 decreases its earnings and profits under section 1552 by $340 (even if S1 does not pay the tax liability). No further allocations are made under paragraph (d)(2) of this section because S2 cannot yet absorb its loss on a separate return basis.

(c) Payment of tax liability. If S1 pays the $340 tax liability, there is no further effect on the income, earnings and profits, or stock basis of any member. If P pays the $340 tax liability (and the payment is not a loan from P to S1), P is treated as making a $340 contribution to the capital of S1; if S2 pays the $340 tax liability (and the payment is not a loan from S2 to S1), S2 is treated as making a $340 distribution to P with respect to its stock, and P is treated as making a $340 contribution to the capital of S1. See § 1.1552-1(b)(2).

(d) Year 2. For Year 2, each member's taxable income, under § 1.1552-1(a)(1)(ii) and redetermined as if the member had filed separate returns, without taking into account any carryover from Year 1, is as follows: P $0, S1 $1,000, and S2 $3,000. Thus, the P group's consolidated tax liability for Year 2 is $1,360 (assuming a 34% tax rate). Of this amount, section 1552 would allocate $340 to S1 and $1,020 to S2. However, under paragraph (d)(2)(i) of this section, no more than $680 may be allocated to S2. This is because S2 would have had an aggregate tax liability of $680 if it had filed separate returns for Years 1 and 2 (a $0 tax liability for Year 1, and a $680 tax liability for Year 2, taking into account a $1,000 net operating loss carryover from Year 1). Under paragraph (d)(2)(ii) of this section, the entire excess of $340 which would otherwise be allocated to S2 under § 1.1552-1(a)(1) is allocated to S1. This is because S1 would have had an additional $340 of aggregate tax liability if it had filed separate returns for Years 1 and 2 (a $680 tax liability for Year 1, and a $340 tax liability for Year 2, not taking into account S2's $1,000 net operating loss for Year 1). The effect of the allocation of $680 to S1 and $680 to S2 is determined under § 1.1552-1(b)(2).

Example 2. Percentage method. (a) Facts. The facts are the same as in Example 1, but the P group uses the percentage method of allocation under paragraph (d)(3) of this section, with a percentage of 100%. In addition, the taxable incomes and losses of the members are the same if computed as provided in § 1.1552-1(a)(2)(ii).

(b) Analysis. Under § 1.1552-1(a)(2)(ii), $340 of tax liability is allocated to S1 for Year 1. Under paragraph (d)(3)(i) of this section, S1 is allocated another $340 of tax liability because S1 would have had a $680 tax liability if it had filed separate returns but only $340 is allocated to S1 under section 1552. Thus, S1's earnings and profits are decreased by the $680 total. Under paragraph (d)(3)(ii) of this section, S2's earnings and profits are increased by $340 because the additional $340 allocated to S1 under paragraph (d)(3)(i) of this section is attributable to the absorption of S2's losses.

(c) Payment of tax liability. If S1 pays the $340 tax liability of the P group and pays $340 to S2, the Year 1 tax liability results in no further adjustments to the income, earnings and profits, or basis of any member's stock. If S1 pays the $340 tax liability of the P group and pays the other $340 to P instead of S2 because, for example, of an agreement among the members, S2 is treated as distributing $340 to P with respect to its stock in the year that S1 makes the payment to P. See § 1.1552-1(b)(2).

(d) Year 2. For Year 2, $340 is allocated to S1 and $1,020 is allocated to S2 under section 1552. No additional amounts are allocated under paragraph (d)(3) of this section.

(e) Deconsolidations—(1) In general. Immediately before it becomes a nonmember, S's earnings and profits are eliminated to the extent they were taken into account by any member under this section. If S's earnings and profits are eliminated under this paragraph (e)(1), no corresponding adjustment is made to the earnings and profits of P (or any other member) under paragraph (b) of this section or to any basis in a member's stock under paragraph (c) of this section. For this purpose, S is treated as becoming a nonmember on the first day of its first separate return year (including another group's consolidated return year).

(2) Acquisition of group—(i) Application. This paragraph (e)(2) applies only if a consolidated group (the terminating group) ceases to exist as a result of—

(A) The acquisition of either the assets of the common parent of the terminating group in a reorganization described in section 381(a)(2), or the stock of the common parent of the terminating group; or

(B) The application of the principles of § 1.1502-75(d)(2) or (d)(3).

(ii) General rule. Paragraph (e)(1) of this section does not apply solely by reason of the termination of a group because it is acquired, if there is a surviving group that is, immediately thereafter, a consolidated group. Instead, the surviving group is treated as the terminating group for purposes of applying this paragraph (e) to the terminating group. This treatment does not apply, however, to members of the terminating group that are not members of the surviving consolidated group immediately after the terminating group ceases to exist (e.g., under section 1504(a)(3) relating to reconsolidation, or section 1504(c) relating to includible insurance companies).

(3) Certain corporate separations and reorganizations. The adjustments under paragraph (e)(1) of this section must be modified to the extent necessary to effectuate the principles of section 312(h). Thus, P's earnings and profits rather than S's earnings and profits may be eliminated immediately before S becomes a nonmember. P's earnings and profits are eliminated to the extent that its earnings and profits reflect S's earnings and profits after applying section 312(h) immediately after S becomes a nonmember (determined without taking this paragraph (e) into account).

(4) Special uses of earnings and profits. Paragraph (e)(1) of this section does not apply for purposes of determining—

(i) The extent to which a distribution is charged to reserve accounts under section 593(e);

(ii) The extent to which a distribution is taxable to the recipient under sections 805(a)(4) and 832; and

(iii) Any other special use identified in guidance published in the Internal Revenue Bulletin.

(5) Example. The principles of this paragraph (e) are illustrated by the following example.

Example. (a) Facts. Individuals A and B own all of P's stock, and P owns all of the stock of S and T, each with a $500 basis. For Year 1, S has $100 of earnings and profits and T has $50 of earnings and profits. Under paragraph (b)(1) of this section, the earnings and profits of S and T tier up to P, and P has $150 of earnings and profits for Year 1. P sells all of S's stock for $600 at the close of Year 1.

(b) Analysis. Under paragraph (e)(1) of this section, S's $100 of earnings and profits is eliminated immediately before S becomes a nonmember because the earnings and profits are taken into account under paragraph (b) of this section in P's earnings and profits. However, no corresponding adjustment is made to P's earnings and profits or to P's basis in S's stock for purposes of earnings and profits. P's earnings and profits for Year 1 remain $150 following the sale of S's stock.

(c) Forward merger. The facts are the same as in paragraph (a) of this Example, except that, rather than P selling S's stock, S merges into a nonmember in a transaction described in section 368(a)(2)(D). Under paragraph (h) of this section, the nonmember is treated as a successor to S. Thus, as in paragraph (b) of this Example, S's $100 of earnings and profits is eliminated immediately before S ceases to be a member.

(d) Acquisition of entire group. The facts are the same as in paragraph (a) of this Example, except that X, the common parent of another consolidated group, purchases all of P's stock at the close of Year 1, and P sells S's stock during Year 3. Under paragraph (e)(2) of this section, the earnings and profits of S and T are not eliminated as a result of X purchasing P's stock. However, S's earnings and profits from consolidated return years of both the P group and the X group are eliminated immediately before S becomes a nonmember of the X group.

(e) Earnings and profits deficit. The facts are the same as in paragraph (d) of this Example, except that S has a $550 deficit in earnings and profits for Year 1. The effect of paragraph (e)(1) of this section is the same. Under paragraph (c)(1) of this section, P would have an excess loss account in S's stock for earnings and profits purposes under the principles of §§ 1.1502-19 and 1.1502-32, and, under the principles of § 1.1502-19(c)(2), the excess loss account is not taken into account as a result of X's purchase of P's stock. Under paragraph (e)(2) of this section, S's deficit is not eliminated under paragraph (e)(1) of this section immediately before X's purchase of P's stock. However, S's earnings and profits (or deficit) is eliminated immediately before S becomes a nonmember of the X group.

(f) Section 355 distribution. The facts are the same as in paragraph (a) of this Example, except that, rather than selling S's stock, P distributes S's stock to A at the close of Year 1 in a distribution to which section 355 applies. Under paragraph (e)(3) of this section, P's earnings and profits may be reduced under section 312(h) as a result of the distribution. To the extent that P's earnings and profits are reduced, S's earnings and profits are not eliminated under paragraph (e)(1) of this section.

(f) Changes in the structure of the group—(1) Changes in the common parent—(i) General rule. If P succeeds another corporation under the principles of § 1.1502-75(d) (2) or (3) as the common parent of a consolidated group (a group structure change), the earnings and profits of P are adjusted immediately after P becomes the new common parent to reflect the earnings and profits of the former common parent immediately before the former common parent ceases to be the common parent. The adjustment is made as if P succeeds to the earnings and profits of the former common parent in a transaction described in section 381(a). See § 1.1502-31 for the basis of the stock of members following a group structure change.

(ii) Minority shareholders. If the former common parent's stock is not wholly owned by members of the consolidated group immediately after the former common parent ceases to be the common parent, appropriate adjustments must be made to reflect in the new common parent only an allocable part of the former common parent's earnings and profits.

(iii) Higher-tier members. To the extent that earnings and profits are adjusted under this paragraph (f)(1), and the former common parent is owned by members other than P, the earnings and profits of the intermediate subsidiaries must be adjusted in accordance with the principles of this section.

(iv) Example. The principles of this paragraph (f)(1) are illustrated by the following example.

Example. (a) Facts. X is the common parent of a consolidated group with $100 of earnings and profits, and P is the common parent of another consolidated group with $20 of earnings and profits. P acquires all of X's stock at the close of Year 1 in exchange for 70% of P's stock. The exchange is a reverse acquisition under § 1.1502-75(d)(3), and the X group is treated as remaining in existence with P as its new common parent.

(b) Adjustments for X group earnings and profits. Under paragraph (f)(1) of this section, P's earnings and profits are adjusted immediately after P becomes the new common parent, to reflect X's $100 of earnings and profits immediately before X ceases to be the common parent. The adjustment is made as if P succeeds to X's earnings and profits in a transaction described in section 381(a). Thus, immediately after the acquisition, P has $120 of accumulated earnings and profits and X continues to have $100 of accumulated earnings and profits.

(c) Adjustments for P group earnings and profits. Although the P group terminates on P's acquisition of X's stock, under paragraph (e)(2) of this section, no adjustments are made to the earnings and profits of any subsidiaries in the terminating P group.

(d) Acquisition of separate return corporation. The facts are the same as in paragraph (a) of this Example, except that, immediately before the acquisition of its stock by P, X is not affiliated with any other corporation. The exchange is a reverse acquisition under § 1.1502-75(d)(3), and P is treated as the common parent of the X group. Consequently, the results are the same as in paragraphs (b) and (c) of this Example.

(2) Change in the location of subsidiaries. If the location of a member within a group changes, appropriate adjustments must be made to the earnings and profits of the members to prevent the earnings and profits from being eliminated. For example, if P transfers all of S's stock to another member in a transaction to which section 351 and § 1.1502-13 apply, the transferee's earnings and profits are adjusted immediately after the transfer to reflect S's earnings and profits immediately before the transfer from consolidated return years. On the other hand, if the transferee purchases S's stock from P, the transferee's earnings and profits are not adjusted.

(g) Anti-avoidance rule. If any person acts with a principal purpose contrary to the purposes of this section, to avoid the effect of the rules of this section or apply the rules of this section to avoid the effect of any other provision of the consolidated return regulations, adjustments must be made as necessary to carry out the purposes of this section.

(h) Predecessors and successors. For purposes of this section, any reference to a corporation or to a share includes a reference to a successor or predecessor as the context may require. A corporation is a successor if its earnings and profits are determined, directly or indirectly, in whole or in part, by reference to the earnings and profits of another corporation (the predecessor). A share is a successor if its basis is determined, directly or indirectly, in whole or in part, by reference to the basis of another share (the predecessor).

(i) [Reserved]

(j) Effective/applicability date—(1) General rule. This section applies with respect to determinations of the earnings and profits of a member (e.g., for purposes of a characterizing a distribution to which section 301 applies) in consolidated return years beginning on or after January 1, 1995. If this section applies, earnings and profits must be determined or redetermined as if this section were in effect for all years (including, for example, the consolidated return years of another consolidated group to the extent the earnings and profits from those years are still reflected). For example, if a distribution by P to a nonmember shareholder in 1990 was a dividend because of an unabsorbed loss carryover attributable to S, P's earnings and profits in tax years beginning after January 1, 1995 are redetermined by taking into account a negative adjustment in the tax year S's loss arose and in 1990 for P's distribution, and any subsequent absorption of the loss has no effect on earnings and profits. Any such determination or redetermination does not, however, affect any prior period. Thus, the shareholder's treatment in 1990 of the distribution as a dividend (and the effect of the distribution on stock basis) is not redetermined under this section. Paragraphs (a)(2) and (e)(2)(i)(A) of this section apply with respect to determinations of the earnings and profits of a member in consolidated return years beginning on or after September 17, 2008. However, taxpayers may apply paragraph (e)(2)(i)(A) of this section with respect to determinations of the earnings and profits of a member in consolidated return years beginning prior to September 17, 2008.

(2) Dispositions of stock before effective date—(i) In general. If P disposes of stock of S in a consolidated return year beginning before January 1, 1995, the amount of P's earnings and profits with respect to S are not redetermined under paragraph (j)(1) of this section. See § 1.1502-19 as contained in the 26 CFR part 1 edition revised as of April 1, 1994 for the definition of disposition, and paragraph (j)(5) of this section for the rules applicable to such dispositions.

(ii) Lower-tier members. Although P disposes of S's stock in a tax year beginning before January 1, 1995, S's determinations or adjustments with respect to lower-tier members with which it continues to file a consolidated return are redetermined in accordance with the rules of this section (even if S's earnings and profits were previously taken into account by P). For example, assume that P owns all of S's stock, S owns all of T's stock, and T owns all of U's stock. If S sells 80% of T's stock in a tax year beginning before January 1, 1995 (the effective date), the amount of S's earnings and profits from the sale, and the adjustments to stock basis for earnings and profits purposes that are reflected in that amount, are not redetermined if P sells S's stock after the effective date. If S sells the remaining 20% of T's stock after the effective date, S's stock basis adjustments with respect to that T stock are also not redetermined because T became a nonmember before the effective date. However, if T and U continue to file a consolidated return with each other, paragraph (e)(1) of this section did not apply, and T sells U's stock after the effective date, T's earnings and profits with respect to U are redetermined (even though some of the earnings and profits may have been taken into account by S in its prior sale of T's stock before the effective date).

(iii) Deferred amounts. For purposes of this paragraph (j)(2), a disposition does not include a transaction to which § 1.1502-13, § 1.1502-13T, § 1.1502-14, or § 1.1502-14T applies. Instead, the transaction is deemed to occur as the earnings and profits (if any) are taken into account.

(3) Deconsolidations and group structure changes—(i) In general. Paragraphs (e) and (f) of this section apply with respect to deconsolidations and group structure changes occurring in consolidated return years beginning on or after January 1, 1995.

(ii) Prior period group structure changes. If there was a group structure change in a consolidated return year beginning before January 1, 1995, and earnings and profits were not determined under § 1.1502-33T(a) as contained in the 26 CFR part 1 edition revised as of April 1, 1994, a distribution in a tax year ending after September 7, 1988, of earnings and profits that are not reflected in the earnings and profits of the distributee member, but would have been so reflected if § 1.1502-33T(a) as contained in the 26 CFR part 1 edition revised as of April 1, 1994 had applied, the negative adjustment under paragraph (b) of this section for distributions does not apply (and there is therefore no offset to the increase in the earnings and profits of the distributee).

(4) Deemed dividend elections. If there is a deemed distribution and recontribution pursuant to § 1.1502-32(f)(2) as contained in the 26 CFR part 1 edition revised as of April 1, 1994 in a consolidated return year beginning before January 1, 1995, the deemed distribution and recontribution under the election are treated as an actual distribution by S and recontribution by P as provided under the election.

(5) Prior law. For prior determinations, see prior regulations under section 1502 as in effect with respect to the determination. See, e.g., §§ 1.1502-33 and 1.1502-33T as contained in the 26 CFR part 1 edition revised as of April 1, 1994.

(k) Effective/applicability date. Paragraph (d)(5)(i)(D) of this section applies to any original consolidated Federal income tax return due (without extensions) after June 14, 2007. For original consolidated Federal income tax returns due (without extensions) after May 30, 2006, and on or before June 14, 2007, see § 1.1502-33T as contained in 26 CFR part 1 in effect on April 1, 2007. For original consolidated Federal income tax returns due (without extensions) on or before May 30, 2006, see § 1.1502-33 as contained in 26 CFR part 1 in effect on April 1, 2006.

[T.D. 8560, 59 FR 41695, Aug. 15, 1994, as amended by T.D. 8597, 60 FR 36710, July 18, 1995; T.D. 9264, 71 FR 30603, May 30, 2006; T.D. 9329, 72 FR 32805, June 14, 2007; T.D. 9424, 73 FR 53951, Sept. 17, 2008; 73 FR 62204, Oct. 20, 2008]

§ 1.1502-34 Special aggregate stock ownership rules.

(a) Determination of stock ownership. For purposes of the consolidated return regulations, in determining the stock ownership of a member of a group in another corporation (issuing corporation) for purposes of determining the application of section 165(g)(3)(A), 332(b)(1), 351(a), 732(f), or 904(f) in a consolidated return year, stock in the issuing corporation owned by all other members of the group is included. For the determination of whether a member of the group is an 80-percent distributee, see section 337(c) (providing that, for purposes of section 337, the determination of whether any corporation is an 80-percent distributee is made without regard to any consolidated return regulation).

(b) Example regarding liquidation of member. The following example illustrates the stock ownership aggregation rule set forth in paragraph (a) of this section.

(1) Facts. P wholly owns A, B, and C, each of which is a member of the P group. A, B, and C each owns 33 1/3 percent of the stock of D. D liquidates in a transaction purported to qualify under section 332.

(2) Analysis. For purposes of determining satisfaction of the 80-percent stock ownership requirement under section 332(b)(1), under the stock ownership aggregation rule set forth in paragraph (a) of this section: A is treated as owning all of the D stock owned by B and C; B is treated as owning all of the D stock owned by A and C; and C is treated as owning all of the D stock owned by A and B. Therefore, each of A, B, and C is treated as owning 100 percent of the stock of D and thus meeting the 80-percent stock ownership requirement for purposes of section 332. However, none of A, B, or C is treated as an 80-percent distributee for purposes of section 337. See section 337(c). Therefore, section 337(a) does not apply.

[T.D. 10018, 89 FR 106871, Dec. 30, 2024]

§ 1.1502-35 Transfers of subsidiary stock and deconsolidations of subsidiaries.

(a) In general—(1) Purpose. The purpose of this section is to prevent a group from obtaining more than one tax benefit from a single economic loss. The provisions of this section shall be construed in a manner that is consistent with that purpose and in a manner that reasonably carries out that purpose.

(2) Dates of applicability. This section applies if—

(i) On or after March 7, 2002, a member recognizes a loss on the disposition of a share of stock of a subsidiary (or, on or after April 10, 2007, a share of stock of a former subsidiary) or a carryover basis asset (subject to paragraph (c)(6) of this section),

(ii) The member's loss on the share of subsidiary stock or the carryover basis asset is allowed on or before the date that is ten years after the disposition of the share or carryover basis asset, and

(iii) If the disposition is of a share of subsidiary stock, it is not a transfer to which § 1.1502-36 applies.

(b) Redetermination of basis on certain nondeconsolidating transfers of subsidiary stock and on certain deconsolidations of subsidiaries—(1) Redetermination of basis on certain nondeconsolidating transfers of subsidiary stock. Except as provided in paragraph (b)(3)(i) of this section, if, immediately after a transfer of stock of a subsidiary that has a basis that exceeds its value, the subsidiary remains a member of the group, then the basis in each share of subsidiary stock owned by each member of the group shall be redetermined in accordance with the provisions of this paragraph (b)(1) immediately before such transfer. All of the members' bases in the shares of subsidiary stock immediately before such transfer shall be aggregated. Such aggregated basis shall be allocated first to the shares of the subsidiary's preferred stock that are owned by the members of the group immediately before such transfer, in proportion to, but not in excess of, the value of those shares at such time. After allocation of the aggregated basis to all shares of the preferred stock of the subsidiary pursuant to the preceding sentence, any remaining basis shall be allocated among all common shares of subsidiary stock held by members of the group immediately before the transfer, in proportion to the value of such shares at such time.

(2) Redetermination of basis on certain deconsolidations of subsidiaries—(i) Allocation of reallocable basis amount. Except as provided in paragraph (b)(3)(ii) of this section, if, immediately before a deconsolidation of a subsidiary, any share of stock of such subsidiary owned by a member of the group has a basis that exceeds its value, then the basis in each share of the subsidiary's stock owned by each member of the group shall be redetermined in accordance with the provisions of this paragraph (b)(2) immediately before such deconsolidation. The basis in each share of the subsidiary's stock held by members of the group immediately before the deconsolidation that has a basis in excess of value at such time shall be reduced, but not below such share's value, in a manner that, to the greatest extent possible, causes the ratio of the basis to the value of each such share to be the same; provided, however, that the aggregate amount of such reduction shall not exceed the reallocable basis amount (as computed pursuant to paragraph (b)(2)(ii) of this section). Then, to the extent of the reallocable basis amount, the basis of each share of the preferred stock of the subsidiary that are held by members of the group immediately before the deconsolidation shall be increased, but not above such share's value, in a manner that, to the greatest extent possible, causes the ratio of the basis to the value of each such share to be the same. Then, to the extent that the reallocable basis amount does not increase the basis of shares of preferred stock of the subsidiary pursuant to the third sentence of this paragraph (b)(2)(i), such amount shall increase the basis of all common shares of the subsidiary's stock held by members of the group immediately before the deconsolidation in a manner that, to the greatest extent possible, causes the ratio of the basis to the value of each such share to be the same.

(ii) Calculation of reallocable basis amount. The reallocable basis amount shall equal the lesser of—

(A) The aggregate of all amounts by which, immediately before the deconsolidation, the basis exceeds the value of a share of subsidiary stock owned by any member of the group at such time; and

(B) The total of the subsidiary's (and any predecessor's) items of deduction and loss, and the subsidiary's (and any predecessor's) allocable share of items of deduction and loss of all lower-tier subsidiaries, that were taken into account in computing the adjustment under § 1.1502-32 to the bases of shares of stock of the subsidiary (and any predecessor) held by members of the group immediately before the deconsolidation, other than shares that have bases in excess of value immediately before the deconsolidation.

(3) Exceptions to application of redetermination rules. (i) Paragraph (b)(1) of this section shall not apply to a transfer of subsidiary stock if—

(A) During the taxable year of such transfer, in one or more fully taxable transactions, the members of the group dispose of all of the shares of the subsidiary stock that they own immediately before the transfer, other than the shares the transfer of which would otherwise trigger the application of paragraph (b)(1) of this section, to a person or persons that are not members of the group;

(B) During the taxable year of such transfer, the members of the group are allowed a worthless stock loss under section 165(g) (taking into account the provisions of § 1.1502-80(c)) with respect to all of the shares of subsidiary stock that they own immediately before the transfer, other than the shares the transfer of which would otherwise trigger the application of paragraph (b)(1) of this section; or

(C) Such transfer is to a member of the group and section 332 (provided the stock is transferred to an 80-percent distributee), section 351, section 354, or section 361 applies to such transfer.

(ii) Paragraph (b)(2) of this section shall not apply to a deconsolidation of a subsidiary if—

(A) During the taxable year of such deconsolidation, in one or more fully taxable transactions, the members of the group dispose of all of the shares of the subsidiary stock that they own immediately before the deconsolidation to a person or persons that are not members of the group;

(B) Such deconsolidation results from a fully taxable disposition, to a person or persons that are not members of the group, of some of the shares of the subsidiary, and, during the taxable year of such deconsolidation, the members of the group are allowed a worthless stock loss under section 165(g) with respect to all of the shares of the subsidiary stock that they own immediately after the deconsolidation;

(C) The members of the group are allowed a worthless stock loss under section 165(g) with respect to all of the shares of the subsidiary stock that they own immediately before the deconsolidation;

(D) The deconsolidation of the subsidiary results from the deconsolidation of a higher-tier subsidiary and, immediately after the deconsolidation of the subsidiary, none of the stock of the subsidiary is owned by a group member; or

(E) The deconsolidation of the subsidiary results from a termination of the group.

(4) Special rule for lower-tier subsidiaries. If, immediately after a transfer of subsidiary stock or a deconsolidation of a subsidiary, a lower-tier subsidiary some of the stock of which is owned by the subsidiary is a member of the group, then, for purposes of applying this paragraph (b), the subsidiary shall be treated as having transferred its stock of the lower-tier subsidiary. This principle shall apply to stock of subsidiaries that are owned by such lower-tier subsidiary.

(5) Stock basis adjustments for higher-tier stock. The basis adjustments required under this paragraph (b) result in basis adjustments to higher-tier member stock. The adjustments are applied in the order of the tiers, from the lowest to highest. For example, if a common parent owns stock of a subsidiary that owns stock of a lower-tier subsidiary and the subsidiary recognizes a loss on the disposition of a portion of its shares of the lower-tier subsidiary stock, the common parent must adjust its basis in its subsidiary stock under the principles of § 1.1502-32 to reflect the adjustments that the subsidiary must make to its basis in its stock of the lower-tier subsidiary.

(6) Ordering rules. (i) The rules of this paragraph (b) apply after the rules of § 1.1502-32 are applied.

(ii) The rules of this paragraph (b) apply before the rules of § 1.337(d)-2 and paragraphs (c) and (f) of this section are applied.

(iii) This paragraph (b) (and any resulting basis adjustments to higher-tier member stock made pursuant to paragraph (b)(5) of this section) applies to redetermine the basis of stock of a lower-tier subsidiary before this paragraph (b) applies to a higher-tier member of such lower-tier subsidiary.

(c) Loss suspension—(1) General rule. Any loss recognized by a member of a consolidated group with respect to the disposition of a share of subsidiary stock shall be suspended to the extent of the duplicated loss with respect to such share of stock if, immediately after the disposition, the subsidiary is a member of the consolidated group of which it was a member immediately prior to the disposition (or any successor group).

(2) Special rule for lower-tier subsidiaries. This paragraph (c)(2) applies if neither paragraph (c)(1) nor (f) of this section applies to a member's disposition of a share of stock of a subsidiary (the departing member), a loss is recognized on the disposition of such share, and the departing member owns stock of one or more other subsidiaries (a remaining member) that is a member of such group immediately after the disposition. In that case, such loss shall be suspended to the extent the duplicated loss with respect to the departing member stock disposed of is attributable to the remaining member or members.

(3) Treatment of suspended loss—(i) General rule. For purposes of the rules of § 1.1502-32, any loss suspended pursuant to paragraph (c)(1) or (c)(2) of this section is treated as a noncapital, nondeductible expense of the member that disposes of subsidiary stock, incurred during the taxable year that includes the date of the disposition of stock to which paragraph (c)(1) or (c)(2) of this section applies. See § 1.1502-32(b)(3)(iii)(C). Consequently, the basis of a higher-tier member's stock of the member that disposes of subsidiary stock is reduced by the suspended loss in the year it is suspended.

(ii) Location of suspended loss following deconsolidation of selling member. If a member recognizes a loss that is suspended under this paragraph (c) but that member ceases to be a member of the group before the loss is allowable, the common parent is treated as succeeding to the loss in a transaction to which section 381(a) applies.

(4) Reduction of suspended loss—(i) General rule. The amount of any loss suspended pursuant to paragraph (c)(1) or (c)(2) of § 1.1502-35 shall be reduced, but not below zero, by the subsidiary's (and any successor's) items of deduction and loss, and the subsidiary's (and any successor's) allocable share of items of deduction and loss of all lower-tier subsidiaries, that are allocable to the period beginning on the date of the disposition that gave rise to the suspended loss and ending on the day before the first date on which the subsidiary (and any successor) is not a member of the group of which it was a member immediately prior to the disposition (or any successor group), and that are taken into account in determining consolidated taxable income (or loss) of such group for any taxable year that includes any date on or after the date of the disposition and before the first date on which the subsidiary (and any successor) is not a member of such group; provided, however, that such reduction shall not exceed the excess of the amount of such items over the amount of such items that are taken into account in determining the basis adjustments made under § 1.1502-32 to stock of the subsidiary (or any successor) owned by members of the group. The preceding sentence shall not apply to items of deduction and loss to the extent that the group can establish that all or a portion of such items was not reflected in the computation of the duplicated loss with respect to the subsidiary on the date of the disposition of stock that gave rise to the suspended loss.

(ii) Operating rules—(A) Year in which deduction or loss is taken into account. For purposes of paragraph (c)(4)(i) of this section, a subsidiary's (or any successor's) deductions and losses are treated as taken into account when and to the extent they are absorbed by the subsidiary (or any successor) or any other member. To the extent that the subsidiary's (or any successor's) deduction or loss is absorbed in the year it arises or is carried forward and absorbed in a subsequent year (e.g., under section 172, 465, or 1212), the deduction is treated as taken into account in the year in which it is absorbed. To the extent that a subsidiary's (or any successor's) deduction or loss is carried back and absorbed in a prior year (whether consolidated or separate), the deduction or loss is treated as taken into account in the year in which it arises and not in the year in which it is absorbed.

(B) Determination of items that are allocable to the post-disposition, pre-deconsolidation period. For purposes of paragraph (c)(4)(i) of this section, the determination of whether a subsidiary's (or any successor's) items of deduction and loss and allocable share of items of deduction and loss of all lower-tier subsidiaries are allocable to the period beginning on the date of the disposition of subsidiary stock that gave rise to the suspended loss and ending on the day before the first date on which the subsidiary (or any successor) is not a member of the consolidated group of which it was a member immediately prior to the disposition (or any successor group) is determined pursuant to the rules of § 1.1502-76(b)(2), without regard to § 1.1502-76(b)(2)(ii)(D), as if the subsidiary ceased to be a member of the group at the end of the day before the disposition and filed separate returns for the period beginning on the date of the disposition and ending on the day before the first date on which it is not a member of such group.

(5) Allowable loss—(i) General rule. To the extent not reduced under paragraph (c)(4) of this section, any loss suspended pursuant to paragraph (c)(1) or (c)(2) of this section shall be allowed, to the extent otherwise allowable under applicable provisions of the Internal Revenue Code and regulations, on a return filed by the group of which the subsidiary was a member on the date of the disposition of subsidiary stock that gave rise to the suspended loss (or any successor group) for the taxable year that includes the earlier of—

(A) The day before the first date on which the subsidiary (and any successor) is not a member of such group or the date the group is allowed a worthless stock loss under section 165 (taking into account the provisions of § 1.1502-80(c)) with respect to all of the subsidiary stock owned by members and;

(B) The date that is ten years after the date of the disposition of subsidiary stock that gave rise to the suspended loss.

(ii) No tiering up of certain adjustments. No adjustments shall be made to a member's basis of stock of a subsidiary (or any successor) for a suspended loss that is taken into account under paragraph (c)(5)(i) of this section. See § 1.1502-32(a)(2).

(iii) Statement of allowed loss. Paragraph (c)(5)(i) of this section applies only if the separate statement required under this paragraph (c)(5)(iii) is filed with, or as part of, the taxpayer's return for the year in which the loss is allowable. The statement must be entitled “ALLOWED LOSS UNDER § 1.1502-35(c)(5)” and must contain the name and employer identification number of the subsidiary the stock of which gave rise to the loss.

(6) Special rule for dispositions of certain carryover basis assets. If—

(i) A member of a group recognizes a loss on the disposition of an asset other than stock of a subsidiary;

(ii) Such member's basis in the asset disposed of was determined, directly or indirectly, in whole or in part, by reference to the basis of stock of a subsidiary and, at the time of the determination of the member's basis in the asset disposed of, there was a duplicated loss with respect to such stock of the subsidiary; and

(iii) Immediately after the disposition, the subsidiary is a member of such group, then such loss shall be suspended pursuant to the principles of paragraphs (c)(1) and (c)(2) of this section to the extent of the duplicated loss with respect to such stock at the time of the determination of basis of the asset disposed of. Principles similar to those set forth in paragraphs (c)(3), (c)(4), and (c)(5) of this section shall apply to a loss suspended pursuant to this paragraph (c)(6).

(7) Coordination with loss deferral, loss disallowance, and other rules—(i) In general. Loss recognized on the disposition of subsidiary stock or another asset is subject to redetermination, deferral, or disallowance under other applicable provisions of the Internal Revenue Code and regulations thereunder, including sections 267(f) and 482. Paragraphs (c)(1), (c)(2), and (c)(6) of this section do not apply to a loss that is disallowed under any other provision. If loss is deferred under any other provision, paragraphs (c)(1), (c)(2), and (c)(6) of this section apply when the loss would otherwise be taken into account under such other provision. However, if an overriding event described in paragraph (c)(7)(ii) of this section occurs before the deferred loss is taken into account, paragraphs (c)(1), (c)(2), and (c)(6) of this section apply to the loss immediately before the event occurs, even though the loss may not be taken into account until a later time.

(ii) Overriding events. For purposes of paragraph (c)(7)(i) of this section, the following are overriding events—

(A) The stock ceases to be owned by a member of the consolidated group;

(B) The stock is canceled or redeemed (regardless of whether it is retired or held as treasury stock); or

(8) No elimination of economic loss. This paragraph (c) shall not be applied in a manner that permanently disallows a deduction for an economic loss, provided that such deduction is otherwise allowable. If the application of any provision of this paragraph (c) results in such a disallowance, proper adjustment may be made to prevent such a disallowance. Whether a provision of this paragraph (c) has resulted in such a disallowance is determined on the date on which the subsidiary (or any successor) the disposition of the stock of which gave rise to a suspended stock loss is not a member of the group or the date the group is allowed a worthless stock loss under section 165(g) (taking into account the provisions of § 1.1502-80(c)) with respect to all of such subsidiary stock owned by members. Proper adjustment in such cases shall be made by restoring the suspended stock loss immediately before the subsidiary ceases to be a member of the group or the group is allowed a worthless stock loss under section 165(g) (taking into account the provisions of § 1.1502-80(c)) with respect to all of such subsidiary stock owned by members, to the extent that its reduction pursuant to paragraph (c)(4) of this section had the result of permanently disallowing a deduction for an economic loss.

(9) Ordering rule. The rules of this paragraph (c) apply after the rules of paragraph (b) of this section and § 1.337(d)-2 are applied.

(d) Definitions—(1) Disposition means any event in which gain or loss is recognized, in whole or in part.

(2) Deconsolidation means any event that causes a subsidiary to no longer be a member of the consolidated group.

(3) Value means fair market value.

(4) Duplicated loss—(i) In general. Duplicated loss is determined immediately after a disposition and equals the excess, if any, of—

(A) The sum of—

(1) The aggregate adjusted basis of the subsidiary's assets other than any stock that subsidiary owns in another subsidiary;

(2) Any losses attributable to the subsidiary and carried to the subsidiary's first taxable year following the disposition; and

(3) Any deductions of the subsidiary that have been recognized but are deferred under a provision of the Internal Revenue Code (such as deductions deferred under section 469); over

(B) The sum of—

(1) The value of the subsidiary's stock; and

(2) Any liabilities of the subsidiary that have been taken into account for tax purposes.

(ii) Special rules. (A) The amounts determined under paragraph (d)(4)(i) (other than amounts described in paragraph (d)(4)(i)(B)(1)) of this section with respect to a subsidiary include its allocable share of corresponding amounts with respect to all lower-tier subsidiaries. If 80 percent or more in value of the stock of a subsidiary is acquired by purchase in a single transaction (or in a series of related transactions during any 12-month period), the value of the subsidiary's stock may not exceed the purchase price of the stock divided by the percentage of the stock (by value) so purchased. For this purpose, stock is acquired by purchase if the transferee is not related to the transferor within the meaning of sections 267(b) and 707(b)(1), using the language “10 percent” instead of “50 percent” each place that it appears, and the transferee's basis in the stock is determined wholly by reference to the consideration paid for such stock.

(B) The amounts determined under paragraph (d)(4)(i) of this section are not applied more than once to suspend a loss under this section.

(5) Predecessor and successor. A predecessor is a transferor of assets to a transferee (the successor) in a transaction—

(i) To which section 381(a) applies;

(ii) In which substantially all of the assets of the transferor are transferred to members in a complete liquidation;

(iii) In which the successor's basis in assets is determined (directly or indirectly, in whole or in part) by reference to the transferor's basis in such assets, but the transferee is a successor only with respect to the assets the basis of which is so determined; or

(iv) Which is an intercompany transaction, but only with respect to assets that are being accounted for by the transferor in a prior intercompany transaction.

(6) Successor group. A surviving group is treated as a successor group of a consolidated group (the terminating group) that ceases to exist as a result of—

(i) The acquisition by a member of another consolidated group of either the assets of the common parent of the terminating group in a reorganization described in section 381(a)(2), or the stock of the common parent of the terminating group; or

(ii) The application of the principles of § 1.1502-75(d)(2) or (3).

(7) Preferred stock, common stock. Preferred stock and common stock shall have the meanings set forth in § 1.1502-32(d)(2) and (3), respectively.

(8) Higher-tier. A subsidiary is higher-tier with respect to a member if or to the extent investment adjustments under § 1.1502-32 with respect to the stock of the latter member would affect investment adjustments with respect to the stock of the former member.

(9) Lower-tier. A subsidiary is lower-tier with respect to a member if or to the extent investment basis adjustments under § 1.1502-32 with respect to the stock of the former member would affect investment adjustments with respect to the stock of the latter member.

(e) Examples. For purposes of the examples in this section, unless otherwise stated, all groups file consolidated returns on a calendar-year basis, the facts set forth the only corporate activity, all transactions are between unrelated persons, and tax liabilities are disregarded. In addition, all transactions described in section 362(a) are completed before October 22, 2004, and therefore are not subject to section 362(e)(2). The principles of paragraphs (a) through (d) of this section are illustrated by the following examples:

Example 1. Nondeconsolidating sale of preferred stock of lower-tier subsidiary. (i) Facts. P owns 100 percent of the common stock of each of S1 and S2. S1 and S2 each have only one class of stock outstanding. P's basis in the stock of S1 is $100 and the value of such stock is $130. P's basis in the stock of S2 is $120 and the value of such stock is $90. P, S1, and S2 are all members of the P group. S1 and S2 form S3. In Year 1, in transfers to which section 351 applies, S1 contributes $100 to S3 in exchange for all of the common stock of S3 and S2 contributes an asset with a basis of $50 and a value of $20 to S3 in exchange for all of the preferred stock of S3. S3 becomes a member of the P group. In Year 3, in a transaction that is not part of the plan that includes the contributions to S3, S2 sells the preferred stock of S3 for $20. Immediately after the sale, S3 is a member of the P group.

(ii) Application of basis redetermination rule. Because S2's basis in the preferred stock of S3 exceeds its value immediately prior to the sale and S3 is a member of the P group immediately after the sale, all of the P group members' bases in the stock of S3 is redetermined pursuant to paragraph (b)(1) of this section. Of the group members' total basis of $150 in the S3 stock, $20 is allocated to the preferred stock, the fair market value of the preferred stock on the date of the sale, and $130 is allocated to the common stock. S2's sale of the preferred stock results in the recognition of $0 of gain/loss. Pursuant to paragraph (b)(5) of this section, the redetermination of S1's and S2's bases in the stock of S3 results in adjustments to P's basis in the stock of S1 and S2. In particular, P's basis in the stock of S1 is increased by $30 to $130 and its basis in the stock of S2 is decreased by $30 to $90.

Example 2. Deconsolidating sale of common stock. (i) Facts. In Year 1, in a transfer to which section 351 applies, P contributes Asset A with a basis of $900 and a value of $200 to S in exchange for one share of S common stock (CS1). In Years 2 and 3, in successive but unrelated transfers to which section 351 applies, P transfers $200 to S in exchange for one share of S common stock (CS2), Asset B with a basis of $300 and a value of $200 in exchange for one share of S common stock (CS3), and Asset C with a basis of $1000 and a value of $200 in exchange for one share of S common stock (CS4). In Year 4, S sells Asset A for $200, recognizing $700 of loss that is used to offset income of P recognized during Year 4. As a result of the sale of Asset A, the basis of each of P's four shares of S common stock is reduced by $175. Therefore, the basis of CS1 is $725. The basis of CS2 is $25. The basis of CS3 is $125, and the basis of CS4 is $825. In Year 5 in a transaction that is not part of a plan that includes the Year 1 contribution, P sells CS4 for $200. Immediately after the sale of CS4, S is not a member of the P group.

(ii) Application of basis redetermination rule. Because P's basis in each of CS1 and CS4 exceeds its value immediately prior to the deconsolidation of S, P's basis in its shares of S common stock is redetermined pursuant to paragraph (b)(2) of this section. Pursuant to paragraph (b)(2)(ii) of this section, the reallocable basis amount is $350 (the lesser of $1150, the gross loss inherent in the stock of S owned by P immediately before the sale, and $350, the aggregate amount of S's items of deduction and loss that were previously taken into account in the computation of the adjustment to the basis of the stock of S that P did not hold at a loss immediately before the deconsolidation). Pursuant to paragraph (b)(2)(i) of this section, first, P's basis in CS1 is reduced from $725 to $600 and P's basis in CS4 is reduced from $825 to $600. Then, the reallocable basis amount increases P's basis in CS2 from $25 to $250 and P's basis in CS3 from $125 to $250. P recognizes $400 of loss on the sale of CS4. The loss suspension rule does not apply because S is no longer a member of the P group. Thus, the loss is allowable at that time.

Example 3. Nondeconsolidating sale of common stock. (i) Facts. In Year 1, P forms S with a contribution of $80 in exchange for 80 shares of the common stock of S, which at that time represents all of the outstanding stock of S. S becomes a member of the P group. In Year 2, P contributes Asset A with a basis of $50 and a value of $20 in exchange for 20 shares of the common stock of S in a transfer to which section 351 applies. In Year 4, in a transaction that is not part of the plan that includes the Year 2 contribution, P sells the 20 shares of the common stock of S that it acquired in Year 2 for $20. Immediately after the Year 4 stock sale, S is a member of the P group. At the time of the Year 4 stock sale, S has $80 and Asset A. In Year 5, S sells Asset A, the basis and value of which have not changed since its contribution to S. On the sale of Asset A for $20, S recognizes a $30 loss. The P group cannot establish that all or a portion of the $30 loss was not reflected in the calculation of the duplicated loss of S on the date of the Year 4 stock sale. The $30 loss is used on the P group return to offset income of P. In Year 6, P sells its remaining S common stock for $80.

(ii) Application of basis redetermination and loss suspension rules. Because P's basis in the common stock sold exceeds its value immediately prior to the sale and S is a member of the P group immediately after the sale, P's basis in all of the stock of S is redetermined pursuant to paragraph (b)(1) of this section. Of P's total basis of $130 in the S common stock, a proportionate amount is allocated to each of the 100 shares of S common stock. Accordingly, $26 is allocated to the common stock of S that is sold and $104 is allocated to the common stock of S that is retained. On P's sale of the 20 shares of the common stock of S for $20, P recognizes a loss of $6. Because the sale of the 20 shares of common stock of S does not result in the deconsolidation of S, under paragraph (c)(1) of this section, that loss is suspended to the extent of the duplicated loss with respect to the shares sold. The duplicated loss with respect to the shares sold is $6. Therefore, the entire $6 loss is suspended.

(iii) Effect of subsequent asset sale on stock basis. Of the $30 loss recognized on the sale of Asset A, $24 is taken into account in determining the basis adjustments made under § 1.1502-32 to the stock of S owned by P. Accordingly, P's basis in its S stock is reduced by $24 from $104 to $80.

(iv) Effect of subsequent asset sale on suspended loss. Because P cannot establish that all or a portion of the loss recognized on the sale of Asset A was not reflected in the calculation of the duplicated loss of S on the date of the Year 4 stock sale and such loss is allocable to the period beginning on the date of the Year 4 disposition of the S stock and ending on the day before the first date on which S is not a member of the P group and is taken into account in determining consolidated taxable income (or loss) of the P group for a taxable year that includes a date on or after the date of the Year 4 disposition and before the first date on which S is not a member of the P group, such asset loss reduces the suspended loss pursuant to paragraph (c)(4) of this section. The amount of such reduction, however, cannot exceed $6, the excess of the amount of such loss, $30, over the amount of such loss that is taken into account in determining the basis adjustment made to the stock of S owned by P, $24. Therefore, the suspended loss is reduced to zero.

(v) Effect of subsequent stock sale. P recognizes $0 gain/loss on the Year 6 sale of its remaining S common stock. No amount of suspended loss remains to be allowed under paragraph (c)(5) of this section.

Example 4. Nondeconsolidating sale of common stock of lower-tier subsidiary. (i) Facts. In Year 1, P forms S1 with a contribution of $200 in exchange for all of the common stock of S1, which represents all of the outstanding stock of S1. In the same year, S1 forms S2 with a contribution of $80 in exchange for 80 shares of the common stock of S2, which at that time represents all of the outstanding stock of S2. S1 and S2 become members of the P group. In the same year, S2 purchases Asset A for $80. In Year 2, S1 contributes Asset B with a basis of $50 and a value of $20 in exchange for 20 shares of the common stock of S2 in a transfer to which section 351 applies. In Year 4, S1 sells the 20 shares of the common stock of S2 that it acquired in Year 2 for $20. Immediately after the Year 4 stock sale, S2 is a member of the P group. At the time of the Year 4 stock sale, the bases and values of Asset A and Asset B are unchanged. In Year 5, S2 sells Asset B for $45, recognizing a $5 loss. The P group cannot establish that all or a portion of the $5 loss was not reflected in the calculation of the duplicated loss of S2 on the date of the Year 4 stock sale. The $5 loss is used on the P group return to offset income of P. In Year 6, S1 sells its remaining S2 common stock for $100.

(ii) Application of basis redetermination and loss suspension rules. Because S1's basis in the S2 common stock sold exceeds its value immediately prior to the sale and S2 is a member of the P group immediately after the sale, S1's basis in all of the stock of S2 is redetermined pursuant to paragraph (b)(1) of this section. Of S1's total basis of $130 in the S2 common stock, a proportionate amount is allocated to each of the 100 shares of S2 common stock. Accordingly, a total of $26 is allocated to the common stock of S2 that is sold and $104 is allocated to the common stock of S2 that is retained. On S1's sale of the 20 shares of the common stock of S2 for $20, S1 recognizes a loss of $6. Because the sale of the 20 shares of common stock of S2 does not result in the deconsolidation of S2, under paragraph (c)(1) of this section, that loss is suspended to the extent of the duplicated loss with respect to the shares sold. The duplicated loss with respect to the shares sold is $6. Therefore, the entire $6 loss is suspended. Pursuant to paragraph (c)(3) of this section and § 1.1502-32(b)(3)(iii)(C), the suspended loss is treated as a noncapital, nondeductible expense incurred by S1 during the tax year that includes the date of the disposition of stock to which paragraph (c)(1) of this section applies. Accordingly, P's basis in its S1 stock is reduced from $200 to $194.

(iii) Effect of subsequent asset sale on stock basis. Of the $5 loss recognized on the sale of Asset B, $4 is taken into account in determining the basis adjustments made under § 1.1502-32 to the stock of S2 owned by S1. Accordingly, S1's basis in its S2 stock is reduced by $4 from $104 to $100 and P's basis in its S1 stock is reduced by $4 from $194 to $190.

(iv) Effect of subsequent asset sale on suspended loss. Because P cannot establish that all or a portion of the loss recognized on the sale of Asset B was not reflected in the calculation of the duplicated loss of S2 on the date of the Year 4 stock sale and such loss is allocable to the period beginning on the date of the Year 4 disposition of the S2 stock and ending on the day before the first date on which S2 is not a member of the P group and is taken into account in determining consolidated taxable income (or loss) of the P group for a taxable year that includes a date on or after the date of the Year 4 disposition and before the first date on which S2 is not a member of the P group, such asset loss reduces the suspended loss pursuant to paragraph (c)(4) of this section. The amount of such reduction, however, cannot exceed $1, the excess of the amount of such loss, $5, over the amount of such loss that is taken into account in determining the basis adjustment made to the stock of S2 owned by members of the P group, $4. Therefore, the suspended loss is reduced to $5.

(v) Effect of subsequent stock sale. In year 6, when S1 sells its remaining S2 stock for $100, it recognizes $0 gain/loss. Pursuant to paragraph (c)(5) of this section, the remaining $5 of the suspended loss is allowed on the P group's return for Year 6 when S1 sells its remaining S2 stock.

Example 5. Deconsolidating sale of subsidiary owning stock of another subsidiary that remains in group. (i) Facts. In Year 1, P forms S1 with a contribution of Asset A with a basis of $50 and a value of $20 in exchange for 100 shares of common stock of S1 in a transfer to which section 351 applies. Also in Year 1, P and S1 form S2. P contributes $80 to S2 in exchange for 80 shares of common stock of S2. S1 contributes Asset A to S2 in exchange for 20 shares of common stock of S2 in a transfer to which section 351 applies. In Year 3, in a transaction that is not part of a plan that includes the Year 1 contributions, P sells its 100 shares of S1 common stock for $20. Immediately after the Year 3 stock sale, S2 is a member of the P group. At the time of the Year 3 stock sale, S1 owns 20 shares of common stock of S2, and S2 has $80 and Asset A. In Year 4, S2 sells Asset A, the basis and value of which have not changed since its contribution to S2. On the sale of Asset A for $20, S2 recognizes a $30 loss. That $30 loss is used on the P group return to offset income of P. In Year 5, P sells its S2 common stock for $80.

(ii) Application of basis redetermination and loss suspension rules. Pursuant to paragraph (b)(4) of this section, because immediately before P's transfer of S1 stock S1 owns stock of S2 (another subsidiary of the same group) that has a basis that exceeds its value, paragraph (b) of this section applies as if S1 had transferred its stock of S2. Because S2 is a member of the group immediately after the transfer of the S1 stock, the group member's basis in the S2 stock is redetermined pursuant to paragraph (b)(1) of this section immediately prior to the sale of the S1 stock. Of the group members' total basis of $130 in the S2 stock, $26 is allocated to S1's 20 shares of S2 common stock and $104 is allocated to P's 80 shares of S2 common stock. Pursuant to paragraph (b)(5) of this section, the redetermination of S1's basis in the stock of S2 results in an adjustment to P's basis in the stock of S1. In particular, P's basis in the stock of S1 is decreased by $24 to $26. On P's sale of its 100 shares of S1 common stock for $20, P recognizes a loss of $6. Because S1 is not a member of the P group immediately after P's sale of the S1 stock, paragraph (c)(1) of this section does not apply to suspend such loss. However, because P recognizes a loss with respect to the disposition of the S1 stock and S1 owns stock of S2 (which is a member of the P group immediately after the disposition), paragraph (c)(2) of this section does apply to suspend up to $6 of that loss, an amount equal to the amount by which the duplicated loss with respect to the stock of S1 sold is attributable to S2's adjusted basis in its assets, loss carryforwards, and deferred deductions.

(iii) Effect of subsequent asset sale on stock basis. Of the $30 loss recognized on the sale of Asset A, $24 is taken into account in determining the basis adjustments made under § 1.1502-32 to the stock of S2 owned by P. Accordingly, P's basis in its S2 stock is reduced by $24 from $104 to $80.

(iv) Effect of subsequent asset sale on suspended loss. Because P cannot establish that all or a portion of the loss recognized on the sale of Asset A was not reflected in the calculation of the duplicated loss of S2 on the date of the Year 3 stock sale and such loss is allocable to the period beginning on the date of the Year 3 deemed disposition of the S2 stock and ending on the day before the first date on which S2 is not a member of the P group and is taken into account in determining consolidated taxable income (or loss) of the P group for a taxable year that includes a date on or after the date of the Year 3 deemed disposition and before the first date on which S2 is not a member of the P group, such asset loss reduces the suspended loss pursuant to paragraph (c)(4) of this section. The amount of such reduction, however, cannot exceed $6, the excess of the amount of such loss, $30, over the amount of such loss that is taken into account in determining the basis adjustment made to the stock of S2 owned by P, $24. Therefore, the suspended loss is reduced to zero.

(v) Effect of subsequent stock sale. P recognizes $0 gain/loss on the Year 5 sale of its remaining S2 common stock. No amount of suspended loss remains to be allowed under paragraph (c)(5) of this section.

Example 6. Loss recognized on asset with basis determined by reference to stock basis of subsidiary. (i) Facts. In Year 1. P forms S with a contribution of $80 in exchange for 80 shares of common stock of S which at that time represents all of the outstanding stock of S. S becomes a member of the P group. In Year 2, P contributes Asset A with a basis of $50 and a value of $20 in exchange for 20 shares of common stock of S in a transfer to which section 351 applies. In Year 4, in a transaction that is not part of a plan that includes the Year 1 and Year 2 contributions, P contributes the 20 shares of S common stock it acquired in Year 2 to PS, a partnership, in exchange for a 20 percent capital and profits interest in a transaction described in section 721. Immediately after the contribution to PS, S is a member of the P group. In Year 5, P sells its interest in PS for $20.

(ii) Application of basis redetermination rule upon nonrecognition transfer. Because P's basis in the S common stock contributed to PS exceeds its value immediately prior to the transfer and S is a member of the P group immediately after the transfer, P's basis in all of the S stock is redetermined pursuant to paragraph (b)(1) of this section. Of P's total basis of $130 in the common stock of S, a proportionate amount is allocated to each share of S common stock. Accordingly, $26 is allocated to the S common stock that is contributed to PS and, under section 722, P's basis in its interest in PS is $26.

(iii) Application of loss suspension rule on disposition of asset with basis determined by reference to stock basis of subsidiary. P recognizes a $6 loss on its disposition of its interest in PS. Because P's basis in its interest in PS was determined by reference to the basis of S stock and at the time of the determination of P's basis in its interest in PS such S stock had a duplicated loss of $6, and, immediately after the disposition, S is a member of the P group, such loss is suspended to the extent of such duplicated loss. Principles similar to those of paragraphs (c)(3), (c)(4), and (c)(5) of this section shall apply to such suspended loss.

(f) Worthlessness not followed by separate return years. Notwithstanding any other provision in the regulations under section 1502, if a member of a group (the claiming group) treats stock of a subsidiary as worthless under section 165 (taking into account the provisions of § 1.1502-80(c)) and, on the day following the last day of the claiming group's taxable year in which the worthless stock deduction is claimed, the subsidiary (or its successor, determined without regard to paragraphs (d)(5)(iii) and (iv) of this section) is a member of a group that includes any corporation that, during that taxable year, was a member of the claiming group (other than a lower-tier subsidiary of the subsidiary) or is a successor (determined without regard to paragraphs (d)(5)(iii) and (iv) of this section) of such a member, then all losses treated as attributable to the subsidiary under the principles of § 1.1502-21(b)(2)(iv) shall be treated as expired as of the beginning of the day following the last day of the claiming group's taxable year in which the worthless stock deduction is claimed. In addition, notwithstanding any other provision in the regulations under section 1502, if a member recognizes a loss with respect to subsidiary stock and on the following day the subsidiary is not a member of the group and does not have a separate return year, then all losses treated as attributable to the subsidiary under the principles of § 1.1502-21(b)(2)(iv) shall be treated as expired as of the beginning of the day following the last day of the group's taxable year in which the stock loss is claimed. For purposes of this paragraph (f), the determination of the losses attributable to the subsidiary shall be made after computing the taxable income of the group for the taxable year in which the group treats the stock of the subsidiary as worthless or the subsidiary liquidates and after computing the taxable income for any taxable year to which such losses may be carried back. The loss treated as expired under this paragraph (f) shall not be treated as a noncapital, nondeductible expense under § 1.1502-32(b)(2)(iii). This paragraph (f) applies to worthlessness determinations and liquidations that occur on or after March 10, 2006. For rules applicable to worthless determinations and liquidations before March 10, 2006, see § 1.1502-35T(f)(1) and (2) as contained in 26 CFR part 1 in effect on January 1, 2006.

(g) Anti-avoidance rules—(1) Transfer of share without a loss in avoidance. If a share of subsidiary stock has a basis that does not exceed its value and the share is transferred with a view to avoiding application of the rules of paragraph (b) of this section prior to the transfer of a share of subsidiary stock that has a basis that does exceed its value or a deconsolidation of a subsidiary, the rules of paragraph (b) of this section shall apply immediately prior to the transfer of stock that has a basis that does not exceed its value.

(2) Transfers of loss property in avoidance. If a member of a consolidated group contributes an asset with a basis that exceeds its value to a partnership in a transaction described in section 721 or a corporation that is not a member of such group in a transfer described in section 351, such partnership or corporation contributes such asset to a subsidiary in a transfer described in section 351, and such contributions are undertaken with a view to avoiding the rules of paragraph (b) or (c) of this section, adjustments must be made to carry out the purposes of this section.

(3) Anti-loss reimportation rule—(i) Conditions for application. This paragraph (g)(3) applies when—

(A) A member of a group (selling group) recognized and was allowed a loss with respect to a share of stock of S, a subsidiary or former subsidiary of the selling group;

(B) That stock loss was duplicated (in whole or in part) in S's attributes (duplicating items) at the earlier of the time that the loss was recognized or that S ceased to be a member; and

(C) Within ten years of the date that S ceased to be a member, there is a reimportation event. For this purpose, a reimportation event is any event after which a duplicating item is a reimported item. A reimported item is any duplicating item that is reflected in the attributes of any member of the selling group, including S, or, if not reflected in the attributes, would be properly taken into account by any member of the selling group (for example as the result of a carryback).

(ii) Effect of application. Immediately before the time that a reimported item (or any portion of a reimported item) would be properly taken into account (but for the application of this paragraph (g)(3)), such item (or such portion of the item) is reduced to zero and no deduction or loss is allowed, directly or indirectly, with respect to that item.

(iii) Operating rules. For purposes of this paragraph (g)(3)—

(A) The terms member, subsidiary, and group include their predecessors and successors to the extent necessary to effectuate the purposes of this section; and

(B) The reduction of a reimported item (other than duplicating items that are carried back to a consolidated return year of the selling group) is a noncapital, nondeductible expense within the meaning of § 1.1502-32(b)(3)(iii).

(4) Avoidance of recognition of gain. (i) If a transaction is structured with a view to, and has the effect of, deferring or avoiding the recognition of gain on a disposition of stock by invoking the application of paragraph (b)(1) of this section to redetermine the basis of stock of a subsidiary, and the stock loss that gives rise to the application of paragraph (b)(1) of this section is not significant, paragraphs (b) and (c) of this section shall not apply.

(ii) If a transaction is structured with a view to, and has the effect of, deferring or avoiding the recognition of gain on a disposition of stock by invoking the application of paragraph (b)(2) of this section to redetermine the basis of stock of a subsidiary, and the duplicated loss of the subsidiary that is reflected in stock of the subsidiary owned by members of the group immediately before the deconsolidation is not significant, paragraphs (b) and (c) of this section shall not apply.

(5) Examples. For purposes of the examples in this section, all transactions described in section 362(a) are completed before October 22, 2004, and therefore are not subject to section 362(e)(2). The principles of this paragraph (g) are illustrated by the following examples:

Example 1. Transfers of property in the avoidance of basis redetermination rule. (i) Facts. In Year 1, P forms S with a contribution of $100 in exchange for 100 shares of common stock of S which at that time represents all of the outstanding stock of S. S becomes a member of the P group. In Year 2, P contributes 20 shares of common stock of S to PS, a partnership, in exchange for a 20 percent capital and profits interest in a transaction described in section 721. In Year 3, P contributes Asset A with a basis of $50 and a value of $20 to PS in exchange for an additional capital and profits interest in PS in a transaction described in section 721. Also in Year 3, PS contributes Asset A to S and P contributes an additional $80 to S in transfers to which section 351 applies. In Year 4, S sells Asset A for $20, recognizing a loss of $30. The P group uses that loss to offset income of P. In Year 5, P sells its entire interest in PS for $40.

(ii) Analysis. Pursuant to paragraph (g)(2) of this section, if P's contributions of S stock and Asset A to PS were undertaken with a view to avoiding the application of the basis redetermination or the loss suspension rule, adjustments must be made such that the group does not obtain more than one tax benefit from the $30 loss inherent in Asset A.

Example 2. Transfers effecting a reimportation of loss. (i) Facts. In Year 1, P forms S with a contribution of Asset A with a value of $100 and a basis of $120, Asset B with a value of $50 and a basis of $70, and Asset C with a value of $90 and a basis of $100 in exchange for all of the common stock of S and S becomes a member of the P group. In Year 2, in a transaction that is not part of a plan that includes the contribution, P sells the stock of S for $240, recognizing a loss of $50. At such time, the bases and values of Assets A, B, and C have not changed since their contribution to S. In Year 3, S sells Asset A, recognizing a $20 loss. In Year 3, S merges into M in a reorganization described in section 368(a)(1)(A). In Year 8, P purchases all of the stock of M for $300. At that time, M has a $10 net operating loss. In addition, M owns Asset D, which was acquired in an exchange described in section 1031 in connection with the surrender of Asset B. Asset C has a value of $80 and a basis of $100. Asset D has a value of $60 and a basis of $70. In Year 9, P has operating income of $100 and M recognizes $20 of loss on the sale of Asset C. In Year 10, P has operating income of $50 and M recognizes $50 of loss on the sale of Asset D.

(ii) Analysis. P's $50 loss on the sale of S stock is entirely attributable to duplicated loss. Therefore, pursuant to paragraph (g)(3) of this section, assuming the P group cannot establish otherwise, M's $10 net operating loss is treated as attributable to assets that were owned by S on the date of the disposition and that had bases in excess of value on such date. Without regard to any other limitations on the group's use of M's net operating loss, the P group cannot use M's $10 net operating loss pursuant to paragraph (g)(3)(iii)(D) of this section. Pursuant to paragraph (g)(3)(iv) of this section and § 1.1502-32(b)(3)(iii)(D), such loss is treated as a noncapital, nondeductible expense of M incurred during the taxable year that it would otherwise be absorbed, namely in Year 9. In addition, the P group is denied the use of $10 of the loss recognized on the sale of Asset C. Finally, the P group is denied the use of $10 of the loss recognized on the sale of Asset D. Pursuant to paragraph (g)(3)(iv) of this section and § 1.1502-32(b)(3)(iii)(D), each such disallowed loss is treated as a noncapital, nondeductible expense of M incurred during the taxable year that includes the date of the disposition of the asset with respect to which such loss was recognized.

Example 3. Transfers to avoid recognition of gain. (i) Facts. P owns all of the stock of S1 and S2. The S2 stock has a basis of $400 and a value of $500. S1 owns 50% of the S3 common stock with a basis of $150. S2 owns the remaining 50% of the S3 common stock with a basis of $100 and a value of $200 and one share of S3 preferred stock with a basis of $10 and a value of $9. P intends to sell all of its S2 stock to an unrelated buyer. P, therefore, engages in the following steps to dispose of S2 without recognizing a substantial portion of the built-in gain in S2. First, P causes a recapitalization of S3 in which S2's S3 common stock is exchanged for new S3 preferred shares. P then sells all of its S2 stock. Immediately after the sale of the S2 stock, S3 is a member of the P group.

(ii) Analysis. Pursuant to paragraph (b)(4) of this section, because S2 owns stock of S3 (another subsidiary of the same group) and, immediately after the sale of the S2 stock, S3 is a member of the group, then for purposes of applying paragraph (b) of this section, S2 is deemed to have transferred its S3 stock. Because S3 is a member of the group immediately after the transfer of the S2 stock and the S3 stock deemed transferred has a basis in excess of value, the group in the S3 stock is redetermined pursuant to paragraph (b)(1) of this section immediately prior to the sale of the S2 stock. Accordingly, P would recognize only $1 of gain on the sale of its S2 stock. However, because the recapitalization of the S3 was structured with a view to, and has the effect of, avoiding the recognition of gain on a disposition of stock by invoking the application of paragraph (b) of this section, paragraph (g)(4)(i) of this section applies. Accordingly, paragraph (b) of this section does not apply upon P's disposition of the S2 stock and P recognizes $100 gain on the disposition of the S2 stock.

(6) General anti-avoidance rule. If a taxpayer acts with a view to avoid the purposes of this section, appropriate adjustments will be made to carry out the purposes of this section.

(h) Application of other rules of law. See § 1.1502-80(a) regarding the general applicability of other rules of law.

(i) [Reserved]

(j) Effective/applicability dates. This section applies after September 16, 2008. For prior law, see §§ 1.1502-35 and 1.1502-35T as contained in 26 CFR part 1 in effect on April 1, 2008.

[T.D. 9254, 71 FR 13010, Mar. 14, 2006, as amended by T.D. 9264, 71 FR 30603, 30607, May 30, 2006; T.D. 9254, 71 FR 48473, Aug. 21, 2006; T.D. 9322, 72 FR 17805, Apr. 10, 2007; T.D. 9342, 72 FR 39736, July 20, 2007; T.D. 9424, 73 FR 53951, Sept. 17, 2008; 75 FR 10172, Mar. 5, 2010]

§ 1.1502-36 Unified loss rule.

(a) In general—(1) Scope. This section provides rules for adjusting members' bases in stock of a subsidiary (S) and for reducing S's attributes when a member (M) transfers a loss share of S stock. See paragraph (f) of this section for definitions of the terms used in this section, including transfer and value.

(2) Purpose. The rules in this section have two principal purposes. The first is to prevent the consolidated return provisions from reducing a group's consolidated taxable income through the creation and recognition of noneconomic loss on S stock. The second is to prevent members (including former members) of the group from collectively obtaining more than one tax benefit from a single economic loss. Additional purposes are set forth in other paragraphs of this section. The rules of this section must be interpreted and applied in a manner that is consistent with and reasonably carries out the purposes of this section.

(3) Overview—(i) General application of section. This section applies when M transfers a share of S stock and, after taking into account the effects of all applicable rules of law (even if the adjustments required by such provisions are not deemed effective until after the transfer, such as certain adjustments required under sections 108 and 1017 and § 1.1502-28), the share is a loss share. When this section applies, paragraph (b) of this section applies first and may redetermine members' bases in their shares of S stock. If the transferred share is a loss share after any basis redetermination under paragraph (b) of this section, paragraph (c) of this section applies and may reduce M's basis in the transferred loss share. If the transferred share is a loss share after any basis reduction required by paragraph (c) of this section, paragraph (d) of this section applies and may reduce attributes of S and subsidiaries that are lower-tier to S. Although the determination of whether there is a transfer of a loss share is made as of the transfer, this section applies, and any adjustments it requires are given effect, immediately before the transfer. Paragraphs (e), (f), and (g) of this section provide general operating rules (including rules for transfers of S stock between members), definitions, and an anti-abuse rule, respectively.

(ii) Stock of multiple subsidiaries transferred in the transaction—(A) Initial application of section to transferred shares in lowest tier. If shares of stock of more than one subsidiary are transferred in a transaction, the application of this section begins at the lowest tier. If no transferred shares of stock of the lowest-tier subsidiary (S2) are loss shares, any gain recognized with respect to the S2 shares immediately tiers up and adjusts members' bases in subsidiary stock under § 1.1502-32. However, if any of the transferred S2 shares are loss shares, paragraph (b) of this section applies with respect to those shares. If, after the application of paragraph (b) of this section, any transferred S2 shares are still loss shares, paragraph (c) of this section applies with respect to those shares. If, after the application of paragraph (c) of this section, any transferred S2 shares are still loss shares and P makes an election under paragraph (d)(6) of this section with respect to those S2 shares, then paragraph (d) of this section applies with respect to those shares, but only to the extent necessary to give effect to the election. After taking into account the effects of any adjustments required by this initial application of this section, recognized gain or loss is computed on all transferred S2 shares. Any adjustments under paragraph (b) or (c) of this section, the effect of any election under paragraph (d)(6) of this section, any gain or loss recognized on the transferred S2 shares (whether allowed or disallowed), and any other related or resulting adjustments then tier-up and apply to adjust members' bases in subsidiary stock under § 1.1502-32.

(B) Initial application of section to transferred shares in higher tiers. After taking into account the effects of any adjustments described in paragraph (a)(3)(ii)(A) of this section, transferred shares in the next higher tier, and then in each next higher tier successively, other than the transferred loss shares at the highest tier, are treated in the manner described in paragraph (a)(3)(ii)(A) of this section.

(C) Application of section to transferred shares in highest tier. After paragraphs (b) and (c) of this section, and, to the extent necessary to give effect to any election under paragraph (d)(6) of this section, paragraph (d) of this section, have been applied to or with respect to all lower-tier transferred loss shares, and after all lower-tier adjustments have been taken into account (whether resulting from the application of paragraph (b) or (c) of this section, an election under paragraph (d)(6) of this section, the recognition of gain or loss on a transfer, or otherwise), paragraphs (b), then (c), and then (d) of this section apply with respect to the highest-tier shares that are transferred loss shares.

(D) Final application of section to transferred shares in lower tiers. After paragraph (d) of this section has been applied with respect to transferred loss shares in the highest tier, it is applied with respect to transferred shares in each next lower tier, successively, to the extent such shares are loss shares after the application of paragraph (d) of this section.

(4) Other rules of law and coordination with deferral and disallowance provisions. In general, this section applies and has effect immediately upon the transfer of a loss share even if the loss is deferred, disallowed, or otherwise not taken into account under any other applicable rules of law. However, see paragraph (e)(3) of this section for special rules applicable to shares of S stock transferred in an intercompany transaction. See section § 1.1502-80(a) for the general applicability of other rules of law and a limitation on duplicative adjustments.

(5) Nomenclature, factual assumptions adopted in this section. Unless otherwise stated, for purposes of this section, the following nomenclature and assumptions are adopted. P is the common parent of a consolidated group of which S, M, and M1 are members. X is not a member of the P group. If a corporation has preferred stock outstanding, it is stock described in section 1504(a)(4). The examples set forth the only facts, elections, and activities relevant to the example. All transactions are between unrelated persons and are independent of each other. Tax liabilities and their effect, and the application of any other loss disallowance or deferral provisions of the Internal Revenue Code (Code) or regulations, including but not limited to section 267, are disregarded. All persons report on a calendar year basis and use the accrual method of accounting. All parties comply with filing and other requirements of this section and all other provisions of the Code and regulations.

(b) Basis redetermination to reduce disparity—(1) In general—(i) Purpose and scope. The rules of this paragraph (b) reduce the extent to which there is disparity in members' bases in shares of S stock. These rules supplement the operation of the investment adjustment system; their purpose is to prevent the realization of noneconomic loss and facilitate the elimination of duplicated loss when members hold S shares with disparate bases. The rules of this paragraph (b) only reallocate investment adjustments previously applied to members' bases in shares of S stock, thus they do not alter the aggregate amount of basis in shares of S stock held by members or the aggregate amount of investment adjustments applied to shares of S stock.

(ii) Special rules for applicability of redetermination rule. Notwithstanding the general rule in paragraph (b)(2) of this section, members' bases in shares of S stock are not redetermined under this paragraph (b) if—

(A) There is no disparity among members' bases in shares of S common stock and no member owns a share of S preferred stock with respect to which there is unrecognized gain or loss; or

(B) All the shares of S stock held by members are transferred to one or more nonmembers, become worthless under section 165 (taking into account the provisions of § 1.1502-80(c)), or a combination thereof, in one fully taxable transaction. However, in such a case, P may elect to redetermine such bases under this paragraph (b). Such an election is made in the manner provided in paragraph (e)(5) of this section. If stock of more than one subsidiary is transferred in the transaction, the election may be made with respect to one or more of such subsidiaries.

(iii) Investment adjustment. For purposes of this paragraph (b), the term investment adjustment includes adjustments specially allocated under § 1.1502-32(c)(1)(ii)(B) and remaining adjustments described in § 1.1502-32(c)(1)(iii). In applying any provision of this section, the term includes all such adjustments reflected in the basis of the share as of the application of the provision, whether originally allocated under § 1.1502-32 or otherwise. The term therefore includes adjustments previously reallocated to the share, and it does not include adjustments previously reallocated from the share, whether pursuant to this section or any other provision of law. It also includes the proportionate amount of adjustments reflected in the exchanged basis of a share, such as the basis determined under section 358 in connection with a reorganization or a transaction qualifying under section 355.

(2) Basis redetermination rule. If M transfers a loss share of S stock, all members' bases in all their shares of S stock are subject to redetermination under this paragraph (b). The determination of whether a share is a loss share is made as of the transfer, taking into account the effects of all applicable rules of law. The redeterminations are made immediately before applying paragraph (c) of this section and in accordance with the following:

(i) Decreasing the bases of transferred loss shares—(A) Removing positive investment adjustments from transferred loss shares of common stock. M's basis in each of its transferred loss shares of S common stock is first reduced, but not below value, by removing positive investment adjustments previously applied to the basis of the share. The positive investment adjustments removed from transferred loss shares of S common stock are reallocated under paragraph (b)(2)(ii) of this section after negative investment adjustments are reallocated under paragraph (b)(2)(i)(B) of this section.

(B) Reallocating negative investment adjustments from shares of S common stock. If a transferred share is still a loss share after applying paragraph (b)(2)(i)(A) of this section, M's basis in the share is reduced, but not below value, by reallocating negative investment adjustments to the transferred loss share (whether common or preferred stock) from members' shares of S common stock that are not transferred loss shares. The adjustments reallocated under this paragraph (b)(2)(i)(B) are reallocated and applied first to M's bases in transferred loss shares of S preferred stock and then to M's bases in transferred loss shares of S common stock. Reallocations under this paragraph (b)(2)(i)(B) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all transferred loss shares of S preferred stock, and reduces the disparity among members' bases in all shares of S common stock.

(ii) Increasing the bases of gain preferred and all common shares—(A) Preferred stock. After the application of paragraph (b)(2)(i) of this section, the positive investment adjustments removed from transferred loss shares of S common stock under paragraph (b)(2)(i)(A) of this section are reallocated and applied to increase, but not above value, members' bases in shares of S preferred stock (without regard to whether such shares are transferred in the transaction). Reallocations under this paragraph (b)(2)(ii)(A) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all shares of S preferred stock.

(B) Common stock. Any positive investment adjustments removed from transferred loss shares of S common stock under paragraph (b)(2)(i)(A) of this section and not reallocated and applied to S preferred shares are reallocated and applied to increase members' bases in shares of S common stock. Reallocations are made to shares of S common stock without regard to whether a particular share is a loss share or a transferred share, and without regard to the share's value. Reallocations under this paragraph (b)(2)(ii)(B) are made in a manner that, to the greatest extent possible, reduces the disparity among members' bases in all shares of S common stock.

(iii) Operating rules—(A) Method. In general, reallocations should be made first with respect to the earliest available adjustments. However, the overall application of this paragraph (b) to a transaction must be made in a manner that, to the greatest extent possible, reduces basis disparity (as provided in paragraphs (b)(2)(i)(B) and (b)(2)(ii) of this section). The specific reallocation of an investment adjustment under this paragraph (b) may be made using any reasonable method or formula that is consistent with the provisions of this paragraph (b)(2) and furthers the purposes of this section.

(B) Limits on reallocation—(1) Restriction to members' outstanding shares. Investment adjustments can only be reallocated to shares that were held by members at the time the adjustment was originally applied.

(2) Limitation by prior use—(i) In general. In order to prevent the reallocation of investment adjustments from either increasing or decreasing members' aggregate bases in subsidiary stock, no investment adjustment (positive or negative) may be reallocated under this paragraph (b)(2) to the extent that it was (or would have been) used prior to the time that it would otherwise be reallocated under this paragraph (b)(2). For this purpose, an investment adjustment was used (or would have been used) to the extent that it was reflected in (or would have been reflected in) the basis of a share of subsidiary stock and the basis of that share has already been taken into account, directly or indirectly, in determining income, gain, deduction, or loss (including by affecting the application of this section to a prior transfer of subsidiary stock) or in determining the basis of any property that is not subject to § 1.1502-32. However, if the prior use was in an intercompany transaction, an investment adjustment may be reallocated to the extent that § 1.1502-13 has prevented the gain or loss on the transaction from being taken into account. (In that case, appropriate adjustments must be made to the intercompany item from the prior intercompany transaction that has not yet been taken into account.) Further, if an investment adjustment was reflected in (or would have been reflected in) the basis of a share that has been taken into account, the limitation on reallocation under this paragraph (b)(2)(iii)(B)(2) does not apply to the extent the basis of that share would not change as a result of the reallocation (for example, because the reallocation is between shares that are both lower-tier to the share with the previously used basis). See § 1.1502-32(c)(1)(ii)(B) regarding special allocations applicable to the tier-up of the reallocated investment adjustment if the reallocation is limited under this paragraph (b)(2)(iii)(B)(2) due to prior use at a higher tier.

(ii) Example. The application of this paragraph (b)(2)(iii)(B)(2) is illustrated by the following example:

Example. (i) Facts. P owns all 20 shares of M stock, and 10 shares of S stock. M owns the remaining 10 shares of S stock. In year 1, S recognizes $200 of income that results in a $10 positive investment adjustment being allocated to each share of S stock. The group does not recognize any other items. The $100 positive adjustment to M's basis in the S stock tiers up, and results in a $5 positive adjustment to each share of M stock. In year 2, P sells one share of M stock and recognizes a gain. In year 3, M sells one loss share of S stock, and this paragraph (b) applies and requires a reallocation of the year 1 positive investment adjustment applied to the basis of the transferred S share.

(ii) Application of limitation by prior use. M's basis in the transferred loss share of S stock reflects a $10 positive investment adjustment attributable to S's year 1 income. Under the general rule of this paragraph (b), that $10 would be subject to reallocation to reduce basis disparity. However, that $10 adjustment had originally tiered up to adjust P's basis in its M shares and, as a result, $.50 of that adjustment was reflected in P's basis in each share of M stock. When P sold the share of M stock, the basis of that share (which included the tiered-up $.50) was used in determining the gain on the sale. Thus, $.50 of the $10 investment adjustment originally allocated to the transferred S share that tiered-up to the sold M share was previously used and, as such, cannot be reallocated in a manner that would (if it were the original allocation) affect the basis of the sold M share. Accordingly, no more than $9.50 of the adjustment to M's transferred S share could be reallocated to P's shares of S stock. If so, under the special allocation rule in § 1.1502-32(c)(1)(ii)(B), the tier-up of this $9.50 would only be allocated among P's remaining 19 shares of M stock. Alternatively, all $10 of the investment adjustment could be reallocated to M's other S shares (because the tier-up to P's M shares would have been the same regardless which of M's shares of S stock were adjusted).

(iii) Application of limitation where adjustment would have been used. The facts are the same as in paragraph (i) of this Example except that M does not sell any shares of S stock and, in year 3, P sells a loss share of S stock. As in paragraph (i) of this Example, when P sold the share of M stock, the basis of that share was used in determining the gain on the share. When P sells the loss share of S stock, the $10 positive investment adjustment from S's year 1 income cannot be reallocated in a manner that would (if it were the original adjustment) affect the basis of the sold M share. If this $10 positive investment adjustment had originally been allocated to the S shares held by M, $.50 of the $10 investment adjustment would have tiered up to the M share that P sold, would have been reflected in P's basis in that M share, and would have been used in determining P's gain or loss on the sale. Accordingly, up to $9.50 of the $10 investment adjustment applied to the basis of P's transferred S share could be reallocated to M's shares of S stock. If so, under the special allocation rule in § 1.1502-32(c)(1)(ii)(B), the tier-up of this $9.50 would only be allocated among P's remaining 19 shares of M stock. Alternatively, all $10 of the investment adjustment could be reallocated to P's other S shares.

(3) Examples. The general application of this paragraph (b) is illustrated by the following examples:

Example 1. Transfer of stock received in section 351 exchange. (i) Redetermination to prevent noneconomic loss. (A) Facts. For many years, M has owned two assets, Asset 1 and Asset 2. On January 1, year 1, M receives the only four outstanding shares of S common stock (Block 1 shares) in exchange for Asset 1, which has a basis and value of $80. Section 351 applies to the exchange and, therefore, under section 358, M's aggregate basis in the Block 1 shares is $80 ($20 per share). On July 1, year 2, M receives another share of S common stock (Block 2 share) in exchange for Asset 2, which has a basis of $0 and value of $20. Section 351 applies to this exchange and, under section 358, M's basis in the Block 2 share is $0. On October 1, year 3, S sells Asset 2 for $20, recognizing a $20 gain. On December 31, year 3, M sells one of its Block 1 shares to X for $20. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $24 (M's original $20 basis increased under § 1.1502-32 by $4, the share's allocable portion of the $20 gain recognized on the sale of Asset 2). In addition, M's basis in its Block 2 share is $4 (M's original $0 basis increased under § 1.1502-32 by $4 (the share's allocable portion of the $20 gain recognized on the sale of Asset 2)). M's sale of the Block 1 share is a transfer of a loss share and therefore subject to this section.

(B) Basis redetermination under this paragraph (b). Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in the transferred loss share, but not below value, by removing positive investment adjustments applied to the basis of the share. Accordingly, M's basis in the transferred Block 1 share is reduced by $4 (the amount of the positive investment adjustment applied to the share), from $24 to $20. Even if there were negative investment adjustments applied to adjust the bases of nontransferred common shares, no further reduction to the basis of the share would be required under this paragraph (b) because the basis of the transferred share is then equal to the share's value. Under paragraph (b)(2)(ii)(B) of this section, the positive investment adjustment removed from the transferred loss share is reallocated and applied to increase M's bases in its S common shares in a manner that reduces disparity in M's bases in all the S common shares, to the greatest extent possible. Accordingly, the $4 positive investment adjustment removed from the Block 1 share is reallocated and applied to the basis of the Block 2 share, increasing it from $4 to $8.

(C) Application of paragraphs (c) and (d) of this section. Because M's sale of the Block 1 share is not a transfer of a loss share after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to the transfer.

(ii) Redetermination to eliminate duplicated loss. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 1, except that, at the time of the second contribution, the value of Asset 1 had declined to $20 and so, instead of contributing Asset 2, M contributed Asset 3 to S in exchange for the Block 2 share. At the time of that exchange, Asset 3 had a basis and value of $5. On October 1, year 3, S sells Asset 1 for $20, recognizing a $60 loss that is absorbed by the group. On December 31, year 3, M sells one of its Block 1 shares to X for $5. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $8 (M's original $20 basis decreased under § 1.1502-32 by $12 (the share's allocable portion of the $60 loss recognized on the sale of Asset 1)). M's basis in its Block 2 share is an excess loss account of $7 (M's original basis of $5 reduced under § 1.1502-32 by $12, the share's allocable portion of the loss recognized on the sale of Asset 1). M's sale of the Block 1 share is a transfer of a loss share and therefore subject to this section.

(B) Basis redetermination under this paragraph (b). Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. There are no positive investment adjustments and so there is no adjustment under paragraph (b)(2)(i)(A) of this section. However, under paragraph (b)(2)(i)(B) of this section, M's basis in the transferred Block 1 share is reduced, but not below value, by reallocating negative investment adjustments from common shares that are not transferred loss shares. In total, there were $48 of negative investment adjustments applied to common shares that are not transferred loss shares. Accordingly, M's basis in the Block 1 share is reduced by $3, from $8 to its value of $5. Under paragraph (b)(2)(i)(B) of this section, the negative investment adjustments applied to the transferred share are reallocated from (and therefore cause an increase in the basis of) S common shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all S common shares to the greatest extent possible. Accordingly, the $3 negative investment adjustment reallocated and applied to the transferred Block 1 share is reallocated entirely from the Block 2 share, increasing the basis in the Block 2 share from an excess loss account of $7 to an excess loss account of $4.

(iii) Nonapplicability of redetermination rule to sale of entire interest. The facts are the same as in paragraph (ii)(A) of this Example 1, except that, on December 31, year 3, M sells all its shares of S stock to X for $25. M's sale of the S stock to X is a transfer of all of the shares of S stock held by members to one or more nonmembers in one fully taxable transaction and, therefore, basis is not redetermined under this paragraph (b). Accordingly, the sale of the Block 1 shares remains a transfer of loss shares and, as such, subject to paragraphs (c) and (d) of this section. However, paragraphs (c)(7) and (d)(3)(i)(A) of this section apply netting principles to prevent adjustments under either paragraph (c) or paragraph (d) of this section, respectively. Alternatively, the group could elect to apply this paragraph (b). In that case, the $12 negative adjustment applied to the Block 2 shares would be reallocated to the Block 1 shares with the result that there would be no loss (or gain) on any of the transferred shares following the application of this paragraph (b). In that case, there would be no further application of this section to the transfer.

(iv) Transfer of entire interest, partially taxable. The facts are the same as in paragraph (iii) of this Example 1, except that, instead of selling the Block 2 share to X, M contributes the share to a nonmember in a section 351 exchange that is part of the same transaction. Although all the S shares held by members are transferred in the transaction, not all the shares are transferred to one or more nonmembers in one fully taxable transaction. Therefore, paragraph (b)(1)(ii)(B) of this section does not apply and M must redetermine its bases in its shares of S stock under this paragraph (b). In total, there were $12 of negative investment adjustments applied to common shares that are not transferred loss shares (the Block 2 share, a gain share). Accordingly, M's basis in each of the Block 1 shares is reduced by $3, from $8 to its value of $5. Under paragraph (b)(2)(i)(B) of this section, the negative investment adjustments applied to the transferred shares are reallocated from (and therefore cause an increase in the basis of) S shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all S common shares to the greatest extent possible. Accordingly, the $12 negative investment adjustment reallocated and applied to the transferred Block 1 shares is reallocated entirely from the Block 2 share, increasing the basis in the Block 2 share from an excess loss account of $7 to a basis of $5. Because M's transfer is not a transfer of loss shares after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to the transfer.

Example 2. Redetermination increases basis of transferred loss share. (i) Facts. On January 1, year 1, M owns all 10 outstanding shares of S common stock. Five of the shares have a basis of $20 per share (Block 1 shares) and five of the shares have a basis of $10 per share (Block 2 shares). S's only asset, Asset 1, has a basis of $50. S has no other attributes. On October 1, year 1, S sells Asset 1 for $100, recognizing a $50 gain. On December 31, year 2, M sells one Block 1 share and one Block 2 share to X for $10 per share. After taking into account the effects of all applicable rules of law, M's basis in each Block 1 share is $25 (M's original $20 basis increased under § 1.1502-32 by $5, the share's allocable portion of the $50 gain recognized on the sale of Asset 1), and M's basis in each Block 2 share is $15 (M's original $10 basis increased under § 1.1502-32 by $5, the share's allocable portion of the $50 gain recognized on the sale of Asset 1). M's sale of the Block 1 and Block 2 shares is a transfer of loss shares and therefore subject to this section.

(ii) Basis redetermination under this paragraph (b). Under this paragraph (b), M's bases in all its shares of S stock are subject to redetermination. First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in the transferred Block 1 and Block 2 shares, but not below value, by removing the positive investment adjustments applied to the bases of the transferred loss shares. Accordingly, the basis of the transferred Block 1 share is reduced by $5, from $25 to $20. The basis of the transferred Block 2 share is also reduced by $5, from $15 to $10. (Although the transferred Block 1 share is still a loss share, there is no reduction to its basis under paragraph (b)(2)(i)(B) of this section because there were no negative investment adjustments applied to the bases of the S common shares that are not transferred loss shares.) Next, paragraph (b)(2)(ii)(B) of this section applies to reallocate and apply the $10 of positive investment adjustments removed from the transferred loss shares to increase M's bases in its S common shares in a manner that reduces the disparity in its bases in all S common shares to the greatest extent possible. Accordingly, of the $10 of positive investment adjustments to be reallocated, $6 is reallocated and applied to the basis of the transferred Block 2 share (increasing it from $10 to $16) and $4 is reallocated and applied equally to the basis of each of the four retained Block 2 shares (increasing the basis of each from $15 to $16). After giving effect to the reallocations under this paragraph (b), M's basis in each retained Block 1 share is $25, M's basis in the transferred Block 1 share is $20, and M's basis in each Block 2 share is $16.

(iii) Application of paragraph (c) of this section. After the application of this paragraph (b), M's sale of the Block 1 and Block 2 shares is still a transfer of loss shares and, accordingly, subject to paragraph (c) of this section. No adjustment is required to the basis of the transferred Block 1 share under paragraph (c) of this section because, after its basis is redetermined under this paragraph (b), the net positive adjustment to the basis of the share is $0. See paragraph (c)(3) of this section. However, under paragraph (c) of this section M's basis in the transferred Block 2 share is reduced by $6 (the lesser of its net positive adjustment, $6, and its disconformity amount, $6), from $16 to $10, its value. See paragraph (c)(2) of this section.

(iv) Application of paragraph (d) of this section. After the application of paragraph (c) of this section, M's sale of the Block 1 share is still a transfer of a loss share and, accordingly, subject to paragraph (d) of this section. No adjustment is required under paragraph (d) of this section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section. Because M's sale of the Block 2 share is no longer a transfer of a loss share after the application of paragraph (c) of this section, paragraph (d) of this section does not apply to the transfer of the Block 2 share.

Example 3. Tiered subsidiaries. (i) Transfer of all shares of common stock. (A) Facts. P owns the sole outstanding share of S stock with a basis of $100, and the sole outstanding share of M stock with a basis of $300. M has $200 and owns an asset with a basis of $0. S owns one asset, Asset 1, with a basis of $100. At a time when Asset 1 has a value of $200, S issues a second share of common stock to M in exchange for $200. Later S sells Asset 1 for $200, recognizing a $100 gain. After taking into account the effects of all applicable rules of law, P's basis in its S stock is $150 (P's original $100 basis increased under § 1.1502-32 by $50, the share's allocable portion of the $100 gain recognized on the sale of Asset 1), M's basis in its S stock is $250 (M's original $200 basis increased under § 1.1502-32 by $50, the share's allocable portion of the $100 gain recognized on the sale of Asset 1), and P's basis in its M stock is $350 (P's original $300 basis increased under § 1.1502-32 by $50, the tier-up of M's increase in its basis in its S stock). P then sells its M share and its S share to X for $300 and $200, respectively. M and S are not members of the same consolidated group immediately after the sale. Therefore, the M share and both of the S shares are transferred in the transaction. Regarding P's sale of its share of S stock and its share of M stock, see paragraph (f)(10)(i)(A) of this section (ceasing to own a share in a taxable transaction) and paragraph (f)(10)(i)(C) of this section (nonmember acquires share); regarding M's share of S stock, see paragraph (f)(10)(i)(B) of this section (ceasing to be members of the same group). The application of this section begins with respect to the stock of S, the subsidiary at the lowest tier in which there is a transfer of subsidiary stock. See paragraph (a)(3)(ii) of this section. Although both P and M transfer their S shares, only M's S share is a loss share. Thus, only M's transfer is a transfer of a loss share of S stock and only M's transfer is subject to this section.

(B) Application of section to transferred S shares. Although only M's transfer is subject to this section, all members' bases in their shares of S stock are subject to redetermination under this paragraph (b). First, paragraph (b)(2)(i)(A) of this section applies to reduce M's basis in its transferred S share, but not below value, by removing the positive investment adjustment applied to that share. Accordingly, the basis of M's S share is reduced by $50, from $250 to $200 (under § 1.1502-32, that redetermination adjustment tiers up to reduce P's basis in its M stock by $50, from $350 to $300). Because there are no negative adjustments to reallocate under paragraph (b)(2)(i)(B) of this section, paragraph (b)(2)(ii)(B) of this section then applies to reallocate and apply the $50 positive investment adjustment removed from the transferred loss S share to increase P's basis in its S share in a manner that reduces disparity among members' bases in all S common shares to the greatest extent possible. Accordingly, all $50 of the positive investment adjustment is reallocated and applied to P's basis in its S share (increasing the basis from $150 to $200). Because M's transfer of its S share is not a transfer of a loss share after the application of this paragraph (b), neither paragraph (c) of this section nor paragraph (d) of this section applies to that transfer.

(C) Application of section to transfers at next higher tier. After the adjustments to M's share of S stock are given effect, P's transfer of its share of M stock is not a transfer of a loss share and so this section does not apply to that transfer.

(D) Result of application of section. After the application of this section, P recognizes no gain or loss on its sale of either the S share or the M share. In addition, the unrecognized (noneconomic) loss in M's basis in its S share is eliminated. The results would be the same if, in addition to the facts in paragraph (i)(A) of this Example 3, M transferred its S share to X in a fully taxable transaction and, as permitted under paragraph (b)(1)(ii)(B) of this section, P elected to redetermine basis under this paragraph (b).

(ii) Transfer of less than all lower-tier shares of stock. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 1, except that M and S are members of the same consolidated group immediately after the sale. Therefore, in this case, M's S share is not transferred and so this section has no application with respect to M's S share. P's transfer of its S share is not a transfer of a loss share and so is also not subject to this section. However, P's sale of its share of M stock is a transfer of a loss share and is subject to this section.

(B) Basis redetermination under this paragraph (b). Although P's transfer of its share of M stock is subject to this section, this paragraph (b) does not apply to the transfer because there is only one share of M stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). Accordingly, after the application of this paragraph (b), P's sale of its M share is still a transfer of a loss share and therefore subject to paragraph (c) of this section.

(C) Application of paragraphs (c) and (d) of this section. Under paragraph (c) of this section, P must reduce its basis in its M share by $50, the lesser of its net positive adjustment ($50, see paragraph (c)(3) of this section) and its disconformity amount ($150, see paragraphs (c)(4), (c)(5), and (c)(6) of this section). As a result, the share is no longer a loss share and the transfer is not subject to paragraph (d) of this section.

(D) Result of application of section. After the application of this section, P recognizes a $50 gain on its sale of the S share and no loss on its sale of the M share. Although there is unrecognized loss preserved in M's basis in its S share, if M later transfers the share when it is a loss share, that transfer will be subject to this section.

Example 4. Application to outstanding common and preferred shares. (i) Facts. P owns all the stock of M and all eight outstanding shares of S common stock. S also has two shares of nonvoting preferred stock outstanding; the preferred shares each have a $100 annual, cumulative preference as to dividends. M owns one of the preferred shares (PS1) and P owns the other (PS2). On January 1, year 1, the bases and values of the outstanding S shares are:

Preferred | Common

PS1 (M) | PS2 (P) | CS1 (P) | CS2 (P) | CS3 (P) | CS4 (P) | CS5 (P) | CS6 (P) | CS7 (P) | CS8 (P)

Basis | 1250 | 990 | 1025 | 710 | 550 | 400 | 375 | 250 | 215 | 100

Value | 1000 | 1000 | 375 | 375 | 375 | 375 | 375 | 375 | 375 | 375

(A) As of January 1, year 1, there are no arrearages on the preferred stock. In year 1, S has a $1100 capital loss and $100 of ordinary income. The group absorbs the loss and the negative remaining adjustment of $1000 is allocable entirely to the common stock, equally to each common share ($125 per share). See § 1.1502-32(c)(1)(iii) and (c)(2).

(B) In year 2, S has $700 of ordinary income and a $100 ordinary loss. Also, on October 1, year 2, S declares and makes a $200 dividend distribution with respect to the preferred stock ($100 per share). Under § 1.1502-32(c)(1)(i), a negative adjustment of $100 is first allocated to each of the preferred shares to reflect the declaration of the dividend. The $600 positive remaining adjustment determined under § 1.1502-32(c)(1)(iii) (reflecting S's net income reduced by the distribution) is then allocated to each of the preferred shares to the extent of its entitlement to dividends accruing in year 1 and year 2 ($200 per share). See § 1.1502-32(c)(1)(iii) and (c)(3). The $200 of the positive remaining adjustment not allocated to the preferred shares is then allocated to the common stock, equally to each common share ($25 per share). See § 1.1502-32(c)(1)(iii) and (c)(2). After taking into account the effects of all applicable rules of law, the adjusted bases and the values of the shares as of January 1, year 3, are:

Preferred | Common

PS1 (M) | PS2 (P) | CS1 (P) | CS2 (P) | CS3 (P) | CS4 (P) | CS5 (P) | CS6 (P) | CS7 (P) | CS8 (P)

Basis | 1250 | 990 | 1025 | 710 | 550 | 400 | 375 | 250 | 215 | 100

Year 1§ 1.1502-32 adjustments | N/A | N/A | −125 | −125 | −125 | −125 | −125 | −125 | −125 | −125

Year 2§ 1.1502-32 adjustments | −100 | −100 | + 25 | + 25 | + 25 | + 25 | + 25 | + 25 | + 25 | + 25

+ 200 | + 200

+ 100 | + 100

Adjusted basis | 1350 | 1090 | 925 | 610 | 450 | 300 | 275 | 150 | 115 | 0

Value | 1100 | 1100 | 275 | 275 | 275 | 275 | 275 | 275 | 275 | 275

Unrecognized gain/(loss) | (250) | 10 | (650) | (335) | (175) | (25) | 0 | 125 | 160 | 275

(C) On January 1, year 3, M sells PS1 for $1100 and P sells CS2 for $275. The sales of PS1 and CS2 are transfers of loss shares and therefore subject to this section.

(ii) Basis redetermination under this paragraph (b). Under this paragraph (b), all members' bases in shares of S stock are subject to redetermination in accordance with the following:

(A) Removing positive investment adjustments from transferred loss common shares. First, paragraph (b)(2)(i)(A) of this section applies to reduce P's basis in CS2, but not below value, by removing the positive investment adjustment applied to the basis of the share. Accordingly, P's basis in CS2 is reduced by $25, from $610 to $585.

(B) Reallocating negative investment adjustments from common shares that are not transferred loss shares. Because the transferred shares remain loss shares after the removal of positive investment adjustments, their bases are further reduced under paragraph (b)(2)(i)(B) of this section, but not below value, by reallocating negative investment adjustments applied to common shares that are not transferred loss shares. Reallocations are made first to preferred shares and then to the common shares, in a manner that reduces disparity among members' bases in transferred loss preferred shares, and reduces disparity among members' bases in all common shares, to the greatest extent possible. The loss on PS1 is $250, the remaining loss on CS2 is $310, and the total amount of negative investment adjustments applied to shares that are not transferred loss shares is $875 (the sum of the negative adjustments applied to all common shares other than CS2). Thus, $250 of negative investment adjustments are reallocated and applied to the basis of PS1, reducing it to the share's value, $1100. The negative investment adjustments are reallocated from the common shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all common shares to the greatest extent possible. The negative investment adjustments may be reallocated to PS1 from the common shares that are not transferred loss shares as follows: $125 from each of CS7 and CS8. Such reallocations increase the basis of CS7 by $125, from $115 to $240, and increase the basis of CS8 by $125, from $0 to $125. Negative investment adjustments are then reallocated to CS2 from the common shares that are not transferred loss shares in a manner that reduces disparity among members' bases in all common shares to the greatest extent possible. The negative investment adjustments may be reallocated to CS2 from the other common shares as follows: $80 from CS4, $105 from CS5, and $125 from CS6. Such reallocations reduce the basis of CS2 by $310, from $585 to $275, increase the basis of CS4 by $80, from $300 to $380, increase the basis of CS5 by $105, from $275 to $380, and increase the basis of CS6 by $125, from $150 to $275. However, there may be other reasonable reallocations.

(C) Increasing basis by reallocated positive investment adjustments. Under paragraph (b)(2)(ii)(A) of this section, the $25 positive investment adjustment removed from CS2 (the transferred loss common share) is then reallocated and applied to increase the basis of preferred shares, but not above value. Accordingly, $10 of that amount is reallocated to PS2, increasing its basis from $1090 to $1100, its value. Under paragraph (b)(2)(ii)(B) of this section, the remaining $15 is reallocated and applied to the common shares in a manner that reduces disparity among members' bases in all common shares to the greatest extent possible. The $15 positive investment adjustment that is reallocated to common shares may be reallocated entirely to CS8, increasing its basis from $125 to $140. However, there may be other reasonable reallocations.

(D) Summary of the reallocation of adjustments. The adjustments made under this paragraph (b) are:

Preferred | Common

PS1 (M) | PS2 (P) | CS1 (P) | CS2 (P) | CS3 (P) | CS4 (P) | CS5 (P) | CS6 (P) | CS7 (P) | CS8 (P)

Adjusted basis before redetermination | 1350 | 1090 | 925 | 610 | 450 | 300 | 275 | 150 | 115 | 0

Removing positive adjustments from transferred loss shares | −25

Reallocating negative adjustments | −250 | −310 | + 80 | + 105 | + 125 | + 125 | + 125

Applying positive adjustments removed from transferred loss shares | + 10 | + 15

Basis after redetermination | 1100 | 1100 | 925 | 275 | 450 | 380 | 380 | 275 | 240 | 140

Value | 1100 | 1100 | 275 | 275 | 275 | 275 | 275 | 275 | 275 | 275

Gain/(loss) | 0 | 0 | (650) | 0 | (175) | (105) | (105) | 0 | 35 | 135

(iii) Application of paragraphs (c) and (d) of this section. Because M's sale of PS1 and P's sale of CS2 are not transfers of loss shares after the application of this paragraph (b), paragraphs (c) and (d) of this section do not apply.

(iv) Higher-tier effects. The $250 reduction in the basis of PS1 under this paragraph (b) is a noncapital, nondeductible expense under § 1.1502-32(b)(3)(iii)(B) that will be included in the year 3 investment adjustment to be applied to P's basis in its M stock.

(c) Stock basis reduction to prevent noneconomic loss—(1) In general. The rules of this paragraph (c) reduce M's basis in a transferred share of S stock to prevent noneconomic stock loss and thus promote the clear reflection of the group's income. These rules limit the reduction to M's basis in the S share to the amount of net unrealized appreciation reflected in the share's basis as of the transfer (the disconformity amount). These rules also limit the reduction to M's basis in the S share to the portion of the share's basis that is attributable to investment adjustments made pursuant to the consolidated return regulations.

(2) Basis reduction rule. This paragraph (c) applies if M transfers a share of S stock and, after taking into account the effects of all applicable rules of law, including any adjustments under paragraph (b) of this section, the share is a loss share. Under this paragraph (c), M's basis in the share is reduced, but not below value, by the lesser of—

(i) The share's net positive adjustment (as defined in paragraph (c)(3) of this section); and

(ii) The share's disconformity amount (as defined in paragraph (c)(4) of this section).

(3) Net positive adjustment. A share's net positive adjustment is the greater of—

(i) Zero; and

(ii) The sum of all investment adjustments reflected in the basis of the share. The term investment adjustment has the same meaning as in paragraph (b)(1)(iii) of this section, except that it includes all adjustments specially allocated under § 1.1502-32(c)(1)(ii).

(4) Disconformity amount. A share's disconformity amount is the excess, if any, of—

(i) M's basis in the share; over

(ii) The share's allocable portion of S's net inside attribute amount (as defined in paragraph (c)(5) of this section).

(5) Net inside attribute amount. S's net inside attribute amount is determined as of the transfer, taking into account all applicable rules of law (even if the adjustments required by such rules are not deemed effective until after the transfer, such as certain adjustments required under sections 108 and 1017 and § 1.1502-28). S's net inside attribute amount is the sum of S's net operating and capital loss carryovers, deferred deductions, money, and basis in assets other than money, reduced by the amount of S's liabilities. For this purpose, S's basis in any share of lower-tier subsidiary stock is generally S's basis in that share, adjusted to reflect any gain or loss recognized in the transaction with respect to the share and any other related or resulting adjustments to the basis of the share. However, see paragraph (c)(6) of this section for special rules regarding the computation of S's net inside attribute amount for purposes of this paragraph (c) if S holds stock of a subsidiary that is not transferred in the transaction. See paragraph (f) of this section for definitions of “allocable portion,” “deferred deduction,” “liability,” “loss carryover,” and other relevant terms.

(6) Determination of S's net inside attribute amount if S owns stock of a lower-tier subsidiary—(i) Overview. If a loss share of S stock is transferred when S holds a share of stock of another subsidiary (S1) and the S1 share is not transferred in the same transaction, S's net inside attribute amount is determined by treating S's basis in its S1 share as tentatively reduced under this paragraph (c)(6). The purpose of this rule is to reduce the extent to which S1's investment adjustments increase noneconomic loss on S stock (as a result of S1's recognition of items that are indirectly reflected in a member's basis in a share of S stock).

(ii) General rule for nontransferred shares of lower-tier subsidiary stock. For purposes of determining the disconformity amount of a share of S stock, S's basis in a nontransferred share of S1 stock is treated as reduced by the share's tentative reduction amount. The tentative reduction amount is the lesser of the S1 share's net positive adjustment and the S1 share's disconformity amount.

(iii) Multiple tiers of nontransferred shares. If S directly or indirectly owns nontransferred shares of stock of subsidiaries in multiple tiers, then, subject to the limitations in paragraph (c)(6)(iv) of this section (regarding nontransferred shares that are lower-tier to transferred shares), the rules of this paragraph (c)(6) first apply to determine the tentatively reduced basis of stock of the subsidiary at the lowest tier. These rules then apply to determine the tentatively reduced basis of nontransferred shares of stock of subsidiaries successively at each next higher tier that is lower-tier to S. The tentative reductions at each tier are treated as noncapital, nondeductible expenses that tier up under the principles of § 1.1502-32, and, as such, result in a tentative reduction of basis and any net positive adjustment of subsidiary shares that are lower-tier to S.

(iv) Nonapplicability of tentative basis reduction rule to transferred shares. The tentative basis reduction rule in this paragraph (c)(6) does not apply to any share of stock of a lower-tier subsidiary (S1) that is transferred in the same transaction in which the S share is transferred. Further, for purposes of determining the S share's disconformity amount, the tentative basis reduction rule in this paragraph (c)(6) only applies with respect to stock of a lower-tier subsidiary if such stock is lower-tier to a nontransferred S1 share. The purpose of this rule is to prevent tentative adjustments to the bases of lower-tier shares if this paragraph (c) has already applied with respect to the shares, without regard to whether such application resulted in the reduction of the basis of any share.

(v) Example. The rules of this paragraph (c)(6) are illustrated by the following example:

Example. (i) Facts. M owns the sole outstanding share of S stock, S owns the sole outstanding share of S1 stock, S1 owns all five outstanding shares of S2 stock (the bases of which are equal), and S2 owns the sole outstanding share of S3 stock. The basis of each of the shares reflects its allocable portion of a $5 positive investment adjustment attributable to income recognized by S3. The basis of the S share exceeds its value by $10 and the basis of the S1 share exceeds its value by $5. The basis of each S2 share is $1 less than its value. In one transaction, M sells its S share to X, S1 issues new shares in an amount that prevents S and S1 from being members of the same group, and S1 sells one of its S2 shares to an unrelated individual. S1, S2, and S3 elect to file a consolidated return following the transaction.

(ii) General applicability of section. As a result of the transaction, there is a transfer of the S share and the S2 share that was sold (because both shares were sold to nonmembers) and of the S1 share (because S and S1 cease to be members of the same group as a result of the stock issuance). The transfer of the S2 share is not a transfer of a loss share, and so this section does not apply to that transfer. The transfers of the S and S1 shares are transfers of loss shares, and so this section applies to those transfers. The S3 share and the four retained S2 shares are not transferred in the transaction. Under paragraph (a)(3)(ii)(A) of this section, this section applies first to the transfer of the S1 share because it is the lowest-tier transferred loss share.

(iii) Application of paragraph (b) of this section and this paragraph (c) to transfer of S1 stock. First, the $1 gain recognized on the transfer of the S2 share tiers up to adjust the basis of each upper-tier share. The transferred S1 share is still a loss share (by $4) and is therefore subject to this section. Although the transfer is subject to paragraph (b) of this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S1 stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the S1 share is still a loss share and, as such, subject to this paragraph (c). In determining the amount of any basis reduction under this paragraph (c), the disconformity amount of the S1 share is computed by comparing S's basis in its S1 share to S1's net inside attribute amount (because there is only one S1 share outstanding, the entire amount is allocable to that share). In determining S1's net inside attribute amount, the tentative reduction rule in this paragraph (c)(6) applies to nontransferred lower-tier shares (provided they are lower-tier to nontransferred shares). Thus, the rule applies to S1's four retained shares of S2 stock and to S2's share of S3 stock. The tentative reduction begins at the lowest level (S2's share of S3 stock) and any tentative reduction amount tiers up as a noncapital, nondeductible expense under the principles of § 1.1502-32, tentatively reducing the bases of any upper tier nontransferred shares that are lower-tier to the transferred loss share (the S1 share). Accordingly, each of S1's nontransferred share of S2 stock is tentatively reduced by its portion of the tentative reduction to S2's share of S3 stock. S1 then applies the tentative reduction rule to its four nontransferred S2 shares. S1's net inside attribute amount is the sum of its basis in each of its nontransferred S2 shares, as tentatively reduced under this paragraph (c)(6) and S1's actual basis in the transferred S2 share, increased to reflect the gain recognized on the sale of that share. After the application of this paragraph (c) to the transfer of the S1 share, paragraph (b) of this section applies to M's transfer of the S share.

(iv) Application of section to transfer of S stock. Because the S share is still a loss share after applying paragraph (b) of this section and this paragraph (c) to the transfer of the S1 stock, this section applies to M's transfer of the S share. Although paragraph (b) of this section applies to the transfer, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c). In determining the disconformity amount of the S share, S's net inside attribute amount is determined using S's actual basis in the transferred S1 stock (after any reduction under this paragraph (c)), because the tentative reduction rule in this paragraph (c)(6) does not apply to shares that are transferred in the transaction. All other shares are lower-tier to the transferred S1 share and are therefore also not subject to tentative reduction for purposes of determining the disconformity amount of the S share. After the application of this paragraph (c) to the transfer of the S share, paragraph (d) of this section applies with respect to M's transfer of the S share. After the application of paragraph (d) of this section with respect to the transfer of the S share, if the S1 share is still a loss share, paragraph (d) of this section applies with respect to S's transfer of the S1 share.

(7) Netting of gains and losses taken into account—(i) General rule. Solely for purposes of computing the basis reduction required under this paragraph (c), the basis of each transferred loss share of S stock is treated as reduced proportionately (as to loss) by the amount of income or gain taken into account by members with respect to transferred shares of S stock, provided that—

(A) The shares are transferred in one transaction; and

(B) The gain is taken into account as of the transaction.

(ii) Example. The netting rule of this paragraph (c)(7) is illustrated by the following example:

Example. Disposition of gain and loss shares. (i) Facts. M owns the only three outstanding shares of S stock. Share A has a basis of $54, Share B has a basis of $100, and Share C has a basis of $80. In the same transaction, M sells all three S shares to X for $60 each. M realizes a gain of $6 on Share A, a loss of $40 on Share B, and a loss of $20 on Share C. M's sales of Share B and Share C are transfers of loss shares and therefore subject to this section. M's sale is a transfer of all of the shares of S stock held by members to one or more nonmembers in one fully taxable transaction and, therefore, basis is not redetermined under paragraph (b) of this section. See paragraph (b)(1)(ii)(B) of this section. The transfer is then subject to this paragraph (c). However, for this purpose, M treats its bases in Share B and Share C as reduced by the $6 gain taken into account on Share A. The gain is allocated to Share B and Share C proportionately based on the amount of loss in each share. Thus, $4 of gain ($40/$60 × $6) is treated as allocated to Share B and $2 of gain ($20/$60 × $6) is treated as allocated to Share C. Accordingly, M computes the basis reduction required under this paragraph (c) by treating its basis in Share B as $96 ($100 less $4) and its basis in Share C as $78 ($80 less $2). If, after the application of this paragraph (c), the sales of Share B and Share C are still transfers of loss shares, then the transfers are subject to paragraph (d) of this section. (Although the bases of Share B and Share C are not actually reduced by any portion of the gain, paragraph (d)(3)(i)(A) of this section applies netting principles to limit adjustments under paragraph (d) of this section.)

(ii) Disposition of stock with deferred gain. The facts are the same as in paragraph (i) of this Example, except that M sells the gain share to another member. Under § 1.1502-13, M's gain recognized on Share A is not taken into account in the taxable year of the transfer and therefore cannot be treated as reducing M's loss recognized on Share B and Share C for purposes of this paragraph (c). The applicability of this section to the transfer of Share A is determined as of the time that the intercompany item (the gain on M's sale to the other member) is taken into account; see paragraph (e)(3) of this section. However, if Share B (instead of Share A) were sold to a member, the entire gain on Share A would be treated as reducing the loss on Share C for purposes of applying this paragraph (c); see paragraph (e)(3) of this section.

(8) Examples. The application of this paragraph (c) is illustrated by the following examples.

Example 1. Appreciation reflected in stock basis at acquisition. (i) Appreciation recognized as gain. (A) Facts. On January 1, year 1, M purchases the sole outstanding share of S stock for $100. At that time, S owns two assets, Asset 1 with a basis of $0 and a value of $40, and Asset 2 with a basis and value of $60. In year 1, S sells Asset 1 for $40, recognizing a $40 gain. On December 31, year 1, M sells its S share for $100. After taking into account the effects of all applicable rules of law, M's basis in the S share is $140 (M's original $100 basis increased under § 1.1502-32 by $40, the share's allocable portion of the gain recognized on the sale of Asset 1). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(B) Application of paragraph (b) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c).

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share, $140, is reduced, but not below value, $100, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is the greater of zero and the sum of all investment adjustments (as defined in paragraph (b)(1)(iii) of this section) applied to the basis of the share. The only investment adjustment applied to the basis of the share is the $40 adjustment attributable to the gain recognized on the sale of Asset 1. Thus, the share's net positive adjustment is $40. The share's disconformity amount is the excess, if any, of its basis, $140, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is the sum of S's money ($40 from the sale of Asset 1) and S's basis in Asset 2, $60, or $100. The share is the only outstanding S share and so its allocable portion of the $100 net inside attribute amount is the entire $100. Thus, the share's disconformity amount is $40, the excess of $140 over $100. The lesser of the net positive adjustment, $40, and the share's disconformity amount, $40, is $40. Accordingly, immediately before the application of paragraph (d) of this section, M's basis in the share is reduced by $40, from $140 to $100.

(D) Application of paragraph (d) of this section. Because M's sale of the S share is not a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply to the transfer.

(ii) Appreciation recognized as income earned in the consumption of built-in gain. The facts are the same as in paragraph (i)(A) of this Example 1, except that, instead of selling Asset 1, the value of Asset 1 is consumed in the production of $40 of income in year 1 (reducing the value of Asset 1 to $0). Because the net positive adjustment includes items of income as well as items of gain, the results are the same as those described in paragraph (i) of this Example 1.

(iii) Post-acquisition appreciation eliminates stock loss. The facts are the same as in paragraph (i)(A) of this Example 1 except that, in addition, the value of Asset 2 increases to $100 before the stock is sold. As a result, M sells the S share for $140. Because M's sale of the S share is not a transfer of a loss share, this section does not apply to the transfer, notwithstanding that P's basis in the S share was increased by the gain recognized on Asset 1.

(iv) Distributions. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 1 except that, in addition, S declares and makes a $10 dividend distribution before the end of year 1. As a result, the value of the share decreases and M sells the share for $90. After taking into account the effects of all applicable rules of law, M's basis in the S share is $130 (M's original $100 basis increased under § 1.1502-32 by $30, the $10 distribution on the share reduced by the share's allocable portion of the $40 gain recognized on the sale of Asset 1). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(B) Application of paragraph (b) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section for the reasons set forth in paragraph (i)(B) of this Example 1. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c).

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share, $130, is reduced, but not below value, $90, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $40 (the sum of all investment adjustments (as defined in paragraph (b)(1)(iii) of this section) applied to the basis of the share). The share's disconformity amount is the excess of its basis, $130, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is $90, the sum of S's money ($30, the $40 sale proceeds less the $10 distribution) and S's basis in Asset 2, $60. The share is the only outstanding S share and so its allocable portion of the $90 net inside attribute amount is the entire $90. The lesser of the share's net positive adjustment, $40, and its disconformity amount, $40, is $40. Accordingly, immediately before the application of paragraph (d) of this section, the basis in the share is reduced by $40, from $130 to $90.

Example 2. Loss of appreciation reflected in basis. (i) Facts. On January 1, year 1, M purchases the sole outstanding share of S stock for $100. At that time, S owns two assets, Asset 1 with a basis of $0 and a value of $40, and Asset 2 with a basis and value of $60. The value of Asset 1 declines to $0 and M sells its S share for $60. After taking into account the effects of all applicable rules of law, M's basis in the S share is $100. M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(ii) Application of paragraph (b) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c).

(iii) Basis reduction under this paragraph (c). Under this paragraph (c), M's $100 basis in the S share is reduced, but not below its $60 value by the lesser of the share's net positive adjustment and disconformity amount. There were no investment adjustments applied to M's basis in the share and so the share's net positive adjustment is $0. Thus, although the share's disconformity amount is $40 (the excess of M's $100 basis in the share over the share's $60 allocable portion of S's net inside attribute amount), no basis reduction is required under this paragraph (c).

(iv) Application of paragraph (d) of this section. After the application of this paragraph (c), M's sale of the S share is still a transfer of a loss share, and, accordingly, subject to paragraph (d) of this section. No adjustment is required under paragraph (d) of this section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.

Example 3. Items accruing after S becomes a member. (i) Recognition of loss accruing after S becomes a member. (A) Facts. On January 1, year 1, M purchases the sole outstanding share of S stock for $100. At that time, S owns two assets, Asset 1, with a basis of $0 and a value of $40, and Asset 2, with a basis and value of $60. In year 1, S sells Asset 1 for $40, recognizing a $40 gain. Also in year 1, the value of Asset 2 declines and S sells Asset 2 for $20, recognizing a $40 loss that is absorbed by the group. On December 31, year 1, M sells its S share for $60. After taking into account the effects of all applicable rules of law, M's basis in the S share is $100 (M's original $100 basis, unadjusted under § 1.1502-32 because the $40 gain recognized on the sale of Asset 1 and the $40 loss on the sale of Asset 2 net, resulting in an adjustment of $0). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share is reduced, but not below the share's $60 value, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $0. Thus, although the share has a disconformity amount of $40 (the excess of M's basis in the share, $100, over the share's allocable portion of S's net inside attribute amount, $60), no basis reduction is required under this paragraph (c).

(D) Application of paragraph (d) of this section. After the application of this paragraph (c), M's sale of the S share is still a transfer of a loss share, and, accordingly, subject to paragraph (d) of this section. No adjustment is required under paragraph (d) of this section because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.

(ii) Recognition of gain accruing after S becomes a member. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 3, except that M does not sell the S share and S does not sell either asset in year 1. In addition, in year 2, the value of Asset 1 declines to $0, the value of Asset 2 returns to $60, and S creates Asset 3 (with a basis of $0). In year 3, S sells Asset 3 for $40, recognizing a $40 gain. On December 31, year 3, M sells its S share for $100. After taking into account the effects of all applicable rules of law, M's basis in the S share is $140 (M's original $100 basis increased under § 1.1502-32 by $40 (the share's allocable portion of the gain recognized on the sale of Asset 3 in year 3)). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(B) Application of paragraph (b) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section for the reasons set forth in paragraph (i)(B) of this Example 3. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c).

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share, $140, is reduced, but not below value, $100, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $40 (the year 3 investment adjustment). The share's disconformity amount is the excess of its basis, $140, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is $100, the sum of S's money ($40 from the sale of Asset 3) and its basis in its assets ($60 (the sum of Asset 1's basis of $0 and Asset 2's basis of $60)). S's $100 net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the share's disconformity amount is the excess of $140 over $100, or $40. The lesser of the share's net positive adjustment, $40, and its disconformity amount, $40, is $40. Accordingly, the basis in the share is reduced by $40, from $140 to $100.

(iii) Recognition of income earned after S becomes a member. The facts are the same as in paragraph (ii)(A) of this Example 3, except that instead of creating Asset 3, S earns $40 of income from services provided in year 3. Because the net positive adjustment includes items of income as well as items of gain, the results are the same as those described in paragraph (ii) of this Example 3.

Example 4. Computing the disconformity amount. (i) Unrecognized loss reflected in stock basis. (A) Facts. M owns the sole outstanding share of S stock with a basis of $100. S owns two assets, Asset 1 with a basis of $20 and a value of $60, and Asset 2 with a basis of $60 and a value of $40. In year 1, S sells Asset 1 for $60, recognizing a $40 gain. On December 31, year 1, M sells the S share for $100. After taking into account the effects of all applicable rules of law, M's basis in the S share is $140 (M's original $100 basis increased under § 1.1502-32 by $40, the share's allocable portion of the gain recognized on the sale of Asset 1). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share, $140, is reduced, but not below the share's $100 value, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $40 (the year 1 investment adjustment). The share's disconformity amount is the excess of its basis, $140, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is $120, the sum of S's money ($60 from the sale of Asset 1) and S's basis in Asset 2, $60. S's net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the share's disconformity amount is $20, the excess of $140 over $120. The lesser of the share's net positive adjustment, $40, and its disconformity amount, $20, is $20. Accordingly, the basis in the share is reduced by $20, from $140 to $120.

(D) Application of paragraph (d) of this section. After the application of this paragraph (c), M's sale of the S share is still a transfer of a loss share, and, accordingly, S's attributes (to the extent of the $20 duplicated loss) are subject to reduction under paragraph (d) of this section.

(ii) Loss carryover. The facts are the same as in paragraph (i)(A) of this Example 4, except that Asset 2 has a basis of $0 (rather than $60) and S has a $60 loss carryover (as defined in paragraph (f)(6) of this section). The analysis is the same as paragraph (i) of this Example 4. Furthermore, the analysis of the application of this paragraph (c) would be the same if the $60 loss carryover were subject to a section 382 limitation from a prior ownership change, or if, instead, the $60 loss carryover were subject to the limitation in § 1.1502-21(c) on losses carried from separate return limitation years.

(iii) Liabilities. The facts are the same as in paragraph (i)(A) of this Example 4, except that S borrows $100 before M sells the S share. S's net inside attribute amount remains $120, computed as the sum of S's money ($160, $60 from the sale of Asset 1 plus the $100 borrowed) and S's basis in Asset 2, $60, less its liabilities, $100. Thus, the S share's disconformity amount remains the excess of $140 over $120, or $20. The results are the same as in paragraph (i) of this Example 4.

Example 5. Computing the allocable portion of the net inside attribute amount. (i) Facts. On January 1, year 1, M owns all five outstanding shares of S stock with a basis of $20 per share. S owns Asset with a basis of $0. In year 1, S sells Asset for $100, recognizing a $100 gain. On December 31, year 1, M sells one of the S shares, Share 1, for $20. After taking into account the effects of all applicable rules of law, M's basis in Share 1 is $40 (M's original $20 basis increased under § 1.1502-32 by $20 (the share's allocable portion of the gain recognized on the sale of Asset)). M's sale of Share 1 is a transfer of a loss share and therefore subject to this section.

(ii) Application of paragraph (b) of this section. Although the transfer is subject to this section, basis is not redetermined under paragraph (b) of this section because there is no disparity among M's bases in shares of S common stock and there are no shares of S preferred stock outstanding (so there can be no unrecognized gain or loss with respect to preferred shares). See paragraph (b)(1)(ii)(A) of this section. After the application of paragraph (b) of this section, M's sale of Share 1 is still a transfer of a loss share and therefore subject to this paragraph (c).

(iii) Basis reduction under this paragraph (c). Under this paragraph (c), M's $40 basis in Share 1 is reduced, but not below its $20 value by the lesser of the share's net positive adjustment and disconformity amount. Share 1's net positive adjustment is $20 (the year 1 investment adjustment). Share 1's disconformity amount is the excess of its $40 basis over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is equal to the amount of S's money ($100 from the sale of the asset). Share 1's allocable portion of S's $100 net inside attribute amount is $20 (1/5 × $100). Thus, Share 1's disconformity amount is the excess of $40 over $20, or $20. The lesser of the share's $20 net positive adjustment and its $20 disconformity amount is $20. Accordingly, the basis in the share is reduced by $20, from $40 to $20.

(iv) Application of paragraph (d) of this section. Because M's sale of Share 1 is not a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply to the transfer.

Example 6. Liabilities. (i) In general. (A) Facts. On January 1, year 1, M purchases the sole outstanding share of S stock for $100. At that time, S owns Asset, with a basis of $0 and value of $100, and $100 cash. S also has a $100 liability. In year 1, S declares and makes a $60 dividend distribution to M and recognizes $20 of income. The value of Asset declines to $60 and, on December 31, year 1, M sells the S share for $20. After taking into account the effects of all applicable rules of law, M's basis in the S share is $60 (M's original $100 basis decreased under § 1.1502-32 by $40 (the net of the $60 distribution and the $20 income recognized)). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share, $60, is reduced, but not below value, $20, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $20 (the year 1 investment adjustment, as defined in paragraph (b)(1)(iii) of this section). The share's disconformity amount is the excess of its basis, $60, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is negative $40, computed as the sum of S's money ($60 ($100 less the $60 distribution plus the $20 income recognized)) and S's basis in Asset, $0, less S's liability, $100. S's net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the share's disconformity amount is the excess of $60 over negative $40, or $100. The lesser of the share's net positive adjustment, $20, and its disconformity amount, $100, is $20. Accordingly, the basis in the share is reduced by $20, from $60 to $40.

(D) Application of paragraph (d) of this section. After the application of this paragraph (c), the S share is still a loss share and, accordingly, S's attributes are subject to reduction under paragraph (d) of this section. No adjustment is required under paragraph (d) of this section, however, because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.

(ii) Excluded cancellation of indebtedness income—insufficient attributes available for reduction under sections 108 and 1017, and § 1.1502-28. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 6, except that M does not sell the S share. Instead, in year 4, Asset is destroyed in a fire and S spends its $60 on deductible expenses that are not absorbed by the group. S's loss becomes part of the consolidated net operating loss (CNOL). In year 5, S becomes insolvent and S's debt is discharged. Because of S's insolvency, S's discharge of indebtedness income is excluded under section 108 and, as a result, S's attributes are subject to reduction under sections 108 and 1017, and § 1.1502-28. S's only attribute is the portion of the CNOL attributable to S, $60, and it is reduced to $0. There are no other consolidated attributes. In year 5, the S stock (which is treated as a capital asset) becomes worthless under section 165, taking into account § 1.1502-80(c). After taking into account the effects of all applicable rules of law, M's basis in the S share is $60 (M's original $100 basis decreased under § 1.1502-32 by the year 1 investment adjustment of $40 (the net of the $60 distribution and the $20 income recognized). The investment adjustment for year 5 is $0 (the net of the $60 tax exempt income from the excluded COD applied to reduce attributes and the $60 noncapital, nondeductible expense from the reduction of S's portion of the CNOL). Under paragraph (f)(10)(i)(D) of this section, a share is transferred on the last day of the taxable year during which it becomes worthless under section 165 if the share is treated as a capital asset, or the date the share becomes worthless if the share is not treated as a capital asset, taking into account § 1.1502-80(c). Accordingly, M transfers the loss share of S stock on December 31, year 5, and the transfer is therefore subject to this section.

(B) Application of paragraph (b) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section for the reasons set forth in paragraph (i)(B) of this Example 6. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c).

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in its S share, $60, is reduced, but not below value, $0, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $20 (the year 1 investment adjustment, as defined in paragraph (b)(1)(iii) of this section). The share's disconformity amount is the excess of its basis, $60, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is $0. (The effects of the attribute reduction required under sections 108 and 1017 and § 1.1502-28 are taken into account in applying this section; therefore, for purposes of this section, S's portion of the CNOL is treated as eliminated under section 108 and § 1.1502-28.) S's net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the share's disconformity amount is the excess of $60 over $0, or $60. The lesser of the share's net positive adjustment, $20, and its disconformity amount, $60, is $20. Accordingly, the basis in the share is reduced by $20, from $60 to $40, immediately before the transfer.

(D) Application of paragraph (d) of this section. After the application of this paragraph (c), the S share is still a loss share, and, accordingly, S's attributes are subject to reduction under paragraph (d) of this section. No adjustment is required under paragraph (d) of this section, however, because there is no aggregate inside loss. See paragraph (d)(3)(iii) of this section.

(iii) Excluded cancellation of indebtedness income—full attribute reduction under sections 108 and 1017, and § 1.1502-28 (using attributes attributable to another member). (A) Facts. The facts are the same as in paragraph (ii)(A) of this Example 6 except that M loses the $60 distributed in year 1 and the group does not absorb the loss. Thus, as of December 31, year 5, the CNOL is $120, attributable $60 to S and $60 to P. As a result, under § 1.1502-28(a)(4), after the portion of the CNOL attributable to S is reduced to $0, the remaining $40 of excluded COD applies to the portion of the CNOL attributable to P, reducing it from $60 to $20. After taking into account the effects of all applicable rules of law, M's basis in the S share at the end of year 5 is $100 (M's original $100 basis decreased under § 1.1502-32 by $40 at the end of the year 1 and then increased under § 1.1502-32 by $40 at end of the year 5 (the net of the $100 tax exempt income from the excluded COD applied to reduce attributes and the $60 noncapital, nondeductible expense from the reduction of S's portion of the CNOL)). Under paragraph (f)(10)(i)(D) of this section, a share is transferred on the last day of the taxable year during which it becomes worthless under section 165 if the share is treated as a capital asset, or the date the share becomes worthless if the share is not treated as a capital asset, taking into account § 1.1502-80(c). Accordingly, M transfers the loss share of S stock on December 31, year 5, and the transfer is therefore subject to this section.

(B) Application of paragraph (b) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section for the reasons set forth in paragraph (i)(B) of this Example 6. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to this paragraph (c).

(C) Basis reduction under this paragraph (c). Under this paragraph (c), M's basis in the S share, $100, is reduced, but not below value, $0, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $60 (the sum of the year 1 investment adjustment, as defined in paragraph (b)(1)(iii) of this section, $20, and the year 5 investment adjustment, $40). The share's disconformity amount is the excess of its basis, $100, over its allocable portion of S's net inside attribute amount. S's net inside attribute amount is $0 (taking into account the effects of the attribute reduction required under sections 108 and 1017 and § 1.1502-28). S's net inside attribute amount is allocable entirely to the sole outstanding S share. The share's disconformity amount is therefore $100. The lesser of the share's net positive adjustment, $60, and its disconformity amount, $100, is $60. Accordingly, M's basis in the share is reduced by $60, from $100 to $40, immediately before the transfer.

Example 7. Lower-tier subsidiary (no transfer of lower-tier stock). (i) Facts. M owns the sole outstanding share of S stock with a basis of $160. S owns two assets, Asset 1 with a basis and value of $100, and the sole outstanding share of S1 stock with a basis of $60. S1 owns one asset, Asset 2, with a basis of $20 and value of $60. In year 1, S1 sells Asset 2 to X for $60, recognizing a $40 gain. On December 31, year 1, M sells its S share to Y, a member of another consolidated group, for $160. After taking into account the effects of all applicable rules of law, M's basis in the S share is $200 (M's original $160 basis increased under § 1.1502-32 by $40 (to reflect the tier-up of the adjustment to S's basis in the S1 stock for the gain recognized on S1's sale of Asset 2)). M's sale of the S share is a transfer of a loss share and therefore subject to this section. (S does not transfer the S1 share because S and S1 are members of the same group following the transfer. See paragraph (f)(10) of this section.)

(iii) Basis reduction under this paragraph (c). (A) In general. Under this paragraph (c), M's basis in the S share, $200, is reduced, but not below value, $160, by the lesser of the share's net positive adjustment and disconformity amount. The S share's net positive adjustment is $40. The share's disconformity amount is the excess of its basis, $200, over the share's allocable portion of S's net inside attribute amount. S's net inside attribute amount is the sum of S's basis in Asset 1, $100, and S's basis in the S1 share.

(B) S's basis in the S1 share. Although S's actual basis in the S1 share is $100 (S's original $60 basis increased under § 1.1502-32 by $40 (the share's allocable portion of the gain recognized on the sale of Asset 2)), for purposes of computing the S share's disconformity amount, S's net inside attribute amount is determined by treating S's basis in the S1 share as tentatively reduced by the lesser of the S1 share's net positive adjustment and the S1 share's disconformity amount. The S1 share's net positive adjustment is $40 (the year 1 investment adjustment). The S1 share's disconformity amount is the excess of its basis, $100, over the share's allocable portion of S1's net inside attribute amount. S1's net inside attribute amount is equal to the amount of S1's money ($60 from the sale of Asset 2), and is allocable entirely to the sole outstanding S1 share. Thus, the S1 share's disconformity amount is the excess of $100 over $60, or $40. The lesser of the S1 share's net positive adjustment, $40, and its disconformity amount, $40, is $40. Accordingly, for purposes of computing the disconformity amount of the S share, S's net inside attribute amount is determined by treating S's basis in its S1 share as tentatively reduced by $40, from $100 to $60.

(C) The disconformity amount of M's S share. S's net inside attribute amount is treated as the sum of its basis in Asset 1, $100, and its tentatively reduced basis in the S1 share, $60, or $160. S's net inside attribute amount is allocable entirely to the sole outstanding S share. Thus, the S share's disconformity amount is the excess of $200 over $160, or $40.

(D) Amount of reduction. M's basis in its S share is reduced by the lesser of the S share's net positive adjustment, $40, and disconformity amount, $40, or $40. Accordingly, M's basis in the S share is reduced by $40, from $200 to $160.

(E) Effect on S's basis in its S1 share. The tentative reduction under this paragraph (c) has no effect on S's actual basis in the S1 share. Thus, after the application of this paragraph (c), S owns the S1 share with a basis of $100 (S's original $60 basis increased under § 1.1502-32 by $40 (the share's allocable portion of the gain recognized on the sale of Asset 2)).

(iv) Application of paragraph (d) of this section. Because M's sale of the S share is not a transfer of a loss share after the application of this paragraph (c), paragraph (d) of this section does not apply to the transfer.

(d) Attribute reduction to prevent duplication of loss—(1) In general. The rules of this paragraph (d) reduce attributes of S and its lower-tier subsidiaries to the extent they duplicate a net loss on shares of S stock transferred by members in one transaction. This rule furthers single-entity principles by preventing S (or its lower-tier subsidiaries) from using deductions and losses to the extent that the group or its members (including former members) have either used, or preserved for later use, a corresponding loss in S shares.

(2) Attribute reduction rule—(i) General rule. If a transferred share is a loss share after taking into account the effects of all applicable rules of law, including any adjustments under paragraph (b), (c), or (d)(5)(iii) of this section, S's attributes are reduced by S's attribute reduction amount immediately before the transfer. S's attribute reduction amount is determined under paragraph (d)(3) of this section and applied in accordance with the provisions of paragraphs (d)(4), (d)(5), and (d)(6) of this section. In addition, paragraph (d)(7) of this section provides for additional attribute reduction in the case of certain transfers due to worthlessness and certain transfers not followed by a separate return year.

(ii) Attribute reduction amount less than five percent of value. This paragraph (d) generally does not apply to a transaction if the aggregate attribute reduction amount in the transaction is less than five percent of the aggregate value of the shares transferred by members in the transaction. However, in such a case, P may elect to apply this paragraph (d) to the transaction. If such an election is made, this paragraph (d) will apply with respect to the entire aggregate attribute reduction amount determined in the transaction. Such an election is made in the manner provided in paragraph (e)(5) of this section.

(3) Attribute reduction amount—(i) In general. S's attribute reduction amount is the lesser of—

(A) The net stock loss (as defined in paragraph (d)(3)(ii) of this section); and

(B) S's aggregate inside loss (as defined in paragraph (d)(3)(iii) of this section).

(ii) Net stock loss. The net stock loss is the excess, if any, of—

(A) The aggregate basis of all shares of S stock transferred by members in the transaction; over

(B) The aggregate value of those shares.

(iii) Aggregate inside loss—(A) In general. S's aggregate inside loss is the excess, if any, of—

(1) S's net inside attribute amount; over

(2) The value of all outstanding shares of S stock.

(B) Net inside attribute amount. S's net inside attribute amount generally has the same meaning as in paragraph (c)(5) of this section. However, if S holds stock of a lower-tier subsidiary, the provisions of paragraph (d)(5) of this section (and not the provisions of paragraph (c)(6) of this section) modify the computation of S's net inside attribute amount for purposes of this paragraph (d).

(iv) Lower-tier subsidiaries. See paragraph (d)(5) of this section for special rules relating to the application of this paragraph (d) if S owns shares of stock of a subsidiary.

(4) Application of attribute reduction amount—(i) Attributes available for reduction. S's attributes available for reduction under this paragraph (d) are—

(A) Category A. Capital loss carryovers;

(B) Category B. Net operating loss carryovers;

(D) Category D. Basis of assets other than assets identified as Class I assets in § 1.338-6(b)(1).

(ii) Rules of application—(A) Category A, Category B, and Category C attributes. S's attribute reduction amount is first allocated and applied to reduce the attributes in Category A, Category B, and Category C.

(1) Attribute reduction amount less than total attributes in Category A, Category B, and Category C. If S's attribute reduction amount is less than S's total attributes in Category A, Category B, and Category C, all of S's attribute reduction amount will be applied to reduce such attributes. However, P may specify the allocation of S's attribute reduction amount among such attributes. An election to specify the allocation of S's attribute reduction amount is made in the manner provided in paragraph (e)(5) of this section. To the extent that P does not specify an allocation of S's attribute reduction amount, S's attribute reduction amount will be applied to reduce any Category A attributes not reduced as a result of the specific allocation of S's attribute reduction amount, from oldest to newest, until they are eliminated. Then, any remaining attribute reduction amount will be applied to reduce any Category B attributes not reduced as a result of the specific allocation of S's attribute reduction amount, from oldest to newest, until they are eliminated. Finally, any remaining attribute reduction amount will be applied to reduce any Category C attributes not reduced as a result of the specific allocation of S's attribute reduction amount, proportionately.

(2) Attribute reduction amount not less than the total attributes in Category A, Category B, and Category C. If S's attribute reduction amount equals or exceeds S's total attributes in Category A, Category B, and Category C, all such attributes are eliminated and any remaining attribute reduction amount is allocated and applied as provided in paragraphs (d)(4)(ii)(B) and (d)(4)(ii)(C) of this section.

(B) Category D attributes. Any attribute reduction amount not applied to reduce S's Category A, Category B, and Category C attributes is allocated and applied as provided in this paragraph (d)(4)(ii)(B) and, to the extent applicable, paragraph (d)(5) of this section.

(1) Allocation if S holds stock of another subsidiary. If S holds shares of stock of another subsidiary, the attribute reduction amount not applied to reduce S's Category A, Category B, and Category C attributes is first allocated between S's shares of lower-tier subsidiary stock and S's other Category D assets in the manner provided in paragraph (d)(5)(ii) of this section. S's attribute reduction amount allocated to shares of lower-tier subsidiary stock is applied to reduce S's bases in those shares, becomes an attribute reduction amount of the lower-tier subsidiary, and, subject to certain limitations, reduces the lower-tier subsidiary's attributes. See paragraphs (d)(5)(iii) through (d)(5)(vi) of this section.

(2) Allocation and application of attribute reduction amount not applied to lower-tier subsidiary stock. Any portion of S's attribute reduction amount not applied to reduce S's Category A, Category B, and Category C attributes and not allocated to lower-tier subsidiary stock is allocated to S's Category D assets other than lower-tier subsidiary stock in the manner provided in this paragraph (d)(4)(ii)(B)(2). Such amount is first allocated to S's bases (if any) in its assets identified as Class VII assets in § 1.338-6(b)(2)(vii). If the attribute reduction amount allocated to Class VII assets is less than S's aggregate basis in those assets, it is applied proportionately (by basis) to reduce the bases of such assets. If the attribute reduction amount allocated to Class VII assets equals or exceeds S's aggregate basis in those assets, it is applied to reduce the bases of such assets to zero. Any remaining attribute reduction amount is then allocated and applied in the same manner to reduce S's bases (if any) in assets identified as Class VI assets in § 1.338-6(b)(2)(vi), and then to reduce S's bases (if any) in its assets identified in § 1.338-6(b)(2) as Class V, Class IV, Class III, and Class II, successively.

(C) Attribute reduction amount exceeding attributes available for reduction. If the amount to be allocated and applied to attributes in Category D other than lower-tier subsidiary stock exceeds the amount of attributes in that category, then—

(1) To the extent of any liabilities of S that are not taken into account for tax purposes before the transfer, such excess amount is suspended. The suspended amount is applied proportionately to reduce any amounts attributable to S that would be deductible or capitalizable as a result of such liabilities being taken into account by S or any other person. Solely for purposes of this paragraph (d)(4)(ii)(C)(1) and paragraph (d)(5)(ii)(B) of this section, the term liability means any liability or obligation the satisfaction of which would be required to be capitalized as an assumed liability by a person that purchased all of S's assets and assumed all of S's liabilities in a single transaction.

(2) To the extent such excess amount is greater than any amount suspended under paragraph (d)(4)(ii)(C)(1) of this section, it is disregarded and has no further effect.

(iii) Time and effect of attribute reduction. In general, the reduction of attributes is effective immediately before the transfer of a loss share of S stock. If the reduction to a member's basis in a share of lower-tier subsidiary stock exceeds the basis of that share, to the extent the excess is not restored under paragraph (d)(5)(vi) of this section it is an excess loss account in that share (and such excess loss account is not taken into account under § 1.1502-19 or otherwise as a result of the transaction). The reductions to attributes required under this paragraph (d)(4), including by reason of paragraph (d)(5)(v) of this section (tier down of attribute reduction amounts to lower-tier subsidiaries), are not noncapital, nondeductible expenses described in § 1.1502-32(b)(2)(iii).

(5) Special rules applicable if S holds stock of another subsidiary. If S holds shares of stock of any other subsidiary (S1) as of a transfer of loss shares of S stock, the rules of this paragraph (d)(5) apply with respect to each such subsidiary.

(i) Treatment of lower-tier subsidiary stock for computation of S's attribute reduction amount. For purposes of determining S's net inside attribute amount and attribute reduction amount under paragraph (d)(3) of this section—

(A) Single share. All of S's shares of S1 stock held as of the transfer of S stock (whether or not transferred in, or held by S immediately after, the transaction) are treated as a single share of stock (generally referred to as the S1 stock); and

(B) Deemed basis. S's basis in its S1 stock is treated as its deemed basis in the stock, which is equal to the greater of—

(1) The sum of S's basis in each share of S1 stock (adjusted to reflect any gain or loss recognized on the transfer of any S1 shares in the transaction, whether allowed or disallowed); and

(2) The portion of S1's net inside attribute amount allocable to S's shares of S1 stock.

(C) Multiple tiers. For purposes of computing deemed basis under paragraph (d)(5)(i)(B) of this section, a subsidiary's basis in stock of a lower-tier subsidiary is the deemed basis in that lower-tier subsidiary stock. Thus, if stock is held in multiple tiers, the computation of deemed basis begins at the lowest tier, so that the computation of deemed basis at each tier takes into account the deemed basis of all lower-tier shares.

(ii) Allocation of S's attribute reduction amount between lower-tier subsidiary stock and other Category D assets. The portion of S's attribute reduction amount that is not applied to reduce S's Category A, Category B, and Category C attributes must be allocated between each of S's deemed single shares of S1 stock and all of S's other Category D assets. For this purpose, S's Category D assets other than lower-tier subsidiary stock are treated as one asset with a basis equal to the aggregate bases of all Category D assets other than lower-tier subsidiary stock (non-stock Category D asset). S's attribute reduction amount is allocated proportionately (by basis) between (among) the non-stock Category D asset and S's deemed single share(s) of subsidiary stock. (See paragraphs (d)(4)(ii)(B)(2) and (d)(4)(ii)(C) of this section regarding the portion of S's attribute reduction amount allocated to the Category D assets other than lower-tier subsidiary stock.) For allocation purposes, S's basis in each deemed single share of S1 stock is its deemed basis (determined under paragraphs (d)(5)(i)(B) and (d)(5)(i)(C) of this section), reduced by—

(A) The value of S's transferred shares of S1 stock; and

(B) The nontransferred S1 shares' allocable portion of the excess of S1's non-loss assets over S1's liabilities (including liabilities described in paragraph (d)(4)(ii)(C)(1) of this section). For this purpose, S1's non-loss assets are—

(1) S1's assets identified as Class I assets in § 1.338-6(b)(1),

(2) The value of S1's transferred shares of lower-tier subsidiary stock, and

(3) The nontransferred lower-tier subsidiary shares' allocable portions of lower-tier non-loss assets (net of liabilities, including liabilities described in paragraph (d)(4)(ii)(C)(1) of this section) of all lower-tier subsidiaries.

(iii) Application of attribute reduction amount to S's S1 stock. The portion of S's attribute reduction amount allocated under paragraph (d)(5)(ii) of this section to each deemed single share of S1 stock (allocated attribute reduction amount) is apportioned among, and applied to reduce S's bases in, individual S1 shares in accordance with the following—

(A) No portion of the allocated attribute reduction amount is apportioned to an individual share of transferred S1 stock if gain or loss is recognized on its transfer (recognition transfer);

(B) The allocated attribute reduction amount is apportioned among all of S's other shares of S1 stock in a manner that, first reduces the loss in and disparity among S's bases in loss shares of S1 preferred stock to the greatest extent possible, and then reduces the disparity among S's bases in the shares of S1 common stock (other than those transferred in a recognition transfer) to the greatest extent possible;

(C) The allocated attribute reduction amount apportioned to an individual S1 share is applied to reduce the basis of that share to, but not below, value if the share is either a preferred share or a common share that is transferred other than in a recognition transfer; and

(D) The allocated attribute reduction amount apportioned to an individual S1 share is applied to reduce the basis of that share without regard to value if the share is a common share that is not transferred in the transaction.

(iv) Unapplied allocated attribute reduction amount. Any portion of the allocated attribute reduction amount that is not applied to reduce S's basis in a share of S1 stock has no effect on any other attributes of S, it is not a noncapital, nondeductible expense of S, and it does not cause S to recognize income or gain. However, such amounts continue to be part of the allocated attribute reduction amount for purposes of the tier down rule in paragraph (d)(5)(v) of this section.

(v) Tier down of attribute reduction amount—(A) General rule. The allocated attribute reduction amount of each deemed single share of S1 stock is an attribute reduction amount of S1 (tier-down attribute reduction amount). Accordingly, the tier-down attribute reduction amount, in combination with any attribute reduction amount computed with respect to the transferred S1 shares (if any) (direct S1 attribute reduction amount), applies to reduce S1's attributes under the provisions of this paragraph (d). The tier-down attribute reduction amount is an attribute reduction amount of S1 that must be allocated to S1's assets, and may become an allocated attribute reduction amount of lower-tier subsidiary stock (and thus a tier-down attribute reduction amount of a lower-tier subsidiary), even if its application to S1's attributes is limited under paragraph (d)(5)(v)(B) of this section.

(B) Conforming limitation on reduction of lower-tier subsidiary's attributes. Notwithstanding the general rule in paragraph (d)(5)(v)(A) of this section, and unless P elects otherwise in the manner provided in paragraph (e)(5) of this section, the application of S1's tier-down attribute reduction amount to S1's attributes is limited to an amount equal to the excess of the portion of S1's net inside attribute amount that is allocable to all S1 shares held by members as of the transaction (whether or not transferred in the transaction) over the sum of—

(1) Any direct S1 attribute reduction amount;

(2) The aggregate value of all S1 shares transferred by members in the transaction with respect to which gain or loss was recognized (recognition transfer);

(3) The sum of all members' bases (after any reduction under this section, including this paragraph (d)) in any shares of S1 stock transferred by members in the transaction (other than in a recognition transfer), reduced by any direct S1 attribute reduction amount computed with respect to the transfer of such S1 shares; and

(4) The sum of all members' bases (after any reduction under this section, including this paragraph (d)) in any nontransferred shares of S1 stock held as of the transaction.

(vi) Stock basis restoration—(A) In general. After paragraph (d)(5)(v) of this section has applied with respect to all shares of subsidiary stock transferred in the transaction, lower-tier subsidiary stock basis is restored under this paragraph (d)(5)(vi). Under this paragraph (d)(5)(vi), the reductions to members' bases in shares of lower-tier subsidiary stock under paragraph (d)(5)(iii) of this section are reversed to the extent necessary to restore such bases to an amount that conforms the basis of each such share to its allocable portion of the subsidiary's net inside attribute amount, taking into account any reductions under this paragraph (d). Restoration adjustments are first made at the lowest tier and then at each next higher tier successively. Restoration adjustments do not tier up to affect the bases of higher-tier shares. Rather, restoration is computed and applied separately at each tier. For purposes of this rule, when computing a subsidiary's net inside attribute amount—

(1) The subsidiary's basis in stock of a lower-tier subsidiary is the actual basis of the stock after application of this paragraph (d); and

(2) Any attribute reduction amount allocated to the subsidiary's Category D assets other than lower-tier subsidiary stock that is suspended under paragraph (d)(4)(ii)(C)(1) of this section is treated as reducing the subsidiary's net inside attribute amount.

(B) Election not to restore basis. Notwithstanding paragraph (d)(5)(vi)(A) of this section, P may elect not to restore basis in stock of a lower-tier subsidiary that was reduced under paragraph (d)(5)(iii) of this section. An election not to restore lower-tier subsidiary stock basis is made in the manner provided in paragraph (e)(5) of this section.

(6) Elections to reduce the potential for loss duplication—(i) In general. Notwithstanding the general operation of this paragraph (d), P may elect to reduce the potential for loss duplication, and thereby reduce or avoid attribute reduction. To the extent of S's attribute reduction amount tentatively computed without regard to any election under this paragraph (d)(6), P may elect—

(A) To reduce all or any portion (including any portion in excess of a specified amount) of members' bases in transferred loss shares of S stock;

(B) To reattribute all or any portion (including any portion in excess of a specified amount) of S's Category A, Category B, and Category C attributes (including such attributes of lower-tier subsidiaries), to the extent they would otherwise be subject to reduction under this paragraph (d); or

(ii) Manner and effect of election. An election to reduce loss duplication under this paragraph (d)(6) is made in the manner provided in paragraph (e)(5) of this section. Although such elections are irrevocable, they have no effect—

(A) If there is no attribute reduction amount; or

(B) To the extent S's attribute reduction amount is less than the amount specified in the election.

(iii) Order of application—(A) Stock of one subsidiary transferred in the transaction. If shares of stock of only one subsidiary are transferred in the transaction, any stock basis reduction and reattribution of attributes (including from lower-tier subsidiaries) is deemed to occur immediately before the application of this paragraph (d). If a transferred share is still a loss share after giving effect to this election, the other provisions of this paragraph (d) then apply with respect to that share.

(B) Stock of multiple subsidiaries transferred in the transaction. If shares of stock of more than one subsidiary are transferred in the transaction and elections under this paragraph (d)(6) are made with respect to transfers of stock of subsidiaries in multiple tiers, effect is given to the elections from the lowest tier to the highest tier in the manner provided in this paragraph (d)(6)(iii)(B). The amount of the election for the transfer at the lowest tier is determined by applying this paragraph (d) with respect to the transferred loss shares of this lowest-tier subsidiary immediately after applying paragraphs (b) and (c) of this section to the stock of such subsidiary. The effect of any stock basis reduction or reattribution of losses immediately tiers up under § 1.1502-32 to adjust members' bases in higher-tier shares. Elections and adjustments are then made with respect to transfers at each next higher tier successively.

(iv) Special rules for reattribution elections—(A) In general. Because the reattribution election is intended to provide the group a means to retain certain S attributes, and not to change the location of attributes where S continues to be a member of the same group as P, the election to reattribute attributes may only be made if S becomes a nonmember (within the meaning of § 1.1502-19(c)(2)) as a result of the transaction and S does not become a member of any group that includes P. The election to reattribute S's attributes can only be made for attributes in Category A, Category B, and Category C. The attributes that would otherwise be reduced under paragraph (d)(4) of this section may be reattributed to P. Accordingly, P may specify the attributes in Category A, Category B, and Category C to be reattributed. Such an election is made in the manner provided in paragraph (e)(5) of this section. To the extent that P elects to reattribute attributes but does not specify the attributes to be reattributed, any attributes not specifically reattributed will be reattributed in the default amount, order, and category described in paragraph (d)(4)(ii)(A)(1) of this section. P succeeds to reattributed attributes as if such attributes were succeeded to in a transaction to which section 381(a) applies. Any owner shift of the subsidiary (including any deemed owner shift resulting from section 382(g)(4)(D) or section 382(l)(3)) in connection with the transaction is not taken into account under section 382 with respect to the reattributed attributes. (See § 1.1502-96(d) for rules relating to section 382 and the reattribution of losses under this paragraph (d)(6).) The reattribution of S's attributes is a noncapital, nondeductible expense described in § 1.1502-32(b)(2)(iii). See § 1.1502-32(c)(1)(ii)(A) regarding special allocations applicable to such noncapital, nondeductible expense. If P elects to reattribute S attributes (including attributes of a lower-tier subsidiary) and reduce S stock basis, the reattribution is given effect before the stock basis reduction.

(B) Insolvency limitation. If S, or any higher-tier subsidiary, is insolvent within the meaning of section 108(d)(3) at the time of the transfer, S's losses may be reattributed only to the extent they exceed the sum of the separate insolvencies of any subsidiaries (taking into account only S and its higher-tier subsidiaries) that are insolvent. For purposes of determining insolvency, liabilities owed to higher-tier members are not taken into account, and stock of a subsidiary that is limited and preferred as to dividends and that is not owned by higher-tier members is treated as a liability to the extent of the amount of preferred distributions to which the stock would be entitled if the subsidiary were liquidated on the date of the transfer.

(C) Limitation on reattribution from lower-tier subsidiaries. P's ability to reattribute attributes of lower-tier subsidiaries is limited under this paragraph (d)(6)(iv)(C) in order to prevent circular computations of the attribute reduction amount. Accordingly, attributes that would otherwise be reduced as a result of tier-down attribute reduction under paragraph (d)(5)(v) of this section may only be reattributed to the extent that the reduction in the basis of any lower-tier subsidiary stock resulting from the noncapital, nondeductible expense (as allocated under § 1.1502-32(c)(1)(ii)(A)(2)) will not create an excess loss account in any such stock.

(v) Special rules for stock basis reduction elections—(A) In general. An election to reduce basis in S stock is made with respect to all members' bases in loss shares of S stock that are transferred in the transaction. The reduction is allocated among all such shares in proportion to the amount of loss on each share. This reduction in S stock basis is a noncapital, nondeductible expense described in § 1.1502-32(b)(2)(iii) of the transferring member.

(B) Adjustment to the attribute reduction amount. The attribute reduction amount (determined under paragraph (d)(3)(i) of this section) is treated as reduced by the amount of any elective reduction in the basis of the S stock under this paragraph (d)(6). Accordingly, the election to reduce stock basis under this paragraph (d)(6) is treated as reducing or eliminating the duplication even if the shares of S stock are loss shares after giving effect to the election.

(C) Deemed stock basis reduction election in the case of certain disallowed stock losses. If there is a net stock loss in transferred shares after taking into account any actual elections under this paragraph (d)(6), and the stock loss would otherwise be permanently disallowed (for example, under section 311(a)), P will be deemed to have made a stock basis reduction election equal to such net stock loss.

(7) Additional attribute reduction in the case of certain transfers due to worthlessness and certain transfers not followed by a separate return year—(i) In general. Notwithstanding any other provision of this paragraph (d), if a transfer is subject to this paragraph (d)(7) any of S's Category A, Category B, and Category C attributes not otherwise reduced or reattributed under this paragraph (d), and any credit carryover attributable to S, including any consolidated credits that would be apportioned to S under the principles of § 1.1502-79 if S had a separate return year, are eliminated. Attributes other than consolidated tax attributes are eliminated under this paragraph (d)(7)(i) immediately before the transfer subject to this paragraph (d)(7)(i). The elimination of attributes under this paragraph (d)(7)(i) is not a noncapital, nondeductible expense described in § 1.1502-32(b)(2)(iii).

(ii) Transfers subject to this paragraph (d)(7). A transfer is subject to this paragraph (d)(7) if—

(A) M transfers a share of S stock solely by reason of a transfer defined in paragraph (f)(10)(i)(D) of this section (worthlessness where the provisions of § 1.1502-80(c) are satisfied), M recognizes a net deduction or loss on the share, and S is a member of the group on the day following the last day of the group's taxable year during which the share becomes worthless under section 165 (taking into account the provisions of § 1.1502-80(c)), or

(B) M recognizes a net deduction or loss on the stock of S in a transaction in which S ceases to be a member and does not become a nonmember within the meaning of § 1.1502-19(c)(2).

(iii) Example. The application of this paragraph (d) to transfers due to worthlessness and to loss transfers not followed by separate return years is illustrated by the following example.

Example. (i) Worthlessness where S continues as a member. M owns the sole share of S stock. The share is worthless under section 165. In addition, S has disposed of all its assets within the meaning of § 1.1502-19(c)(1)(iii)(A) and therefore satisfies the provisions of § 1.1502-80(c). M claims a worthless securities deduction with respect to the share. The worthlessness is a transfer of the S share, a loss share, and therefore subject to this section. After the application of paragraphs (b) and (c) of this section, M's basis in the share (and therefore M's net stock loss) is $75. The portion of the consolidated net operating loss attributable to S is $100. Under the general rules of this paragraph (d), S's attribute reduction amount is $75 (the lesser of M's $75 net stock loss and S's $100 aggregate inside loss ($100 net inside attribute amount over $0 value of S share)). S's attributes are reduced by $75, from $100 to $25. In addition, if S remains a member of the P group, this paragraph (d)(7) applies to eliminate the remaining $25 of the consolidated net operating loss attributable to S because the S share is worthless, and M recognizes a deduction (taking into account § 1.1502-80(c)) with respect to the share. Accordingly, after the application of this section, M recognizes a $75 worthless securities deduction, S has $0 net inside attributes, and the consolidated net operating loss is reduced by a total of $100.

(ii) Dissolution of insolvent subsidiary. The facts are the same as in paragraph (i) of this Example, except that S is insolvent, does not dispose of all its assets within the meaning of § 1.1502-19(c)(1)(iii)(A), M causes S to be legally dissolved, and the S share held by M is cancelled without consideration. Under paragraph (d)(7)(ii)(B) of this section, the dissolution of S is subject to this paragraph (d)(7) and the result is the same as in paragraph (i) of this Example. The result would also be the same if instead of being legally dissolved, S was converted into an entity that is disregarded as separate from M.

(iii) Stock cancelled in connection with a section 381(a) transaction with another member. M owns the sole share of S common stock with a basis of $75. M1 owns the sole share of S preferred stock. The value of S's assets (net of liabilities) is less than the liquidation preference on the S preferred stock. In a reorganization described in section 368(a)(1)(D), S transfers all of its assets to M2 in exchange for M2 common stock and M2's assumption of S's liabilities, S distributes all of the M2 common stock received in the exchange to M1 in exchange for M1's S preferred stock, the S common stock held by M is cancelled without consideration, and S ceases to exist. Notwithstanding that M is not entitled to treat its common share of S stock as worthless until § 1.1502-80(c) is satisfied, M's share is transferred within the meaning of paragraph (f)(10)(i)(A) of this section because M ceases to own the share in a transaction in which, but for this section (and notwithstanding the deferral of any amount recognized on the transfer, other than by reason of § 1.1502-13), M would recognize a loss or deduction with respect to the share. Accordingly, there is a transfer of the S common share and this section applies to the transfer. There are no adjustments under paragraphs (b) or (c) of this section because no investment adjustments have been applied to the bases of the shares. The transfer of the S common stock is subject to the general rules of this paragraph (d), but is not subject to the additional attribute reduction under this paragraph (d)(7) because the transfer was not solely by reason of worthlessness where § 1.1502-80(c) is satisfied, and S did not cease to be a member because M2 is a successor to S.

(iv) Stock cancelled in connection with a section 381(a) transaction with a nonmember. The facts are the same as in paragraph (iii) of this Example, except that the S preferred share is held by X, instead of M2 acquiring S's assets, S merges into Y in a reorganization described in section 368(a)(1)(A), M1 receives all of the Y stock issued in the merger in exchange for M1's S preferred stock, and Y does not become a member as a result of the transaction. M treats the cancelled S common stock as worthless, and § 1.1502-80(c) is satisfied because S ceases to be a member. In this case, there is a transfer of M's S common share because it becomes worthless (taking into account § 1.1502-80(c)); because M ceases to own the share in a transaction in which, but for this section (and notwithstanding the deferral of any amount recognized on the transfer, other than by reason of § 1.1502-13), M would recognize a loss or deduction with respect to the share; and because M and S cease to be members of the same group. The transfer of the S common stock is subject to the general rules of this paragraph (d), but is not subject to the additional attribute reduction under this paragraph (d)(7) because the transfer was not solely by reason of worthlessness where § 1.1502-80(c) is satisfied and, although S did cease to be a member, S became a nonmember within the meaning of § 1.1502-19(c)(2) because Y is a successor to S.

(8) Examples. The application of this paragraph (d) is illustrated by the following examples:

Example 1. Computation of attribute reduction amount. (i) Transfer of all S shares. (A) Facts. M owns all 100 of the outstanding shares of S stock with a basis of $2 per share. S owns land with a basis of $100, has a $120 loss carryover, and has no liabilities. Each share has a value of $1. M sells 30 of the S shares to X for $30. As a result of the sale, M and S cease to be members of the same group. Accordingly, all 100 of the S shares are transferred. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) (with respect to the 30 S shares sold to X) of this section. M's transfer of the S shares is a transfer of loss shares and therefore subject to this section.

(B) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is no disparity among M's bases in shares of S common stock and there are no shares of S preferred stock outstanding (so there can be no unrecognized gain or loss on preferred stock). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. No adjustment is required under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's transfer of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). Under this paragraph (d), S's attributes are reduced by S's attribute reduction amount. Paragraph (d)(3) of this section provides that S's attribute reduction amount is the lesser of the net stock loss and S's aggregate inside loss. The net stock loss is the excess of the $200 aggregate bases of the transferred shares over the $100 aggregate value of the transferred shares, or $100. S's aggregate inside loss is the excess of its $220 net inside attribute amount (the sum of the $100 basis in the land and the $120 loss carryover) over the $100 value of all outstanding S shares, or $120. The attribute reduction amount is therefore the lesser of the $100 net stock loss and the $120 aggregate inside loss, or $100. Under paragraph (d)(4) of this section, S's $100 attribute reduction amount is allocated and applied to reduce S's $120 loss carryover to $20. Under paragraph (d)(4)(iii) of this section, the reduction of the loss carryover is not a noncapital, nondeductible expense and has no effect on M's basis in the S stock.

(ii) Transfer of less than all S shares. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 1, except that M only sells 20 S shares to X. M's sale of the 20 S shares is a transfer of loss shares and therefore subject to this section. See paragraph (f)(10)(i)(A) and (f)(10)(i)(C) of this section. (There is no transfer of the remaining shares because S and M remain members of the same group.)

(B) Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of this Example 1. Thus, after the application of paragraph (c) of this section, M's transfer of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). Under this paragraph (d), S's attributes are reduced by S's attribute reduction amount. Paragraph (d)(3) of this section provides that S's attribute reduction amount is the lesser of the net stock loss and S's aggregate inside loss. The net stock loss is $20, the excess of the $40 aggregate bases of the transferred shares over the $20 aggregate value of the transferred shares. S's aggregate inside loss is $120, the excess of its $220 net inside attribute amount (the sum of the $100 basis in the land and the $120 loss carryover) over the $100 value of all outstanding S shares. The attribute reduction amount is therefore $20, the lesser of the $20 net stock loss and the $120 aggregate inside loss. Under paragraph (d)(4) of this section, S's $20 attribute reduction amount is allocated and applied to reduce S's $120 loss carryover to $100.

Example 2. Proportionate allocation of attribute reduction amount. (i) Facts. M owns the sole outstanding share of S stock with a basis of $150. S owns land with a basis of $60, a factory with a basis of $30, publicly traded property with a basis of $30 and goodwill with a basis of $30. M sells its S share for $90. M's sale of the S share is a transfer of a loss share and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.

(ii) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. No adjustment is required under paragraph (c) of this section because both the disconformity amount and the net positive adjustment are $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(iii) Attribute reduction under this paragraph (d). Under paragraph (d)(3) of this section, S's attribute reduction amount is determined to be $60, the lesser of the $60 net stock loss ($150 basis over $90 value) and S's $60 aggregate inside loss (the excess of S's $150 net inside attribute amount (the $60 basis of the land, plus the $30 basis of the factory, plus the $30 basis of the publicly traded property, plus the $30 basis of the goodwill) over the $90 value of the S share). Under paragraph (d)(4)(ii)(B)(2) of this section, the $60 attribute reduction amount is allocated and applied to reduce S's bases in its Category D assets, S's only attributes available for reduction, as follows:

Available attributes, basis in Category D assets | Attribute amount | Allocable portion of attribute reduction amount | Adjusted attribute amount

Class VII, Goodwill | $30 | $30 | $0

Class V:

Land | 60 | (60/90 × 60) 40 | 20

Factory | 30 | (30/90 × 60) 20 | 10

Total Class V | 90 | 60 | 30

Class II, publicly traded property | 30 | 0 | 30

Totals | 150 | 60 | 90

Example 3. Attribute reduction amount less than total attributes in Category A, Category B, and Category C. (i) No election to prescribe the allocation of S's attribute reduction amount. (A) Facts. P owns the sole outstanding share of M stock with a basis of $1,000 and M owns the sole outstanding share of S stock with a basis of $210. M sells its S share to X for $100. M's sale of the S share is a transfer of a loss share and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section. At the time of the sale, S has no liabilities and the following attributes:

Category | Attribute | Attribute amount

Category A | Capital loss carryover | $10

Category B | NOL carryover | 200

Category C | Deferred deductions | 40

Category D, Class V | Basis in Land | 50

Total Attributes | 300

(B) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. No adjustment is required under paragraph (c) of this section because both the disconformity amount and the net positive adjustment are $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's transfer of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of the $110 net stock loss ($210 basis over $100 value) and S's aggregate inside loss. S's aggregate inside loss is $200 (S's $300 net inside attribute amount (the $10 capital loss carryover, plus the $200 NOL carryover, plus the $40 deferred deductions, plus the $50 basis in land) less the $100 value of all outstanding S shares). Thus, the attribute reduction amount is $110, the lesser of the $110 net stock loss and S's $200 aggregate inside loss. Under paragraph (d)(4)(ii)(A)(1) of this section, the $110 attribute reduction amount is allocated and applied to reduce S's attributes as follows:

Category | Attribute | Attribute amount | Allocation of attribute reduction amount | Adjusted attribute amount

Category A | Capital loss carryover | $10 | $10 | $0

Category B | NOL carryover | 200 | 100 | 100

Category C | Deferred deductions | 40 | 0 | 40

Category D, Class V | Basis in land | 50 | 0 | 50

Totals | 300 | 110 | 190

(ii) Election to prescribe the allocation of attribute reduction amount. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 3, except that P elects to allocate the attribute reduction amount to eliminate the Category C attributes, preserve the capital loss carryover, and reduce Category B attributes.

(B) Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of this Example 3. Thus, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share, and accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). For the reasons set forth in paragraph (i)(C) of this Example 3, under this paragraph (d)(3), S's attribute reduction amount is determined to be $110. M elects to apply S's $110 attribute reduction amount as follows:

Category | Attribute | Attribute amount | Allocation of attribute reduction amount | Adjusted attribute amount

Category A | Capital loss carryover | $10 | $0 | $10

Category B | NOL carryover | 200 | 70 | 130

Category C | Deferred deductions | 40 | 40 | 0

Category D, Class V | Basis of land | 50 | 0 | 50

Totals | 300 | 110 | 190

Example 4. Attributes attributable to liability not taken into account. (i) S operates one business. (A) Facts. On January 1, year 1, M forms S by exchanging $150 for the sole outstanding share of S stock. In year 1, S earns $500, purchases land for $50, spends $100 to build a factory on that land, and then purchases publicly traded property for $250. In year 2, S earns a section 38 general business credit of $50. However, pollution generated by S's business gives rise to an environmental remediation liability under Federal law that would be required to be capitalized if a person purchased S's assets and assumed the liability. Before any amounts have been taken into account with respect to the environmental remediation liability, when the liability has a present value of $500, M sells its S share to X for $150. After giving effect to all other provisions of law, M's basis in the S share is $650 (the original basis of $150 increased under § 1.1502-32 by $500 for the income earned). The sale is therefore a transfer of a loss share of subsidiary stock and subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.

(B) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. No adjustment to basis is made under paragraph (c) of this section because, although the net positive adjustment is $500, the disconformity amount is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of the $500 net stock loss ($650 basis over $150 value) and the aggregate inside loss. The aggregate inside loss is $500, computed as the excess of S's $650 net inside attribute amount (the sum of S's $100 basis in the factory, $50 basis in the land, $250 basis in the publicly traded property, and $250 cash remaining after the purchases) over the $150 value of the S share. Thus, S's attribute reduction amount is $500, the lesser of the $500 net stock loss and the $500 aggregate inside loss. Under paragraph (d)(4)(ii)(B)(2) of this section, S's $500 attribute reduction amount is allocated and applied to reduce S's attributes as follows:

Available attributes | Attribute amount | Allocable portion of attribute reduction amount | Adjusted attribute amount

Category D:

Class V Assets:

Basis of factory | $100 | $100 | $0

Basis of land | 50 | 50 | 0

Class II Assets:

Publicly traded property | 250 | 250 | 0

(2) The remaining $100 attribute reduction amount is not applied to S's $250 cash (Class I asset) or to S's $50 general business tax credit. Under the general rule of this paragraph (d), that remaining $100 attribute reduction amount would have no further effect on S's attributes. However, S has a $500 liability that has not been taken into account. Therefore, under paragraph (d)(4)(ii)(C)(1) of this section, the remaining $100 attribute reduction amount is suspended and will be allocated and applied to reduce any amounts that become deductible or capitalizable as a result of the environmental remediation liability later being taken into account. If the liability is satisfied for an amount that is less than $100, under paragraph (d)(4)(ii)(C)(2) of this section the remaining portion of that $100 suspended attribute reduction amount is disregarded and has no further effect.

(ii) Lower-tier subsidiary with additional liability. (A) Facts. The facts are the same as in paragraph (i)(A) of Example 4, except that, in addition, S exchanged $50 for the sole outstanding share of stock of S1. S1 has $50 and equipment with an aggregate basis of $0. S1 also has employee medical expense liabilities that have not been taken into account and that would be required to be capitalized if a person purchased S1's assets and assumed the liabilities. At the time of the sale, S's environmental remediation liability had a present value of $475 and S1's employee medical expenses had a present value of $25. For the reasons set forth in paragraph (i)(A) of this Example 4, M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(B) Application of paragraphs (b) and (c) of this section. No adjustment is made under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of this Example 4. Thus, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of the $500 net stock loss ($650 basis over $150 value) and the aggregate inside loss. The aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net inside attribute amount is determined by using S's $50 deemed basis in the S1 share (the greater of S's $50 actual basis in the share and S1's $50 net inside attribute amount). Accordingly, S's net inside attribute amount is $650 (the sum of its $100 basis in the factory, $50 basis in the land, $250 basis in the publicly traded property, $200 cash, and $50 deemed basis in its S1 share). The aggregate inside loss is $500, the excess of S's $650 net inside attribute amount over the $150 value of the S share. Thus, S's attribute reduction amount is $500, the lesser of the $500 net stock loss and S's $500 aggregate inside loss.

(2) Allocation, apportionment, and application of attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $500 attribute reduction amount is allocated proportionately (by basis) between its S1 share and its non-stock Category D asset (consisting of all S's Category D assets other than its share of S1 stock, with a basis equal to $600, the aggregate basis of S's non-stock assets). However, under paragraph (d)(5)(ii) of this section, for purposes of allocating S's attribute reduction amount between its non-stock Category D asset and the S1 share, S's $50 deemed basis in its S1 share is treated as reduced by S1's $25 net non-loss assets (its Class I asset, $50 cash over S1's liabilities (which, for this purpose include the $25 of employee medical expense liabilities not taken into account as of the transfer)). As a result, S's attribute reduction amount is allocated $480 (600/625 × 500) to S's non-stock Category D asset and $20 (25/625 × 500) to the S1 share. The $480 attribute reduction amount allocated to S's non-stock Category D asset produces the same reduction in the bases of S's assets (other than the S1 stock) as in paragraph (i)(C) of this Example 4; in addition, the $80 attribute reduction amount not applied to reduce S's attributes is suspended and applied to reduce any amounts that become deductible or capitalizable as a result of the environmental remediation liability later being taken into account. If the liability is satisfied for an amount that is less than $80, under paragraph (d)(4)(ii)(C)(2) of this section the remaining portion of that $80 suspended attribute reduction amount is disregarded and has no further effect. Because the S1 share is not transferred within the meaning of paragraph (f)(10) of this section, the allocated attribute reduction amount apportioned to the S1 share is applied fully to reduce the basis of the S1 share to $30. See paragraph (d)(5)(iii) of this section.

(D) Tier down of S's attribute reduction amount. The $20 portion of S's attribute reduction amount allocated to the S1 share is an attribute reduction amount of S1. Because S1 holds only cash, it has no attributes available for reduction under this paragraph (d). However, because S1 has a $25 liability not taken into account for tax purposes, paragraph (d)(4)(ii)(C)(1) of this section requires that $20 of the unapplied attribute reduction amount be suspended and then allocated and applied to reduce any amounts that become deductible or capitalizable as a result of the employee medical expense liabilities later being taken into account. If these liabilities are satisfied for an amount that is less than $20, under paragraph (d)(4)(ii)(C)(2) of this section the remaining portion of that $20 suspended attribute reduction amount is disregarded and has no further effect.

Example 5. Wholly owned lower-tier subsidiary (no lower-tier transfer). (i) Application of conforming limitation. (A) Facts. M owns the sole outstanding share of S stock with a basis of $250. S owns Asset with a basis of $100 and the only two outstanding shares of S1 stock (Share A has a basis of $40 and Share B has a basis of $60). S1 owns Asset 1 with a basis of $50. M sells its S share to P1, the common parent of another consolidated group, for $50. The sale is a transfer of a loss share and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.

(B) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. No adjustment is required under paragraph (c) of this section because, although there is a $50 disconformity amount, the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of M's net stock loss and S's aggregate inside loss. M's net stock loss is $200 ($250 basis over $50 value). S's aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net inside attribute amount is $200, computed as the sum of S's $100 basis in Asset and its $100 deemed basis in the deemed single share of S1 stock (computed as the greater of S's $100 aggregate basis in the S1 shares and S1's $50 basis in Asset 1). S's aggregate inside loss is therefore $150, $200 net inside attribute amount over the $50 value of the S share. Accordingly, S's attribute reduction amount is $150, the lesser of the $200 net stock loss and the $150 aggregate inside loss.

(2) Allocation, apportionment, and application of S's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $150 attribute reduction amount is allocated proportionately (by basis) between Asset (non-stock Category D asset) with a basis of $100, and the S1 stock (treated as a single share with a deemed basis of $100). Accordingly, $75 of the attribute reduction amount ($100/$200 × $150) is allocated to Asset and $75 of the attribute reduction amount ($100/$200 × $150) is allocated to the S1 stock. The $75 of the attribute reduction amount allocated to Asset is applied to reduce S's basis in Asset from $100 to $25. The $75 of the attribute reduction amount allocated to the S1 stock is first apportioned between the shares in a manner that reduces disparity to the greatest extent possible. Thus, of the total $75 allocated to the S1 stock, $27.50 is apportioned to Share A and $47.50 is apportioned to Share B. Because neither of the S1 shares is transferred within the meaning of paragraph (f)(10) of this section, the allocated attribute reduction amount apportioned to each of the individual S1 shares is applied fully to reduce the basis of each share to $12.50. See paragraph (d)(5)(iii) of this section. As a result, immediately after the allocation, apportionment, and application of S's attribute reduction amount, S's basis in Asset is $25 and S's basis in each of the S1 shares is $12.50.

(3) Tier down of S's attribute reduction amount, application of conforming limitation. Under paragraph (d)(5)(v)(A) of this section, the $75 portion of S's attribute reduction amount allocated to the S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Under the general rules of this paragraph (d), the $75 tier-down attribute reduction amount would be allocated and applied to reduce S1's basis in Asset 1 from $50 to $0. However, under paragraph (d)(5)(v)(B) of this section, S1's attributes can be reduced by only $25, the excess of the $50 portion of S1's net inside attribute amount that is allocable to all S1 shares held by members as of the transaction over $25, the aggregate amount of members' bases in nontransferred S1 shares after reduction under this paragraph (d). Thus, of S1's $75 tier-down attribute reduction amount, only $25 is applied to reduce S1's basis in Asset 1, from $50 to $25. The $50 unapplied portion of the tier-down attribute reduction amount subject to the conforming limitation has no further effect.

(ii) Application of basis restoration rule. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 5, except that S's basis in Share A is $15 and S's basis in Share B is $35, and S1's basis in Asset 1 is $100.

(B) Basis redetermination and basis reduction under paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of this Example 5. Thus, after the application of paragraph (c) of this section, M's transfer of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of M's net stock loss and S's aggregate inside loss. M's net stock loss is $200 ($250 basis over $50 value). S's aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net inside attribute amount is $200, the sum of S's $100 basis in Asset and its $100 deemed basis in the deemed single share of S1 stock (computed as the greater of S's $50 aggregate basis in the S1 shares and S1's $100 basis in Asset 1). S's aggregate inside loss is therefore $150, $200 net inside attribute amount over the $50 value of the S share. Accordingly, S's attribute reduction amount is $150, the lesser of the $200 net stock loss and the $150 aggregate inside loss.

(2) Allocation, apportionment, and application of S's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $150 attribute reduction amount is allocated proportionately (by basis) between Asset (non-stock Category D asset) with a basis of $100, and the S1 stock (treated as a single share with a deemed basis of $100). Accordingly, $75 of the attribute reduction amount ($100/$200 × $150) is allocated to Asset and $75 of the attribute reduction amount ($100/$200 × $150) is allocated to the S1 stock. The $75 of the attribute reduction amount allocated to Asset is applied to reduce S's basis in Asset from $100 to $25. The $75 of the attribute reduction amount allocated to the S1 stock is first apportioned between the shares in a manner that reduces disparity to the greatest extent possible. Thus, of the total $75 allocated to the S1 stock, $27.50 is apportioned to Share A and $47.50 is apportioned to Share B. Because neither of the S1 shares is transferred within the meaning of paragraph (f)(10) of this section, the allocated attribute reduction amount apportioned to each of the individual S1 shares is applied fully to reduce the basis of each share to an excess loss account of $12.50. See paragraph (d)(5)(iii) of this section. As a result, immediately after the allocation, apportionment, and application of S's attribute reduction amount, S's basis in Asset is $25 and S's basis in each of the S1 shares is an excess loss account of $12.50.

(3) Tier down of S's attribute reduction amount. Under paragraph (d)(5)(v)(A) of this section, the $75 portion of S's attribute reduction amount allocated to S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Accordingly, under the general rules of this paragraph (d), the $75 tier-down attribute reduction amount is applied to reduce S1's basis in Asset 1 from $100 to $25.

(4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of lower-tier subsidiary stock under paragraph (d)(5)(iii) of this section is reversed to the extent necessary to conform the basis of that share to the share's allocable portion of the subsidiary's net inside attribute amount (after reduction). S1's net inside attribute amount after the application of this paragraph (d) is $25 and thus each of the two S1 share's allocable portion of S1's net inside attribute amount is $12.50. Accordingly, the reductions to Share A and to Share B under paragraph (d)(5)(iii) of this section are reversed to the extent necessary to restore the basis of each share to $12.50. Thus, $25 of the $27.50 of reduction to the basis of Share A, and $25 of the $47.50 of reduction to the basis of share B, is reversed, restoring the basis of each share to $12.50.

Example 6. Multiple blocks of lower-tier subsidiary stock outstanding. (i) Excess loss account taken into account (transfer of upper-tier share causes disposition within the meaning of § 1.1502-19(c)(1)(ii)(B)). (A) Facts. M owns the sole outstanding share of S stock with a basis of $200. S holds all five outstanding shares of S1 common stock (Shares A, B, C, D, and E). S has an excess loss account of $20 in Share A and a positive basis of $20 in each of the other shares. The only investment adjustment applied to any S1 share was a negative $20 investment adjustment applied to Share A when it was the only outstanding share, and this amount tiered up and adjusted M's basis in the S share. S1 owns one asset with a basis of $250. M sells its S share to P1, the common parent of a consolidated group, for $20. The sale of the S share is a disposition of Share A under § 1.1502-19(c)(1)(ii)(B) (S1 becomes a nonmember because it will have a separate return year as a member of the P1 group). Accordingly, under § 1.1502-19(b)(1)(i) and paragraph (a)(3)(i) of this section, before the application of this section, S's excess loss account in Share A is taken into account, increasing S's basis in Share A to $0 and M's basis in its S share to $220. After giving effect to the recognition of the excess loss account, M's sale of the S share is a transfer of a loss share and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.

(B) Basis redetermination and basis reduction under paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. No adjustment is made under paragraph (c) of this section because, even though there is a disconformity amount of $140, the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's sale of the S share remains a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of M's net stock loss and S's aggregate inside loss. M's net stock loss is $200 ($220 basis over $20 value). S's aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net inside attribute amount is $250, S's $250 deemed basis in the deemed single share of S1 stock (computed as the greater of S's $80 aggregate basis in the S1 shares ($0 basis in Share A plus $20 basis in each of the four other shares) and S1's $250 basis in its asset). S's aggregate inside loss is therefore $230, $250 net inside attribute amount over the $20 value of the S share. Accordingly, S's attribute reduction amount is $200, the lesser of the $200 net stock loss and the $230 aggregate inside loss.

(2) Allocation, apportionment, and application of S's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $200 attribute reduction amount is allocated entirely to the S1 stock (treated as a single share) and then apportioned among the shares in a manner that reduces disparity to the greatest extent possible. Thus, $24 is apportioned to Share A and $44 is apportioned to each of the other shares. Because none of the S1 shares are transferred within the meaning of paragraph (f)(10) of this section (notwithstanding that there is a disposition under § 1.1502-19(c)(1)(ii)(B)), the allocated attribute reduction amount apportioned to each of the individual S1 shares is applied fully to reduce the basis of each share to an excess loss account of $24. See paragraph (d)(5)(iii) of this section.

(3) Tier down of S's attribute reduction amount. Under paragraph (d)(5)(v)(A) of this section, the $200 of S's attribute reduction amount allocated to the S1 shares is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Under the general rules of this paragraph (d), S1's $200 tier-down attribute reduction amount is allocated and applied to reduce S1's basis in its asset from $250 to $50.

(4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of lower-tier subsidiary stock under paragraph (d)(5)(iii) of this section is reversed to the extent necessary to conform the basis of that share to the share's allocable portion of the subsidiary's net inside attribute amount (after reduction). S1's net inside attribute amount after the application of this paragraph (d) is $50 and thus each of the five S1 share's allocable portion of S1's net inside attribute amount is $10. Accordingly, the reductions to the bases of S1 shares under paragraph (d)(5)(iii) of this section are reversed to the extent necessary to restore (to the extent possible) the basis of each share to $10. Thus, $24 of the $24 of reduction to the basis of Share A is reversed, restoring the basis of Share A to $0, and $34 of the $44 of reduction to the basis of each other share is reversed, restoring the basis of each of those shares to $10.

(ii) Sale of gain share to member. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 6, except that M owns Shares A, B, C, and D, S owns Share E, S has a liability of $20, and S1's basis in its asset is $500. Also, as part of the transaction, S sells Share E to M for $40. Unlike under the facts of paragraph (i)(A) of this Example 6, there is no disposition of Share A within the meaning of § 1.1502-19(c)(1)(ii)(B) (S1 continues to be a member of the group, and thus does not have a separate return year). As a result, the Share A excess loss account is not taken into account. Although S's sale of Share E is a transfer of that share, the share is not a loss share and thus the transfer is not subject to this section. M's sale of the S share, however, is a transfer of a loss share and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.

(B) Transfer in lowest tier (gain share). S's sale of Share E is the lowest-tier transfer in the transaction. Under paragraph (a)(3)(ii)(A) of this section, because there are no transfers of loss shares at that tier, no adjustments are required under paragraph (b) or (c) of this section. However, S's gain recognized on the transfer of Share E is computed and immediately adjusts members' bases in subsidiary stock under § 1.1502-32 (because M and S are not members of the same group immediately after the transaction, the sale is not an intercompany transaction subject to § 1.1502-13). Accordingly, M's basis in its S share is increased by $20, from $200 to $220.

(C) Transfers in next higher tier, application of paragraphs (b) and (c) of this section. The next higher tier transfer is M's sale of the S stock. The sale is a transfer of a loss share and therefore subject to this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. Under paragraph (c) of this section, M's basis in its S share is decreased by $20, the lesser of S's $200 disconformity amount (computed as the excess of M's $220 basis in the S stock over S's $20 net inside attribute amount (computed as the $20 basis in Share E, increased by $20 to reflect the gain recognized with respect to the share, less the $20 liability)), and the $20 net positive adjustment. Thus, after the application of paragraph (c) of this section, M's basis in the S share is $200, and the sale remains a transfer of a loss share. There are no higher tier transfers and, therefore, M's transfer of the S share is then subject to this paragraph (d).

(D) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of M's net stock loss and S's aggregate inside loss. M's net stock loss is $180 ($200 basis over $20 value). S's aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net inside attribute amount is $80, computed as $100 (S's deemed basis in Share E (the greater of $40 (S's $20 basis in Share E, adjusted for the $20 gain recognized with respect to the share), and Share E's allocable portion of S1's net inside attribute amount of $100 (1/5 of S1's $500 basis in its asset)), less S's $20 liability. Accordingly, S's aggregate inside loss is $60 ($80 net inside attribute amount over the $20 value of the S stock). S's attribute reduction amount is therefore $60, the lesser of $180 net stock loss and $60 aggregate inside loss.

(2) Allocation, apportionment, and application of S's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $60 attribute reduction amount is allocated entirely to its S1 stock, Share E. However, because Share E was transferred within the meaning of paragraph (f)(10) of this section and gain was recognized on its transfer, none of the allocated amount is apportioned to, or applied to reduce the basis of Share E. See paragraph (d)(5)(iii)(A) of this section. Under paragraph (d)(5)(iv) of this section, the $60 allocated attribute reduction amount not apportioned or applied to Share E has no effect on S or S's attributes.

(3) Tier down of S's attribute reduction amount. Notwithstanding the fact that no portion of the allocated attribute reduction amount was apportioned to or applied to reduce the basis of Share E, the entire $60 allocated attribute reduction amount is an attribute reduction amount of S1. See paragraph (d)(5)(v)(A) of this section. Under the general rules of this paragraph (d), S1's $60 tier-down attribute reduction amount is allocated and applied to reduce S1's basis in its asset from $500 to $440.

Example 7. Allocation of attribute reduction if lower-tier subsidiary has non-loss assets or liabilities. (i) S1 holds cash. (A) Facts. M owns the sole outstanding share of S stock with a basis of $800. S owns Asset with a basis of $400 and the sole outstanding share of S1 stock with a basis of $300. S1 holds Asset 1 with a basis of $50, and $100 cash. M sells its S share to P1, the common parent of a consolidated group, for $100. The sale is not a transfer of the S1 share because S and S1 are members of the same group following the transaction. However, the sale is a transfer of the S share, a loss share, and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section.

(B) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to the provisions of this paragraph (c). No adjustment is required under paragraph (c) of this section because, even though there is a disconformity amount of $100, the net positive adjustment is $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of M's net stock loss and S's aggregate inside loss. M's net stock loss is $700 ($800 basis over $100 value). S's aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. Under paragraphs (d)(3)(iii)(B) and (d)(5)(i)(B) of this section, S's net inside attribute amount is $700, the sum of its $400 basis in Asset and its $300 deemed basis in the S1 share (computed as the greater of S's $300 basis in the S1 share and S1's $150 net inside attribute amount (reflecting the sum of S1's $50 basis in Asset 1 and S1's $100 cash)). Therefore, S's aggregate inside loss is $600 ($700 net inside attribute amount over the $100 value of the S stock). S's attribute reduction amount is $600, the lesser of the $700 net stock loss and the $600 aggregate inside loss.

(3) Tier down of S's attribute reduction amount. Under paragraph (d)(5)(v)(A) of this section, the $200 portion of S's attribute reduction amount allocated to the S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Under the general rules of this paragraph (d), S1's $200 tier-down attribute reduction amount is allocated and applied to reduce S1's basis in Asset 1 (S1's only attribute available for reduction) from $50 to $0. The $150 unapplied attribute reduction amount is disregarded and has no further effect.

(4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of subsidiary stock under paragraph (d)(5)(iii) of this section is reversed to the extent necessary to conform the basis of that share to the share's allocable portion of the subsidiary's net inside attribute amount. There is only one share of S1 stock outstanding and so S1's entire $100 net inside attribute amount is allocable to that share. Because S's $100 basis in the S1 share (as reduced under this paragraph (d)) is already conformed with its $100 allocable portion of S1's net inside attribute amount, there is no restoration under paragraph (d)(5)(vi)(A) of this section.

(ii) S1 borrows cash. The facts are the same as in paragraph (i)(A) of this Example 7 except that, in addition, S1 borrows $50 from X immediately before M sells the S share. The computation of the attribute reduction amount is the same as in paragraph (i)(C) of this Example 7 (the $50 cash from the loan proceeds and the $50 liability offset in the computation of S1's net inside attribute amount and so the net amount is unaffected, and the computation of S's deemed basis in the S1 stock is unaffected). Similarly, for purposes of allocating the attribute reduction amount between the non-stock Category D asset and the S1 stock, paragraph (d)(5)(ii) of this section requires S's deemed basis in the S1 share to be treated as reduced by S1's net non-loss assets (S1's non-loss assets over S1's liabilities). Accordingly, the additional $50 cash proceeds is offset by the $50 liability and there is no effect on the allocation of the attribute reduction amount. The results are the same as in paragraph (i) of this Example 7.

(iii) S1 has a liability not taken into account for tax purposes. (A) Facts. The facts are the same as in paragraph (ii) of this Example 7 except that, in addition, S1 has a $40 liability that is not taken into account for tax purposes as of the transfer and that would be required to be capitalized if a person purchased S1's assets and assumed the liability.

(B) Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of this Example 7. Thus, after the application of paragraph (c) of this section, P's sale of the S share is still a transfer of a loss share and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. The attribute reduction amount is the same as computed in paragraph (i)(C)(1) of this Example 7 (under paragraph (f)(5) of this section, the term liability does not include liabilities not taken into account for tax purposes and so the additional $40 liability not yet taken into account for tax purposes does not affect the computation of S's attribute reduction amount).

(2) Allocation, apportionment, and application of S's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $600 attribute reduction amount is allocated proportionately (by basis) between S's $400 basis in Asset 1 (non-stock Category D asset) and its deemed basis in the S1 share. However, under paragraph (d)(5)(ii) of this section, for purposes of allocating the attribute reduction amount, S's $300 deemed basis in the S1 share is treated as reduced by S1's net non-loss assets (S1's non-loss assets over S1's liabilities). For this purpose, the term liabilities includes liabilities not taken into account for tax purposes, as described in paragraph (d)(4)(ii)(C)(1) of this section (generally, liabilities that, if assumed in a purchase, would give rise to a capitalized amount when satisfied). Thus, for this purpose, S's $300 deemed basis in the S1 share is reduced by S1's $60 net non-loss assets (the excess of S1's $150 non-loss assets (its Class I asset, $150 cash) over S1's $90 liabilities ($50 loan and $40 liability not yet taken into account for tax purposes)), to $240. Accordingly, S's $600 attribute reduction amount is allocated and applied $375 ($400/$640 × $600) to Asset (reducing S's basis in Asset from $400 to $25) and $225 ($240/$640 × $600) to the S1 share. Because the S1 share is not transferred within the meaning of paragraph (f)(10) of this section, the allocated attribute reduction amount apportioned to the S1 share is applied fully to reduce the basis of the S1 share to $75. See paragraph (d)(5)(iii) of this section.

(3) Tier down of S's attribute reduction amount, application of conforming limitation. Under paragraph (d)(5)(v)(A) of this section, the $225 portion of S's attribute reduction amount allocated to the S1 stock is an attribute reduction amount of S1 (regardless of the extent, if any, to which it is apportioned and applied to reduce the basis of any shares of S1 stock). Under the general rules of this paragraph (d), S1's $225 tier-down attribute reduction amount would be allocated and applied to reduce S1's attributes. However, under paragraph (d)(5)(v)(B) of this section, S1's attributes can be reduced by only $75, the excess of the $150 portion of S1's net inside attribute amount that is allocable to all S1 shares held by members as of the transaction over $75, the aggregate amount of members' bases in nontransferred S1 shares, after reduction under this paragraph (d). Thus, of S1's $225 tier-down attribute reduction amount, $50 is applied to reduce S1's basis in Asset 1, from $50 to $0. Although the $25 unapplied attribute reduction amount not subject to the conforming limitation would generally be disregarded without further effect, because S1 has a $40 liability not taken into account for tax purposes, paragraph (d)(4)(ii)(C)(1) of this section requires that the $25 of the unapplied attribute reduction amount not subject to the conforming limitation be suspended and then allocated and applied to reduce any amounts that become deductible or capitalizable as a result of that liability later being taken into account. If the liability is satisfied for an amount that is less than $25, under paragraph (d)(4)(ii)(C)(2) of this section the remaining portion of that $25 suspended attribute reduction amount is disregarded and has no further effect. The $150 unapplied portion of the tier-down attribute reduction amount subject to the conforming limitation has no further effect.

(4) Basis restoration. Under paragraph (d)(5)(vi)(A) of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of lower-tier subsidiary stock under paragraph (d)(5)(iii) of this section is reversed to the extent necessary to conform the basis of that share to the share's allocable portion of the subsidiary's net inside attribute amount. Paragraph (d)(5)(vi)(A) provides that, for this purpose, S1's net inside attribute amount is its net inside attribute amount, taking into account any reductions under this paragraph (d) and treating it as reduced by any attribute reduction amount suspended under paragraph (d)(4)(ii)(C)(1) of this section. Because S's $75 basis in its S1 stock (after application of this paragraph (d)) is already conformed with its $75 allocable portion of S1's net inside attribute amount ($100 net inside attributes after reduction, reduced by S1's $25 suspended attribute reduction amount), there is no restoration under paragraph (d)(5)(vi)(A) of this section.

Example 8. Election to reduce stock basis or reattribute attributes under paragraph (d)(6) of this section. (i) Deconsolidating sale. (A) Facts. P owns the sole outstanding share of M stock with a basis of $1,000. M owns all 100 outstanding shares of S stock with a basis of $2.10 per share ($210 total). M sells all its S shares to X for $1 per share ($100 total). M's sale of the S shares is a transfer of loss shares and therefore subject to this section. See paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section. At the time of the sale, S has no liabilities and the following:

Category | Attribute | Attribute amount

Category A | Capital loss carryover | $10

Category B | NOL carryover | 90

Category C | Deferred deduction | 40

Total Category A, Category B, and Category C Attributes | 140

Category D, Class V | Basis in land | 70

Total Attributes | 210

(B) Application of paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is no disparity among M's bases in shares of S common stock and there are no shares of S preferred stock outstanding (so there can be no unrecognized gain or loss with respect to preferred shares). See paragraph (b)(1)(ii)(A) of this section. No adjustment is required under paragraph (c) of this section because both the disconformity amount and the net positive adjustment are $0. See paragraph (c)(3) of this section. Thus, after the application of paragraph (c) of this section, M's transfer of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d).

(2) Application of attribute reduction amount. (i) S's $110 attribute reduction amount is applied as follows:

Category | Attribute | Attribute amount | Allocation of attribute reduction amount | Adjusted attribute amount

Category A | Capital loss carryover | $10 | $10 | $0

Category B | NOL carryover | 90 | 90 | 0

Category C | Deferred deduction | 40 | 10 | 30

Category D, Class V | Basis in land | 70 | 0 | 70

Totals | 210 | 110 | 100

(ii) Alternatively, under paragraph (d)(4)(ii)(A)(1) of this section, P could specify the allocation of S's $110 attribute reduction amount among S's $10 capital loss carryover, S's $90 NOL carryover, and S's $40 deferred deduction.

(D) Results. The P group recognizes a $110 loss on M's sale of the S shares that is absorbed by the group, which reduces P's basis in the M share under § 1.1502-32 from $1,000 to $890. Immediately after the transaction, the entities own the following:

Entity | Asset | Basis

P | M share | $890

X | 100 S shares | 100

S | Category C, deferred deduction | 30

Category D, Class V Asset (land) | 70

(E) Election to reduce stock basis. The facts are the same as in paragraph (i)(A) of this Example 8 except that P elects under paragraph (d)(6) of this section to reduce M's basis in the S shares by the full attribute reduction amount of $110, in lieu of S reducing its attributes. The election is effective for all transferred loss shares and is allocated to those shares in proportion to the loss in each. See paragraph (d)(6)(v)(A) of this section. Accordingly, the basis of each of the 100 transferred shares is reduced from $2.10 to $1.00. After giving effect to the election, the S shares are not loss shares and this section has no further application to the transfer. The $110 reduction in M's basis in the S shares pursuant to the election under paragraph (d)(6) of this section is a noncapital, nondeductible expense of M that will reduce P's basis in the M share. See paragraph (d)(6)(v)(A) of this section. Immediately after the transaction, the entities own the following:

Entity | Asset | Basis/ attribute

P | M share | $890

X | 100 S shares | 100

S | Category A, capital loss carryover | 10

Category B, NOL carryover | 90

Category C, deferred deduction | 40

Category D, Class V Asset (land) | 70

(F) Election to reattribute losses. The facts are the same as in paragraph (i)(A) of this Example 8 except that P elects under paragraph (d)(6) of this section to reattribute S's attributes. S's attribute reduction amount is $110, and P can reattribute all or any portion of the attributes in Category A, Category B, and Category C to the extent of $110. P elects to reattribute the $90 NOL, and, as a result, S's NOL is $0. Under paragraph (d)(6)(iv)(A) of this section, the reattribution of the $90 NOL is a noncapital, nondeductible expense of S. Under § 1.1502-32(c)(1)(ii)(A)(1) this $90 expense is allocated to the transferred loss shares of S stock in proportion to the loss in the shares, or $.90 per share. Further, this expense tiers up under § 1.1502-32 and reduces P's basis in the M stock by $90. After giving effect to the election, the P group would recognize a $20 loss on M's sale of the S shares, S would have an aggregate inside loss of $20 (S's $120 net inside attribute amount (the $10 capital loss carryover, plus the $40 deferred deduction, plus the $70 basis in the land) over the $100 value of all outstanding S shares), and S's attribute reduction amount would be $20 (applied $10 to the $10 capital loss carryover and $10 to the $40 deferred deduction). (Alternatively, under paragraph (d)(4)(ii)(A)(1) of this section, P could specify the allocation of S's $20 attribute reduction amount between S's $10 capital loss carryover and S's $40 deferred deduction. Further, P could elect to reduce M's remaining basis in the S shares by any amount up to the $20 attribute reduction amount, thereby reducing or eliminating S's attribute reduction amount.)

(ii) Nondeconsolidating sale. (A) Facts. The facts are the same as in paragraph (i)(A) of this Example 8, except that M only sells 20 S shares ($20 total).

(B) Application of paragraphs (b) and (c) of this section. No adjustment is required under paragraph (b) or paragraph (c) of this section for the reasons set forth in paragraph (i)(B) of this Example 8. Thus, after the application of paragraph (c) of this section, M's sale of the S shares is still a transfer of loss shares and, accordingly, subject to this paragraph (d).

(C) Attribute reduction under this paragraph (d). (1) Computation of attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of the $22 net stock loss ($42 aggregate basis over $20 aggregate value) and S's $110 aggregate inside loss (as calculated in paragraph (i)(C)(1) of this Example 8). S's attribute reduction amount is $22, the lesser of the $22 net stock loss and the $110 aggregate inside loss.

(2) Application of attribute reduction amount. (i) S's $22 attribute reduction amount is applied as follows:

Category | Attribute | Attribute amount | Allocation of attribute reduction amount | Adjusted attribute amount

Category A | Capital loss carryover | $10 | $10 | $0

Category B | NOL carryover | 90 | 12 | 78

Category C | Deferred deduction | 40 | 0 | 40

Category D, Class V | Land | 70 | 0 | 70

(ii) Alternatively, under paragraph (d)(4)(ii)(A)(1) of this section, P could specify the allocation of S's $22 attribute reduction amount among S's $10 capital loss carryover, S's $90 NOL carryover, and S's $40 deferred deduction.

(D) Results. The P group recognizes a $22 loss on M's sale of the S shares that is absorbed by the group, which reduces P's basis in the M share under § 1.1502-32 from $1,000 to $978. Immediately after the transaction, the entities have the following:

Entity | Asset | Basis

P | M share | $978

X | 20 S shares | 20

S | Category B, NOL carryover | 78

Category C, deferred deduction | 40

Category D, Class V Asset (land) | 70

(E) Election to reduce stock basis. The facts are the same as in paragraph (ii)(A) of this Example 8, except that P elects under paragraph (d)(6) of this section to reduce M's basis in the S shares by the full attribute reduction amount of $22, in lieu of S reducing its attributes. The election is effective for all transferred loss shares and is allocated to such shares in proportion to the loss in each share. See paragraph (d)(6)(v)(A) of this section. Accordingly, the basis of each of the 20 transferred shares is reduced from $2.10 to $1.00. After giving effect to the election, the transferred S shares are not loss shares and this section has no further application to the transfer. The $22 reduction in M's basis in the S shares pursuant to the election under paragraph (d)(6) of this section is a noncapital, nondeductible expense of M that will reduce P's basis in the M share. See paragraph (d)(6)(v)(A) of this section. Immediately after the transaction, the entities have the following:

Entity | Asset | Basis/ attribute

P | M share | $978

M | 80 S shares | 168

X | 20 S shares | 20

S | Category A, capital loss carryover | 10

Category B, NOL | 90

Category C, deferred deduction | 40

Category D Class V Asset (land) | 70

(F) Election to reattribute attributes. The facts are the same as in paragraph (ii)(A) of this Example 8. Because S remains a member of the same group as P following M's sale of S stock, P cannot elect under paragraph (d)(6) of this section to reattribute any portion of S's attributes in lieu of attribute reduction.

Example 9. Transfers at multiple tiers, gain and loss shares. (i) Facts. M owns the sole outstanding share of S stock with a basis of $700. S owns Asset 1 (basis of $170) and all ten outstanding shares of S1 common stock ($170 basis in share 1, $10 basis in share 2, and $15 basis in each of share 3 through share 10). S1 owns the sole outstanding share of S2 ($0 basis), the sole outstanding share of S3 ($60 basis), and the sole outstanding share of S4 ($100 basis). S2's sole asset is Asset 2 ($75 basis). S3's sole asset is Asset 3 ($75 basis). S4's sole asset is Asset 4 ($80 basis). In one transaction, M sells its S share to P1 (the common parent of a consolidated group) for $240, S sells S1 share 1 to X for $20, S contributes S1 share 2 to a partnership in a section 721 transaction, and S1 sells its S2 share to Y for $50. M's sale of the S share and S1's sale of the S2 share are transfers under paragraphs (f)(10)(i)(A), (f)(10)(i)(B), and (f)(10)(i)(C) of this section. S's sale of S1 share 1 to X is a transfer under paragraphs (f)(10)(i)(A) and (f)(10)(i)(C) of this section. S's contribution of S1 share 2 to the partnership is a transfer under paragraph (f)(10)(i)(C) of this section.

(ii) Transfer in lowest tier (gain share). However, S1's gain recognized on the transfer of the S2 share is computed and immediately adjusts members' bases in subsidiary stock under § 1.1502-32. Under paragraph (a)(3)(ii)(A) of this section, because there are no transfers of loss shares at that tier, no adjustments are required under paragraph (b) or (c) of this section. However, S1's gain recognized on the transfer of the S2 share is computed and immediately adjusts members bases in subsidiary stock under § 1.1502-32. Accordingly, $5 is allocated to each of 10 S1 shares, increasing the basis of share 1 to $175, the basis of share 2 to $15, and the basis of each other share to $20. The $50 applied to S's bases in the S1 shares then tiers up to increase P's basis in the S share from $700 to $750.

(iii) Transfers in next highest tier (loss share). S's sale of the S1 share 1 and S's transfer of the S1 share 2 to a partnership are both transfers of stock in the next higher tier. However, only the S1 share 1 is a loss share and so this section only applies with respect to the transfer of that share.

(A) Basis redetermination under paragraph (b) of this section. Under paragraph (b)(2)(i)(A) of this section, members' bases in S1 shares are redetermined by first removing the positive investment adjustments applied to the bases of transferred loss common shares. Accordingly, the $5 positive investment adjustment applied to the basis of S1 share 1 is removed, reducing the basis of S1 share 1 from $175 to $170. Because there were no negative adjustments applied to the bases of S1 shares, there are no negative adjustments that can be reallocated to further reduce the basis of S1 share 1 under paragraph (b)(2)(i)(B) of this section. Finally, under paragraph (b)(2)(ii)(B) of this section, the $5 positive investment adjustment removed from S1 share 1 is reallocated and applied to increase the bases of other S1 common shares in a manner that reduces disparity to the greatest extent possible. Accordingly, the entire $5 investment adjustment removed from S1 share 1 is reallocated and applied to increase the basis of S1 share 2, from $15 to $20. After basis is redetermined under paragraph (b) of this section, the S1 share 1 is still a loss share and therefore subject to basis reduction under paragraph (c) of this section. (Because the S1 share 2 is not a loss share, this section does not apply with respect to the transfer of that share.)

(B) Basis reduction under paragraph (c) of this section. No adjustment is required to the basis of S1 share 1 under paragraph (c) of this section. The S1 share 1 has a disconformity amount of $149. This $149 disconformity amount is computed as the excess of the $170 basis in the S1 share 1 over the S1 share 1's $21 allocable portion (1/10) of S1's $210 net inside attribute amount. S1's $210 net inside attribute amount is determined under paragraph (c)(5) of this section as the sum of $50 (S1's $0 basis in the S2 share, adjusted for the $50 gain recognized with respect to that share), S1's $60 basis in the S3 stock, and S1's $100 basis in the S4 stock. (In computing the disconformity amount, the basis of the S2 share is not treated as tentatively reduced because that share is transferred in the transaction, and the bases of the S3 and S4 shares are not treated as tentatively reduced because no positive investment adjustments were applied to the bases of those shares.) However, the S1 share 1's net positive adjustment is $0 because the $5 positive investment adjustment originally allocated to S1 share 1 was reallocated to S1 share 2 under paragraph (b) of this section. See paragraph (c)(3) of this section. No adjustment is required to the basis of S1 share 2 under paragraph (c) of this section because S1 share 2 is not a loss share.

(C) Computation of loss, adjustments to stock basis. S recognizes a loss of $150 on the sale of the S1 share 1 ($170 basis over $20 amount realized) that is absorbed by the group. Under § 1.1502-32, M's basis in its S share is therefore decreased by $100, the net of the $150 loss recognized by S on the sale of the S1 share, and the $50 gain that tiered up from S1 (as a result of S1's sale of the S2 share). Following these adjustments, M's basis in the S share is $600 and the sale of the S share is still a transfer of a loss share.

(iv) Transfer in highest tier (loss share). The sale of the S share is a transfer in the next higher tier, which is the highest tier in this transaction. Because the sale is a transfer of a loss share, it is subject to this section.

(A) Basis redetermination and basis reduction under paragraphs (b) and (c) of this section. Although the transfer is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is only one share of S stock outstanding (and so there can be no disparity among members' bases in common shares and there are no outstanding preferred shares with respect to which there can be unrecognized gain or loss). See paragraph (b)(1)(ii)(A) of this section. Therefore, after the application of paragraph (b) of this section, the share is still a loss share and, as such, subject to paragraph (c) of this section. In addition, no adjustment is required under paragraph (c) of this section. The S share has a disconformity amount of $230. This $230 disconformity amount is computed as the excess of the $600 basis in the S share over the S share's $370 allocable portion (1/1) of S's $370 net inside attribute amount. S's $370 net inside attribute amount is determined under paragraph (c)(5) of this section as the sum of $200 (S's $170 basis in the S1 share 1, adjusted for the $150 loss recognized with respect to that share, and S's $20 basis in each of S1 share 2 through share 10), and S's $170 basis in Asset 1. (In computing the disconformity amount, the bases of S1 share 1 and share 2 are not treated as tentatively reduced because those shares are transferred in the transaction, and the bases of S1 share 3 through share 10 are not treated as tentatively reduced because none of those shares have a disconformity amount—each share has a basis of $20 and a $21 allocable portion (1/10) of S1's $210 net inside attribute amount, as determined in paragraph (iii)(B) of this Example 9.) However, the S share's net positive adjustment is $0 (the S share's net adjustment is negative $100). See paragraph (c)(3) of this section. Accordingly, the sale of the S share is still a transfer of a loss share. Because there are no higher-tier loss shares transferred in the transaction, this paragraph (d) then applies with respect to the transfer of the S share.

(B) Attribute reduction under this paragraph (d). (1) Computation of S's attribute reduction amount. Under paragraph (d)(3) of this section, S's attribute reduction amount is the lesser of P's net stock loss and S's aggregate inside loss. P's net stock loss is $360 ($600 basis over $240 amount realized). S's aggregate inside loss is the excess of S's net inside attribute amount over the value of the S share. S's net inside attribute amount is the sum of its bases in its assets, treating its S1 shares as a single share (the S1 stock) and treating S's deemed basis in the S1 stock as its basis in that stock. Under paragraph (d)(5)(i)(C) of this section, when subsidiaries are owned in multiple tiers, deemed basis is first determined for shares at the lowest tier, and then for stock in each next higher tier. Under paragraph (d)(5)(i)(B) of this section, S1's deemed basis in the S2 stock is $75 (computed as the greater of $50 (S1's $0 basis in the S2 share, adjusted for the $50 gain recognized with respect to the share) and $75 (S2's net inside attribute amount, the basis in Asset 2)). S1's deemed basis in the S3 stock is $75 (computed as the greater of $60 (S1's basis in the S3 share) and $75 (S3's net inside attribute amount, the basis in Asset 3)). S1's deemed basis in the S4 stock is $100 (computed as the greater of $100 (S1's basis in the S4 share) and $80 (S4's net inside attribute amount, the basis in Asset 4)). Accordingly, S1's net inside attribute amount is $250 ($75 deemed basis in the S2 stock plus $75 deemed basis in the S3 stock plus $100 deemed basis in the S4 stock). S's deemed basis in the S1 stock is the greater of the sum of S's actual basis in each share of S1 stock (adjusted for any gain or loss recognized) and S1's net inside attribute amount. S's actual basis in the S1 stock, adjusted for the loss recognized, is $200 (the sum of S's $170 basis in the S1 share 1, adjusted by the $150 loss recognized with respect to the share, and S's $20 basis in each of S1 share 2 through share 10). Thus, S's deemed basis in the S1 stock is $250, the greater of $200 (aggregate basis in S1 shares, adjusted for loss recognized) and $250 (S1's net inside attribute amount). As a result, S's net inside attribute amount is $420, the sum of S's $250 deemed basis in the S1 stock and S's $170 basis in Asset 1. Accordingly, the aggregate inside loss is $180, the excess of S's $420 net inside attribute amount over the $240 value of all of the S stock. S's attribute reduction amount is therefore $180, the lesser of the $360 net stock loss and the $180 aggregate inside loss.

(2) Allocation, apportionment, and application of S's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S's $180 attribute reduction amount is allocated proportionately (by basis) between Asset 1 (non-stock Category D asset) and the S1 stock. However, under paragraph (d)(5)(ii) of this section, for purposes of allocating S's $180 attribute reduction amount between S's non-stock Category D asset and the S1 stock, S's $250 deemed basis in the S1 stock is reduced by the $40 value of the transferred S1 shares (S1 share 1 and share 2) and the nontransferred S1 shares' $40 allocable portion (8/10) of S1's $50 net non-loss assets. S1's net non-loss assets is the $50 value of S1's transferred S2 shares. (S1 has no other non-loss assets, and there are no non-loss assets held by lower-tier subsidiaries.) Accordingly, for this purpose, S's deemed basis in the S1 stock is reduced by $80, from $250 to $170. Thus, $90 of the attribute reduction amount ($170/$340 × $180) is allocated to Asset 1 (reducing S's basis in Asset 1 from $170 to $80) and $90 of the attribute reduction amount ($170/$340 × $180) is allocated to the S1 stock. Under paragraph (d)(5)(iii)(A) of this section, none of the $90 allocated attribute reduction amount is apportioned to S1 share 1 because loss is recognized on the transfer of S1 share 1. Under paragraph (d)(5)(iii)(B) of this section, the $90 allocated attribute reduction amount is apportioned among the other nine shares of S1 common stock in a manner that reduces disparity to the greatest extent possible. Accordingly, of the total $90 allocated amount, $10 is apportioned to each of the remaining nine shares of S1 stock. Under paragraph (d)(5)(iii)(C) of this section, the allocated attribute reduction amount apportioned to an individual share cannot be applied to reduce the basis of the share below its value if the share is transferred other than in a recognition transfer. Because the S1 share 2 is transferred (contributed to the partnership) and the basis of S1 share 2 is already equal to its value, none of the $10 allocated attribute reduction amount apportioned to S1 share 2 is applied to reduce its basis. Because none of S1 share 3 through share 10 are transferred within the meaning of paragraph (f)(10) of this section, the $10 allocated attribute reduction amount apportioned to each of S1 share 3 through share 10 is applied fully to reduce the basis of each of those shares from $20 to $10. As a result, immediately after the allocation and application of S's attribute reduction amount, S's basis in Asset 1 is $80 ($170 minus $90), its bases in S1 share 1 and share 2 are not adjusted under paragraph (d)(5)(iii), and its basis in each of S1 share 3 through share 10 is $10. Under paragraph (d)(5)(v)(A) of this section, the entire $90 of S's attribute reduction amount that was allocated to the S1 stock is an attribute reduction amount of S1, regardless of the fact that none of the allocated amount was apportioned to S1 share 1 and none of the amount apportioned to S1 share 2 was applied to reduce the basis of S1 share 2.

(v) Attribute reduction under this paragraph (d) in next lower tier. (A) Computation of S1's attribute reduction amount. S's sale of S1 share 1 is a transfer of a loss share and it is in the next lower tier. Thus, this paragraph (d) next applies with respect to S's transfer of S1 share 1. S1's attribute reduction amount will include both the $90 attribute reduction amount that tiered down from S and any attribute reduction amount resulting from the application of this paragraph (d) with respect to S's transfer of S1 share 1 and share 2 (S1's direct attribute reduction amount). Under paragraph (d)(3) of this section, S1's direct attribute reduction amount is the lesser of the net stock loss on transferred S1 shares and S1's aggregate inside loss. The net stock loss on transferred S1 shares is $150, computed as the excess of S's $190 adjusted bases in transferred shares of S1 stock ($170 in S1 share 1 plus $20 in S1 share 2) over the $40 aggregate value of those shares. S1's aggregate inside loss is $50, the excess of S1's $250 net inside attribute amount (as calculated in paragraph (iv)(B)(1) of this Example 9) over the $200 value of all outstanding S1 shares. Therefore, S1's direct attribute reduction amount is $50, the lesser of the $150 net stock loss and S1's $50 aggregate inside loss. S1's total attribute reduction amount is thus $140, the sum of the $90 tier-down attribute reduction amount and the $50 direct attribute reduction amount.

(B) Allocation, apportionment, and application of S1's attribute reduction amount. Under paragraphs (d)(4) and (d)(5)(ii) of this section, S1's $140 attribute reduction amount is allocated proportionately (by basis) among the S2 stock, the S3 stock, and the S4 stock. However, under paragraph (d)(5)(ii) of this section, for purposes of allocating S1's $140 attribute reduction amount among S1's lower-tier subsidiary stock, S1's $75 deemed basis in the S2 stock is reduced by the $50 value of the transferred S2 share. Accordingly, for this purpose, S1's deemed basis in the S2 stock is reduced by $50, from $75 to $25. Thus, $17.50 of S1's attribute reduction amount ($25/$200 × $140) is allocated to the S2 stock, $52.50 of S1's attribute reduction amount ($75/$200 × $140) is allocated to the S3 stock, and $70 of S1's attribute reduction amount ($100/$200 × $140) is allocated to the S4 stock. Under paragraph (d)(5)(iii)(A) of this section, none of the $17.50 of S1's attribute reduction amount allocated to S2 stock is apportioned to the S2 share because gain was recognized on the transfer of the S2 share. Because neither the S3 share nor the S4 share is transferred within the meaning of paragraph (f)(10) of this section, the $52.50 of S1's attribute reduction amount allocated to the S3 stock, and the $70 of S1's attribute reduction amount allocated to the S4 stock, is apportioned to and applied fully to reduce the basis of such shares. Thus, S1's basis in the S3 share is reduced by $52.50, from $60 to $7.50, and S1's basis in the S4 stock is reduced by $70, from $100 to $30. (Note: The conforming limitation in paragraph (d)(5)(v)(B) of this section limits the application of the $90 tier down attribute reduction amount to $80, the amount by which the portion (10/10) S1's $250 net inside attribute amount attributable to S1 shares held by members exceeds $170 (the sum of the $50 direct attribute reduction amount, the $20 value of the S1 share 1 transferred in a recognition transfer, the $20 basis (after reduction) in the S1 share 2 transferred other than in a recognition transfer, and the $80 aggregate basis (after reduction) in the nontransferred S1 shares held by members). However, the conforming limitation does not limit the application of S1's $90 tier-down attribute reduction amount because none of the $17.50 of S1's total attribute reduction amount allocated to the S2 share was applied to reduce the basis of the share. Accordingly, only $78.75 ($90—($17.50 × ($90/$140)) of the $90 tier-down attribute reduction was applied to reduce S1's attributes.) Under paragraph (d)(5)(v)(A) of this section, the attribute reduction amount allocated to the S2 stock, the S3 stock, and the S4 stock becomes an attribute reduction amount of S2, S3, and S4, respectively (even though the amount allocated to S2 stock was not apportioned to or applied to reduce the basis of the S2 share).

(vi) Attribute reduction under this paragraph (d) in lowest tier. Although the sale of the S2 share is a transfer of subsidiary stock at the next lower tier, the S2 share is not a loss share. Thus, this paragraph (d) does not apply with respect to that transfer. However, S2, S3, and S4 have attribute reduction amounts that tiered down from S1 and that are applied to reduce attributes under this paragraph (d).

(A) Tier down of S1's attribute reduction amount to S2. Under the general rules of this paragraph (d), S2's $17.50 tier-down attribute reduction amount is allocated and applied to reduce S2's basis in Asset 2 from $75 to $57.50.

(B) Tier down of S1's attribute reduction amount to S3. Under the general rules of this paragraph (d), S3's $52.50 tier-down attribute reduction amount is allocated and applied to reduce S3's basis in Asset 3 from $75 to $22.50.

(C) Tier down of S1's attribute reduction amount to S4, application of conforming limitation. Under the general rules of this paragraph (d), S4's $70 tier-down attribute reduction amount is allocated to, and would be applied to reduce, S4's basis in Asset 4. However, under paragraph (d)(5)(v)(B) of this section, the reduction is limited to the excess of S4's $80 net inside attribute amount over the $30 basis of the S4 share (after reduction under this paragraph (d)). As a result, only $50 (the excess of $80 over $30) of S4's $70 attribute reduction amount is applied to S4's basis in Asset 4, reducing it from $80 to $30. The $20 unapplied portion of S4's tier-down attribute reduction amount subject to the conforming limitation is disregarded and has no further effect.

(vii) Application of basis restoration rule. Under paragraph (d)(5)(vi)(A) of this section, after this paragraph (d) has been applied with respect to all transfers of subsidiary stock, any reduction made to the basis of a share of lower-tier subsidiary stock under paragraph (d)(5)(iii) of this section is reversed to the extent necessary to conform the basis of that share to the share's allocable portion of the subsidiary's net inside attribute amount. Restoration adjustments are first made at the lowest tier and then at each next higher tier successively.

(A) Basis restoration at lowest tier. The basis of the S2 share was not reduced under paragraph (d)(5)(iii) of this section and so there is no restoration of any basis in the S2 share. S3's $22.50 net inside attribute amount (after reduction under this paragraph (d)) exceeds S1's $7.50 basis in the S3 share (after reduction under this paragraph (d)) by $15. To conform S1's basis in the S3 share to S3's net inside attribute amount, the $52.50 reduction to the basis of the S3 share under paragraph (d)(5)(iii) of this section is reversed by $15 (restoring S1's basis in the S3 share to $22.50). The restoration of S1's basis in the S3 share does not tier up to affect the basis in stock of any other subsidiary. S1's $30 basis in the S4 share (after reduction under this paragraph (d)) is already conformed with S4's $30 net inside attribute amount (after reduction under this paragraph (d)) and so there is no restoration of any basis in the S4 share.

(B) Basis restoration at next higher tier. Each share of S1 stock has an allocable portion of S1's net inside attribute amount (after reduction) equal to $10.25 (1/10 × $102.50, the sum of S1's $0 basis in the S2 stock, adjusted for the $50 gain recognized with respect to the share, S1's $22.50 basis in the S3 stock (after restoration), and S1's $30 basis in the S4 stock). Neither S's basis in S1 share 1 nor S's basis in S1 share 2 was reduced under paragraph (d)(5)(iii) of this section. Accordingly, there is no restoration of any basis in either S1 share 1 or share 2. However, S's basis in each of S1 share 3 through share 10 was reduced under paragraph (d)(5)(iii) of this section by $10, from $20 to $10. Accordingly, the $10 reduction to the basis of each of those shares is reversed to the extent of $.25, to restore the basis of each such share to $10.25 (its allocable portion of S1's net inside attribute amount).

(viii) Results. After the application of this section, P recognizes a loss of $360 on the sale of the S share, S recognizes a loss of $150 on the sale of S1 share 1, and S1 recognizes a $50 gain on the sale of the S2 share. Immediately after the transaction, the entities each directly own the following:

Entity | Asset | Basis | Value

P1 | S share | $240 | $240

P | Proceeds of the sale of S share | 240 | 240

S | Proceeds of sale of S1 share 1 | 20 | 20

Partnership interest received for S1 share 2 | 20 | 20

S1 share 3 through share 10 | 82 ($10.25 per share)

Asset 1 | 80

S1 | Proceeds of sale of S2 share | 50 | 50

The S3 share | 22.50

The S4 share | 30

S2 | Asset 2 | 57.50

S3 | Asset 3 | 22.50

S4 | Asset 4 | 30

X | S1 share 1 | 20 | 20

Partnership | S1 share 2 | 20 | 20

Y | The S2 share | 50 | 50

(e) Operating rules—(1) Predecessors, successors. This section applies to predecessor or successor persons, groups, and assets to the extent necessary to effectuate the purposes of this section.

(2) Adjustments for prior transactions that altered stock basis or other attributes. In certain situations, M's basis in S stock or S's attributes may be adjusted in a manner that alters the relationship between stock basis and inside attributes and prevents that relationship from identifying the extent to which stock basis reflects unrecognized gain and duplicated loss. The provisions of this paragraph (e)(2) modify the computations in paragraphs (c) and (d) of this section to adjust for the effects of such adjustments.

(i) Prior reductions to S's basis in assets or other attributes pursuant to section 362(e)(2)(A). If M transferred loss property to S in an intercompany transaction subject to section 362(e)(2) (for example, if the transfer was prior to September 17, 2008, no election was made to apply § 1.1502-80(h), and, as a result, S's attributes were reduced under section 362(e)(2)), then the disconformity amount of the S shares received in the section 362(e)(2) transaction is reduced by the amount that the basis in such shares would have been reduced under section 362(e)(2)(C) had such an election been made. In addition, for purposes of determining the attribute reduction amount under paragraph (d) of this section resulting from the transfer of any S shares received (or deemed received) in such a transfer, and for purposes of applying paragraph (d)(5)(v)(B) of this section (conforming limitation) to S, the bases in such shares is treated as reduced by the amount the bases in such shares would have been reduced under section 362(e)(2)(C) had such an election been made.

(ii) Prior reductions to the basis of any share of S stock pursuant to an election under section 362(e)(2)(C). If M transferred loss property to S in an intercompany transaction subject to section 362(e)(2) and the basis of any share of S stock was reduced as the result of an election under section 362(e)(2)(C) (including in the hands of a predecessor, to the extent that the effect of the election remains reflected in the basis of the S stock), then, for purposes of computing either any S share's disconformity amount or S's aggregate inside loss, and for purposes of applying paragraph (d)(5)(vi)(A) of this section (stock basis restoration) to S, S's net inside attribute amount is treated as reduced by the amount that S's attributes would have been reduced under section 362(e)(2)(A) in the absence of an election under section 362(e)(2)(C). Notwithstanding the general rule of this paragraph (e)(2)(ii), no reduction will be required to the extent that the group can establish that the net loss in the S shares transferred by M is no longer reflected in S's net inside attributes.

(iii) Other adjustments. Appropriate adjustments will be made in any other case in which an adjustment to S's net inside attributes or to M's basis in a share of S stock alters the relationship between such amounts, and the adjustment does not relate to the extent to which loss reflected in M's basis in S stock is noneconomic or duplicated within the meaning of this section.

(3) Special rules for subsidiary stock transferred in an intercompany transaction—(i) In general. This section applies with respect to M's transfer of a share of S stock to another member in an intercompany transaction in which M's intercompany item is deferred under § 1.1502-13 (and to any subsequent transfer of that share by a member) as of the time M's intercompany item is taken into account under § 1.1502-13. In determining the application of this section, all transferor-members are treated as divisions of a single corporation. Appropriate adjustments will be made to the intercompany item(s), any member's basis in an S share, to S's attributes, or any combination thereof, to further the purposes of this section and § 1.1502-13.

(ii) Certain prior intercompany transactions. If M transferred a share of S stock to another member before September 17, 2008 and M's intercompany item related to the transfer is taken into account on or after September 17, 2008, P may elect to apply this paragraph (e)(3) to the transfer. The election is made in the manner provided in paragraph (e)(5) of this section.

(iii) Examples. The application of this paragraph (e)(3) is illustrated by the following examples:

Example 1. Intercompany sale with duplicated loss. (i) Buying member later sells at gain. (A) Facts. M owns the sole outstanding share of stock of S with a basis of $100. S has one asset with a basis of $100. M sells the S share to M1 for $70, recognizing a loss of $30. While owned by M1, S recognizes $10 of depreciation deductions that are absorbed by the group. S's basis in the asset is reduced by $10 (from $100 to $90), and M1's basis in the S stock is reduced under § 1.1502-32 by $10 (from $70 to $60). Later, M1 sells the S share to X, an unrelated person, for $80.

(B) Analysis. M's sale of its S share to M1 is a transfer of the share, but this section applies as of the time M's intercompany item is taken into account under § 1.1502-13, as if M and M1 were divisions of a single corporation. If M and M1 were divisions of a single corporation, the S share's basis would be $90 ($100 reduced by $10 for the depreciation deductions absorbed by the group) and the group would recognize a $10 loss on the sale of the share that is potentially subject to this section. Thus, the sale would be a transfer of a loss share (to the extent of $10) and would be subject to this section (to the extent of that $10). Although the transfer would be subject to this section, there would be no adjustment under paragraph (b) of this section (S has only one share outstanding and so there is no disparity in bases of common shares and no unrecognized gain or loss with respect to preferred) or under paragraph (c) of this section (S has no net positive adjustment). Thus, after the application of paragraph (c) of this section, the share would still be a loss share and would therefore be subject to paragraph (d) of this section. Under paragraph (d) of this section, S would be subject to $10 of attribute reduction (the lesser of the $10 net stock loss and S's $10 aggregate inside loss), allocable to the basis in S's asset. Accordingly, S's basis in its asset is reduced by $10, from $90 to $80, M takes its $30 intercompany stock loss into account, and M1 recognizes a $20 stock gain.

(ii) Selling member deconsolidates. Assume the same facts as in paragraph (i)(A) of this Example 1, except that M1 does not sell the S share and M ceases to be a member of the group when the value of the S share is $80. Under § 1.1502-13, M's deconsolidation causes M's intercompany loss to be taken into account and this section applies at that time. At the time that M deconsolidates, if M and M1 were divisions of a single corporation, the basis in the S share would be $90 ($100 reduced by $10 for the depreciation deductions absorbed by the group) and the group would recognize a $10 loss on the sale of the share that is potentially subject to this section. Such a sale would be a transfer of a loss share (to the extent of $10) and would be subject to this section (to the extent of that $10). The analysis is then the same as in paragraph (i)(B) of this Example 1. As a result, S's basis in its asset is reduced from $90 to $80, M takes its $30 intercompany stock loss into account, and M1 holds the S stock with a basis of $60 (and an unrecognized gain of $20).

(iii) M1 sells the S share at a loss. Assume the same facts as in paragraph (i)(A) of this Example 1, except that S declines in value and M1 sells the S share to X for $50, realizing a $10 loss. In this case, if M and M1 were divisions of a single corporation, the share's basis would be $90 ($100 reduced by $10 for the depreciation deductions absorbed by the group) and the group would recognize a $40 loss on the sale of the share that is potentially subject to this section. Thus, the sale would be a transfer of a loss share (to the extent of $40) and would be subject to this section (to the extent of that $40). Although the transfer would be subject to this section, for the reasons set forth in paragraph (i)(B) of this Example 1, there would be no adjustment under either paragraph (b) or paragraph (c) of this section. Thus, after the application of paragraph (c), the share would still be a loss share and would therefore be subject to paragraph (d) of this section. Under paragraph (d) of this section, S would be subject to $40 of attribute reduction (the lesser of the $40 net stock loss and S's $40 aggregate inside loss), allocable to the basis in S's asset. Accordingly, S's basis in its asset is reduced by $40, from $90 to $50, M takes its $30 intercompany stock loss into account, and M1 recognizes a $10 stock loss.

Example 2. Intercompany sale of built-in gain stock. (i) Facts. M owns the sole outstanding share of stock of S with a basis of $100. S's sole asset has a basis of $0. S sells its asset for $100 and recognizes a $100 gain that increases M's basis in its S share under § 1.1502-32 to $200. M sells the S share to M1 for $100 and recognizes a $100 intercompany loss. Later, M1 sells the S share to X, an unrelated person, for $120.

(ii) Analysis. M's sale of the S share to M1 is a transfer of the share, but this section applies as of the time M's intercompany item is taken into account under § 1.1502-13, as if M and M1 were divisions of a single corporation. If M and M1 were divisions of a single corporation, the S share's basis would be $200 ($100 increased by $100 for the gain recognized on the sale of the asset) and the group would recognize an $80 loss on the sale of the share that is potentially subject to this section. Thus, the sale would be a transfer of a loss share (to the extent of $80) and would be subject to this section (to the extent of that $80). Although the transfer would be subject to this section, there would be no adjustment under paragraph (b) of this section (S has only one share outstanding and so there is no disparity in bases of common shares and no unrecognized gain or loss with respect to preferred). Thus, after the application of paragraph (b), the share would still be a loss share and would therefore be subject to paragraph (c) of this section. Under paragraph (c) of this section, the basis in the S share would be reduced, but not below its $120 value, by the lesser of the $100 disconformity amount and the $100 net positive adjustment that was applied to the share when held by M. Accordingly, the basis in the S share would be reduced by $80, to $120. Because the S share would not be a loss share after the application of paragraph (c) of this section, paragraph (d) of this section would not apply to the transfer. As a result, because the positive adjustment was applied to the share when held by M, M's intercompany item is adjusted to reflect what it would have been had M's basis in its S share been reduced by $80 immediately before its sale to M1. Thus, M's intercompany loss is reduced to $20 and M takes this loss into account, and M1 recognizes a gain of $20.

Example 3. Intercompany sale creates built-in gain stock. (i) Facts. M owns the sole outstanding share of stock of S with a basis of $0. S's sole asset has a basis of $0. M sells the S share to M1 for $100 and recognizes a $100 intercompany gain. While owned by M1, S sells its asset for $100, recognizing a $100 gain that increases M1's basis in the S share under § 1.1502-32 to $200. Later, M1 sells the S share to X for $120.

(ii) Analysis. M's sale of its S share to M1 is a transfer of the share, but this section applies as of the time M's intercompany item is taken into account under § 1.1502-13, as if M and M1 were divisions of a single corporation. If M and M1 were divisions of a single corporation, the S share's basis would be $100 ($0 increased by $100 for the gain recognized on the sale of the asset) and the group would recognize a $20 gain on the sale of the share. Thus, the sale would not be a transfer of a loss share and this section would not apply to the transfer. Accordingly, under this paragraph (e)(3), no portion of M1's $80 loss is subject to this section. M takes its $100 intercompany stock gain into account, and M1 recognizes an $80 loss.

Example 4. Disparate bases in members' shares. (i) Facts. M holds Share A, one of the two outstanding shares of S stock, with a basis of $50 and M1 holds Share B, the other outstanding share of S stock with a basis of $0. S has $50 cash and an asset with a basis of $0. S sells the asset for $50, recognizing a $50 gain that increases M's basis in its S share under § 1.1502-32 by $25 (from $50 to $75) and increases M1's basis under § 1.1502-32 by $25 (from $0 to $25). Later, M sells its Share A to M1 for $50 and recognizes a $25 intercompany loss. Later, M1 sells both S shares to X for $100.

(ii) Analysis. M's sale of its Share A to M1 is a transfer of the share, but this section applies as of the time M's intercompany item is taken into account under § 1.1502-13, as if M and M1 were divisions of a single corporation. If M and M1 were divisions of a single corporation, the basis of Share A would be $75 ($50 increased by $25 for its share of the gain recognized on the sale of the asset), the basis of Share B would be $25, and the group would recognize a $25 loss on the sale of Share A that is potentially subject to this section and a $25 gain on the sale of Share B. Thus, the sale would be a transfer of a loss share (to the extent of $25) and would be subject to this section (to the extent of that $25). Although the transfer is subject to this section, there would be no adjustment under paragraph (b) of this section (all S shares held by members are transferred to a nonmember in one taxable transaction). Thus, after the application of paragraph (b), Share A would still be a loss share and therefore subject to paragraph (c) of this section. Under paragraph (c)(7) of this section, the basis of Share A would be treated as reduced by the gain recognized and taken into account with respect to the transfer of Share B in the same transaction, and so Share A would not be a loss share for purposes of paragraph (c) of this section. Although the share would be a loss share after the application of paragraph (c) of this section, no adjustment would be required under paragraph (d) of this section because there would be no net stock loss in the transaction. Because no adjustment would be made under this section if M and M1 were divisions of a single corporation, M takes its $25 intercompany stock loss into account and M1 recognizes a gain of $25. Alternatively, if the group elects to apply paragraph (b) of this section, M's intercompany item would be adjusted to reflect what it would have been had the $25 investment adjustment applied to Share A been reallocated to Share B, and M1's basis in Share B would be increased by that amount. If so, M's $25 intercompany loss would be reduced to zero, M1's basis in Share B would be increased from $25 to $50, and there would be no gain or loss recognized on either share.

Example 5. Subsidiary with built-in gain and built-in loss assets. (i) Facts. M owns the sole outstanding share of stock of S with a basis of $100. S has two assets, Asset 1 with a basis of $0 and Asset 2 with a basis of $80. M sells the S share to M1 for $90 and recognizes a $10 intercompany loss. While owned by M1, S sells Asset 1 for $60, recognizing a $60 gain that increases M1's basis in the S share under § 1.1502-32 to $150. Later, M1 sells the S share to X for $90.

(ii) Analysis. M's sale of the S share to M1 is a transfer of the share, but this section applies as of the time M's intercompany item is taken into account under § 1.1502-13, as if M and M1 were divisions of a single corporation. If M and M1 were divisions of a single corporation, the S share's basis would be $160 ($100 increased by $60 for the gain recognized on the sale of Asset 1) and the group would recognize a $70 loss on the sale of the share that is potentially subject to this section. Thus, the sale would be a transfer of a loss share (to the extent of $70) and would be subject to this section (to the extent of that $70). Although the transfer is subject to this section, there would be no adjustment under paragraph (b) of this section (S has only one share outstanding and so there is no disparity in bases of common shares and no unrecognized gain or loss with respect to preferred). Thus, after the application of paragraph (b), the share would still be a loss share and would therefore be subject to paragraph (c) of this section. Under paragraph (c) of this section, the basis in the S share would be reduced, but not below its $90 value, by the lesser of the $20 disconformity amount ($160 stock basis over $140 net inside attribute amount) and the $60 net positive adjustment that was applied to the share when held by M1. Accordingly, the basis in the S share would be reduced by $20, to $140. Because the S share would still be a loss share after the application of paragraph (c) of this section, paragraph (d) of this section would apply to the transfer. Under paragraph (d) of this section, S would have an attribute reduction amount of $50, the lesser of the $50 net stock loss ($140 basis over $90 value) and S's $50 aggregate inside loss (the excess of the sum of S's $80 basis in Asset 2 and S's $60 cash from the sale of Asset 1, over the $90 value of the S share). The adjustments required under this section are applied as follows: because the positive adjustment was applied to the share when held by M1, the $20 basis reduction required under paragraph (c) of this section is applied to M1's basis in its S share immediately before its sale to X, reducing it from $150 to $130. In addition, pursuant to paragraph (d) of this section, S's basis in Asset 2 is reduced by $50, from $80 to $30. M takes its $10 intercompany stock loss into account and M1 recognizes a loss of $40.

(iii) Allocation of basis reduction. Assume the same facts as in paragraph (i) of this Example 5, except that, while S is held by M, S earns $30 (consuming a portion of Asset 1) and, while S is held by M1, S earns $20 (consuming a portion of Asset 1) and sells Asset 1 for $10. Thus, M's basis in the S share immediately before the sale to M1 is $130, and M recognizes a $40 intercompany stock loss, and M1's basis in the S share immediately before the sale to X is $120. The analysis regarding the application of this section is the same as in paragraph (ii) of this Example 5. On a separate entity basis, M's basis in the S share would be subject to a $20 reduction under paragraph (c) of this section (at the time M transferred the S share the share had a $30 net positive adjustment and a $20 disconformity amount), and M1's basis in the S share would not be subject to reduction under paragraph (c) of this section (at the time M1 transferred the S share the share had a $30 net positive adjustment and a $20 negative disconformity amount). Therefore, the $20 basis reduction required under paragraph (c) of this section is allocated entirely to M. Accordingly, M's intercompany item is adjusted to reflect what it would have been had the entire $20 basis reduction been applied to the S share while held by M, and M1's basis in the S share is not reduced. Thus, M's intercompany stock loss is reduced by $20 to $20 and M takes this loss into account, and M1 recognizes a $30 loss. S's basis in Asset 2 is reduced by $50, from $80 to $30.

(4) Limited application to multiple-member section 332 liquidations. If more than one member owns shares of S stock, paragraphs (c) and (d) of this section do not apply to any transfer of S shares resulting from a liquidation of S to which section 332 applies.

(5) Form and manner of election(s) under this section. The elections provided in this section are irrevocable and made in the form of a statement titled “Section 1.1502-36 Statement.” The statement must be included on or with the group's timely filed return (original or amended, if filed by the due date for the return, including extensions) for the taxable year of the transfer of the subsidiary stock to which the election relates or, in the case of an intercompany transfer, the year in which the intercompany item from the transfer is taken into account. The statement must include—

(i) The name and employer identification number (E.I.N.) of each subsidiary with respect to which an election is being made;

(ii) If P is electing under paragraph (b)(1)(ii) of this section to redetermine basis with respect to the transfer of stock of one or more subsidiaries, a statement that members' bases in shares of [name of subsidiary or subsidiaries] stock are being redetermined notwithstanding that all members' shares of [name of subsidiary or subsidiaries] are being transferred to one or more nonmembers in one fully taxable transaction;

(iii) If P is electing under paragraph (d)(2)(ii) of this section (attribute reduction amount less than five percent of value) to apply the attribute reduction provisions, a statement that paragraph (d) of this section is being applied to the transfer of shares of stock of [names of all subsidiaries whose shares are transferred] notwithstanding that the aggregate attribute reduction amount in the transaction is less than five percent of the aggregate value of the stock of [names of all subsidiaries whose shares are transferred] transferred by members in the transaction;

(iv) If P is electing under paragraph (d)(4)(ii)(A)(1) of this section to specify the allocation of the attribute reduction amount, a statement (for each subsidiary for which the election is being made) that the attribute reduction amount of [name of subsidiary] is being applied (or not applied) to reduce [identify the attributes in Category A, Category B, and Category C, and the amount of each, with respect to which the election is being made];

(v) If P is electing under paragraph (d)(5)(v)(B) of this section not to apply the conforming limitation on tier-down attribute reduction with respect to one or more subsidiaries, a statement that the conforming limitation in paragraph (d)(5)(v)(B) of this section is not being applied with respect to [name of subsidiary or subsidiaries];

(vi) If P is electing under paragraph (d)(5)(vi)(B) of this section not to restore lower-tier subsidiary stock basis with respect to one or more subsidiaries, a statement that members' bases in [name of subsidiary or subsidiaries] is not being restored under paragraph (d)(5)(vi)(A) of this section;

(vii) If P is electing under paragraph (d)(6) of this section to reattribute attributes, a statement (for each subsidiary for which the election is being made) that [identify the attributes in Category A, Category B, and Category C, and the amount of each or the amount in excess of an amount, with respect to which the election is being made] of [name of subsidiary] are being reattributed (or not) to P;

(viii) If P is electing under paragraph (d)(6) of this section to reduce stock basis, a statement (for each subsidiary for which the election is being made) that members' bases in shares of stock of [name of subsidiary] are being reduced by [specify amount or the amount in excess of an amount];

(ix) If P is electing under paragraph (e)(3)(ii) of this section to apply paragraph (e)(3) of this section to an intercompany transfer that occurred before September 17, 2008, a statement that paragraph (e)(3) of this section is being elected to apply to the transfer of stock of [name of subsidiary] by [name of transferor subsidiary] to [name of transferee subsidiary] on [date of transfer]; and

(x) If P is electing under § 1.1502-96(d)(5) to reattribute to itself all or any part of a section 382 limitation, a statement that P is electing to reattribute a section 382 limitation with respect to losses of [name of subsidiary or, if two or more subsidiaries are members of a loss subgroup, the name of each subsidiary in the loss subgroup]. A separate statement is made for each subsidiary or loss subgroup for which an election is being made. Each statement must include—

(A) The date of the ownership change giving rise to the separate section 382 limitation or subgroup section 382 limitation that is being apportioned;

(B) The amount of the separate (or subgroup) section 382 limitation for the taxable year in which the reattribution occurs (determined without reference to any apportionment under this section or § 1.1502-95(c)); and

(C) The amount of each net operating loss carryover, capital loss carryover, or deferred deduction, and the year in which it arose, of the subsidiary (or subsidiaries) that is subject to the separate section 382 limitation or subgroup section 382 limitation that is being apportioned to the common parent, and the amount of the value element and adjustment element of that limitation that is apportioned to the common parent.

(f) Definitions. In addition to the definitions in other paragraphs of this section and in other provisions of the regulations under section 1502, the following definitions apply for purposes of this section.

(1) Allocable portion has the same meaning as in § 1.1502-32(b)(4)(iii)(B). Thus, for example, within a class of stock, each share has the same allocable portion of the net inside attribute amount and, if there is more than one class of stock, the net inside attribute amount is allocated to each class by taking into account the terms of each class and all other facts and circumstances relating to the overall economic arrangement.

(2) Deferred deduction means any deduction for expenses or loss that would be taken into account under general tax accounting principles as of the time of the transfer of the share, but that is nevertheless not taken into account immediately after the transfer by reason of the application of a deferral provision. Such provisions include, for example, sections 163(j), 267(f), and 469, and § 1.1502-13. “Deferred deduction” also includes S's portion of such consolidated tax attributes, for example consolidated excess charitable contributions that would be apportioned to S under the principles of § 1.1502-79(e) if S had a separate return year. Additionally, it includes amounts equivalent to deductions, such as negative adjustments under section 475 (mark to market accounting method for dealers in securities) and section 481 (adjustments required by changes in method of accounting).

(3) Distribution has the same meaning as in § 1.1502-32(b)(3)(v).

(4) Higher-tier, lower-tier. A subsidiary (S1) (and its shares of stock) is “higher-tier” with respect to another subsidiary (S2) (and its shares of stock) if investment adjustments made to the bases of shares of S2 stock under § 1.1502-32 affect the investment adjustments made to the bases of shares of S1 stock. A subsidiary (S1) (and its shares of stock) is “lower-tier” with respect to another subsidiary (S) (and its shares of stock) if investment adjustments made to the bases of shares of S1 stock affect the investment adjustments made to the bases of shares of S stock. The term lowest-tier subsidiary generally refers to a subsidiary that owns no stock of another subsidiary. The term highest-tier subsidiary generally refers to a subsidiary the stock of which is not lower tier to any shares transferred in the transaction.

(5) Liability means a liability that has been incurred within the meaning of section 461(h), except to the extent otherwise provided in paragraph (d)(4)(ii)(C)(1) of this section.

(6) Loss carryover means any net operating or capital loss carryover that is attributable to S, including any losses that would be apportioned to S under the principles of § 1.1502-21(b)(2) if S had a separate return year. However, solely for purposes of applying paragraph (d) of this section, loss carryovers do not include the amount of any losses waived under § 1.1502-32(b)(4).

(7) Loss share, gain share. A loss share is a share of stock with a basis that exceeds its value. A gain share is a share of stock with a value that exceeds its basis.

(8) Preferred stock, common stock. Preferred stock and common stock have the same meanings as in § 1.1502-32(d)(2) and (3), respectively.

(9) Transaction includes all the steps taken pursuant to the same plan or arrangement.

(10) Transfer—(i) Definition. Except as provided in paragraph (f)(10)(ii) of this section, for purposes of this section, M transfers a share of S stock on the earliest of—

(A) The date that M ceases to own the share as a result of a transaction in which, but for the application of this section (and notwithstanding the deferral of any amount recognized on the transfer, other than by reason of § 1.1502-13), M would recognize income, gain, loss or deduction with respect to the share (see paragraph (e)(3) of this section in the case of a transfer in an intercompany transaction);

(B) The date that M and S cease to be members of the same group;

(D) The last day of the taxable year during which the share becomes worthless under section 165 (taking into account the provisions of § 1.1502-80(c)) if the share is treated as a capital asset, or the date the share becomes worthless (taking into account the provisions of § 1.1502-80(c)) if the share is not treated as a capital asset.

(ii) Excluded transactions. Notwithstanding paragraph (f)(10)(i) of this section, M does not transfer a share of S stock if—

(A) M ceases to own the share as a result of a transaction to which section 381(a) applies and in which either a member acquires assets from S or S acquires assets from M, provided that—

(1) M recognizes no income, gain, loss, or deduction with respect to the share, and

(2) If the transaction is a liquidation to which section 332 applies, M is the only member that owns shares of S stock (if another member owns shares of S stock, see paragraph (e)(4) of this section for a limitation on the application of this section); or

(B) M ceases to own the share as a result of a distribution of the share to a nonmember in a transaction to which section 355 applies, and in which the share is treated as qualified property for purposes of section 355(c) or section 361(c).

(11) Value means the amount realized, if any, or otherwise the fair market value.

(g) Anti-abuse rule—(1) General rule. If a taxpayer acts with a view to avoid the purposes of this section or to apply the rules of this section to avoid the purposes of any other rule of law, appropriate adjustments will be made to carry out the purposes of this section or such other rule of law.

(2) Examples. The following examples illustrate the principles of the anti-abuse rule in this paragraph (g). No implication is intended regarding the potential applicability of any other anti-abuse rules:

Example 1. Loss Trafficking. (i) Facts. M purchases the sole outstanding share of S stock for $100. At that time, S owns Asset 1 with a basis of $0. S sells Asset 1 for $100. Later, S purchases the sole outstanding share of X stock, a corporation with losses, with a view to liquidating X in a transaction to which section 332 applies in order to reduce S's disconformity amount. S purchases the X share for $1, and X has a $100 NOL and an asset with a basis of $1. Subsequently, M sells its S share for $100. After taking into account the effects of all applicable rules of law, M's basis in the S share is $200 (M's original $100 basis, increased under § 1.1502-32 to reflect the $100 gain recognized on the sale of Asset 1). M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(ii) Analysis. Although M's transfer of the S share is subject to this section, there is no adjustment under paragraph (b) of this section (S has only one share outstanding and so there is no disparity in bases of common shares and no shares of S preferred stock outstanding (and so there is no unrecognized gain or loss on S preferred stock)). See paragraph (b)(1)(ii)(A) of this section. Accordingly, after the application of paragraph (b) of this section, M's sale of the S share is still a transfer of a loss share and therefore subject to paragraph (c) of this section. Under paragraph (c) of this section, M's $200 basis in the S share is reduced, but not below the share's $100 value, by the lesser of the share's net positive adjustment and disconformity amount. The share's net positive adjustment is $100, the positive adjustment attributable to the gain recognized on the sale of Asset 1. The share's disconformity amount is $0, the excess of M's $200 basis in the S share over S's $200 net inside attribute amount. Thus, the reduction to basis under paragraph (c) of this section would be $0. However, because S purchased the X stock and liquidated X with a view to avoiding the purposes of this section (by using X's attributes to minimize the disconformity amount of the S share), the attributes acquired from X are disregarded for purposes of applying this section. Accordingly, S's net inside attribute amount is limited to the $100 of attributes S would have had absent the purchase of the X stock, S's money ($100 from the sale of Asset 1). The loss share's disconformity amount is therefore the excess of $200 over $100, or $100. The lesser of the share's $100 net positive adjustment and $100 disconformity amount is $100. As a result, M's $200 basis in the S share is reduced by $100, to $100, and M recognizes no gain or loss on the sale of the S share.

Example 2. Use of a partnership to prevent current attribute reduction. (i) Facts. M owns all 5 outstanding shares of S common stock with a basis of $200 each. S owns Asset 1 with a basis of $1000. In year 1, with a view to preventing a current reduction in the basis of Asset 1, S contributes Asset 1 to a partnership in a transaction in which S recognizes no gain or loss. On December 31, year 2, M sells one S share for $20. After taking into account the effects of all applicable rules of law, M's basis in each S share is $200. M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(ii) Analysis. Although M's transfer of the S share is subject to this section, there is no basis redetermination under paragraph (b) of this section because there is no disparity among M's bases in its shares of S common stock and there are no shares of S preferred stock outstanding (and so there is no unrecognized gain or loss on S preferred stock). See paragraph (b)(1)(ii)(A) of this section. Accordingly, after the application of paragraph (b) of this section, M's sale of the S share is still a transfer of a loss share and therefore subject to paragraph (c) of this section. However, no adjustment is required under paragraph (c) of this section because both the disconformity amount and the net positive adjustment are $0. See paragraph (c)(3) of this section. Under paragraph (d) of this section, S's attribute reduction amount is $180 (the lesser of the $180 net stock loss and S's $900 aggregate inside loss ($1000 of attributes over $100 value of all of the S shares)). Absent the application of this paragraph (g), the $180 attribute reduction amount would be applied to reduce S's basis in the partnership interest. However, because S acted with a view to avoiding a current reduction in the basis of Asset 1 under paragraph (d) of this section, this section is applied by treating S as if it held Asset 1 at the time of the stock sale. The basis of Asset 1 is reduced by $180, to $820, effective immediately before the transfer to the partnership and, as a result, S's basis in its partnership interest is $820.

Example 3. Creation of an intercompany receivable to mitigate attribute reduction. (i) Facts. M owns all five outstanding shares of S common stock each with equal basis that exceeds value. S holds cash and Asset 1 with a basis that exceeds value. In year 1, with a view to mitigating a reduction in the basis of Asset 1, S lends the cash to M1. Asset 1 and the intercompany note received from M1 are assets of the same class under § 1.338-6(b)(2). On December 31, year 2, M sells one of its S shares and, without regard to this section, recognizes a loss. M's sale of the S share is a transfer of a loss share and therefore subject to this section.

(ii) Analysis. Although M's transfer of the S share is subject to this section, no adjustment is required under paragraph (b) of this section because there is no disparity among M's bases in shares of S common stock and there are no shares of S preferred stock outstanding (and so there is no unrecognized gain or loss on S preferred stock). See paragraph (b)(1)(ii)(A) of this section. Accordingly, after the application of paragraph (b) of this section, M's sale of the S shares is still a transfer of a loss share and therefore subject to paragraph (c) of this section. However, there is no adjustment under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Under paragraph (d) of this section, S's attribute reduction amount would be applied to reduce S's basis in Asset 1 and the intercompany receivable in proportion to basis. However, because S acted with a view to mitigating the reduction in the basis of Asset 1 under paragraph (d) of this section, this section is applied without regard to the intercompany receivable. Accordingly, S's basis in Asset 1 is reduced by the full attribute reduction amount.

Example 4. Use of a partnership to reduce net stock loss. (i) Facts. M owns all ten outstanding shares of S common stock, one share (Share 1) has a basis of $0, and one share (Share 2) has a basis of $160. S has an aggregate inside loss of $80. In one transaction and with a view to mitigating a reduction in S's attributes, M contributes Share 1 to a partnership, recognizing no gain or loss, and sells Share 2 for $80. M's contribution of Share 1 to the partnership is a transfer, but the share is not a loss share and so the transfer is not subject to this section. M's sale of Share 2 is a transfer of a loss share and is therefore subject to this section.

(ii) Analysis. Although M's transfer of Share 2 is subject to this section, there is no adjustment under paragraph (b) of this section because there are no investment adjustments that have been applied to the shares. Accordingly, after the application of paragraph (b) of this section, M's sale of Share 2 is still a transfer of a loss share and therefore subject to paragraph (c) of this section. There is no adjustment under paragraph (c) of this section because the net positive adjustment is $0. See paragraph (c)(3) of this section. Accordingly, after the application of paragraph (c) of this section, M's sale of Share 2 is still a transfer of loss shares and therefore subject to paragraph (d) of this section. Under paragraph (d) of this section, the net stock loss would be determined to be $0, the excess of the $160 aggregate basis in all of the transferred shares over the $160 aggregate value of those shares. S's attribute reduction amount would be determined to be $0, the lesser of the $0 net stock loss and S's $80 aggregate inside loss. Thus, there would be no reduction of attributes under this paragraph (d) of this section. However, because M acted with a view to reducing the attribute reduction amount by transferring a gain share to a partnership while avoiding the recognition of the gain on the share, this section is applied without regard to the transfer of the gain share. Accordingly, the net stock loss is determined to be $80, and the attribute reduction amount is determined to be $80.

Example 5. Stuffing gain asset. (i) Facts. M owns the sole outstanding share of S stock (Share 1) with a basis of $100. S owns Asset 1 with a basis of $100 and a value of $20. With a view to avoid the purposes of this section, M transfers Asset 2 with a basis of $0 and a value of $80 to S in exchange for four additional shares of S stock (Share 2 through Share 5) in a transaction to which section 351 applies. M later sells Share 1 to X for $20. M's sale of Share 1 is a transfer of a loss share and therefore subject to this section.

(ii) Analysis. Although M's transfer of the Share 1 is subject to this section, there is no adjustment under paragraph (b) of this section because no investment adjustments have been applied to the basis of any S shares. Thus, after the application of paragraph (b) of this section, M's sale of the S share is still a transfer of a loss share and therefore subject to paragraph (c) of this section. There is no adjustment under paragraph (c) of this section because the net positive adjustment is $0. Accordingly, after the application of paragraph (c) of this section, M's sale of the S share is still a transfer of a loss share and therefore subject to paragraph (d) of this section. Under paragraph (d) of this section, S's attribute reduction amount would be $0, the lesser of the $80 net stock loss and S's $0 aggregate inside loss ($100 of attributes does not exceed the $100 value of all of the S shares). However, because M transferred Asset 2 to S with a view to avoid the purposes of this section, the application of this section to M's transfer of Share 1 is made without regard to the transfer of Asset 2. Accordingly, under paragraph (d) of this section, S's attribute reduction amount is $80, the lesser of the $80 net stock loss and S's $80 aggregate inside loss (computed without regard to Asset 2). S's basis in Asset 1 is therefore reduced by $80, from $100 to $20, under paragraph (d) of this section.

(iii) Transfer of all S shares. Assume the same facts as in paragraph (i) of this Example 5, except that M sells all five S shares to X, recognizing both the gain and the loss on the S shares. The transfer of Share 1 is still a transfer of a loss share and therefore subject to this section. However, because all the shares are transferred, the group's income is clearly reflected. Therefore, the purposes of this section are not avoided and this section applies without modification. S's attribute reduction amount is $0, the lesser of the $0 net stock loss and S's $0 aggregate inside loss.

(h) Applicability date—(1) In general. This section applies to transfers of shares of subsidiary stock on or after September 17, 2008 unless the transfer was made pursuant to a binding agreement that was in effect prior to September 17, 2008 and at all times thereafter. For transfers of shares of subsidiary stock that are not subject to this section, see §§ 1.337(d)-2 and 1.1502-35.

(2) Definition in paragraph (f)(2) of this section. Paragraph (f)(2) of this section applies to taxable years beginning on or after November 13, 2020. For taxable years beginning before November 13, 2020, see § 1.1502-36 as contained in 26 CFR part 1, revised April 1, 2019. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of this section to a taxable year beginning after December 31, 2017, and before November 13, 2020, so long as the taxpayers and their related parties consistently apply the rules of this section, the section 163(j) regulations (as defined in § 1.163(j)-1(b)(37)), and, if applicable, §§ 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§ 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-1), and 1.1504-4, to that taxable year.

[T.D. 9424, 73 FR 53952, Sept. 17, 2008, as amended at 73 FR 62204, Oct. 20, 2008; 73 FR 65982, Nov. 6, 2008; T.D. 9905, 85 FR 56843, Sept. 14, 2020]

15 Special Taxes and Taxpayers

§ 1.1502-43 Consolidated accumulated earnings tax.

(a) Group subject to tax—(1) General rule. For a group filing a consolidated return for the taxable year, the accumulated earnings tax under section 531 is imposed on consolidated accumulated taxable income (as defined in paragraph (b) of this section). This tax applies to any group that is formed or availed of to avoid or prevent the imposition of the individual income tax on the shareholders of either any of its members or any other corporation by permitting earnings and profits to accumulate instead of dividing or distributing them. Section 531 and this section do not apply to a group that is treated as a “personal holding company” under section 542(a)(1) as a result of the application of section 542(b)(1). Special rules are provided in this section for other groups which include one or more personal holding companies.

(2) Evidence of purpose to avoid income tax. (i) Under section 533(a), the fact that the group's earnings and profits are permitted to accumulate beyond the reasonable needs of its business is determinative of the purpose to avoid the income tax with respect to shareholders, unless the group by the preponderance of the evidence proves to the contrary.

(ii) The fact that a group is a mere holding or investment group is prima facie evidence of the group's purpose to avoid the income tax with respect to the shareholders. The activities of a member which is a personal holding company are not taken into account in determining if the group is a mere holding or investment group.

(3) Earnings and profits. For purposes of this paragraph (a) and paragraph (d) of this section, the following rules apply:

(i) If no member of the group is a personal holding company, the group's earnings and profits are the aggregate of the earnings and profits (or deficit) of each corporation that is a member at the close of the taxable year, determined in accordance with § 1.1502-33.

(ii) Earnings and profits resulting from the application of § 1.1502-33(b) are not taken into account.

(iii) Earnings and profits resulting from the disposition of a member's stock are determined without regard to the stock basis adjustments under §§ 1.1502-32 and 1.1502-33(c)(1).

(4) Reasonable needs of the business. The reasonable needs of the group's business include the reasonable needs of the business of any corporation (other than a personal holding company) that is a member at the close of the taxable year. Thus, the earnings and profits of one member may be accumulated with respect to the reasonable business needs of another member. If under § 1.537-3(b) the business of a nonmember corporation is considered the business of a member, then the earnings and profits of any member may be accumulated with respect to such nonmember's reasonable business needs.

(5) Burden of proof. The notification described in section 534(b) and the statement described in section 534(c) are made to or by the common parent corporation in accordance with § 1.1502-77.

(b) Consolidated accumulated taxable income—(1) In general. “Consolidated accumulated taxable income” is the group's consolidated taxable income determined under § 1.1502-11 adjusted in the manner provided in paragraph (b)(2) of this section, minus the sum of—

(i) The consolidated dividends paid deduction determined under paragraph (c) of this section and

(ii) The consolidated accumulated earnings credit determined under paragraph (d) of this section.

(2) Adjustments to consolidated taxable income. For purposes of paragraph (b)(1) of this section, consolidated taxable income is adjusted as follows:

(i) Under section 535(b)(1), the deduction for taxes is the excess of—

(A) The consolidated liability for tax determined without § 1.1502-2(a)(2) through (4), and without the foreign tax credit provided by section 27, over

(B) The consolidated foreign tax credit determined pursuant to § 1.1502-4. Foreign taxes deductible under § 1.535-2(a)(2) are also allowed as a deduction under section 535(b)(1).

(ii) The consolidated charitable contributions deduction under § 1.1502-24 does not apply. Under section 535(b)(2), there shall be allowed the aggregate charitable contributions of the members allowable under section 170, determined without section 170 (b)(2) and (d)(2).

(iii) Under section 535(b)(3), the deduction determined under § 1.1502-26 is not allowed.

(iv) Under section 535(b)(4), the consolidated net operating loss deduction described in § 1.1502-21(a) is not allowed.

(v) Under section 535(b)(5), there is allowed as a deduction the consolidated net capital loss, determined under § 1.1502-22(a).

(vi) Under section 535(b)(6), there is allowed as a deduction an amount equal to—

(A) The consolidated capital gain net income for the taxable year (determined under § 1.1502-22(a) and without the consolidated net capital loss carryovers and carrybacks to the taxable year), minus

(B) The taxes attributable to such gain.

(vii) Under section 535(b)(7), the consolidated net capital loss carryovers and carrybacks are not allowed. See § 1.1502-22(b).

(viii) Section 1.1502-15 does not apply.

(3) Personal holding company a member. If a member is a personal holding company for the taxable year—

(i) [Reserved]

(ii) In applying paragraph (b)(2)(i) of this section, consolidated liability for tax (as determined under that paragraph (b)(2)(i)) is reduced by the portion thereof allocable to that member under section 1552(a) (1), (2), (3), or (4) (or § 1.1502-33(d)), whichever is applicable. The consolidated foreign tax credit is computed by excluding the taxable income and any foreign taxes paid or accrued by that member, and foreign taxes deductible under § 1.535-2(a)(2) do not include foreign taxes attributable to that member.

(c) Consolidated dividends paid deduction—(1) General rule. For purposes of this section, the consolidated dividends paid deduction is the aggregate of the members' deductions under section 561(a) (1) and (2). This deduction is determined by excluding deductions for dividends paid to other members.

(2) Exception for certain personal holding companies. [Reserved]

(3) Dividends paid defined. For purposes of this paragraph (c), “dividends paid” and “dividend (or portion thereof) paid” include amounts treated as dividends paid during the taxable year under sections 562(b)(1), 563, and 565 (relating respectively to liquidating distributions, dividends paid after year end, and consent dividends).

(4) Examples. This paragraph (c) can be illustrated by the following examples:

Example 1.Corporations P and S constitute an affiliated group which files a consolidated return on a calendar year basis for 1984 and 1985. P owns all of S's stock and two individuals own all of P's stock. Neither member of the group is a personal holding company for 1984. Assume that on December 15, 1984, S pays a dividend (as defined in section 316 (a)) of $2,000 to P, and P pays a dividend (as so defined) of $3,000 on January 15, 1985, to its individual shareholders. All dividends are paid in cash and are pro rata with no preference as to any shares or class of stock. For purposes of this paragraph (c), the consolidated dividends paid deduction for 1984 is $3,000, i.e., the dividend paid on January 15, 1985, by P to its nonmember shareholders. See section 563 (a). The $2,000 dividend paid by S to P is not taken into account in computing the consolidated dividends paid deduction.

Example 2.[Reserved]

(d) Consolidated accumulated earnings credit—(1) In general. [Reserved]

(2) Special rule if a consolidated group is part of a controlled group. If a consolidated group is treated collectively as being one component member of a controlled group, or if each member of a consolidated group is treated as being a separate component member of a controlled group, see section 1561 for determining the portion of the accumulated earnings credit to be allocated to such group or to such members.

(e) Effective/applicability date. This section applies to any consolidated Federal income tax return due (without extensions) on or after December 21, 2009.

[T.D. 7937, 49 FR 3462, Jan. 27, 1984, as amended by T.D. 8560, 59 FR 41674, Aug. 15, 1994; T.D. 8677, 61 FR 33324, June 27, 1996; T.D. 8560, 62 FR 12098, Mar. 14, 1997; T.D. 8823, 64 FR 36100, July 2, 1999; T.D. 9304, 71 FR 76907, Dec. 22, 2006; T.D. 9476, 74 FR 68532, Dec. 28, 2009; T.D. 9885, 84 FR 67039, Dec. 6, 2019; T.D. 10018, 89 FR 106872, Dec. 30, 2024]

§ 1.1502-44 Percentage depletion for independent producers and royalty owners.

(a) In general. The sum of the percentage depletion deductions for the taxable year for all oil or gas property owned by all members, plus any carryovers under section 613A(d)(1) or paragraph (d) of this section from a prior taxable year, may not exceed 65 percent of the group's adjusted consolidated taxable income (under paragraph (b) of this section) for the consolidated return year.

(b) Adjusted consolidated taxable income. For purposes of this section, adjusted consolidated taxable income is an amount (not less than zero) equal to the group's consolidated taxable income determined without—

(1) Any depletion with respect to an oil or gas property (other than a gas property with respect to which the depletion allowance for all production is determined pursuant to section 613A(b)) for which percentage depletion would exceed cost depletion in the absence of the depletable quantity limitations contained in section 613A(c)(1) and (6) and the consolidated taxable income limitation contained in paragraph (a) of this section;

(2) Any consolidated net operating loss carryback to the consolidated return year under § 1.1502-21; and

(3) Any consolidated net capital loss carryback to the consolidated return year under § 1.1502-22.

(c) Allocation to oil and gas properties. The maximum amount allowable as a deduction under section 613A(c), after the application of paragraph (a) of this section, is allocated to properties held by members in accordance with the regulations under section 613A(d). Those regulations provide for an initial allocation and possible reallocation of the maximum allowable percentage depletion deduction among oil and gas properties. Thus, if, after the initial allocation, cost depletion exceeds the percentage depletion that would be allowable for a particular oil or gas property, cost depletion must be used for that property and the maximum amount of percentage depletion allowable as a deduction for the group is reallocated among only the remaining properties held by all members.

(d) Carryover for disallowed amounts. (1) If any amount is disallowed as a deduction for the taxable year by reason of section 613A(d)(1) or paragraph (a) of this section, the disallowed amount for each oil or gas property is treated as an amount allowed as a deduction under section 613A(c), for the following taxable year for the member that owned the property, in accordance with the regulations under section 613A and paragraphs (a) and (d)(2) of this section.

(2) Any amount that was disallowed as a deduction in a separate return limitation year of a member may be carried to a consolidated return year only to the extent that 65 percent of the excess determined under paragraph (d)(3) of this section exceeds the sum of the otherwise allowable percentage depletion deductions for the member's oil and gas properties for the year.

(3) The excess determined in this subparagraph (3) for a member is the excess, if any, of adjusted consolidated taxable income for the year under paragraph (b) of this section over that income recomputed by excluding the items of income and deductions of the member.

(e) Effective date. This section applies to taxable years for which the due date (without extensions) for filing returns is after September 30, 1980.

[T.D. 7725, 45 FR 65561, Oct. 3, 1980, as amended by T.D. 8677, 61 FR 33324, June 27, 1996; T.D. 8823, 64 FR 36100, July 2, 1999; T.D. 10018, 89 FR 106872, Dec. 30, 2024]

§ 1.1502-45 Limitation on losses to amount at risk.

(a) In general—(1) Scope. This section applies to a loss of any subsidiary if the common parent's stock meets the stock ownership requirement described in section 465(a)(1)(B).

(2) Limitation on use of losses. Except as provided in paragraph (a)(4) of this section, a loss from an activity of a subsidiary during a consolidated return year is includible in the computation of consolidated taxable income (or consolidated net operating loss) and consolidated capital gain net income (or consolidated net capital loss) only to the extent the loss does not exceed the amount that the parent is at risk in the activity at the close of that subsidiary's taxable year. In addition, the sum of a subsidiary's losses from all its activities is includible only to the extent that the parent is at risk in the subsidiary at the close of that year. Any excess may not be taken into account for the consolidated return year but will be treated as a deduction allocable to that activity of the subsidiary in the first succeeding taxable year.

(3) Amount parent is at risk in subsidiary's activity. The amount the parent is at risk in an activity of a subsidiary is the lesser of the amount the parent is at risk in the subsidiary, or the amount the subsidiary is at risk in the activity. These amounts are determined under paragraph (b) of this section and the principles of section 465. See section 465 and the regulations thereunder and the examples in paragraph (e) of this section.

(4) Excluded activities. The limitation on the use of losses in paragraph (a)(2) of this section does not apply to a loss attributable to an activity described in section 465(c)(4).

(5) Substance over form. Any transaction or arrangement between members (or between a member and a person that is not a member) which does not cause the parent to be economically at risk in an activity of a subsidiary will be treated in accordance with the substance of the transaction or arrangement notwithstanding any other provision of this section.

(b) Rules for determining amount at risk—(1) Excluded amounts. The amount a parent is at risk in an activity of a subsidiary at the close of the subsidiary's taxable year does not include any amount that would not be taken into account under section 465 were the subsidiary not a separate corporation. Thus, for example, if the amount a parent is at risk in the activity of a subsidiary is attributable to nonrecourse financing, the amount at risk is not more than the fair market value of the property (other than the subsidiary's stock or debt or assets) pledged as security.

(2) Guarantees. If a parent guarantees a loan by a person other than a member to a subsidiary, the loan increases the amount the parent is at risk in the activity of the subsidiary.

(c) Application of section 465. This section applies in a manner consistent with the provisions of section 465. Thus, for example, the recapture of losses provided in section 465(e) applies if the amount the parent is at risk in the activity of a subsidiary is reduced below zero.

(d) Other consolidated return provisions unaffected. This section limits only the extent to which losses of a subsidiary may be used in a consolidated return year. This section does not apply for other purposes, such as §§ 1.1502-32 and 1.1502-19, relating to investment in stock of a subsidiary and excess loss accounts, respectively. Thus, a loss which reduces a subsidiary's earnings and profits in a consolidated return year, but is disallowed as a deduction for the year by reason of this section, may nonetheless result in a negative adjustment to the basis of an owning member's stock in the subsidiary or create (or increase) an excess loss account.

(e) Examples. The provisions of this section may be illustrated by the examples in this paragraph (e). In each example, the stock ownership requirement of section 465(a)(1)(B) is met for the stock of the parent (P), and each affiliated group files a consolidated return on a calendar year basis and comprises only the members described.

(1) Example 1. In 2022, P forms S with a contribution of $200 in exchange for all of S's stock. During the year, S borrows $400 from a commercial lender and P guarantees $100 of the loan. S uses $500 of its funds to acquire a motion picture film. S incurs a loss of $120 for the year with respect to the film. At the close of 2022, the amount P is at risk in S's activity is $300 ($200 contribution plus $100 guarantee). If S has no gain or loss in 2023, and there are no contributions from or distributions to P, at the close of 2023 P's amount at risk in S's activity will be $180.

(2) Example 2. P forms S-1 with a capital contribution of $1 on January 1, 2023. On February 1, 2023. S-1 borrows $100 with full recourse and contributes all $101 to its newly formed subsidiary S-2. S-2 uses the proceeds to explore for natural oil and gas resources. S-2 incurs neither gain nor loss from its explorations during the taxable year. As of December 31, 2023, P is at risk in the exploration activity of S-2 only to the extent of $1.

(f) Applicability date. This section applies to consolidated return years for which the due date of the income tax return (without regard to extensions) is after December 30, 2024.

[T.D. 10018, 89 FR 106872, Dec. 30, 2024]

§ 1.1502-47 Consolidated returns by life-nonlife groups.

(a) Scope—(1) In general. Under section 1504(b)(2), insurance companies that are taxed under section 801 (relating to life insurance companies) are not treated as includible corporations for purposes of determining under section 1504(a) the existence of an affiliated group and the composition of its membership. Section 1504(c)(2) provides an election whereby certain life insurance companies may be treated as includible corporations, and thus members, of a group composed of other includible corporations. This section provides regulations for the making of this election and for the determination of an electing group's composition, its consolidated taxable income (or loss), and its consolidated tax liability.

(2) General method of consolidation—(i) Subgroup method. The regulations adopt a subgroup method to determine consolidated taxable income. One subgroup is the group's nonlife companies. The other subgroup is the group's life insurance companies. Initially, the nonlife subgroup computes nonlife consolidated taxable income and the life subgroup computes consolidated LICTI. A subgroup's income may in effect be reduced by a loss of the other subgroup, subject to the limitations in sections 172 and 1503(c). The life subgroup losses consist of life consolidated net operating loss, consolidated operations loss carryovers from taxable years beginning before January 1, 2018 (consolidated operations loss carryovers), and life consolidated net capital loss. The nonlife subgroup losses consist of nonlife consolidated net operating loss and nonlife consolidated net capital loss. Consolidated taxable income is therefore defined in pertinent part as the sum of nonlife consolidated taxable income and consolidated LICTI, reduced by life subgroup losses and/or nonlife subgroup losses.

(ii) Subgroup loss. A subgroup loss does not actually affect the computation of nonlife consolidated taxable income or consolidated LICTI. It merely constitutes a bottom-line adjustment in reaching consolidated taxable income. Furthermore, the amount of a subgroup's loss, if any, that is eligible to be carried back to a prior taxable year first must be carried back against income of the same subgroup before it may be used as a setoff against the other subgroup's income in the taxable year the loss arose. (See sections 172(b)(1) and 1503(c)(1); see also § 1.1502-21(b).) The carryback of losses from one subgroup may not be used to offset income of the other subgroup in the year to which the loss is to be carried. This carryback of one subgroup's loss may “bump” the other subgroup's loss that, in effect, previously reduced the income of the first subgroup. The subgroup's loss that is bumped in appropriate cases may, in effect, reduce a succeeding year's income of either subgroup. This approach gives the group the tax savings of the use of losses, but the bumping rule assures that, insofar as possible, life deductions will be matched against life income and nonlife deductions against nonlife income.

(iii) Carryover of subgroup loss. A subgroup's loss may be used in a succeeding year, but in any particular succeeding year the loss must be used to reduce the income of the same subgroup before it may be used as a setoff against the other subgroup's income.

(3) Other provisions. The provisions of the consolidated return regulations apply unless this section provides otherwise. Further, unless otherwise indicated in this section, a term used in this section has the same meaning as in sections 801-848.

(b) Definitions. For purposes of this section:

(1) Life company. The term life company means a life insurance company as defined in section 816 and subject to tax under section 801. Section 816 applies to each company separately.

(2) Nonlife insurance company. The term nonlife insurance company has the meaning provided in § 1.1502-1(k).

(3) Life insurance company taxable income. The term life insurance company taxable income or LICTI has the meaning provided in section 801(b).

(4) Group. The term group has the meaning provided in § 1.1502-1(a). Unless otherwise indicated in this section, a group's composition is determined without regard to section 1504(b)(2).

(5) Member. The term member has the meaning provided in § 1.1502-1(b). A life company is tentatively treated as a member for any taxable year for purposes of determining if it is an eligible corporation under paragraph (b)(12) of this section and, therefore, if it is an includible corporation under section 1504(c)(2). If such a company is eligible and includible (under section 1504(c)(2)), it will actually be treated as a member of the group.

(6) Life member. A life member is a member of the group that is a life company.

(7) Nonlife member. A nonlife member is a member of the group that is not a life company.

(8) Life subgroup. A life subgroup is composed of those members that are life members. If the group has only one life member, it constitutes a life subgroup.

(9) Nonlife subgroup. A nonlife subgroup is composed of those members that are nonlife members. If the group has only one nonlife member, it constitutes a nonlife subgroup.

(10) Separate return year. The term separate return year has the meaning provided in § 1.1502-1(e). For purposes of this paragraph (b)(10), the term group is defined with regard to section 1504(b)(2) for years in which an election under section 1504(c)(2) is not in effect. Thus, a separate return year includes a taxable year for which that election is not in effect.

(11) Separate return limitation year. Section 1.1502-1(f)(2) provides exceptions to the definition of the term separate return limitation year. For purposes of applying those exceptions to this section, the term group is defined without regard to section 1504(b)(2), and the definition in this paragraph (b)(11) applies separately to the nonlife subgroup in determining nonlife consolidated taxable income under paragraph (f) of this section and to the life subgroup in determining consolidated LICTI under paragraph (g) of this section. Paragraph (h)(3)(ix) of this section defines the term separate return limitation year for purposes of determining whether the losses of one subgroup may be used against the income of the other subgroup.

(12) Eligible corporations—(i) In general. A corporation is an eligible corporation for a taxable year of a group only if, throughout every day of the base period the corporation:

(A) Was in existence and a member of the group determined without the exclusions in section 1504(b)(2) (see paragraphs (b)(12) (iii) through (vi) of this section),

(B) Was engaged in the active conduct of a trade or business (“active business”),

(D) Did not undergo disproportionate asset acquisitions (see paragraph (b)(12)(viii) of this section).

(ii) Base period. The base period consists of the common parent's five taxable years immediately preceding the group's taxable year for which the consolidated return and the determination of eligibility are made. Eligibility is determined for each consolidated return year beginning with the first year for which the election under section 1504(c)(2) is effective.

(iii) In existence. Except as provided in paragraphs (b)(12) (v) and (vi) of this section, a corporation organized after the base period begins is not eligible even though it is a member of the group immediately after its organization. For purposes of this paragraph (b)(12)(iii), a corporation that was a party to a reorganization described in section 368(a)(1)(F) shall be treated as the same entity both before and after the reorganization.

(iv) Membership period. Except as provided in paragraphs (b)(12) (v) and (vi) of this section, a corporation must have been a member of the group throughout the base period to be eligible. Thus, an ineligible corporation includes one whose stock was acquired from outside the group at any time during the base period or one which was a member of a different group (whether by application of reverse acquisition rules in § 1.1502-75(d)(3) or otherwise) at any time during the base period. For purposes of this subdivision (iv), the common parent of a group is treated as constituting a group (and hence is a member) during any period when it was not a member of an affiliated group within the meaning of section 1504(a) (applied without section 1504(b)(2)).

(v) Tacking rule. The period during which an old corporation is in existence and a member of the group engaged in active business is included in (or tacks onto) the period for the new corporation if the following four conditions listed in this paragraph (b)(12)(v) are met. For purposes of this paragraph (b)(12)(v), a new corporation is a corporation (whether or not newly organized) during the period its eligibility depends upon the tacking rule. The four conditions are as follows—

(A) The first condition is that, at any time, 80 percent or more of the new corporation's assets it acquired (other than in the ordinary course of its trade or business) were acquired from the old corporation in one or more transactions described in section 351(a) or 381(a). This asset test is applied by using the fair market values of assets on the date they were acquired and without regard to liabilities. Assets acquired in the ordinary course of business will be excluded from total assets only if they were acquired after the new corporation became a member of the group (determined without section 1504(b)(2)). In addition, assets that the old corporation acquired from outside the group in transactions not conducted in the ordinary course of its trade or business are not included in the 80 percent (but are included in total assets) if the old corporation acquired those assets within five calendar years before the date of their transfer to the new corporation.

(B) The second condition is that at the end of the taxable year during which the first condition is first met, the old corporation and the new corporation must both have the same tax character. For purposes of this paragraph (b)(12), a corporation's tax character is the section under which it would be taxed (for example, section 11, section 801, or section 831) if it filed a separate return. If the old corporation is not in existence (or adopts a plan of complete liquidation) at the end of that taxable year, this paragraph (b)(12)(v)(B) will apply to the old corporation's taxable year immediately preceding the beginning of the taxable year during which the first condition is first met.

(C) The third condition is that, at the end of the taxable year during which the first condition is first met, the new corporation does not undergo a disproportionate asset acquisition under paragraph (b)(12)(viii) of this section.

(D) The fourth condition is that, if there is more than one old corporation, the first two conditions apply to all of the corporations. Thus, the second condition (tax character) must be met by all of the old corporations transferring assets taken into account in meeting the test in paragraph (b)(12)(v)(A) of this section.

(vi) Old group remaining in existence. If the common parent of a group (or a new common parent) became the common parent in a transaction described in § 1.1502-75 (d)(2) or (d)(3) where a group remained in existence, then paragraph (b)(12) (ii) through (iv) of this section apply by treating that common parent as if it were also the previous common parent of the group that remains in existence. If this paragraph (b)(12)(vi) applies to a transaction, the tacking rule in paragraph (b)(12)(v) of this section does not apply to the transaction.

(vii) Change in tax character. A corporation must not experience during the base period a change in tax character (as defined in paragraph (b)(12)(v)(B) of this section) if the change is attributable to an acquisition of assets from outside the group in transactions not conducted in the ordinary course of its trade or business. However, if a new corporation relies on the tacking rules in paragraph (b)(12)(v) of this section, this paragraph (b)(12)(vii) shall apply during the base period and the current consolidated return year even if the change in tax character is attributable to an asset acquisition from within the group.

(viii) Disproportionate asset acquisition. To be eligible, a corporation must not undergo during the base period disproportionate asset acquisitions which are attributable to an acquisition (or a series of acquisitions) of assets from outside the group in transactions not conducted in the ordinary course of its trade or business (special acquisition). Whether special acquisitions are disproportionate is determined at the end of each base period. Whether an acquisition results in a disproportionate asset acquisition depends on all of the facts and circumstances including the following factors and rules:

(A) One factor is the portion of the insurance reserves (that is, total reserves in section 816(c), as modified by section 816(h)) of the acquiring company at the end of the base period which is attributable to special acquisitions.

(B) A second factor is the portion of the fair market value of the assets (without reduction for liabilities) of the acquiring company at the end of the base period that is attributable to special acquisitions.

(C) A third factor is the portion of the premiums generated during the last taxable year of the base period which are attributable to special acquisitions.

(D) A corporation will not experience a disproportionate asset acquisition unless 75 percent of one factor (whether or not listed in this paragraph (b)(12)(viii)) is attributable to special acquisitions.

(E) Money or other property contributed to a corporation by a shareholder that is not a member of the group (without section 1504(b)(2)) is not a special acquisition.

(F) If a new corporation relies on the tacking rules in paragraph (b)(12)(v) of this section, this paragraph (b)(12)(viii) applies to that corporation during a consolidated return year. Thus, if at any time during a consolidated return year, a new corporation undergoes a disproportionate asset acquisition, the corporation becomes ineligible at that time.

(13) Ineligible corporation. A corporation that is not an eligible corporation is ineligible. If a life company is ineligible, it is not treated under section 1504(c)(2) as an includible corporation. Losses of a nonlife member arising in years when it is ineligible may not be used under section 1503(c)(2) and paragraph (g) of this section to set off the income of a life member. If a life company is ineligible and is the common parent of the group (without regard to section 1504(b)(2)), the election under section 1504(c)(2) may not be made.

(14) Examples The following examples illustrate this paragraph (b). In each example, L indicates a life company, another letter indicates a nonlife company, and each corporation uses the calendar year as its taxable year.

(i) Example 1. P has owned all of the stock of S since 2012. On January 1, 2018, P purchased all of the stock of L1 which owns all of the stock of L2 and S2. L1 and L2 are treated as members for purposes of determining if they are eligible for 2020. However, for 2020, L1, L2, and S2 are ineligible because none of them has been a member of the group for P's five taxable years preceding 2020. For 2020, L1 and L2 may elect to file a consolidated return because they constitute an affiliated group under section 1504(c)(1), and P and S may file a consolidated return. S2 must file its own separate return for 2020.

(ii) Example 2. Since 2012, L1 has been a life company owning all the stock of L2. In 2018, L1 transfers assets to S1, a new nonlife insurance company subject to taxation under section 831(a). For 2020, only L1 and L2 are eligible corporations. The tacking rule in paragraph (b)(12)(v) of this section does not apply in 2020 because the old corporation (L1) and the new corporation (S1) do not have the same tax character.

(iii) Example 3. Since 2012, L has owned all the stock of L1, which has owned all the stock of S1, a nonlife insurance company. L1 writes some accident and health insurance business. In 2018, L1 transfers this business, and S1 transfers some of its business, to a new nonlife insurance company, S2, in a transaction described in section 351(a). The property transferred to S2 by L1 had a fair market value of $50 million. The property transferred by S1 had a fair market value of $40 million. S2 is ineligible for 2020 because the tacking rule in paragraph (b)(12)(v) of this section does not apply. The old corporations (L1 and S1) and the new corporation (S2) do not all have the same tax character. See paragraph (b)(12)(v)(B) and (D) of this section. The result would be the same if L1 transferred other property (for example, stock and securities) with the same value, rather than accident and health insurance contracts, to S2.

(iv) Example 4. Since 2012, P has owned all the stock of S and L1. L1 is a large life company engaged in active business since 2012. On January 1, 2020, L1 transfers in a section 351 (a) transaction assets (not acquired from outside the group) to a new life company, L2. For 2020, L2 is eligible because under paragraph (b)(12)(v) of this section, L2 is considered to have been in existence and a member of the group engaged in the active business since 2012 which is the period L1, the old corporation, was in existence and a member of the group so engaged.

(v) Example 5. The facts are the same as in example (4). Assume that the fair market value of the assets L1 transferred to L2 was $10 million on January 1, 2020 and that L2 acquired no other assets prior to June 30, 2021. Assume further that on January 1, 2021, L1 acquires (other than in the ordinary course of its trade or business) assets having a fair market value of $40 million from L3, an unrelated life company. On June 30, 2021, L1 transfers those assets to L2. L2 becomes ineligible on June 30, 2021. Since by fair market values, 80 percent (in other words, 40/50) of L2's assets are attributable to special acquisitions, L2 has undergone a disproportionate asset acquisition at that time. See paragraph (b)(12)(viii)(B), (D), and (F) of this section.

(vi) Example 6. The facts are the same as in example (5) except that L1 transfers assets (other than life insurance contracts) having a fair market value of $40 million to L2 and L2 purchases the assets of L3 on June 30, 2021. the result of the 2021 acquisition is the same as in example (5).

(vii) Example 7. The facts are the same as in example (5) except the acquired assets acquired by L2 in 2021 from L1 have a fair market value of $20 million. In 2021, L2 had $1 million of premiums on its pre-existing contracts but premiums generated by the acquired business for the entire year would have been $2 million. L2 is eligible in 2021 because it did not experience a disproportionate asset acquisition on June 30, 2021.

(viii) Example 8. Since 2012, L, a State A corporation, has owned all of the stock of L1 and S1. On January 1, 2020, L merges into L3, a smaller State B corporation, which owns the stock of S2. The transaction is a reverse acquisition described in § 1.1502-75(d)(3) and the group of which L was the common parent remains in existence. Under paragraph (b)(12)(vi) of this section, L3 is eligible for 2020. However, S2 is ineligible in 2020 under paragraph (b)(12)(iv) of this section.

(ix) Example 9. The facts are the same as in example (8) except that L acquires the stock of L3. L3 and S2 are both ineligible for 2020. On January 1, 2021, the fair market value of L3's assets are $5 million (without liabilities) and on that date L transfers assets (not acquired from outside the group) having a fair market value of $95 million (without liabilities) to L3. L and L3 are life companies at the end of 2021. L3 is eligible in 2021 under the tacking rule in paragraph (b)(12)(v) of this section. S2 is ineligible in that year. The result would be the same if L3 was not a life company prior to January 1, 2021. See paragraph (b)(12)(v)(B) of this section.

(x) Example 10. Since 2012, X, a foreign corporation, has owned all the stock of S2 and S1, and S1 has owned all of the stock of L1. On January 1, 2020, X incorporates a new U.S. company P, and transfers the stock of S1 and S2 to P. Assume that under § 1.1502-75(d)(3) (relating to reverse acquisitions), the S1-L1 affiliated group remains in existence. Under paragraph (b)(12)(vi) of this section, P, S1, and L1 are eligible but S2 is ineligible. The result would be the same if X were an individual.

(xi) Example 11. The facts are the same as in Example (10) except that X owns all of the stock of S1, L1, and S2. In addition, on January 1, 2020, X transfers the stock of S1 and S2 to L1. L1 is eligible in 2020 under paragraph (b)(12)(iv) of this section. L1 would still be eligible even if it owned a subsidiary during the base period but sold the subsidiary prior to January 1, 2020. S1 and S2 are ineligible in 2020.

(xii) Example 12. Since 2012, S1 has owned all of the stock of L1. S2, an unrelated company, has owned all of the stock of L2 and S3 for 10 years. S1 and S2 are active nonlife insurance companies and not holding companies. On January 1, 2020, S1 and S2 merge into a new nonlife insurance company, S, in a transaction described in § 1.1502-75(d)(3) so that the group of which S1 was the common parent remains in existence. S and L1 are eligible in 2020 under paragraph (b)(12)(vi) of this section. L2 and S3 are ineligible.

(xiii) Example 13. The facts are the same as in Example (12) except that S2 (the first corporation in § 1.1502-75(d)(3)) acquires the stock of S1 in exchange for the stock of S2. The result is that only S2, S1, and L1 are eligible in 2020.

(c) Election—(1) In general. The election under section 1504(c)(2) may not be made if the group's common parent is an ineligible life company. The election under section 1504(c)(2) may only be made by the common parent of the group (as defined in section 1504(c)(2) without the exclusions in section 1504(b)(2)). For example, assume that P owns all of the stock of L1, an eligible life company, which owns the stock of S1. Assume further that P also owns the stock of L2, an ineligible life member, which (for more than five years) has owned the stock of a nonlife company, S2. Only P may make the election and, if it does so, P, L1, and S1 may file a consolidated return under this section. L2 may not make the election under section 1504(c)(2) and may not file a consolidated return with S2.

(2) How election is made—(i) General rule. The election under section 1504(c)(2) is generally made by the group's common parent in the same manner (and it has the same effect) as the election to file a consolidated return is made under § 1.1502-75 (a) and (b) for a group which did not file a consolidated return for the immediately preceding taxable year. The procedure for making the election under section 1504(c)(2) is the same whether or not a consolidated return was filed by the life members or the nonlife members for the immediately preceding taxable year.

(ii) Special rule. Notwithstanding the general rule, however, if the nonlife members in the group filed a consolidated return for the immediately preceding taxable year and had executed and filed a Form 1122 (or successor form) that is effective for the preceding year, then such members will be treated as if they filed a Form 1122 (or successor form) when they join in the filing of a consolidated return under section 1504(c)(2) and they will be deemed to consent to the regulations under this section. However, an affiliation schedule (Form 851, or any successor form) must be filed by the group and the life members must execute a Form 1122 (or successor form) in the manner prescribed in § 1.1502-75(h)(2).

(3) Irrevocability. Except as provided in § 1.1502-75(c), the election under section 1504(c)(2) is irrevocable.

(4) Cross reference. If an election is made under section 1504(c)(2), see § 1.1502-75 (e) and (f) for rules that apply for not including (or including) a member or a nonmember in the consolidated return.

(d) Effect of election. If the common parent makes the election under section 1504(c)(2), the following rules apply:

(1) Termination of group. A mere election under section 1504(c)(2) will not cause the creation of a new group or the termination of an affiliated group that files a consolidated return in the immediately preceding taxable year.

(2) Effect of eligibility. If a life member is eligible after an election under section 1504(c)(2), it may not be included as a member of an affiliated group as defined in section 1504(c)(1).

(3) Eligible and ineligible life companies. If any life company was a member of an affiliated group of life companies (as defined in section 1504(c)(1)) but is ineligible for a taxable year for which the election under section 1504(c)(2) is effective, that year is not a separate return year merely by reason of the election under section 1504(c)(2) in applying §§ 1.1502-13 and 1.1502-19 to transactions occurring in prior consolidated return years of that affiliated group. In addition, if more than one ineligible life member of the group (as defined in section 1504(c)(1)) joined in the filing of a consolidated return in the taxable year immediately preceding the year for which the election under section 1504(c)(2) is effective and, solely as a result of the election, one of the ineligible life members becomes the common parent of such a group (section 1504(c)(1)), the group must continue to file a consolidated return. For example, assume that L1 owns all of the stock of S1 and all of the stock of L2. L2 owns the stock of L3. L1, L2, and L3 are life companies and S1 is a nonlife company. Assume further that in 2019, L1, L2, and L3 file a consolidated return but L1 makes the election under section 1504(c)(2) for 2020 and L2 and L3 are ineligible. L2 and L3 must continue to file a consolidated return in 2020. Moreover, L2 could elect in 2020 to file a consolidated return (section 1504(c)(1)) with L3 even if they did not file a consolidated return in 2019 with L1.

(4) Inclusion of life company. If a life company is ineligible in the consolidated return year for which the election is effective, it will be treated as an includible corporation for the common parent's first taxable year in which the company becomes eligible.

(5) Dividends received deduction—(i) Dividends received by an includible insurance company. Dividends received by an includible member insurance company, taxed under either section 801 or section 831, from another includible member of the group are treated for Federal income tax purposes as if the group did not file a consolidated return. See sections 818(e)(2) and 805(a)(4) for rules regarding a member taxed under section 801, and see sections 832(g) and 832(b)(5)(B) through (E) for rules regarding a member taxed under section 831.

(ii) Other dividends. Dividends received from a life company member of the group that are not subject to paragraph (d)(5)(i) of this section are not included in gross income of the distributee member. See section 1504(c)(2)(B)(i). If the distributee corporation is a nonlife insurance company subject to tax under section 831, the rules of section 832(b)(5)(B) through (E) apply.

(6) Controlled group. Sections 1563 (a)(4), (b)(2)(D), and (b)(3)(C) (insofar as it applies to corporations described in section 1563(b)(2)(D)) do not apply to any eligible or ineligible life company that is a member of the group for a taxable year during which the election is effective.

(7) Consolidated tax. The tax liability of a group for a consolidated return year (before application of credits against that tax) is computed on a consolidated basis by adding together the following taxes:

(i) The tax imposed under section 11 on consolidated taxable income (as determined under paragraph (e) of this section). The taxes imposed under sections 801(a) and 831(a) will each be treated as a tax imposed under section 11.

(ii) Any taxes described in § 1.1502-2 (other than in § 1.1502-2(a)(1), (a)(6), and (a)(7)).

(e) Consolidated taxable income. The consolidated taxable income is the sum of the following two amounts:

(1) Nonlife consolidated taxable income. The nonlife consolidated taxable income (as defined in paragraph (f) of this section) of the nonlife subgroup, as set off by the life subgroup losses as provided in paragraph (j) of this section. The amount in this paragraph (e)(1) may not be less than zero.

(2) Consolidated LICTI. The consolidated LICTI (as defined in paragraph (g)(1) of this section) of the life subgroup, as set off by the nonlife subgroup losses as provided in paragraph (h) of this section. The amount in this paragraph (e)(2) may not be less than zero.

(f) Nonlife consolidated taxable income—(1) In general. Nonlife consolidated taxable income is the consolidated taxable income of the nonlife subgroup, computed under § 1.1502-11 as modified by this paragraph (f). For this purpose, separate taxable income of a member includes insurance company taxable income (as defined in section 832).

(2) Nonlife consolidated net operating loss deduction—(i) In general. In applying § 1.1502-21, the rules in this paragraph (f)(2) apply in determining for the nonlife subgroup the nonlife net operating loss and the portion of the nonlife net operating loss carryovers and carrybacks to the taxable year.

(ii) Nonlife CNOL. The nonlife consolidated net operating loss is determined under § 1.1502-21(e) by treating the nonlife subgroup as the group.

(iii) Carrybacks. The portion of the nonlife consolidated net operating loss for the nonlife subgroup described in paragraph (f)(2)(vi) of this section, if any, that is eligible to be carried back to prior taxable years under § 1.1502-21 is carried back to the appropriate years (whether consolidated or separate) before the nonlife consolidated net operating loss may be used as a nonlife subgroup loss under paragraphs (e)(2) and (h) of this section to set off consolidated LICTI in the year the loss arose. The election under section 172(b)(3) to relinquish the entire carryback period for the net operating loss of the nonlife subgroup may be made by the agent for the group within the meaning of § 1.1502-77.

(iv) Subgroup rule. In determining the portion of the nonlife consolidated net operating loss that is absorbed when the loss is carried back to a consolidated return year, § 1.1502-21 is applied by treating the nonlife subgroup as the group. Therefore, the absorption is determined without taking into account any life subgroup losses that were previously reported on a consolidated return as setting off nonlife consolidated taxable income for the year to which the nonlife subgroup loss is carried back.

(v) Carryover. The portion of the nonlife consolidated net operating loss that is not absorbed in a prior year as a carryback, or as a nonlife subgroup loss that set off consolidated LICTI for the year the loss arose, constitutes a nonlife carryover under this paragraph (f)(2) to reduce nonlife consolidated taxable income before that portion may constitute a nonlife subgroup loss that sets off consolidated LICTI for a particular year. For limitations on the use of nonlife carryovers to offset nonlife consolidated taxable income or consolidated LICTI, see § 1.1502-21.

(vi) Portion of nonlife consolidated net operating loss that is carried back to prior taxable years. The portion of the nonlife consolidated net operating loss that (absent an election to waive carrybacks) is carried back to the two preceding taxable years is the sum of the nonlife subgroup's farming loss (within the meaning of section 172(b)(1)(B)(ii)) and the amount of the subgroup's net operating loss that is attributable to nonlife insurance companies (as determined under § 1.1502-21). For rules governing the absorption of net operating loss carrybacks, including limitations on the amount of net operating loss carrybacks that may be absorbed in prior taxable years, see § 1.1502-21(b).

(vii) Example. P, a holding company that is not an insurance company, owns all of the stock of S, a nonlife insurance company, and L1, a life insurance company. L1 owns all of the stock of L2, a life insurance company. Both L1 and L2 satisfy the eligibility requirements of § 1.1502-47(b)(12). Each corporation uses the calendar year as its taxable year, and no corporation has incurred farming losses (within the meaning of section 172(b)(1)(B)(ii)). For 2021, the group first files a consolidated return for which the election under section 1504(c)(2) is effective. P and S filed consolidated returns for 2019 and 2020. In 2021, the P-S group sustains a nonlife consolidated net operating loss that is attributable entirely to S (see § 1.1502-21(b)). The election in 2021 under section 1504(c)(2) does not result under paragraph (d)(1) of this section in the creation of a new group or the termination of the P-S group. The loss is carried back to the consolidated return years 2019 and 2020 of P and S. Pursuant to § 1.1502-21(b), the loss may be used to offset S's income in 2019 and 2020 without limitation, and the loss may be used to offset P's income in those years, subject to the limitation in section 172(a) (see § 1.1502-21(b)). The portion of the loss not absorbed in 2019 and 2020 may serve as a nonlife subgroup loss in 2021 that may set off the consolidated LICTI of L1 and L2 under paragraphs (e)(2) and (h) of this section.

(3) Nonlife consolidated capital gain net income or loss—(i) In general. In applying § 1.1502-22, the rules in this paragraph (f)(3) apply in determining for the nonlife subgroup the nonlife consolidated capital gain net income or loss and the portion of the nonlife net capital loss carryovers and carrybacks to the taxable year. In particular, the nonlife consolidated capital gain net income and nonlife consolidated net capital loss are determined under the principles of § 1.1502-22 by treating the nonlife subgroup as the group.

(ii) Additional principles. In applying § 1.1502-22 to nonlife consolidated net capital loss carryovers and carrybacks, the principles set forth in paragraph (f)(2)(iii) through (v) of this section for applying § 1.1502-21 to nonlife consolidated net operating loss carryovers and carrybacks also apply, without regard to the limitation in paragraph (f)(2)(vi) of this section.

(iii) Special rules. The nonlife consolidated net capital loss is reduced, for purposes of determining the carryovers and carrybacks under § 1.1502-22(b) by the lesser of:

(A) The aggregate of the additional capital loss deductions allowed under section 832(c)(5), or

(B) The nonlife consolidated taxable income computed without capital gains and losses.

(g) Consolidated LICTI—(1) General rule. Consolidated LICTI is the consolidated taxable income of the life subgroup, computed under § 1.1502-11 as modified by this paragraph (g).

(2) Life consolidated net operating loss deduction—(i) In general. In applying § 1.1502-21, the rules in this paragraph (g)(2) apply in determining for the life subgroup the life net operating loss and the portion of the life net operating loss carryovers and carrybacks to the taxable year.

(ii) Life CNOL. The life consolidated net operating loss is determined under § 1.1502-21(e) by treating the life subgroup as the group.

(iii) Carrybacks—(A) General rule. The portion of the life consolidated net operating loss for the life subgroup, if any, that is eligible to be carried back under § 1.1502-21 is carried back to the appropriate years (whether consolidated or separate) before the life consolidated net operating loss may be used as a life subgroup loss under paragraphs (e)(1) and (j) of this section to set off nonlife consolidated taxable income in the year the loss arose. The election under section 172(b)(3) to relinquish the entire carryback period for the consolidated net operating loss of the life subgroup may be made by the agent for the group within the meaning of § 1.1502-77.

(B) Special rule for life consolidated net operating losses arising in 2018, 2019, or 2020. If a life consolidated net operating loss arising in a taxable year beginning after December 31, 2017, and before January 1, 2021, is carried back to a life insurance company taxable year beginning before January 1, 2018, then such life consolidated net operating loss is treated as an operations loss carryback (within the meaning of section 810, as in effect prior to its repeal) of such company to such taxable year.

(iv) Subgroup rule. In determining the portion of the life consolidated net operating loss that is absorbed when the loss is carried back to a consolidated return year, § 1.1502-21 is applied by treating the life subgroup as the group. Therefore, the absorption is determined without taking into account any nonlife subgroup losses that were previously reported on a consolidated return as setting off life consolidated taxable income for the year to which the life subgroup loss is carried back.

(v) Carryovers. The portion of the life consolidated net operating loss that is not absorbed in a prior year as a carryback, or as a life subgroup loss that set off nonlife consolidated taxable income for the year the loss arose, constitutes a life carryover under this paragraph (g)(2) to reduce consolidated LICTI before that portion may constitute a life subgroup loss that sets off nonlife consolidated taxable income for that particular year. For limitations on the use of life carryovers to offset nonlife consolidated taxable income or consolidated LICTI, see § 1.1502-21(b).

(3) Life consolidated capital gain net income or loss—(i) [Reserved].

(ii) Life consolidated net capital loss carryovers and carrybacks. The life consolidated net capital loss carryovers and carrybacks for the life subgroup are determined by applying the principles of § 1.1502-22 as modified by the following rules in this paragraph (g)(3)(ii):

(A) Life consolidated net capital loss is first carried back (or apportioned to the life members for separate return years) to be absorbed by life consolidated capital gain net income without regard to any nonlife subgroup capital losses and before the life consolidated net capital loss may serve as a life subgroup capital loss that sets off nonlife consolidated capital gain net income in the year the life consolidated net capital loss arose.

(B) If a life consolidated net capital loss is not carried back or is not a life subgroup loss that sets off nonlife consolidated capital gain net income in the year the life consolidated net capital loss arose, then it is carried over to the particular year under this paragraph (g)(3)(ii) first against life consolidated capital gain net income before it may serve as a life subgroup capital loss that sets off nonlife consolidated capital gain net income in that particular year.

(h) Consolidated LICTI setoff by nonlife subgroup losses—(1) In general. The nonlife subgroup losses consist of the nonlife consolidated net operating loss and the nonlife consolidated net capital loss. Under paragraph (e)(2) of this section, consolidated LICTI is set off by the amounts of these two consolidated losses specified in paragraph (h)(2) of this section. The setoff is subject to the rules and limitations in paragraph (h)(3) of this section.

(2) Amount of setoff—(i) Current year. Consolidated LICTI for the current taxable year is set off by the portion of the nonlife consolidated net operating loss and nonlife consolidated net capital loss arising in that year that cannot be carried back under paragraph (f) of this section to prior taxable years (whether consolidated or separate return years) of the nonlife subgroup.

(ii) Carryovers. The portion of the offsettable nonlife consolidated net operating loss or nonlife consolidated net capital loss that has not been used as a nonlife subgroup loss setoff against consolidated LICTI in the year it arose may be carried over to succeeding taxable years under the principles of § 1.1502-21 (relating to net operating loss deduction) or § 1.1502-22 (as appropriate) (relating to net capital loss carryovers). However, in any particular succeeding year, the losses will be used under paragraph (f) of this section in computing nonlife consolidated taxable income before being used in that year as a nonlife subgroup loss that sets off consolidated LICTI. Additionally, the amount of consolidated LICTI that may be offset by nonlife consolidated net operating loss carryovers may be subject to limitation (see section 172 and § 1.1502-21).

(3) Nonlife subgroup loss rules and limitations. The nonlife subgroup losses are subject to the following operating rules and limitations:

(i) Separate return years. The carryovers in paragraph (h)(2)(ii) of this section may include net operating losses and net capital losses of the nonlife members arising in separate return years, that may be carried over to a succeeding year under the principles (including limitations) of §§ 1.1502-21 and 1.1502-22. But see paragraph (h)(3)(ix) of this section.

(ii) Capital loss. Nonlife consolidated net capital loss sets off consolidated LICTI only to the extent of life consolidated capital gain net income (as determined under paragraph (g)(3) of this section) and this setoff applies before any nonlife consolidated net operating loss sets off consolidated LICTI.

(iii) Capital gain. Life consolidated capital gain net income is zero in any taxable year in which the life subgroup has a life consolidated net operating loss and, in any taxable year, it may not exceed consolidated LICTI.

(iv) Ordering rule. Consolidated LICTI for a consolidated return year is set off by nonlife subgroup losses for that year before being set off (under paragraph (h)(2)(ii) of this section) by a carryover of a nonlife subgroup loss to that year. The amount of consolidated LICTI that may be offset by nonlife consolidated net operating loss carryovers may be subject to limitation (see section 172 and § 1.1502-21).

(v) Setoff at bottom line. The setoff of nonlife subgroup losses against consolidated LICTI does not affect life member deductions that depend in whole or in part on taxable income. Thus, the setoff does not affect the amount of consolidated LICTI for any for any taxable year but it merely constitutes an adjustment in arriving at the group's consolidated taxable income under paragraph (e) of this section.

(vi) Ineligible nonlife member. (A) The offsetable nonlife consolidated net operating loss that arises in any consolidated return year (that may be set off against consolidated LICTI in the current taxable year or in a succeeding taxable year) is the amount computed under paragraph (f)(2)(ii) of this section reduced by the ineligible NOL. For purposes of this paragraph (h)(3), the “ineligible NOL” is in the year the loss arose the amount of the separate net operating loss (determined under §§ 1.1502-21(b) of any nonlife member that is ineligible in that year (and not the portion of the nonlife consolidated net operating loss attributable under §§ 1.1502-21(b) to such a member).

(B) The carryovers of offsetable nonlife net operating losses under paragraph (h)(2)(ii) of this section do not include an ineligible NOL arising in a consolidated return year or a loss attributable to an ineligible member arising in a separate return year. See section 1503(c)(2). (C) For absorption within the nonlife subgroup of an ineligible NOL arising in a consolidated return year or a loss of an ineligible member arising in a separate return year which is not a separate return limitation year under paragraph (h)(3)(ix) of this section, see paragraph (h)(3)(vii) of this section.

(vii) Absorption of ineligible NOL. (A) If all or a portion of a nonlife member's ineligible NOL (determined under paragraph (h)(3)(vi)(A) of this section) may be carried back or carried over under paragraph (f)(2) of this section to a particular consolidated return year of the nonlife subgroup (absorption year), then notwithstanding § 1.1502-21(b), the amount carried to the absorption year will be absorbed by that member's contribution (to the extent thereof) to nonlife consolidated taxable income for that year, subject to the limitation in section 172(a).

(B) For purposes of paragraph (h)(3)(vii)(A) of this section, a member's contribution to nonlife consolidated taxable income for an absorption year is the amount of such income (computed without the portion of the nonlife consolidated net operating loss deduction attributable to taxable years subsequent to the year the loss arose), minus such consolidated taxable income recomputed by excluding both that member's items of income and deductions for the absorption year. The deductions of the member include the prior application of this paragraph (h)(3)(vii) to the absorption of the nonlife consolidated net operating loss deduction for losses arising in taxable years prior to the particular loss year.

(viii) Election to relinquish carryback. The offsetable nonlife consolidated net operating loss does not include the amount that could be carried back under paragraph (f)(2) of this section but for the election by the agent for the group (within the meaning of § 1.1502-77) under section 172(b)(3) to relinquish the carryback. See section 1503(c)(1).

(ix) Separate return limitation year. The offsetable nonlife consolidated net operating and capital loss carryovers do not include any losses attributable to a nonlife member that were sustained (A) in a separate return limitation year (determined without section 1504(b)(2)) of that member (or a predecessor), or (B) in a separate return year, in which an election was in effect under neither section 1504(c)(2) nor section 243(b)(3).

(x) Percentage limitation. The offsetable nonlife consolidated net operating losses that may be set off against consolidated LICTI in a particular year may not exceed a percentage limitation. This limitation is the applicable percentage in section 1503(c)(1) of the lesser of two amounts—

(A) The first amount is the sum of the offsetable nonlife consolidated net operating losses under paragraph (h)(2) of this section that may serve in the particular year (determined without this limitation) as a setoff against consolidated LICTI.

(B) The second amount is consolidated LICTI in the particular year reduced by any nonlife consolidated net capital loss that sets off consolidated LICTI in that year.

(xi) Further limitation. Any offsetable nonlife consolidated net operating loss remaining after applying the percentage limitation that is carried over to a succeeding taxable year may not be set off against the consolidated LICTI attributable to a life member that was not an eligible life member in the year the loss arose. See section 1503(c)(2).

(xii) Restoration rule. The carryback of a life consolidated net operating loss or life consolidated net capital loss under paragraph (g) of this section that reduces consolidated LICTI (or life consolidated capital gain net income) for a prior year may reduce the amount of nonlife subgroup losses that would offset consolidated LICTI in that prior year. Thus, that amount may be carried over under paragraph (f)(2) or (3) of this section from that prior year in determining nonlife consolidated taxable income in a succeeding year or serve as offsetable nonlife subgroup losses in a succeeding year.

(4) Examples. The following examples illustrate the principles of this paragraph (h). In the examples, L indicates a life company, S is a nonlife insurance company, another letter indicates a nonlife company that is not an insurance company, no company has farming losses (within the meaning of section 172(b)(1)(B)(ii)), and each corporation uses the calendar year as its taxable year.

(i) Example 1. P owns all of the stock of L and S. S owns all of the stock of I, a nonlife member that is an ineligible corporation for 2021 under paragraph (b)(13) of this section. For 2021, the group elects under section 1504(c)(2) to file a consolidated return. For 2021, assume that any nonlife consolidated net operating loss may not be carried back to a prior taxable year. Other facts are summarized in the following table.

Separate taxable income (loss)

P | $100

S | (100)

I | (100)

Nonlife consolidated net operating loss | (100)

Under paragraph (h)(3)(vi) of this section, P's separate income is considered to absorb the loss of S, an eligible member, first and the offsetable nonlife consolidated net operating loss is zero, that is, the consolidated net operating loss ($100) reduced by I's loss ($100). The consolidated net operating loss ($100) may be carried over, but since it is entirely attributable to I (an ineligible member that is not a nonlife insurance company) its use is subject to the restrictions in paragraph (h)(3)(vi) of this section and section 172(a). The result would be the same if the group contained two additional members, S1, an eligible member, and I1, an ineligible member, where S1 had a loss of ($100) and I1 had income of $100.

(ii) Example 2. (A) The facts are the same as in paragraph (h)(4)(i) of this section (Example 1), except that, for 2021, S's separate net operating loss is $200. Assume further that L's consolidated LICTI is $200. Under paragraph (h)(3)(vi) of this section, the offsetable nonlife consolidated net operating loss is $100 (the nonlife consolidated net operating loss computed under paragraph (f)(2)(ii) of this section ($200), reduced by the separate net operating loss of I ($100)). The offsetable nonlife consolidated net operating loss that may be set off against consolidated LICTI in 2021 is $35 (35 percent of the lesser of the offsetable $100 or consolidated LICTI of $200). See section 1503(c)(1) and paragraph (h)(3)(x) of this section. S carries over a loss of $65, and I carries over a loss of $100, to 2022 under paragraph (f)(2) of this section to be used against nonlife consolidated taxable income (consolidated net operating loss ($200) less amount used in 2021 ($35)). Under paragraph (h)(2)(ii) of this section, the offsetable nonlife consolidated net operating loss that may be carried to 2022 is $65 ($100 minus $35). The facts and results are summarized in the following table.

Table 1 to Paragraph (h)(4)(ii)(A)

Facts (a) | Offsetable (b) | Limit (c) | Unused loss (d)

P | 100

S | (200) | (100) | (65)

I | (100) | (100)

Nonlife subgroup | (200) | (100) | (100) | (165)

L | 200 | 200

35% of the lower of line 4(c) or 5(c) | 35

Unused offsetable loss | (65)

(B) Accordingly, under paragraph (e) of this section, consolidated taxable income is $165 (line 5(a) minus line 6(c)).

(iii) Example 3. The facts are the same as in paragraph (h)(4)(ii) of this section (Example 2), with the following additions for 2022. The nonlife subgroup has nonlife consolidated taxable income of $50 (all of which is attributable to I) before the nonlife consolidated net operating loss deduction under paragraph (f)(2) of this section. Consolidated LICTI is $100. Under paragraph (f)(2) of this section, $50 of the nonlife consolidated net operating loss carryover ($165) is used in 2022 and, under paragraph (h)(3)(vi) and (vii) of this section, the portion used in 2022 is attributable to I, the ineligible nonlife member. Accordingly, the offsetable nonlife consolidated net operating loss from 2021 under paragraph (h)(3)(ii) of this section is $65, the unused loss from 2021. The offsetable nonlife consolidated net operating loss in 2022 is $22.75 (35 percent of the lesser of the offsetable loss of $65 or consolidated LICTI of $100). Accordingly, under paragraph (e) of this section, consolidated taxable income is $77.25 (consolidated LICTI of $100 minus the offsetable loss of $22.75).

(iv) Example 4. P owns all of the stock of S and L. For 2021, all corporations are eligible corporations, and the group elects under section 1504(c)(2) to file a consolidated return, the nonlife consolidated net operating loss is $100, and the nonlife consolidated net capital loss is $50. Assume that the losses may not be carried back and the capital losses are not attributable to built-in deductions under paragraph (h)(3)(ix) of this section. Other facts and the results are set forth in the following table:

P-S | L

1. Nonlife consolidated net operating loss | ($100)

2. Nonlife consolidated capital loss | (50)

3. Consolidated LICTI | $100

4. Life consolidated capital gain net income included in line 3 | 50

5. Offsetable:

(a) 35% of lower of line (1) or line (3)-(4) | (17.5)

(b) Line 2 | (50)

6. Unused losses available to be carried over:

(a) From line 1 (line 1 minus line 5 (a)) | (82.5)

(b) From line 2 (line 2 minus line 5 (b)) | 0

Accordingly, under paragraph (e) of this section consolidated taxable income is $32.5, that is, line 3 minus line 5(c).

(i) [Reserved]

(j) Nonlife consolidated taxable income set off by life subgroup losses—(1) In general. The life subgroup losses consist of the life consolidated net operating loss and consolidated operations loss carryovers and the life consolidated net capital loss. Under paragraph (e)(1) of this section, nonlife consolidated taxable income is set off by the amounts of these two consolidated losses specified in paragraph (j)(2) of this section, subject to the rules and limitations in paragraph (j)(3) of this section.

(2) Amount of setoff. The portion of the life consolidated net operating loss and consolidated operations loss carryovers or life consolidated net capital loss that may be set off against nonlife consolidated taxable income (determined under paragraph (f) of this section) is determined by applying the rules prescribed in paragraphs (h)(2) and (3) of this section in the following manner:

(i) Substitute the term “life” for “nonlife”, and vice versa.

(ii) Substitute the term “nonlife consolidated taxable income” for “consolidated LICTI”, and vice versa.

(iii) Substitute the term “life consolidated net operating loss and consolidated operations loss carryovers” for “nonlife consolidated net operating loss”, and “paragraph (g)” for “paragraph (f)”.

(iv) Paragraphs (h)(3)(vi), (vii), (x), and (xi) of this section do not apply to a life consolidated net operating loss and consolidated operations loss carryovers.

(v) The setoff of life subgroup losses against nonlife consolidated taxable income does not affect nonlife member deductions that depend in whole or in part on taxable income.

(3) Examples. The following examples illustrate the principles of this paragraph (j). In the examples, L indicates a life company, S is a nonlife insurance company, another letter indicates a nonlife company that is not an insurance company, no company has farming losses (within the meaning of section 172(b)(1)(B)(ii)), and each corporation uses the calendar year as its taxable year.

(i) Example 1. P, S, L1 and L2 constitute a group that elects under section 1504(c)(2) to file a consolidated return for 2021. In 2021, the nonlife subgroup consolidated taxable income is $100 and there is $20 of nonlife consolidated net capital loss that cannot be carried back under paragraph (f) of this section to taxable years (whether consolidated or separate) preceding 2021. The nonlife subgroup has no carryover from years prior to 2021. The life consolidated net operating loss is $150, which under paragraph (g) of this section includes life consolidated capital gain net income of $25. Since life consolidated capital gain net income is zero for 2021 (see paragraph (h)(3)(iii) of this section), the nonlife capital loss offset is zero (see paragraph (h)(3)(ii) of this section). However, $100 of life consolidated net operating loss sets off the $100 nonlife consolidated taxable income in 2021. The life subgroup carries under paragraph (g)(2) of this section to 2022 $50 of the life consolidated net operating loss ($150 minus $100). The $50 carryover will be used in 2022 (subject to the limitation in section 172(a)) against life subgroup income before it may be used in 2022 to setoff nonlife consolidated taxable income.

(ii) Example 2. The facts are the same as in paragraph (j)(3)(i) of this section, except that, for 2021, the nonlife consolidated taxable income is $150 (this amount is entirely attributable to S and includes nonlife consolidated capital gain net income of $50), consolidated LICTI is $200, and a life consolidated net capital loss is $50. The $50 life consolidated net capital loss sets off the $50 nonlife consolidated capital gain net income. Consolidated taxable income under paragraph (e) of this section is $300 (nonlife consolidated taxable income ($150) minus the setoff of the life consolidated net capital loss ($50), plus consolidated LICTI ($200)).

(iii) Example 3. The facts are the same as in paragraph (j)(3)(ii) of this section, except that, for 2022, the nonlife consolidated net operating loss is $150. This entire amount is attributable to S; thus, it is eligible to be carried back to 2021 against nonlife consolidated taxable income under paragraph (f)(2) of this section and § 1.1502-21(b). If P, the agent for the group within the meaning of § 1.1502-77, does not elect to relinquish the carryback under section 172(b)(3), the entire $150 will be carried back, reducing 2021 nonlife consolidated taxable income to zero and nonlife consolidated capital gain net income to zero. Under paragraph (h)(3)(xii) of this section, the setoff in 2021 of the nonlife consolidated capital gain net income ($50) by the life consolidated net capital loss ($50) is restored. Accordingly, the 2021 life consolidated net capital loss may be carried over by the life subgroup to 2022. Under paragraph (e) of this section, after the carryback, consolidated taxable income for 2021 is $200 (nonlife consolidated taxable income ($0) plus consolidated LICTI ($200)).

(iv) Example 4. The facts are the same as in paragraph (j)(3)(iii) of this section, except that P elects under section 172(b)(3) to relinquish the carryback of $150 arising in 2022. The setoff in Example 2 is not restored. However, the offsettable nonlife consolidated net operating loss for 2022 (or that may be carried over from 2022) is zero. See paragraph (h)(3)(viii) of this section. Nevertheless, the $150 nonlife consolidated net operating loss may be carried over to be used by the nonlife group.

(v) Example 5. P owns all of the stock of S1 and of L1. On January 1, 2017, L1 purchases all of the stock of L2. For 2021, the group elects under section 1504(c)(2) to file a consolidated return. For 2021, L1 is an eligible corporation under paragraph (b)(12) of this section but L2 is ineligible. Thus, L1 but not L2 is a member for 2021. For 2021, L2 sustains a net operating loss, which cannot be carried back (see section 172(b)). For 2021, L2 is treated under paragraph (d)(6) of this section as a member of a controlled group of corporations under section 1563 with P, S, and L1. For 2022, L2 is eligible and is included on the group's consolidated return. L2's net operating loss for 2021 that may be carried to 2022 is not treated under paragraph (b)(11) of this section as having been sustained in a separate return limitation year for purposes of computing consolidated LICTI of the L1-L2 life subgroup for 2022. Furthermore, the portion of L2's net operating loss not used under paragraph (g)(2) of this section against life subgroup income in 2022 may be included in offsettable life consolidated net operating loss under paragraph (j)(2) and (h)(3)(i) of this section that reduces in 2022 nonlife consolidated taxable income (subject to the limitation in section 172(a)) because L2's loss in 2021 was not sustained in a separate return limitation year under paragraph (j)(2) and (h)(3)(ix)(A) of this section or in a separate return year (2021) when an election was in effect under neither section 1504(c)(2) nor section 243(b)(3).

(k) Preemption. The rules in this section preempt any inconsistent rules in other sections of the consolidated return regulations. For example, the rules in paragraph (h)(3)(vi) of this section apply notwithstanding § 1.1502-21.

(l) Other consolidation principles. The fact that this section treats the life and nonlife members as separate groups in computing, respectively, consolidated LICTI (or life consolidated net operating loss) and nonlife consolidated taxable income (or loss) does not affect the usual rules in the consolidated return regulations unless this section provides otherwise. Thus, the usual rules in § 1.1502-13 (relating to intercompany transactions) apply to both the life and nonlife members by treating them as members of one affiliated group.

(m) Filing requirements—(1) In general. To file a consolidated income tax return for a life-nonlife consolidated group, the common parent shall—

(i) File the applicable consolidated corporate income tax return: a Form 1120-L, U.S. Life Insurance Company Income Tax Return, where the common parent is a life insurance company; a Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return, where the common parent is an insurance company, other than a life insurance company; a Form 1120, U.S. Corporation Income Tax Return, where the common parent is any other type of corporation; or any successor form;

(ii) Indicate clearly on the face of this return that such corporate tax return is a life-nonlife return;

(iii) Show any set offs required by paragraphs (e), (h), and (j) of this section;

(iv) Report separately the nonlife consolidated taxable income or loss, determined under paragraph (f) of this section, on a Form 1120 or 1120-PC (or any successor forms) (whether filed by the common parent or as an attachment to the consolidated return), as the case may be, of all nonlife members of the consolidated group; and

(v) Report separately the consolidated Life Insurance Company Taxable Income or life consolidated net operating loss, on a Form 1120-L (or any successor form) (whether filed by the common parent or as an attachment to the consolidated return), of all life members of the consolidated group.

(2) Cross reference. See § 1.1502-75(j), regarding the inclusion in a corporate tax return of the required statements and schedules for subsidiaries.

(n) Effective/applicability dates. The rules of this section apply to taxable years beginning after December 31, 2020. However, a taxpayer may choose to apply the rules of this section to taxable years beginning on or before December 31, 2020. If a taxpayer makes the choice described in the previous sentence, the taxpayer must apply those rules in their entirety and consistently with the provisions of subchapter L of the Internal Revenue Code applicable to the years at issue.

(Secs. 1502 and 7805 of the Internal Revenue Code of 1954 (68A Stat. 637, 917; 26 U.S.C. 1502, 7805))

[T.D. 7877, 48 FR 11441, Mar. 18, 1983]

Editorial Notes: 1. For Federal Register citations affecting § 1.1502-47, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov..

2. By T.D. 9927, 85 FR 67988, Oct. 27, 2020, § 1.1502-47 was amended; however, a portion of the amendment could not be incorporated due to inaccurate amendatory instruction.

§ 1.1502-50 Consolidated section 250.

(a) In general—(1) Scope. This section provides rules for applying section 250 and §§ 1.250-1 through 1.250(b)-6 (the section 250 regulations) to a member of a consolidated group (member). Paragraph (b) of this section provides rules for the determination of the amount of the deduction allowed to a member under section 250(a)(1). Paragraph (c) of this section provides rules governing the impact of intercompany transactions on the determination of a member's qualified business asset investment (QBAI) and the effect of intercompany transactions on the determination of a member's foreign-derived deduction eligible income (FDDEI). Paragraph (d) of this section provides rules governing basis adjustments to member stock resulting from the application of paragraph (b)(1) of this section. Paragraph (e) of this section provides definitions. Paragraph (f) of this section provides examples illustrating the rules of this section. Paragraph (g) of this section provides an applicability date.

(2) Overview. The rules of this section ensure that the aggregate amount of deductions allowed under section 250 to members appropriately reflects the income, expenses, gains, losses, and property of all members. Paragraph (b) of this section allocates the consolidated group's overall deduction amount under section 250 to each member on the basis of its contribution to the consolidated foreign-derived deduction eligible income (consolidated FDDEI) and consolidated global intangible low-taxed income (consolidated GILTI). The definitions in paragraph (e) of this section provide for the aggregation of the deduction eligible income (DEI), FDDEI, deemed tangible income return, and global intangible low-taxed income (GILTI) of all members in order to calculate the consolidated group's overall deduction amount under section 250.

(b) Allowance of deduction—(1) In general. A member is allowed a deduction for a consolidated return year under section 250. See § 1.250(a)-1(b). The amount of the deduction is equal to the sum of—

(i) The product of the consolidated FDII deduction amount and the member's FDII deduction allocation ratio; and

(ii) The product of the consolidated GILTI deduction amount and the member's GILTI deduction allocation ratio.

(2) Consolidated taxable income limitation. For purposes of applying the limitation described in § 1.250(a)-1(b)(2) to the determination of the consolidated FDII deduction amount and the consolidated GILTI deduction amount of a consolidated group for a consolidated return year—

(i) The consolidated foreign-derived intangible income (consolidated FDII) (if any) is reduced (but not below zero) by an amount which bears the same ratio to the consolidated section 250(a)(2) amount that such consolidated FDII bears to the sum of the consolidated FDII and the consolidated GILTI; and

(ii) The consolidated GILTI (if any) is reduced (but not below zero) by the excess of the consolidated section 250(a)(2) amount over the reduction described in paragraph (b)(2)(i) of this section.

(c) Impact of intercompany transactions—(1) Impact on qualified business asset investment determination—(i) In general. For purposes of determining a member's QBAI, the basis of specified tangible property does not include an amount equal to any gain or loss recognized with respect to such property by another member in an intercompany transaction (as defined in § 1.1502-13(b)(1)) until the time that such gain or loss is no longer deferred under § 1.1502-13. Thus, for example, if a selling member owns specified tangible property with an adjusted basis (within the meaning of section 1011) of $60x and an adjusted basis (for purposes of calculating QBAI) of $80x, and sells it for $50x to the purchasing member (and the intercompany loss remains deferred), the basis of such property for purposes of computing the purchasing member's QBAI is $80x.

(ii) Partner-specific QBAI basis. A member's partner-specific QBAI basis (as defined in § 1.250(b)-2(g)(7)) includes a basis adjustment under section 743(b) resulting from an intercompany transaction only at the time, and to the extent, gain or loss, if any, is recognized in the transaction and no longer deferred under § 1.1502-13.

(2) Impact on foreign-derived deduction eligible income characterization. For purposes of redetermining attributes of members from an intercompany transaction as FDDEI, see § 1.1502-13(c)(1)(i) and (c)(7)(ii)(R) (Example 18).

(d) Adjustments to the basis of a member. For adjustments to the basis of a member related to paragraph (b)(1) of this section, see § 1.1502-32(b)(3)(ii)(B).

(e) Definitions. The following definitions apply for purposes of this section.

(1) Consolidated deduction eligible income (consolidated DEI). With respect to a consolidated group for a consolidated return year, the term consolidated deduction eligible income or consolidated DEI means the greater of the sum of the DEI (whether positive or negative) of all members or zero.

(2) Consolidated deemed intangible income. With respect to a consolidated group for a consolidated return year, the term consolidated deemed intangible income means the excess (if any) of the consolidated DEI, over the consolidated deemed tangible income return.

(3) Consolidated deemed tangible income return. With respect to a consolidated group for a consolidated return year, the term consolidated deemed tangible income return means the sum of the deemed tangible income return of all members.

(4) Consolidated FDII deduction amount. With respect to a consolidated group for a consolidated return year, the term consolidated FDII deduction amount means the product of the FDII deduction rate and the consolidated FDII, as adjusted by paragraph (b)(2) of this section.

(5) Consolidated foreign-derived deduction eligible income (consolidated FDDEI). With respect to a consolidated group for a consolidated return year, the term consolidated foreign-derived deduction eligible income or consolidated FDDEI means the greater of the sum of the FDDEI (whether positive or negative) of all members or zero.

(6) Consolidated foreign-derived intangible income (consolidated FDII). With respect to a consolidated group for a consolidated return year, the term consolidated foreign-derived intangible income or consolidated FDII means the product of the consolidated deemed intangible income and the consolidated foreign-derived ratio.

(7) Consolidated foreign-derived ratio. With respect to a consolidated group for a consolidated return year, the term consolidated foreign-derived ratio means the ratio (not to exceed one) of—

(i) The consolidated FDDEI; to

(ii) The consolidated DEI.

(8) Consolidated GILTI deduction amount. With respect to a consolidated group for a consolidated return year, the term consolidated GILTI deduction amount means the product of the GILTI deduction rate and the sum of the consolidated GILTI, as adjusted by paragraph (b)(2) of this section, and the amounts treated as dividends received by the members under section 78 which are attributable to their GILTI for the consolidated return year.

(9) Consolidated global intangible low-taxed income (consolidated GILTI). With respect to a consolidated group for a consolidated return year, the term consolidated global intangible low-taxed income or consolidated GILTI means the sum of the GILTI of all members.

(10) Consolidated section 250(a)(2) amount. With respect to a consolidated group for a consolidated return year, the term consolidated section 250(a)(2) amount means the excess (if any) of the sum of the consolidated FDII and the consolidated GILTI (determined without regard to section 250(a)(2) and paragraph (b)(2) of this section), over the consolidated taxable income of the consolidated group (within the meaning of § 1.1502-11).

(11) Deduction eligible income (DEI). With respect to a member for a consolidated return year, the term deduction eligible income or DEI means the member's gross DEI for the year (within the meaning of § 1.250(b)-1(c)(15)) reduced (including below zero) by the deductions properly allocable to gross DEI for the year (as determined under § 1.250(b)-1(d)(2)).

(12) Deemed tangible income return. With respect to a member for a consolidated return year, the term deemed tangible income return means an amount equal to 10 percent of the member's QBAI, as adjusted by paragraph (c)(1) of this section.

(13) FDII deduction allocation ratio. With respect to a member for a consolidated return year, the term FDII deduction allocation ratio means the ratio of—

(i) The member's positive FDDEI (if any); to

(ii) The sum of the positive FDDEI of all members.

(14) FDII deduction rate. The term FDII deduction rate means 37.5 percent for consolidated return years beginning before January 1, 2026, and 21.875 percent for consolidated return years beginning after December 31, 2025.

(15) Foreign-derived deduction eligible income (FDDEI). With respect to a member for a consolidated return year, the term foreign-derived deduction eligible income or FDDEI means the member's gross FDDEI for the year (within the meaning of § 1.250(b)-1(c)(16)) reduced (including below zero) by the deductions properly allocable to gross FDDEI for the year (as determined under § 1.250(b)-1(d)(2)).

(16) GILTI deduction allocation ratio. With respect to a member for a consolidated return year, the term GILTI deduction allocation ratio means the ratio of—

(i) The sum of the member's GILTI and the amount treated as a dividend received by the member under section 78 which is attributable to its GILTI for the consolidated return year; to

(ii) The sum of consolidated GILTI and the amounts treated as dividends received by the members under section 78 which are attributable to their GILTI for the consolidated return year.

(17) GILTI deduction rate. The term GILTI deduction rate means 50 percent for consolidated return years beginning before January 1, 2026, and 37.5 percent for consolidated return years beginning after December 31, 2025.

(18) Global intangible low-taxed income (GILTI). With respect to a member for a consolidated return year, the term global intangible low-taxed income or GILTI means the sum of the member's GILTI inclusion amount under § 1.1502-51(b) and the member's distributive share of any domestic partnership's GILTI inclusion amount under § 1.951A-5(b)(2).

(19) Qualified business asset investment (QBAI). The term qualified business asset investment or QBAI has the meaning provided in § 1.250(b)-2(b).

(20) Specified tangible property. The term specified tangible property has the meaning provided in § 1.250(b)-2(c)(1).

(f) Examples. The following examples illustrate the rules of this section.

(1) Example 1: Calculation of deduction attributable to FDII—(i) Facts. P is the common parent of the P group and owns all of the only class of stock of subsidiaries USS1 and USS2. The consolidated return year of all persons is the calendar year. In 2018, P has DEI of $400x, FDDEI of $0, and QBAI of $0; USS1 has DEI of $200x, FDDEI of $200x, and QBAI of $600x; and USS2 has DEI of −$100x, FDDEI of $100x, and QBAI of $400x. The P group has consolidated taxable income that is sufficient to make inapplicable the limitation in paragraph (b)(2) of this section. No member of the P group has GILTI.

(ii) Analysis—(A) Consolidated DEI. Under paragraph (e)(1) of this section, the P group's consolidated DEI is $500x, the greater of the sum of the DEI (whether positive or negative) of all members ($400x + $200x−$100x) or zero.

(B) Consolidated FDDEI. Under paragraph (e)(5) of this section, the P group's consolidated FDDEI is $300x, the greater of the sum of the FDDEI (whether positive or negative) of all members ($0 + $200x + $100x) or zero.

(C) Consolidated deemed tangible income return. Under paragraph (e)(12) of this section, a member's deemed tangible income return is 10 percent of its QBAI. Therefore, P's deemed tangible income return is $0 (0.10 × $0), USS1's deemed tangible income return is $60x (0.10 × $600x), and USS2's deemed tangible income return is $40x (0.10 × $400x). Under paragraph (e)(3) of this section, the P group's consolidated deemed tangible income return is $100x, the sum of the deemed tangible income return of all members ($0 + $60x + $40x).

(D) Consolidated deemed intangible income. Under paragraph (e)(2) of this section, the P group's consolidated deemed intangible income is $400x, the excess of its consolidated DEI over its consolidated deemed tangible income return ($500x −$100x).

(E) Consolidated FDII. Under paragraph (e)(7) of this section, the P group's consolidated foreign-derived ratio is 0.60, the ratio of its consolidated FDDEI to its consolidated DEI ($300x/$500x). Under paragraph (e)(6) of this section, the P group's consolidated FDII is $240x, the product of its consolidated deemed intangible income and its consolidated foreign-derived ratio ($400x × 0.60).

(F) Consolidated FDII deduction amount. Under paragraph (e)(4) of this section, the P group's consolidated FDII deduction amount is $90x, the product of the FDII deduction rate and the consolidated FDII (0.375 × $240x).

(G) Member's deduction attributable to consolidated FDII deduction amount. Under paragraph (b)(1) of this section, a member is allowed a deduction equal, in part, to the product of the consolidated FDII deduction amount of the consolidated group to which the member belongs and the member's FDII deduction allocation ratio. Under paragraph (e)(13) of this section, a member's FDII deduction allocation ratio is the ratio of its positive FDDEI to the sum of each member's positive FDDEI for such consolidated return year. As a result, the FDII deduction allocation ratios of P, USS1, and USS2 are 0 ($0/$300x), 2/3 ($200x/$300x), and 1/3 ($100x/$300x), respectively. Therefore, P, USS1, and USS2 are permitted deductions under paragraph (b)(1) of this section in the amount of $0 (0 × $90x), $60x ( 2/3 × $90x), and $30x ( 1/3 × $90x), respectively.

(2) Example 2: Limitation on consolidated foreign-derived deduction eligible income—(i) Facts. The facts are the same as in paragraph (f)(1)(i) of this section (the facts in Example 1), except that P's FDDEI is $300x.

(ii) Analysis—(A) Consolidated DEI and consolidated deemed tangible income return. As in paragraphs (f)(1)(ii)(A) and (C) of this section (the analysis in Example 1), the P group's consolidated DEI is $500x and the P group's consolidated deemed tangible income return is $100x.

(B) Consolidated FDDEI. Under paragraph (e)(5) of this section, the P group's consolidated FDDEI is $600x, the greater of the sum of the FDDEI (whether positive or negative) of all members ($300x + $200x + $100x) or zero.

(C) Consolidated deemed intangible income and consolidated FDII. Under paragraph (e)(2) of this section, the P group's consolidated deemed intangible income is $400x ($500x − $100x). Under paragraph (e)(7) of this section, the P group's consolidated foreign-derived ratio is 1.00 ($600x/$500x, but not in excess of one). Under paragraph (e)(6) of this section, the P group's consolidated FDII is $400x ($400x × 1.00).

(D) Consolidated FDII deduction amount and member's deduction attributable to consolidated FDII deduction amount. Under paragraph (e)(4) of this section, the P group's consolidated FDII deduction amount is $150x (0.375 × $400x). Under paragraph (e)(13) of this section, the FDII deduction allocation ratios of P, USS1, and USS2 are 1/2 ($300/$600x), 1/3 ($200x/$600x), and 1/6 ($100x/$600x), respectively. Therefore, P, USS1, and USS2 are permitted deductions under paragraph (b)(1) of this section in the amounts of $75x ( 1/2 × $150x), $50x ( 1/3 × $150x), and $25x ( 1/6 × $150x), respectively.

(3) Example 3: Member with negative FDDEI—(i) Facts. The facts are the same as in paragraph (f)(1)(i) of this section (the facts in Example 1), except that P's FDDEI is -$100x.

(ii) Analysis—(A) Consolidated DEI and consolidated deemed tangible income return. As in paragraphs (f)(1)(ii)(A) and (C) of this section (the facts in Example 1), the P group's consolidated DEI is $500x and the P group's consolidated deemed tangible income return is $100x.

(B) Consolidated FDDEI. Under paragraph (e)(5) of this section, the P group's consolidated FDDEI is $200x, the greater of the sum of the FDDEI (whether positive or negative) of all members (−$100x + $200x + $100x) or zero.

(C) Consolidated deemed intangible income and consolidated FDII. Under paragraphs (e)(2) and (6) of this section, the P group's consolidated deemed intangible income is $400x ($500x −$100x), and the P group's consolidated FDII is $160x ($400x × ($200x/$500x)).

(D) Consolidated FDII deduction amount and member's deduction attributable to consolidated FDII deduction amount. Under paragraph (e)(4) of this section, the P group's consolidated FDII deduction amount is $60x (0.375 × $160x). Under paragraph (e)(13) of this section, the FDII deduction allocation ratios of P, USS1, and USS2 are 0 ($0/$300x), 2/3 ($200x/$300x), and 1/3 ($100x/$300x), respectively. Therefore, P, USS1, and USS2 are permitted deductions under paragraph (b)(1) of this section in the amounts of $0 (0 × $60x), $40x ( 2/3 × $60x), and $20x ( 1/3 × $60x), respectively.

(4) Example 4: Calculation of deduction attributable to GILTI—(i) Facts. The facts are the same as in paragraph (f)(1)(i) of this section (the facts in Example 1), except that USS1 owns CFC1 and USS2 owns CFC2. USS1 and USS2 have GILTI of $65x and $20x, respectively, and amounts treated as dividends received under section 78 attributable to their GILTI of $10x and $5x, respectively.

(ii) Analysis—(A) Consolidated GILTI. Under paragraph (e)(9) of this section, the P group's consolidated GILTI is $85x, the sum of the GILTI of all members ($0 + $65x + $20x).

(B) Consolidated GILTI deduction amount. Under paragraph (e)(8) of this section, the P group's consolidated GILTI deduction amount is $50x, the product of the GILTI deduction rate and the sum of its consolidated GILTI and the amounts treated as dividends received by the members under section 78 which are attributable to their GILTI for the consolidated return year (0.50 × ($85x + $10x + $5x)).

(C) Member's deduction attributable to consolidated GILTI deduction amount. Under paragraph (b)(1) of this section, a member is allowed a deduction equal, in part, to the product of the consolidated GILTI deduction amount of the consolidated group to which the member belongs and the member's GILTI deduction allocation ratio. Under paragraph (e)(16) of this section, a member's GILTI deduction allocation ratio is the ratio of the sum of its GILTI and the amount treated as a dividend received by the member under section 78 which is attributable to its GILTI for the consolidated return year to the sum of the consolidated GILTI and the amounts treated as dividends received by the members under section 78 which are attributable to their GILTI for the consolidated return year. As a result, the GILTI deduction allocation ratios of P, USS1, and USS2 are 0 ($0/($85x + $10x + $5x)), 3/4 (($65x + $10x)/($85x + $10x + $5x)), and 1/4 (($20x + $5x)/($85x + $10x + $5x)), respectively. Therefore, P, USS1, and USS2 are permitted deductions of $0 (0 × $50x), $37.50x ( 3/4 × $50x), and $12.50x ( 1/4 × $50x), respectively.

(D) Member's deduction under section 250. Under paragraph (b)(1) of this section, a member is allowed a deduction equal to the sum of the member's deduction attributable to the consolidated FDII deduction amount and the member's deduction attributable to the consolidated GILTI deduction amount. As a result P, USS1, and USS2 are entitled to deductions under paragraph (b)(1) of this section of $0 ($0 + $0), $97.50x ($60x + $37.50x), and $42.50x ($30x + $12.50x), respectively.

(5) Example 5: Taxable income limitation—(i) Facts. The facts are the same as in paragraph (f)(4)(i) of this section (the facts in Example 4), except that the P group's consolidated taxable income (within the meaning of paragraph (e)(10) of this section) is $300x.

(ii) Analysis—(A) Determination of whether the limitation described in paragraph (b)(2) of this section applies. Under paragraph (b)(2) of this section, in the case of a consolidated group with a consolidated section 250(a)(2) amount for a consolidated year, the amount of the consolidated FDII and the consolidated GILTI otherwise taken into account in the determination of the consolidated FDII deduction amount and the consolidated GILTI deduction amount are subject to reduction. As in paragraph (f)(1)(ii)(E) of this section (the facts in Example 1), the P group's consolidated FDII is $240x. As in paragraph (f)(4)(ii)(A) of this section (the analysis in Example 4), the P group's consolidated GILTI is $85x. The P group's consolidated taxable income is $300x. Under paragraph (e)(10) of this section, the P group's consolidated section 250(a)(2) amount is $25x (($240x + $85x) − $300x), the excess of the sum of the consolidated FDII and the consolidated GILTI, over the P group's consolidated taxable income. Therefore, the limitation described in paragraph (b)(2) of this section applies.

(B) Allocation of reduction. Under paragraph (b)(2)(i) of this section, the P group's consolidated FDII is reduced by an amount which bears the same ratio to the consolidated section 250(a)(2) amount as the consolidated FDII bears to the sum of the consolidated FDII and consolidated GILTI, and the P group's consolidated GILTI is reduced by the excess of the consolidated section 250(a)(2) amount over the reduction described in paragraph (b)(2)(i) of this section. Therefore, for purposes of determining the P group's consolidated FDII deduction amount and consolidated GILTI deduction amount, its consolidated FDII is reduced to $221.54x ($240x −($25x × ($240x/$325x))) and its consolidated GILTI is reduced to $78.46x ($85x −($25x −($25x × ($240x/$325x)))).

(C) Calculation of consolidated FDII deduction amount and consolidated GILTI deduction amount. Under paragraph (e)(4) of this section, the P group's consolidated FDII deduction amount is $83.08x ($221.54x × 0.375). Under paragraph (e)(8) of this section, the P group's consolidated GILTI deduction amount is $46.73x (($78.46x + 10x + 5x) × 0.50).

(D) Member's deduction attributable to the consolidated FDII deduction amount. As in paragraph (f)(1)(ii)(G) of this section (the analysis in Example 1), the FDII deduction allocation ratios of P, USS1, and USS2 are 0, 2/3, and 1/3, respectively. Therefore, P, USS1, and USS2 are permitted deductions attributable to the consolidated FDII deduction amount of $0 (0 × $83.08x), $55.39x ( 2/3 × $83.08x), and $27.69x ( 1/3 × $83.08x), respectively.

(E) Member's deduction attributable to the consolidated GILTI deduction amount. As in paragraph (f)(4)(ii)(C) of this section (the analysis in Example 4), the GILTI deduction allocation ratios of P, USS1, and USS2 are 0, 3/4, and 1/4, respectively. Therefore, P, USS1, and USS2 are permitted deductions attributable to the consolidated GILTI deduction amount of $0 (0 × $46.73x), $35.05x ( 3/4 × $46.73x), and $11.68x ( 1/4 × $46.73x), respectively.

(F) Member's deduction pursuant section 250. Under paragraph (b)(1) of this section, a member is allowed a deduction equal to the sum of the member's deduction attributable to the consolidated FDII deduction amount and the member's deduction attributable to the consolidated GILTI deduction amount. As a result, P, USS1, and USS2 are entitled to deductions under paragraph (b)(1) of this section of $0 ($0 + $0), $90.44x ($55.39x + $35.05x), and $39.37 × ($27.69x + $11.68x), respectively.

(g) Applicability date. This section applies to consolidated return years beginning on or after January 1, 2021. A taxpayer that chooses to apply the rules in §§ 1.250(a)-1 and 1.250(b)-1 through 1.250(b)-6 to taxable years beginning before January 1, 2021, pursuant to § 1.250-1(b), must also apply the rules of this section in their entirety to consolidated return years beginning after December 31, 2017, and before January 1, 2021.

[T.D. 9901, 85 FR 43113, July 15, 2020]

§ 1.1502-51 Consolidated section 951A.

(a) In general. This section provides rules for applying section 951A to each member of a consolidated group (each, a member) that is a United States shareholder of any controlled foreign corporation. Paragraph (b) of this section describes the inclusion of the GILTI inclusion amount by a member of a consolidated group. Paragraphs (c) and (d) of this section are reserved. Paragraph (e) of this section provides definitions for purposes of this section. Paragraph (f) of this section provides examples illustrating the rules of this section. Paragraph (g) of this section provides an applicability date.

(b) Calculation of the GILTI inclusion amount for a member of a consolidated group. Each member who is a United States shareholder of any controlled foreign corporation includes in gross income in the U.S. shareholder inclusion year the member's GILTI inclusion amount, if any, for the U.S. shareholder inclusion year. See section 951A(a) and § 1.951A-1(b). The GILTI inclusion amount of a member for a U.S. shareholder inclusion year is the excess (if any) of the member's net CFC tested income for the U.S. shareholder inclusion year, over the member's net deemed tangible income return for the U.S. shareholder inclusion year, determined using the definitions provided in paragraph (e) of this section. In addition, see § 1.951A-1(e) (cross-referencing § 1.958-1(d)).

(c)-(d) [Reserved]

(e) Definitions. Any term used but not defined in this section has the meaning set forth in §§ 1.951A-1 through 1.951A-6. In addition, the following definitions apply for purposes of this section.

(1) Aggregate tested income. With respect to a member, the term aggregate tested income means the aggregate of the member's pro rata share (determined under § 1.951A-1(d)(2)) of the tested income of each tested income CFC for a CFC inclusion year that ends with or within the U.S. shareholder inclusion year.

(2) Aggregate tested loss. With respect to a member, the term aggregate tested loss means the aggregate of the member's pro rata share (determined under § 1.951A-1(d)(4)) of the tested loss of each tested loss CFC for a CFC inclusion year that ends with or within the U.S. shareholder inclusion year.

(3) Allocable share. The term allocable share means, with respect to a member that is a United States shareholder and a U.S. shareholder inclusion year—

(i) With respect to consolidated QBAI, the product of the consolidated QBAI of the member's consolidated group and the member's GILTI allocation ratio.

(ii) With respect to consolidated specified interest expense, the product of the consolidated specified interest expense of the member's consolidated group and the member's GILTI allocation ratio.

(iii) With respect to consolidated tested loss, the product of the consolidated tested loss of the member's consolidated group and the member's GILTI allocation ratio.

(4) Consolidated QBAI. With respect to a consolidated group, the term consolidated QBAI means the sum of each member's pro rata share (determined under § 1.951A-1(d)(3)) of the qualified business asset investment of each tested income CFC for a CFC inclusion year that ends with or within the U.S. shareholder inclusion year.

(5) Consolidated specified interest expense. With respect to a consolidated group, the term consolidated specified interest expense means the excess (if any) of—

(i) The sum of each member's pro rata share (determined under § 1.951A-1(d)(5)) of the tested interest expense of each controlled foreign corporation for a CFC inclusion year that ends with or within the U.S. shareholder inclusion year, over

(ii) The sum of each member's pro rata share (determined under § 1.951A-1(d)(6)) of the tested interest income of each controlled foreign corporation for a CFC inclusion year that ends with or within the U.S. shareholder inclusion year.

(6) Consolidated tested income. With respect to a consolidated group, the term consolidated tested income means the sum of each member's aggregate tested income for the U.S. shareholder inclusion year.

(7) Consolidated tested loss. With respect to a consolidated group, the term consolidated tested loss means the sum of each member's aggregate tested loss for the U.S. shareholder inclusion year.

(8) Controlled foreign corporation. The term controlled foreign corporation has the meaning provided in § 1.951A-1(f)(2).

(9) Deemed tangible income return. With respect to a member, the term deemed tangible income return means 10 percent of the member's allocable share of the consolidated QBAI.

(10) GILTI allocation ratio. With respect to a member, the term GILTI allocation ratio means the ratio of—

(i) The aggregate tested income of the member for the U.S. shareholder inclusion year, to

(ii) The consolidated tested income of the consolidated group of which the member is a member for the U.S. shareholder inclusion year.

(11) GILTI inclusion amount. With respect to a member, the term GILTI inclusion amount has the meaning provided in paragraph (b) of this section.

(12) Net CFC tested income. With respect to a member, the term net CFC tested income means the excess (if any) of—

(i) The member's aggregate tested income, over

(ii) The member's allocable share of the consolidated tested loss.

(13) Net deemed tangible income return. With respect to a member, the term net deemed tangible income return means the excess (if any) of the member's deemed tangible income return over the member's allocable share of the consolidated specified interest expense.

(14) through (16) [Reserved]

(17) Qualified business asset investment. The term qualified business asset investment has the meaning provided in § 1.951A-3(b).

(18) Tested income. The term tested income has the meaning provided in § 1.951A-2(b)(1).

(19) Tested income CFC. The term tested income CFC has the meaning provided in § 1.951A-2(b)(1).

(20) Tested interest expense. The term tested interest expense has the meaning provided in § 1.951A-4(b)(1).

(21) Tested interest income. The term tested interest income has the meaning provided in § 1.951A-4(b)(2).

(22) Tested loss. The term tested loss has the meaning provided in § 1.951A-2(b)(2).

(23) Tested loss CFC. The term tested loss CFC has the meaning provided in § 1.951A-2(b)(2).

(24) United States shareholder. The term United States shareholder has the meaning provided in § 1.951A-1(f)(6).

(25) U.S. shareholder inclusion year. The term U.S. shareholder inclusion year has the meaning provided in § 1.951A-1(f)(7).

(f) Examples. The following examples illustrate the rules of this section. For purposes of the examples in this section, unless otherwise stated: P is the common parent of the P consolidated group; P owns all of the single class of stock of subsidiaries USS1, USS2, and USS3, all of whom are members of the P consolidated group; CFC1, CFC2, CFC3, and CFC4 are all controlled foreign corporations (within the meaning of paragraph (e)(8) of this section); and the taxable year of all persons is the calendar year.

(1) Example 1: Calculation of net CFC tested income within a consolidated group when all CFCs are wholly owned by a member—(i) Facts. USS1 owns all of the single class of stock of CFC1. USS2 owns all of the single class of stock of each of CFC2 and CFC3. USS3 owns all of the single class of stock of CFC4. In Year 1, CFC1 has tested loss of $100x, CFC2 has tested income of $200x, CFC3 has tested loss of $200x, and CFC4 has tested income of $600x. None of CFC1, CFC2, CFC3, or CFC4 has qualified business asset investment in Year 1.

(ii) Analysis—(A) Consolidated tested income and GILTI allocation ratio. USS1 has no aggregate tested income; USS2's aggregate tested income is $200x, its pro rata share (determined under § 1.951A-1(d)(2)) of CFC2's tested income; and USS3's aggregate tested income is $600x, its pro rata share (determined under § 1.951A-1(d)(2)) of CFC4's tested income. Therefore, under paragraph (e)(6) of this section, the P consolidated group's consolidated tested income is $800x ($200x + $600x). As a result, the GILTI allocation ratios of USS1, USS2, and USS3 are 0 ($0/$800x), 0.25 ($200x/$800x), and 0.75 ($600x/$800x), respectively.

(B) Consolidated tested loss. Under paragraph (e)(7) of this section, the P consolidated group's consolidated tested loss is $300x ($100x + $200x), the sum of USS1's aggregate tested loss, which is equal to its pro rata share (determined under § 1.951A-1(d)(4)) of CFC1's tested loss ($100x), and USS2's aggregate tested loss, which is equal to its pro rata share (determined under § 1.951A-1(d)(4)) of CFC3's tested loss ($200x). Under paragraph (e)(3)(iii) of this section, a member's allocable share of the consolidated tested loss is the product of the consolidated tested loss of the member's consolidated group and the member's GILTI allocation ratio. Therefore, the allocable shares of the consolidated tested loss of USS1, USS2, and USS3 are $0 (0 × $300x), $75x (0.25 × $300x), and $225x (0.75 × $300x), respectively.

(C) Calculation of net CFC tested income. Under paragraph (e)(12) of this section, a member's net CFC tested income is the excess (if any) of the member's aggregate tested income over the member's allocable share of the consolidated tested loss. As a result, the net CFC tested income of USS1, USS2, and USS3 are $0 ($0−$0), $125x ($200x−$75x), and $375x ($600x−$225x), respectively.

(2) Example 2: Calculation of net CFC tested income within a consolidated group when ownership of a tested loss CFC is split between members—(i) Facts. The facts are the same as in paragraph (f)(1)(i) of this section (the facts in Example 1), except that USS2 and USS3 each own 50% of the single class of stock of CFC3.

(ii) Analysis. As in paragraph (f)(1)(ii)(A) of this section (paragraph (A) of the analysis in Example 1), USS1 has no aggregate tested income and a GILTI allocation ratio of 0, USS2 has $200x of aggregate tested income and a GILTI allocation ratio of 0.25, and USS3 has $600x of aggregate tested income and a GILTI allocation ratio of 0.75. Additionally, the P consolidated group's consolidated tested loss is $300x (the aggregate of USS1's aggregate tested loss, which is equal to its pro rata share (determined under § 1.951A-1(d)(4)) of CFC1's tested loss ($100x); USS2's aggregate tested loss, which is equal to its pro rata share (determined under § 1.951A-1(d)(4)) of CFC3's tested loss ($100x); and USS3's aggregate tested loss, which is equal to its pro rata share (determined under § 1.951A-1(d)(4)) of CFC3's tested loss ($100x)). As a result, under paragraph (e)(12) of this section, as in paragraph (f)(1)(ii)(C) of this section (paragraph (C) of the analysis in Example 1), the net CFC tested income of USS1, USS2, and USS3 are $0 ($0−$0), $125x ($200x−$75x), and $375x ($600x−$225x), respectively.

(3) Example 3: Calculation of GILTI inclusion amount—(i) Facts. The facts are the same as in paragraph (f)(1)(i) of this section (the facts in Example 1), except that CFC2 and CFC4 have qualified business asset investment of $500x and $2,000x, respectively, for Year 1. In Year 1, CFC1 and CFC4 each have tested interest expense (within the meaning of § 1.951A-4(b)(1)) of $25x, and none of CFC1, CFC2, CFC3, and CFC4 have tested interest income (within the meaning of § 1.951A-4(b)(2)). CFC1's tested loss of $100x and CFC4's tested income of $600x take into account the tested interest expense.

(ii) Analysis—(A) GILTI allocation ratio. As in paragraph (f)(1)(ii)(A) of this section (paragraph (A) of the analysis in Example 1), the GILTI allocation ratios of USS1, USS2, and USS3 are 0 ($0/$800x), 0.25 ($200x/$800x), and 0.75 ($600x/$800x), respectively.

(B) Consolidated QBAI. Under paragraph (e)(4) of this section, the P consolidated group's consolidated QBAI is $2,500x ($500x + $2,000x), the aggregate of USS2's pro rata share (determined under § 1.951A-1(d)(3)) of the qualified business asset investment of CFC2 and USS3's pro rata share (determined under § 1.951A-1(d)(3)) of the qualified business asset investment of CFC4. Under paragraph (e)(3)(i) of this section, a member's allocable share of consolidated QBAI is the product of the consolidated QBAI of the member's consolidated group and the member's GILTI allocation ratio. Therefore, the allocable shares of the consolidated QBAI of each of USS1, USS2, and USS3 are $0 (0 × $2,500x), $625x (0.25 × $2,500x), and $1,875x (0.75 × $2,500x), respectively.

(C) Consolidated specified interest expense—(1) Pro rata share of tested interest expense. USS1's pro rata share (determined under § 1.951A-1(d)(5)) of the tested interest expense of CFC1 is $25x, the amount by which the tested interest expense increases USS1's pro rata share of CFC1's tested loss (from $75x to $100x) for Year 1. USS3's pro rata share (determined under § 1.951A-1(d)(5)) of the tested interest expense of CFC4 is also $25x, the amount by which the tested interest expense decreases USS3's pro rata share of CFC4's tested income (from $625x to $600x).

(2) Consolidated specified interest expense. Under paragraph (e)(5) of this section, the P consolidated group's consolidated specified interest expense is $50x, the excess of the sum of each member's pro rata share of the tested interest expense of each controlled foreign corporation ($50x, $25x from USS1 + $25x from USS3), over the sum of each member's pro rata share of tested interest income ($0). Under paragraph (e)(3)(ii) of this section, a member's allocable share of consolidated specified interest expense is the product of the consolidated specified interest expense of the member's consolidated group and the member's GILTI allocation ratio. Therefore, the allocable shares of consolidated specified interest expense of USS1, USS2, and USS3 are $0 (0 × $50x), $12.50x (0.25 × $50x), and $37.50x (0.75 × $50x), respectively.

(D) Calculation of deemed tangible income return. Under paragraph (e)(9) of this section, a member's deemed tangible income return means 10 percent of the member's allocable share of the consolidated QBAI. As a result, the deemed tangible income returns of USS1, USS2, and USS3 are $0 (0.1 × $0), $62.50x (0.1 × $625x), and $187.50x (0.1 × $1,875x), respectively.

(E) Calculation of net deemed tangible income return. Under paragraph (e)(13) of this section, a member's net deemed tangible income return means the excess (if any) of a member's deemed tangible income return over the member's allocable share of the consolidated specified interest expense. As a result, the net deemed tangible income returns of USS1, USS2, and USS3 are $0 ($0−$0), $50x ($62.50x−$12.50x), and $150x ($187.50x−$37.50x), respectively.

(F) Calculation of GILTI inclusion amount. Under paragraph (b) of this section, a member's GILTI inclusion amount for a U.S. shareholder inclusion year is the excess (if any) of the member's net CFC tested income for the U.S. shareholder inclusion year, over the shareholder's net deemed tangible income return for the U.S. shareholder inclusion year. As described in paragraph (f)(1)(ii)(C) of this section (paragraph (C) of the analysis in Example 1), the net CFC tested income of USS1, USS2, and USS3 are $0, $125x, and $375x, respectively. As described in paragraph (f)(3)(ii)(E) of this section (paragraph (E) of the analysis in this example), the net deemed tangible income returns of USS1, USS2, and USS3 are $0, $50x, and $150x, respectively. As a result, under paragraph (b) of this section, the GILTI inclusion amounts of USS1, USS2, and USS3 are $0 ($0−$0), $75x ($125x−$50x), and $225x ($375x−$150x), respectively.

(g) Applicability date—(1) In general. Except as otherwise provided in this paragraph (g), this section applies to taxable years of United States shareholders for which the due date (without extensions) of the consolidated return is after June 21, 2019. However, a consolidated group may apply the rules of this section in their entirety to all taxable years of its members that are described in § 1.951A-7(a). In such a case, the consolidated group must apply the rules of this section to all taxable years described in § 1.951A-7(a) and with respect to all members.

(2) [Reserved]

[T.D. 9866, 84 FR 29367, June 21, 2019, as amended by T.D. 9902, 85 FR 44649, July 23, 2020; T.D. 9960, 87 FR 3656, Jan. 25, 2022]

§ 1.1502-55 Computation of alternative minimum tax of consolidated groups.

(a)-(h)(3) [Reserved]

(h)(4) Separate return year minimum tax credit. (i)-(ii) [Reserved]

(iii)(A) Limitation on portion of separate return year minimum tax credit arising in separate return limitation years. The aggregate of a member's minimum tax credits arising in SRLYs that are included in the consolidated minimum tax credits for all consolidated return years of the group may not exceed—

(1) The aggregate for all consolidated return years of the member's contributions to the consolidated section 53(c) limitation for each consolidated return year; reduced by

(2) The aggregate of the member's minimum tax credits arising and absorbed in all consolidated return years (whether or not absorbed by the member).

(B) Computational rules—(1) Member's contribution to the consolidated section 53(c) limitation. Except as provided in the special rule of paragraph (h)(4)(iii)(B)(2) of this section, a member's contribution to the consolidated section 53(c) limitation for a consolidated return year equals the member's share of the consolidated net regular tax liability minus its share of consolidated tentative minimum tax. The group computes the member's shares by applying to the respective consolidated amounts the principles of section 1552 and the percentage method under § 1.1502-33(d)(3), assuming a 100% allocation of any decreased tax liability. The group makes proper adjustments so that taxes and credits not taken into account in computing the limitation under section 53(c) are not taken into account in computing the member's share of the consolidated net regular tax, etc. (See, for example, the taxes described in section 26(b) that are disregarded in computing regular tax liability.)

(2) Adjustment for year in which alternative minimum tax is paid. For a consolidated return year for which consolidated tentative minimum tax is greater than consolidated regular tax liability, the group reduces the member's share of the consolidated tentative minimum tax by the member's share of the consolidated alternative minimum tax for the year. The group determines the member's share of consolidated alternative minimum tax for a year using the same method it uses to determine the member's share of the consolidated minimum tax credits for the year.

(3) Years included in computation. For purposes of computing the limitation under this paragraph (h)(4)(iii), the consolidated return years of the group include only those years, including the year to which a credit is carried, that the member has been continuously included in the group's consolidated return, but exclude any years after the year to which the credit is carried.

(4) Subgroup principles. The SRLY subgroup principles under § 1.1502-21(c)(2) apply for purposes of this paragraph (h)(4)(iii). The predecessor and successor principles under § 1.1502-21(f) also apply for purposes of this paragraph (h)(4)(iii).

(5) Overlap with section 383. The principles under § 1.1502-21(g) apply for purposes of this paragraph (h)(4)(iii). For example, an overlap of this paragraph (h)(4)(iii) and the application of section 383 with respect to a credit carryover occurs if a corporation becomes a member of a consolidated group (the SRLY event) within six months of the change date of an ownership change giving rise to a section 383 credit limitation with respect to that carryover (the section 383 event), with the result that the limitation of this paragraph (h)(4)(iii) does not apply. See §§ 1.1502-21(g)(2)(ii)(A) and 1.383-1; see also § 1.1502-21(g)(4) (subgroup rules).

(C) Effective date—(1) In general. This paragraph (h)(4)(iii) generally applies to consolidated return years for which the due date of the income tax return (without extensions) is after March 13, 1998. See § 1.1502-3(d)(4) for an optional effective date rule (generally making this paragraph (h)(4)(iii) also applicable to a consolidated return year beginning on or after January 1, 1997, if the due date of the income tax return (without extensions) was on or before March 13, 1998).

(i) Contribution years. In general, a group does not take into account a consolidated taxable year for which the due date of the income tax return (without extensions) is on or before March 13, 1998, in determining a member's (or subgroup's) contributions to the consolidated section 53(c) limitation under this paragraph (h)(4)(iii). However, if a consolidated group chooses to apply the optional effective date rule, the consolidated group shall not take into account a consolidated taxable year beginning before January 1, 1997 in determining a member's (or subgroup's) contributions to the consolidated section 53(c) limitation under this paragraph (h)(4)(iii).

(ii) Special subgroup rule. In the event that the principles of § 1.1502-21(g)(1) do not apply to a particular credit carryover in the current group, then solely for purposes of applying this paragraph (h)(4)(iii) to determine the limitation with respect to that carryover and with respect to which the SRLY register (the aggregate of the member's or subgroup's contribution to consolidated section 53(c) limitation reduced by the aggregate of the member's or subgroup's minimum tax credits arising and absorbed in all consolidated return years) began in a taxable year for which the due date of the return is on or before May 25, 2000, the principles of § 1.1502-21(c)(2) shall be applied without regard to the phrase “or for a carryover that was subject to the overlap rule described in paragraph (g) of this section or § 1.1502-15(g) with respect to another group (the former group).”

(2) Overlap rule. Paragraph (h)(4)(iii)(B)(5) of this section (relating to overlap with section 383) applies to taxable years for which the due date (without extensions) of the consolidated return is after May 25, 2000. For purposes of paragraph (h)(4)(iii)(B)(5) of this section, only an ownership change to which section 383, as amended by the Tax Reform Act of 1986 (100 Stat. 2095), applies and which results in a section 383 credit limitation shall constitute a section 383 event. The optional effective date rule of § 1.1502-3(d)(4) (generally making this paragraph (h)(4)(iii) also applicable to a consolidated return year beginning on or after January 1, 1997, if the due date of the income tax return (without extensions) was on or before March 13, 1998) does not apply with respect to paragraph (h)(4)(iii)(B)(5) of this section (relating to the overlap rule).

[T.D. 8884, 65 FR 33759, May 25, 2000]

§ 1.1502-59A Application of section 59A to consolidated groups.

(a) Scope. This section provides rules for the application of section 59A and the regulations thereunder (the section 59A regulations) to consolidated groups and their members (as defined in § 1.1502-1(h) and (b), respectively). Rules in the section 59A regulations apply to consolidated groups except as modified in this section. Paragraph (b) of this section provides rules treating a consolidated group (rather than each member of the group) as a single taxpayer, and a single applicable taxpayer, as relevant, for certain purposes. Paragraph (c) of this section coordinates the application of the business interest stacking rule under § 1.59A-3(c)(4) to consolidated groups. Paragraph (d) of this section addresses how the base erosion minimum tax amount is allocated among members of the consolidated group. Paragraph (e) of this section coordinates the application of this section and § 1.1502-47. Paragraph (f) of this section sets forth definitions. Paragraph (g) of this section provides examples. Paragraph (h) of this section provides the applicability date.

(b) Consolidated group as the applicable taxpayer—(1) In general. For purposes of determining whether the consolidated group is an applicable taxpayer (within the meaning of § 1.59A-2(b)) and the amount of tax due pursuant to section 59A(a), all members of a consolidated group are treated as a single taxpayer. Thus, for example, members' deductions are aggregated in making the required computations under section 59A. In addition, to ensure that intercompany transactions (as defined in § 1.1502-13(b)(1)(i)) do not affect the consolidated group's base erosion percentage or base erosion minimum tax amount, items resulting from intercompany transactions are not taken into account in making such computations under section 59A. For example, additional depreciation deductions resulting from intercompany asset sales are not taken into account for purposes of applying the base erosion percentage test under § 1.59A-2(e).

(2) Consolidated group as member of the aggregate group. The consolidated group is treated as a single member of an aggregate group for purposes of § 1.59A-2(c).

(3) Related party determination. For purposes of section 59A and the section 59A regulations, if a person is a related party with respect to any member of a consolidated group, that person is a related party of the group and of each of its members.

(c) Coordination of section 59A(c)(3) and section 163(j) in a consolidated group—(1) Overview. This paragraph (c) provides rules regarding the application of § 1.59A-3(c)(4) to a consolidated group's section 163(j) interest deduction. The classification rule in paragraph (c)(3) of this section addresses how to determine if, and to what extent, the group's section 163(j) interest deduction is a base erosion tax benefit. These regulations contain a single-entity classification rule with regard to the deduction of the consolidated group's aggregate current year business interest expense (“BIE”), but a separate-entity classification rule for the deduction of the consolidated group's disallowed BIE carryforwards. Paragraph (c)(3) of this section classifies the group's aggregate current year BIE deduction, in conformity with § 1.59A-3(c)(4), as constituting domestic related current year BIE deduction, foreign related current year BIE deduction, or unrelated current year BIE deduction. The allocation rules in paragraph (c)(4) of this section then allocate to specific members of the group the domestic related current year BIE deduction, foreign related current year BIE deduction, and unrelated current year BIE deduction taken in the taxable year. Any member's current year BIE that is carried forward to the succeeding taxable year as a disallowed BIE carryforward is allocated a status as domestic related BIE carryforward, foreign related BIE carryforward, or unrelated BIE carryforward under paragraph (c)(5) of this section. The status of any disallowed BIE carryforward deducted by a member in a later year is classified on a separate-entity basis by the deducting member under paragraph (c)(3) of this section, based on the status allocated to the member's disallowed BIE carryforward under paragraph (c)(5) of this section. This paragraph (c) also provides rules regarding the consequences of the deconsolidation of a corporation that has been allocated a domestic related BIE carryforward status, a foreign related BIE carryforward status, or an unrelated BIE carryforward status; and the consolidation of a corporation with a disallowed BIE carryforward classified as from payments to a domestic related party, foreign related party, or unrelated party.

(2) Absorption rule for the group's business interest expense. To determine the amount of the group's section 163(j) interest deduction, and to determine the year in which the member's business interest expense giving rise to the deduction was incurred or accrued, see §§ 1.163(j)-4(d) and 1.163(j)-5(b)(3).

(3) Classification of the group's section 163(j) interest deduction—(i) In general. Consistent with § 1.59A-3(c)(4)(i) and paragraph (b) of this section, the classification rule of this paragraph (c)(3) determines whether the consolidated group's section 163(j) interest deduction is a base erosion tax benefit. To the extent the consolidated group's business interest expense is permitted as a deduction under section 163(j)(1) in a taxable year, the deduction is classified first as from business interest expense paid or accrued to a foreign related party and business interest expense paid or accrued to a domestic related party (on a pro-rata basis); any remaining deduction is treated as from business interest expense paid or accrued to an unrelated party.

(ii) Year-by-year application of the classification rule. If the consolidated group's section 163(j) interest deduction in any taxable year is attributable to business interest expense paid or accrued in more than one taxable year (for example, the group deducts the group's aggregate current year BIE, the group's disallowed BIE carryforward from year 1, and the group's disallowed BIE carryforward from year 2), the classification rule in paragraph (c)(3)(i) of this section applies separately to each of those years, pursuant to paragraphs (c)(3)(iii) and (iv) of this section.

(iii) Classification of current year BIE deductions. Current year BIE deductions are classified under the section 59A regulations and this paragraph (c) as if the consolidated group were a single taxpayer that had paid or accrued the group's aggregate current year BIE to domestic related parties, foreign related parties, and unrelated parties. The rules of paragraph (c)(4) of this section apply for allocating current year BIE deductions among members of the consolidated group. To the extent the consolidated group's aggregate current year BIE exceeds its section 163(j) limitation, the rules of paragraph (c)(5) of this section apply.

(iv) Classification of deductions of disallowed BIE carryforwards. Each member of the group applies the classification rule in this paragraph (c)(3) to its deduction of any part of a disallowed BIE carryforward from a year, after the group applies paragraph (c)(5) of this section to the consolidated group's disallowed BIE carryforward from that year. Therefore, disallowed BIE carryforward that is actually deducted by a member is classified based on the status of the components of that carryforward, assigned pursuant to paragraph (c)(5) of this section.

(4) Allocation of domestic related current year BIE deduction status and foreign related current year BIE deduction status among members of the consolidated group—(i) In general. This paragraph (c)(4) applies if the group has domestic related current year BIE deductions, foreign related current year BIE deductions, or both, as a result of the application of the classification rule in paragraph (c)(3) of this section. Under this paragraph (c)(4), the domestic related current year BIE, foreign related current year BIE, or both, that is treated as deducted in the current year are deemed to have been incurred pro-rata by all members that have current year BIE deduction in that year, regardless of which member or members actually incurred the current year BIE to a domestic related party or a foreign related party.

(ii) Domestic related current year BIE deduction—(A) Amount of domestic related current year BIE deduction status allocable to a member. The amount of domestic related current year BIE deduction status that is allocated to a member is determined by multiplying the group's domestic related current year BIE deduction (determined pursuant to paragraph (c)(3) of this section) by the percentage of current year BIE deduction allocable to such member in that year.

(B) Percentage of current year BIE deduction allocable to a member. The percentage of current year BIE deduction allocable to a member is equal to the amount of the member's current year BIE deduction divided by the amount of the group's aggregate current year BIE deduction.

(iii) Amount of foreign related current year BIE deduction status allocable to a member. The amount of foreign related current year BIE deduction status that is allocated to a member is determined by multiplying the group's foreign related current year BIE deduction (determined pursuant to paragraph (c)(3) of this section) by the percentage of current year BIE deduction allocable to such member (defined in paragraph (c)(4)(ii)(B) of this section).

(iv) Treatment of amounts as having unrelated current year BIE deduction status. To the extent the amount of a member's current year BIE that is absorbed under paragraph (c)(2) of this section exceeds the domestic related current year BIE deduction status and foreign related current year BIE deduction status allocated to the member under paragraph (c)(4)(ii) and (iii) of this section, such excess amount is treated as from payments or accruals to an unrelated party.

(5) Allocation of domestic related BIE carryforward status and foreign related BIE carryforward status to members of the group—(i) In general. This paragraph (c)(5) applies in any year the consolidated group's aggregate current year BIE exceeds its section 163(j) limitation. After the application of paragraph (c)(4) of this section, any remaining domestic related current year BIE, foreign related current year BIE, and unrelated current year BIE is deemed to have been incurred pro-rata by members of the group pursuant to the rules in paragraph (c)(5)(ii), (iii), and (iv) of this section, regardless of which member or members actually incurred the business interest expense to a domestic related party, foreign related party, or unrelated party.

(ii) Domestic related BIE carryforward—(A) Amount of domestic related BIE carryforward status allocable to a member. The amount of domestic related BIE carryforward status that is allocated to a member equals the group's domestic related BIE carryforward from that year multiplied by the percentage of disallowed BIE carryforward allocable to the member.

(B) Percentage of disallowed BIE carryforward allocable to a member. The percentage of disallowed BIE carryforward allocable to a member for a taxable year equals the member's disallowed BIE carryforward from that year divided by the consolidated group's disallowed BIE carryforwards from that year.

(iii) Amount of foreign related BIE carryforward status allocable to a member. The amount of foreign related BIE carryforward status that is allocated to a member equals the group's foreign related BIE carryforward from that year multiplied by the percentage of disallowed BIE carryforward allocable to the member (as defined in paragraph (c)(5)(ii)(B) of this section).

(iv) Treatment of amounts as having unrelated BIE carryforward status. If a member's disallowed BIE carryforward for a year exceeds the amount of domestic related BIE carryforward status and foreign related BIE carryforward status that is allocated to the member pursuant to paragraphs (c)(5)(ii) and (iii) of this section, respectively, the excess carryforward amount is treated as from payments or accruals to an unrelated party.

(v) Coordination with section 381. If a disallowed BIE carryforward is allocated a status as a domestic related BIE carryforward, foreign related BIE carryforward, or unrelated BIE carryforward under the allocation rule of paragraph (c)(5) of this section, the acquiring corporation in a transaction described in section 381(a) will succeed to and take into account the allocated status of the carryforward for purposes of section 59A. See § 1.381(c)(20)-1.

(6) Member deconsolidates from a consolidated group—(i) General rule. When a member deconsolidates from a group (the original group), the member's disallowed BIE carryforwards retain their allocated status, pursuant to paragraph (c)(5) of this section, as a domestic related BIE carryforward, foreign related BIE carryforward, or unrelated BIE carryforward (as applicable). Following the member's deconsolidation, the status of the disallowed BIE carryforwards of the remaining members is not redetermined.

(ii) Gross receipts exception. This paragraph (c)(6)(ii) applies if the original group had insufficient gross receipts to satisfy the gross receipts test under § 1.59A-2(d) and thus was not an applicable taxpayer in the year in which the deconsolidating member's disallowed BIE carryforward was incurred. If this paragraph (c)(6)(ii) applies, the deconsolidating member may determine the status of its disallowed BIE carryforward from that year by applying the classification rule of § 1.59A-3(c)(4) solely to the interest payments or accruals of the deconsolidating member, rather than by applying § 1.1502-59A(c)(3).

(iii) Failure to substantiate. If the deconsolidating member fails to substantiate a disallowed BIE carryforward as a domestic related BIE carryforward, foreign related BIE carryforward, or unrelated BIE carryforward, then the disallowed BIE carryforward is treated as a foreign related BIE carryforward.

(7) Corporation joins a consolidated group. If a corporation joins a consolidated group (the acquiring group), and that corporation was allocated a domestic related BIE carryforward status, foreign related BIE carryforward status, or unrelated BIE carryforward status pursuant to paragraph (c)(5) of this section from another consolidated group (the original group), or separately has a disallowed BIE carryforward that is classified as from payments or accruals to a domestic related party, foreign related party, or unrelated party, the status of the carryforward is taken into account in determining the acquiring group's base erosion tax benefit when the corporation's disallowed BIE carryforward is absorbed.

(d) Allocation of the base erosion minimum tax amount to members of the consolidated group. For rules regarding the allocation of the base erosion minimum tax amount, see section 1552. Allocations under section 1552 take into account the classification and allocation provisions of paragraphs (c)(3) through (5) of this section.

(e) [Reserved]

(f) Definitions. The following definitions apply for purposes of this section—

(1) Aggregate current year BIE. The consolidated group's aggregate current year BIE is the aggregate of all members' current year BIE.

(2) Aggregate current year BIE deduction. The consolidated group's aggregate current year BIE deduction is the aggregate of all members' current year BIE deductions.

(3) Applicable taxpayer. The term applicable taxpayer has the meaning provided in § 1.59A-2(b).

(4) Base erosion minimum tax amount. The consolidated group's base erosion minimum tax amount is the tax imposed under section 59A.

(5) Base erosion tax benefit. The term base erosion tax benefit has the meaning provided in § 1.59A-3(c)(1).

(6) Business interest expense. The term business interest expense, with respect to a member and a taxable year, has the meaning provided in § 1.163(j)-1(b)(3), and with respect to a consolidated group and a taxable year, has the meaning provided in § 1.163(j)-4(d)(2)(iii).

(7) Consolidated group's disallowed BIE carryforwards. The term consolidated group's disallowed BIE carryforwards has the meaning provided in § 1.163(j)-5(b)(3)(i).

(8) Current year BIE. A member's current year BIE is the member's business interest expense that would be deductible in the current taxable year without regard to section 163(j) and that is not a disallowed business interest expense carryforward from a prior taxable year.

(9) Current year BIE deduction. A member's current year BIE deduction is the member's current year BIE that is permitted as a deduction in the taxable year.

(10) Domestic related BIE carryforward. The consolidated group's domestic related BIE carryforward for any taxable year is the excess of the group's domestic related current year BIE over the group's domestic related current year BIE deduction (if any).

(11) Domestic related current year BIE. The consolidated group's domestic related current year BIE for any taxable year is the consolidated group's aggregate current year BIE paid or accrued to a domestic related party.

(12) Domestic related current year BIE deduction. The consolidated group's domestic related current year BIE deduction for any taxable year is the portion of the group's aggregate current year BIE deduction classified as from interest paid or accrued to a domestic related party under paragraph (c)(3) of this section.

(13) Domestic related party. A domestic related party is a related party that is not a foreign related party and is not a member of the same consolidated group.

(14) Disallowed BIE carryforward. The term disallowed BIE carryforward has the meaning provided in § 1.163(j)-1(b)(11).

(15) Foreign related BIE carryforward. The consolidated group's foreign related BIE carryforward for any taxable year, is the excess of the group's foreign related current year BIE over the group's foreign related current year BIE deduction (if any).

(16) Foreign related current year BIE. The consolidated group's foreign related current year BIE for any taxable year is the consolidated group's aggregate current year BIE paid or accrued to a foreign related party.

(17) Foreign related current year BIE deduction. The consolidated group's foreign related current year BIE deduction for any taxable year is the portion of the consolidated group's aggregate current year BIE deduction classified as from interest paid or accrued to a foreign related party under paragraph (c)(3) of this section.

(18) Foreign related party. A foreign related party has the meaning provided in § 1.59A-1(b)(12).

(19) Related party. The term related party has the meaning provided in § 1.59A-1(b)(17), but excludes members of the same consolidated group.

(20) Section 163(j) interest deduction. The term section 163(j) interest deduction means, with respect to a taxable year, the amount of the consolidated group's business interest expense permitted as a deduction pursuant to § 1.163(j)-5(b)(3) in the taxable year.

(21) Section 163(j) limitation. The term section 163(j) limitation has the meaning provided in § 1.163(j)-1(b)(36).

(22) Unrelated BIE carryforward. The consolidated group's unrelated BIE carryforward for any taxable year is the excess of the group's unrelated current year BIE over the group's unrelated current year BIE deduction.

(23) Unrelated current year BIE. The consolidated group's unrelated current year BIE for any taxable year is the consolidated group's aggregate current year BIE paid or accrued to an unrelated party.

(24) Unrelated current year BIE deduction. The consolidated group's unrelated current year BIE deduction for any taxable year is the portion of the group's aggregate current year BIE deduction classified as from interest paid or accrued to an unrelated party under paragraph (c)(3) of this section.

(25) Unrelated party. An unrelated party is a party that is not a related party.

(g) Examples. The following examples illustrate the general application of this section. For purposes of the examples, a foreign corporation (FP) wholly owns domestic corporation (P), which in turn wholly owns S1 and S2. P, S1, and S2 are members of a consolidated group. The consolidated group is a calendar year taxpayer.

(1) Example 1: Computation of the consolidated group's base erosion minimum tax amount. (i) The consolidated group is the applicable taxpayer—(A) Facts. The members have never engaged in intercompany transactions. For the 2019 taxable year, P, S1, and S2 were permitted the following amounts of deductions (within the meaning of section 59A(c)(4)), $2,400x, $1,000x, and $2,600x; those deductions include base erosion tax benefits of $180x, $370x, and $230x. The group's consolidated taxable income for the year is $150x. In addition, the group satisfies the gross receipts test in § 1.59A-2(d).

(B) Analysis. Pursuant to paragraph (b) of this section, the receipts and deductions of P, S1, and S2 are aggregated for purposes of making the computations under section 59A. The group's base erosion percentage is 13% (($180x + $370x + $230x)/($2,400x + $1,000x + $2,600x)). The consolidated group is an applicable taxpayer under § 1.59A-2(b) because the group satisfies the gross receipts test and the group's base erosion percentage (13%) is higher than 3%. The consolidated group's modified taxable income is computed by adding back the members' base erosion tax benefits (and, when the consolidated group has consolidated net operating loss available for deduction, the consolidated net operating loss allowed multiplied by the base erosion percentage) to the consolidated taxable income, $930x ($150x + $180x + $370x + $230x). The group's base erosion minimum tax amount is then computed as 10 percent of the modified taxable income less the regular tax liability, $61.5x ($930x × 10%−$150x × 21%).

(ii) The consolidated group engages in intercompany transactions—(A) Facts. The facts are the same as in paragraph (g)(1)(i)(A) of this section (the facts in Example 1(i)), except that S1 sold various inventory items to S2 during 2019. Such items are depreciable in the hands of S2 (but would not have been depreciable in the hands of S1) and continued to be owned by S2 during 2019.

(B) Analysis. The result is the same as paragraph (g)(1)(i)(A) of this section (the facts in Example 1(i)). Pursuant to paragraph (b)(2) of this section, items resulting from the intercompany sale (for example, gross receipts, depreciation deductions) are not taken into account in computing the group's gross receipts under § 1.59A-2(d) and base erosion percentage under § 1.59A-2(e)(3).

(2) Example 2: Business interest expense subject to section 163(j) and the group's domestic related current year BIE and foreign related current year BIE for the year equals its section 163(j) limitation—(i) Facts. During the current year (Year 1), P incurred $150x of business interest expense to domestic related parties; S1 incurred $150x of business interest expense to foreign related parties; and S2 incurred $150x of business interest expense to unrelated parties. The group's section 163(j) limitation for the year is $300x. After applying the rules in § 1.163(j)-5(b)(3), the group deducts $150x of P's Year 1 business interest expense, and $75x each of S1 and S2's Year 1 business interest expense. Assume the group is an applicable taxpayer for purposes of section 59A.

(ii) Analysis—(A) Application of the absorption rule in paragraph (c)(2) of this section. Following the rules in section 163(j), the group's section 163(j) interest deduction for Year 1 is $300x, and the entire amount is from members' Year 1 business interest expense.

(B) Application of the classification rule in paragraph (c)(3) of this section. Under paragraph (c)(3) of this section, the group's aggregate current year BIE deduction of $300x is first classified as payments or accruals to related parties (pro-rata among domestic related parties and foreign related parties), and second as payments or accruals to unrelated parties. For Year 1, the group has $150x of domestic related current year BIE and $150x of foreign related current year BIE, and the group's aggregate current year BIE deduction will be classified equally among the related party expenses. Therefore, $150x of the group's deduction is classified as domestic related current year BIE deduction and $150x is classified as a foreign related current year BIE deduction.

(C) Application of the allocation rule in paragraph (c)(4) of this section. After the application of the classification rule in paragraph (c)(3) of this section, the group has $150x each of domestic related current year BIE deduction and foreign related current year BIE deduction from the group's aggregate current year BIE in Year 1. The domestic related current year BIE deduction and foreign related current year BIE deduction will be allocated to P, S1, and S2 based on each member's deduction of its Year 1 business interest expense.

(1) Allocations to P. The percentage of current year BIE deduction attributable to P is 50% (P's deduction of its Year 1 current year BIE, $150x, divided by the group's aggregate current year BIE deduction for Year 1, $300x). Thus, the amount of domestic related current year BIE deduction status allocated to P is $75x (the group's domestic related current year BIE deduction, $150x, multiplied by the percentage of current year BIE deduction allocable to P, 50%); and the amount of foreign related current year BIE deduction status allocated to P is $75x (the group's foreign related current year BIE deduction, $150x, multiplied by the percentage of current year BIE deduction allocable to P, 50%).

(2) Allocations to S1 and S2. The percentage of current year BIE deduction attributable to S1 is 25% (S1's deduction of its Year 1 current year BIE, $75x, divided by the group's aggregate current year BIE deduction for Year 1, $300x). Thus, the amount of domestic related current year BIE deduction status allocated to S1 is $37.5x (the group's domestic related current year BIE deduction, $150x, multiplied by the percentage of current year BIE deduction allocable to S1, 25%); and the amount of foreign related current year BIE deduction status allocated to S1 is $37.5x (the group's foreign related current year BIE deduction, $150x, multiplied by the percentage of current year BIE deduction allocable to S1, 25%). Because S2 also deducted $75 of its Year 1 current year BIE, S2's deductions are allocated the same pro-rata status as those of S1 under this paragraph (f)(2)(ii)(C)(2).

(D) Application of the allocation rule in paragraph (c)(5) of this section. Although the group will have disallowed BIE carryforwards after Year 1 (the group's aggregate current year BIE of $450x ($150x + $150x + $150x) exceeds the section 163(j) limitation of $300x), all of the domestic related current year BIE and foreign related current year BIE in Year 1 has been taken into account pursuant to the classification rule in paragraph (c)(3) of this section. Thus, under paragraph (c)(5)(iv) of this section, each member's disallowed BIE carryforward is treated as from payments or accruals to unrelated parties.

(3) Example 3: Business interest expense subject to section 163(j)—(i) The group's domestic related current year BIE and foreign related current year BIE for the year exceeds its section 163(j) limitation. (A) Facts. During the current year (Year 1), P incurred $60x of business interest expense to domestic related parties; S1 incurred $40x of business interest expense to foreign related parties; and S2 incurred $80x of business interest expense to unrelated parties. The group's section 163(j) limitation for the year is $60x. After applying the rules in § 1.163(j)-5(b)(3), the group deducts $20x each of P, S1, and S2's current year business interest expense. Assume the group is an applicable taxpayer for purposes of section 59A.

(B) Analysis—(1) Application of the absorption rule in paragraph (c)(2) of this section. Following the rules in section 163(j), the group's section 163(j) interest deduction is $60x, and the entire amount is from members' Year 1 business interest expense.

(2) Application of the classification rule in paragraph (c)(3) of this section. Under paragraph (c)(3) of this section, the group's $60x of aggregate current year BIE deduction is first classified as payments or accruals to related parties (pro-rata among domestic related parties and foreign related parties), and second as payments or accruals from unrelated parties. The group's total related party interest expense in Year 1, $100x (sum of the group's Year 1 domestic related current year BIE, $60x, and the group's Year 1 foreign related current year BIE, $40x), exceeds the group's aggregate current year BIE deduction of $60x. Thus, the group's aggregate current year BIE deduction will be classified, pro-rata, as from payments or accruals to domestic related parties and foreign related parties. Of the group's aggregate current year BIE deduction in Year 1, $36x is classified as a domestic related current year BIE deduction (the group's aggregate current year BIE deduction, $60x, multiplied by the ratio of domestic related current year BIE over the group's total Year 1 related party interest expense ($60x/($60x + $40x))); and $24x of the group's aggregate current year BIE deduction is classified as a foreign related current year BIE deduction (the group's section 163(j) interest deduction, $60x, multiplied by the ratio of foreign related current year BIE over the group's total Year 1 related party interest expense ($40x/($60x + $40x))).

(3) Application of the allocation rule in paragraph (c)(4) of this section. After the application of the classification rule in paragraph (c)(3) of this section, the group has $36x of domestic related current year BIE deduction and $24x of foreign related current year BIE deduction from the group's aggregate current year BIE in Year 1. The domestic related current year BIE deduction and foreign related current year BIE deduction will be allocated to P, S1, and S2 based on each member's current year BIE deduction in Year 1.

(i) Allocation of the group's domestic related current year BIE deduction status. Because each member is deducting $20x of its Year 1 business interest expense, all three members have the same percentage of current year BIE deduction attributable to them. The percentage of current year BIE deduction attributable to each of P, S1, and S2 is 33.33% (each member's current year BIE deduction in Year 1, $20x, divided by the group's aggregate current year BIE deduction for Year 1, $60x). Thus, the amount of domestic related current year BIE deduction status allocable to each member is $12x (the group's domestic related current year BIE deduction, $36x, multiplied by the percentage of current year BIE deduction allocable to each member, 33.33%).

(ii) Allocations of the group's foreign related current year BIE deduction status. The amount of foreign related current year BIE deduction status allocable to each member is $8x (the group's foreign related current year BIE deduction, $24x, multiplied by the percentage of current year BIE deduction allocable to each member, 33.33%, as computed earlier in paragraph (f)(3) of this section (Example 3).

(4) Application of the allocation rule in paragraph (c)(5) of this section. In Year 1 the group has $60x of domestic related current year BIE, of which $36x is deducted in the year (by operation of the classification rule). Therefore, the group has $24x of domestic related BIE carryforward. Similarly, the group has $40x of foreign related current year BIE in Year 1, of which $24x is deducted in the year. Therefore, the group has $16x of foreign related BIE carryforward. The $24x domestic related BIE carryforward status and $16x foreign related BIE carryforward status will be allocated to P, S1, and S2 in proportion to the amount of each member's disallowed BIE carryforward.

(i) Allocation to P. The percentage of disallowed BIE carryforward allocable to P is 33.33% (P's Year 1 disallowed BIE carryforward, $40x ($60x − $20x), divided by the group's Year 1 disallowed BIE carryforward, $120x ($60x + $40x + 80x − $60x)). Thus, the amount of domestic related BIE carryforward status allocated to P is $8x (the group's domestic related BIE carryforward, $24x, multiplied by the percentage of disallowed BIE carryforward allocable to P, 33.33%); and the amount of foreign related BIE carryforward status allocated to P is $5.33x (the group's foreign related BIE carryforward, $16x, multiplied by the percentage of disallowed BIE carryforward allocable to P, 33.33%). Under paragraph (c)(5)(iv) of this section, P's disallowed BIE carryforward that has not been allocated a status as either a domestic related BIE carryforward or a foreign related BIE carryforward will be treated as interest paid or accrued to an unrelated party. Therefore, $26.67x ($40x P's disallowed BIE carryforward −$8x domestic related BIE carryforward status allocated to P −$5.33x foreign related BIE carryforward status allocated to P) is treated as interest paid or accrued to an unrelated party.

(ii) Allocation to S1. The percentage of disallowed BIE carryforward allocable to S1 is 16.67% (S1's Year 1 disallowed BIE carryforward, $20x ($40x − $20x), divided by the group's Year 1 disallowed BIE carryforward, $120x ($60x + $40x + 80x − $60x). Thus, the amount of domestic related BIE carryforward status allocated to S1 is $4x (the group's domestic related BIE carryforward, $24x, multiplied by the percentage of disallowed BIE carryforward allocable to S1, 16.67%); and the amount of foreign related BIE carryforward status allocated to S1 is $2.67x (the group's foreign related BIE carryforward, $16x, multiplied by the percentage of disallowed BIE carryforward allocable to S1, 16.67%). Under paragraph (c)(5)(iv) of this section, S1's disallowed BIE that has not been allocated a status as either a domestic related BIE carryforward or a foreign related BIE carryforward will be treated as interest paid or accrued to an unrelated party. Therefore, $13.33x ($20x S1's disallowed BIE carryforward −$4x domestic related BIE carryforward status allocated to S1 − $2.67x foreign related BIE carryforward status allocated to S1) is treated as interest paid or accrued to an unrelated party.

(iii) Allocation to S2. The percentage of disallowed BIE carryforward allocable to S2 is 50% (S2's Year 1 disallowed BIE carryforward, $60x ($80x − $20x), divided by the group's Year 1 disallowed BIE carryforward, $120x ($60x + $40x + 80x − $60x). Thus, the amount of domestic related BIE carryforward status allocated to S2 is $12x (the group's domestic related BIE carryforward, $24x, multiplied by the percentage of disallowed BIE carryforward allocable to S2, 50%); and the amount of foreign related BIE carryforward status allocated to S2 is $8x (the group's foreign related BIE carryforward, $16x, multiplied by the percentage of disallowed BIE carryforward allocable to S2, 50%). Under paragraph (c)(5)(iv) of this section, S2's disallowed BIE that has not been allocated a status as either a domestic related BIE carryforward or a foreign related BIE carryforward will be treated as interest paid or accrued to an unrelated party. Therefore, $40x ($60x S2's disallowed BIE carryforward −$12x domestic related BIE carryforward status allocated to S2 − $8x foreign related BIE carryforward status allocated to S2) is treated as interest paid or accrued to an unrelated party.

(ii) The group deducting its disallowed BIE carryforwards—(A) Facts. The facts are the same as in paragraph (g)(3)(i)(A) of this section (the facts in Example 3(i)), and in addition, none of the members incurs any business interest expense in Year 2. The group's section 163(j) limitation for Year 2 is $30x.

(B) Analysis—(1) Application of the absorption rule in paragraph (c)(2) of this section. Following the rules in section 163(j), each member of the group is deducting $10x of its disallowed BIE carryforward from Year 1. Therefore, the group's section 163(j) deduction for Year 2 is $30x.

(2) Application of the classification rule in paragraph (c)(3) of this section. Under paragraph (c)(3)(iv) of this section, to the extent members are deducting their Year 1 disallowed BIE carryforward in Year 2, the classification rule will apply to the deduction in Year 2 after the allocation rule in paragraph (c)(5) of this section has allocated the related and unrelated party status to the member's disallowed BIE carryforward in Year 1. The allocation required under paragraph (c)(5) of this section is described in paragraph (f)(3)(i)(B)(4) of this section.

(i) Use of P's allocated domestic related BIE carryforward status and foreign related BIE carryforward status. P has $40x of Year 1 disallowed BIE carryforward, and P was allocated $8x of domestic related BIE carryforward status and $5.33x of foreign related BIE carryforward status. In Year 2, P deducts $10x of its Year 1 disallowed BIE carryforward. Under the classification rule of paragraph (c)(3) of this section, P is treated as deducting pro-rata from its allocated status of domestic related BIE carryforward and foreign related BIE carryforward. Therefore, P is treated as deducting $6x of its allocated domestic related BIE carryforward ($10x × $8x/($8x + $5.33x)), and $4x of its allocated foreign related BIE carryforward ($10x × $5.33x/$8x + $5.33x)). After Year 2, P has remaining $30x of Year 1 disallowed BIE carryforward, of which $2x has a status of domestic related BIE carryforward, $1.33x has the status of foreign related BIE carryforward, and $26.67x of interest treated as paid or accrued to unrelated parties.

(ii) Use of S1's allocated domestic related BIE carryforward status and foreign related BIE carryforward status. S1 has $20x of Year 1 disallowed BIE carryforward, and S1 was allocated $4x of domestic related BIE carryforward status and $2.67x of foreign related BIE carryforward status. In Year 2, S2 deducts $10x of its Year 1 disallowed BIE carryforward. Because S2's deduction of its Year 1 disallowed BIE carryforward, $10x, exceeds its allocated domestic related BIE carryforward status ($4x) and foreign related BIE carryforward status ($2.67x), all of the allocated related party status are used up. After Year 2, all of S1's Year 1 disallowed BIE carryforward, $10x, is treated as interest paid or accrued to an unrelated party.

(iii) Use of S2's allocated domestic related BIE carryforward status and foreign related BIE carryforward status. S2 has $60x of Year 1 disallowed BIE carryforward, and S2 was allocated $12x of domestic related BIE carryforward status and $8x of foreign related BIE carryforward status. In Year 2, S2 deducts $10x of its Year 1 disallowed BIE carryforward. Under the classification rule of paragraph (c)(3) of this section, S2 is treated as deducting $6x of its allocated domestic related BIE carryforward ($10x × $12x/($12x + $8x)), and $4x of its allocated foreign related BIE carryforward ($10x × $8x/$8x + $12x)). After Year 2, P has remaining $50x of Year 1 disallowed BIE carryforward, of which $6x has a status of domestic related BIE carryforward, $4x has the status of foreign related BIE carryforward, and $40x of interest treated as paid or accrued to unrelated parties.

(h) Applicability date. This section applies to taxable years for which the original consolidated Federal income tax return is due (without extensions) after December 6, 2019.

[T.D. 9885, 84 FR 67039, Dec. 6, 2019; 85 FR 49595, Aug. 14, 2020, as amended by T.D 9910, 85 FR 64369, Oct. 9, 2020]

§ 1.1502-68 Additional first year depreciation deduction for property acquired and placed in service after September 27, 2017.

(a) In general—(1) Overview. This section provides rules governing the availability of the additional first year depreciation deduction allowable under section 168(k) for qualified property that is acquired and placed in service after September 27, 2017, by a member of a consolidated group. Except as otherwise provided in paragraph (c) of this section, the rules in § 1.168(k)-2 apply to members of a consolidated group in addition to the rules in this section. Paragraph (a)(2) of this section provides definitions of terms used in this section. Paragraph (b) of this section provides rules addressing the application of § 1.168(k)-2(b)(3)(iii)(A)(1) (requiring that a taxpayer claiming the additional first year depreciation deduction for used property not previously have used the property) to members of a consolidated group. Paragraph (c) of this section provides rules addressing certain transfers of eligible property (as defined in paragraph (a)(2)(vii) of this section) between members of a consolidated group if the transferee member (as defined in paragraph (a)(2)(xii) of this section) leaves the group pursuant to the same series of related transactions. Paragraph (d) of this section provides examples illustrating the application of the rules of this section. Paragraph (e) of this section provides the applicability dates.

(2) Definitions. The following definitions apply for purposes of this section.

(i) Consolidated Asset Acquisition Rule. The term Consolidated Asset Acquisition Rule refers to the rule set forth in paragraph (c)(1)(i) of this section addressing certain intercompany transfers of eligible property.

(ii) Consolidated Deemed Acquisition Rule. The term Consolidated Deemed Acquisition Rule refers to the rule set forth in paragraph (c)(2)(i) of this section addressing certain intercompany transfers of the stock of target (as defined in paragraph (a)(2)(xi) of this section).

(iii) Deconsolidation date. The term deconsolidation date means the date on which a transferee member ceases to be a member of a consolidated group.

(iv) Designated transaction. The term designated transaction has the meaning provided in paragraph (c)(4)(i) of this section.

(v) Deemed replacement property. The term deemed replacement property means used property that is identical to (but is separate and distinct from) the eligible property that the transferee member or target is deemed to sell to an unrelated party under the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule. For all Federal income tax purposes, the deemed purchase of deemed replacement property by the transferee member or target under paragraph (c)(1)(i)(B) or (c)(2)(i)(B) of this section, respectively, does not result in the basis in such property being determined, in whole or in part, by reference to the basis of other property held at any time by the transferee member or target. See section 179(d)(3) and § 1.168(k)-2(b)(3)(iii)(A)(3).

(vi) Deemed sale amount. The term deemed sale amount means an amount equal to the transferee member's or the target's adjusted basis in the eligible property immediately before the transferee member or target is deemed to sell the property to an unrelated party under the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule.

(vii) Eligible property. The term eligible property means depreciable property (as defined in § 1.168(b)-1(a)(1)) that meets the requirements in § 1.168(k)-2(b)(2), determined without regard to § 1.168(k)-2(b)(2)(ii)(C) (property subject to an election not to claim the additional first year depreciation for a class of property) except on the day after the deconsolidation date.

(viii) Group Prior Use Rule. The term Group Prior Use Rule refers to the rule set forth in paragraph (b)(1) of this section addressing when a member of a consolidated group is attributed another member's depreciable interest in property.

(ix) Lookback Period. The term lookback period means, with respect to a member of a consolidated group, the period that includes the five calendar years immediately prior to the current calendar year in which the property is placed in service by such member, as well as the portion of such current calendar year before the date on which the member placed the property in service (without taking into account the applicable convention).

(x) Stock and Asset Acquisition Rule. The term Stock and Asset Acquisition Rule refers to the rule set forth in paragraph (b)(2) of this section addressing when a member of a consolidated group is attributed a new member's depreciable interest in property.

(xi) Target. The term target means the member whose stock is transferred in a transaction that is subject to the Consolidated Deemed Acquisition Rule.

(xii) Transferee member. The term transferee member means the member that acquires eligible property or target stock, respectively, in a transaction that is subject to the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule.

(xiii) Transferor member. The term transferor member means the member that transfers eligible property or target stock, respectively, in a transaction that is subject to the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule.

(b) Acquisitions of depreciable property by a member of a consolidated group—(1) General rule (Group Prior Use Rule). Solely for purposes of applying § 1.168(k)-2(b)(3)(iii)(A)(1), if a member of a consolidated group acquires depreciable property in which the group had a depreciable interest at any time within the lookback period, the member is treated as having a depreciable interest in the property prior to the acquisition. For purposes of this paragraph (b)(1), a consolidated group is treated as having a depreciable interest in property during the time any current or previous member of the group had a depreciable interest in the property while a member of the group. For special rules that apply when a member of a consolidated group acquires depreciable property in an intercompany transaction (as defined in § 1.1502-13(b)(1)(i)) and then leaves the group pursuant to the same series of related transactions, see paragraph (c) of this section.

(2) Certain acquisitions pursuant to a series of related transactions (Stock and Asset Acquisition Rule). Solely for purposes of applying § 1.168(k)-2(b)(3)(iii)(A)(1), if a series of related transactions includes one or more transactions in which property is acquired by a member of a consolidated group, and one or more transactions in which a corporation that had a depreciable interest in the property (determined without regard to the application of the Group Prior Use Rule) within the lookback period becomes a member of the group, then the member that acquires the property is treated as having a depreciable interest in the property prior to the acquisition.

(c) Certain intercompany transfers of eligible property followed by deconsolidation—(1) Acquisition of eligible property by a member that leaves the group—(i) General rule (Consolidated Asset Acquisition Rule). This paragraph (c)(1) applies to certain transactions pursuant to which one member of a consolidated group (transferee member) acquires from another member of the same consolidated group (transferor member) eligible property. Except as otherwise provided in paragraph (c)(3) or (4) of this section, if a transaction satisfies the requirements of paragraph (c)(1)(ii) of this section, then § 1.168(k)-2(b)(3)(iii)(C) (providing special rules when depreciable property is acquired as part of a series of related transactions) does not apply to the transaction, and for all Federal income tax purposes—

(A) The transferee member is treated as selling the eligible property to an unrelated person on the day after the deconsolidation date in exchange for an amount of cash equal to the deemed sale amount; and

(B) Immediately after the deemed sale in paragraph (c)(1)(i)(A) of this section, the transferee member is treated as purchasing deemed replacement property from an unrelated person for an amount of cash equal to the deemed sale amount.

(ii) Requirements. A transaction satisfies the requirements of this paragraph (c)(1)(ii) if—

(A) The transferee member's acquisition of the eligible property meets the requirements of § 1.168(k)-2(b)(3)(iii)(A) without regard to section 179(d)(2)(A) or (B) and § 1.179-4(c)(1)(ii) or (iii) or the Group Prior Use Rule;

(B) As part of the same series of related transactions that includes the acquisition, the transferee member ceases to be a member of the consolidated group and ceases to be related, within the meaning of section 179(d)(2)(A) or (B) and § 1.179-4(c)(1)(ii) or (iii), to the transferor member; and

(C) The acquired eligible property continues to be eligible property on the deconsolidation date and the day after the deconsolidation date.

(2) Deemed acquisition of eligible property pursuant to an election under section 338 or 336(e) by a member that leaves the group—(i) General rule (Consolidated Deemed Acquisition Rule). This paragraph (c)(2) applies to certain transactions pursuant to which a transferee member acquires from a transferor member the stock of another member of the same consolidated group that holds eligible property (target) in either a qualified stock purchase for which a section 338 election is made or a qualified stock disposition described in § 1.336-2(b)(1) for which a section 336(e) election is made. Except as otherwise provided in paragraph (c)(3) or (4) of this section, if a transaction satisfies the requirements of paragraph (c)(2)(ii) of this section, then § 1.168(k)-2(b)(3)(iii)(C) does not apply to the transaction, and for all Federal income tax purposes—

(A) The target is treated as selling the eligible property to an unrelated person on the day after the deconsolidation date in exchange for an amount of cash equal to the deemed sale amount; and

(B) Immediately after the deemed sale in paragraph (c)(2)(i)(A) of this section, the target is treated as purchasing deemed replacement property from an unrelated person for an amount of cash equal to the deemed sale amount.

(ii) Requirements. A transaction satisfies the requirements of this paragraph (c)(2)(ii) if:

(A) The target's acquisition of the eligible property meets the requirements of § 1.168(k)-2(b)(3)(iii)(A) without regard to the Group Prior Use Rule;

(B) As part of the same series of related transactions that includes the qualified stock purchase or qualified stock disposition, the transferee member and the target cease to be members of the transferor member's consolidated group and cease to be related, within the meaning of section 179(d)(2)(A) or (B) and § 1.179-4(c)(1)(ii) or (iii), to the transferor member; and

(C) The target's eligible property on the acquisition date (within the meaning of § 1.338-2(c)(1)) or the disposition date (within the meaning of § 1.336-1(b)(8)) continues to be eligible property on the deconsolidation date and the day after the deconsolidation date.

(3) Disposition of depreciable property pursuant to the same series of related transactions. Paragraph (c)(1) of this section does not apply if, following the acquisition of eligible property, the transferee member disposes of such property pursuant to the same series of related transactions that includes the property acquisition. Paragraph (c)(2) of this section does not apply if, following the deemed acquisition of eligible property, the target disposes of such property pursuant to the same series of related transactions that includes the qualified stock purchase or qualified stock disposition. See § 1.168(k)-2(b)(3)(iii)(C) for rules regarding the transfer of property in a series of related transactions. See also § 1.168(k)-2(g)(1) for rules regarding property placed in service and disposed of in the same taxable year. For purposes of this paragraph (c)(3), the deemed sale of eligible property by the transferee member or the target pursuant to paragraph (c)(1)(i)(A) or (c)(2)(i)(A) of this section is not treated as a “disposition” of such property.

(4) Election to not apply paragraph (c)(1)(i) or (c)(2)(i) of this section—(i) In general. If a transaction satisfies the requirements of the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule in paragraph (c)(1)(ii) or (c)(2)(ii) of this section, respectively, the transferee member or the target nonetheless may elect not to apply the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule, respectively, to all eligible property that is acquired or deemed acquired in such transaction. If a transferee member or target makes an election under this paragraph (c)(4) with respect to any transaction (designated transaction), then—

(A) The transferee member or target is deemed to have made such an election for all other transactions—

(1) That satisfy the requirements of the Consolidated Asset Acquisition Rule or the Consolidated Deemed Acquisition Rule;

(2) That are part of the same series of related transactions as the designated transaction; and

(3) In which the transferee member or target either is the same transferee member or target as in the designated transaction or is related, within the meaning of section 179(d)(2)(A) or (B) and § 1.179-4(c)(1)(ii) or (iii), to the transferee member or target in the designated transaction immediately after the end of the series of related transactions; and

(B) Any eligible property acquired or deemed acquired in the designated transaction and in any transactions described in paragraph (c)(4)(i)(A) of this section does not satisfy either the original use requirement or the used property acquisition requirements in § 1.168(k)-2(b)(3) and, thus, is not “qualified property” within the meaning of § 1.168(k)-2(b)(1).

(ii) Time and manner for making election—(A) Time to make election. An election under this paragraph (c)(4) must be made by the due date, including extensions, for the Federal tax return for the taxable year of the transferee member or target that begins on the day after the deconsolidation date.

(B) Manner of making election. A transferee member or target, as applicable, makes the election under this paragraph (c)(4) by attaching a statement to its return for the taxable year that begins on the day after the deconsolidation date. The statement must describe the transaction(s) to which the Consolidated Asset Acquisition Rule or Consolidated Deemed Acquisition Rule otherwise would apply and state that the transferee member or the target, as applicable, is not claiming the additional first year depreciation deduction for any eligible property transferred in such transaction(s). If, at the time the election is made, the transferee member or the target is a member of a consolidated group, the statement is made by the agent for the group (within the meaning of § 1.1502-77(a) and (c)) on behalf of the transferee member or the target and is attached to the consolidated return of the group for the taxable year of the group that includes the taxable year of the transferee member or target that begins on the day after the deconsolidation date.

(C) Additional procedural guidance. The IRS may publish procedural guidance in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter) that provides alternative procedures for complying with paragraph (c)(4)(ii)(A) or (B) of this section.

(iii) Revocation of election. An election specified in this paragraph (c)(4), once made, may be revoked only by filing a request for a private letter ruling and obtaining the Commissioner of Internal Revenue's written consent to revoke the election. The Commissioner may grant a request to revoke the election if the taxpayer acted reasonably and in good faith, and the revocation will not prejudice the interests of the Government. See generally § 301.9100-3 of this chapter. An election specified in this paragraph (c)(4) may not be revoked through a request under section 446(e) to change the taxpayer's method of accounting.

(d) Examples. For purposes of the examples in this section, unless otherwise stated: Parent, S, B, Controlled, and T are members of a consolidated group of which Parent is the common parent (Parent group); Parent owns all of the only class of stock of each of S, B, Controlled, and T; X is the common parent of the X consolidated group (X group); no member of the X group is related, within the meaning of section 179(d)(2)(A) or (B) and § 1.179-4(c)(1)(ii) or (iii) (Related), to any member of the Parent group; G and U are corporations that are not Related to each other or to any member of the Parent group or the X group; the Equipment in each example is eligible property; no member of the Parent group or the X group has had a depreciable interest in the Equipment within the lookback period; § 1.168(k)-2(b)(3)(iii)(A)(1) is referred to as the No Prior Use Requirement; and § 1.168(k)-2(b)(3)(iii)(A)(2) is referred to as the Unrelated Party Requirement. The rules of this section are illustrated by the following examples.

(1) Example 1: Intercompany sale of eligible property—(i) Facts. S has a depreciable interest in Equipment #1. In 2018, S sells Equipment #1 to B, and B places Equipment #1 in service in the same year.

(ii) Analysis. B's acquisition of Equipment #1 does not satisfy either the No Prior Use Requirement or the Unrelated Party Requirement. Under the Group Prior Use Rule, B is treated as previously having a depreciable interest in Equipment #1 because B (a member of the Parent group) acquired Equipment #1 and S, while a member of the Parent group, had a depreciable interest in Equipment #1 within the lookback period. In addition, B acquires Equipment #1 from S, and B and S are Related at the time of the acquisition. Accordingly, B is not eligible to claim the additional first year depreciation deduction for Equipment #1 in 2018.

(2) Example 2: Sale outside of the consolidated group followed by a reacquisition within the lookback period—(i) Facts. S has a depreciable interest in Equipment #2. In 2018, S sells Equipment #2 to G. In 2019, in an unrelated transaction, B acquires Equipment #2 from G and places it in service in the same year.

(ii) Analysis. B's acquisition of Equipment #2 does not satisfy the No Prior Use Requirement as a result of the Group Prior Use Rule. Pursuant to the Group Prior Use Rule, B is treated as previously having a depreciable interest in Equipment #2 because B is a member of the Parent group and S, while a member of the Parent group, had a depreciable interest in Equipment #2 within the lookback period. Thus, B is not eligible to claim the additional first year depreciation deduction for Equipment #2 in 2019. The result would be the same if, after selling Equipment #2 to G, S had ceased to be a member of the Parent group prior to B's acquisition of Equipment #2.

(iii) Sale outside of the consolidated group followed by a reacquisition beyond the lookback period. The facts are the same as in paragraph (d)(2)(i) of this section, except that B acquires Equipment #2 and places it in service in 2024 instead of 2019. B's acquisition of Equipment #2 satisfies the No Prior Use Requirement. B would not be treated as previously having a depreciable interest in Equipment #2 under the Group Prior Use Rule because the Parent group did not have a depreciable interest in Equipment #2 within the lookback period. Further, B itself did not have a prior depreciable interest in Equipment #2 within the lookback period. Assuming all other requirements in § 1.168(k)-2 are satisfied, B is eligible to claim the additional first year depreciation deduction for Equipment #2 in 2024. The result would be the same if S, rather than B, acquired and placed in service Equipment #2 in 2024.

(3) Example 3: Acquisition of eligible property by the consolidated group followed by a corporation with a prior depreciable interest joining the group as part of the same series of related transactions—(i) Facts. G has a depreciable interest in Equipment #3. During 2018, G sells Equipment #3 to U. In a series of related transactions that does not include the 2018 sale, Parent acquires all of the stock of G in 2019. Later in 2019, B purchases Equipment #3 from U and places it in service immediately thereafter.

(ii) Analysis. B's acquisition of Equipment #3 does not satisfy the No Prior Use Requirement as a result of the Stock and Asset Acquisition Rule. In a series of related transactions, G became a member of the Parent group and B acquired Equipment #3. Because G had a depreciable interest in Equipment #3 within the lookback period, B is treated as having a depreciable interest in Equipment #3 under the Stock and Asset Acquisition Rule. Thus, B is not eligible to claim the additional first year depreciation deduction for Equipment #3 in 2019.

(iii) B purchases Equipment #3 in 2024. The facts are the same as in paragraph (d)(3)(i) of this section, except that B acquires and places in service Equipment #3 in 2024 instead of 2019. B is not treated under the Stock and Asset Acquisition Rule as having a prior depreciable interest in Equipment #3 because G (which sold Equipment #3 to U in 2018) did not have a depreciable interest in Equipment #3 within the lookback period. In addition, B is not treated under the Group Prior Use Rule as having a prior depreciable interest in Equipment #3 at the time of the purchase because neither G nor any other member of the Parent group had a depreciable interest in Equipment #3 while a member of the Parent group within the lookback period. Further, B itself did not have a depreciable interest in Equipment #3 within the lookback period. Accordingly, B's acquisition of Equipment #3 satisfies the No Prior Use Requirement. Assuming all other requirements in § 1.168(k)-2 are satisfied, B is eligible to claim the additional first year depreciation deduction for Equipment #3 in 2024.

(iv) No series of related transactions. The facts are the same as in paragraph (d)(3)(i) of this section, except that Parent's acquisition of the G stock and B's purchase of Equipment #3 are not part of the same series of related transactions. Because B's purchase of Equipment #3 and Parent's acquisition of the G stock did not occur pursuant to the same series of related transactions, the Stock and Asset Acquisition Rule does not apply. In addition, B is not treated under the Group Prior Use Rule as having a prior depreciable interest in Equipment #3 at the time of the purchase because neither G nor any other member of the Parent group had a depreciable interest in Equipment #3 while a member of the Parent group within the lookback period. Further, B itself did not have a depreciable interest in Equipment #3 within the lookback period. Accordingly, B's acquisition of Equipment #3 satisfies the No Prior Use Requirement. Assuming all other requirements in § 1.168(k)-2 are satisfied, B is eligible to claim the additional first year depreciation deduction for Equipment #3 in 2019.

(4) Example 4: Termination of the consolidated group—(i) Facts. S owns Equipment #4. In 2018, S sells Equipment #4 to U. In 2019, X acquires all of the stock of Parent in a transaction that causes the Parent group to terminate and Parent, B, and S to become members of the X group. In 2020, in a transaction that is not part of a series of related transactions, B purchases Equipment #4 from U and places it in service in the same year.

(ii) Analysis. B's acquisition of Equipment #4 satisfies the No Prior Use Requirement. The Group Prior Use Rule does not apply to treat B as having a prior depreciable interest in Equipment #4 because B is a member of the X group and no member of the X group had a depreciable interest in Equipment #4 while a member of the X group within the lookback period. Further, B itself did not have a prior depreciable interest in Equipment #4 within the lookback period. Assuming all other requirements in § 1.168(k)-2 are satisfied, B is eligible to claim the additional first year depreciation deduction for Equipment #4 in 2020.

(iii) S purchases Equipment #4 in 2020. The facts are the same as in paragraph (d)(4)(i) of this section, except that S rather than B purchases and places in service Equipment #4 in 2020. S's purchase of Equipment #4 does not satisfy the No Prior Use Requirement because S had a depreciable interest in Equipment #4 within the lookback period. Thus, S is not eligible to claim the additional first year depreciation deduction for Equipment #4 in 2020.

(iv) Acquisitions are part of the same series of related transactions. The facts are the same as in paragraph (d)(4)(i) of this section, except that X's acquisition of the Parent stock and B's purchase of Equipment #4 are part of the same series of related transactions. Thus, pursuant to the same series of related transactions, S became a member of the X group and B (another member of the X group) acquired Equipment #4. Because S had a depreciable interest in Equipment #4 within the lookback period, B is treated as having a depreciable interest in Equipment #4 under the Stock and Asset Acquisition Rule. As a result, B's acquisition of Equipment #4 does not satisfy the No Prior Use Requirement, and B is not eligible to claim the additional first year depreciation deduction for Equipment #4 in 2020.

(5) Example 5: Intercompany sale of eligible property followed by sale of B stock as part of the same series of related transactions—(i) Facts. S has a depreciable interest in Equipment #5. On January 1, 2019, B purchases Equipment #5 from S and places it in service. On June 1, 2019, as part of the same series of related transactions that includes B's purchase of Equipment #5, Parent sells all of the stock of B to X. Thus, B leaves the Parent group at the end of the day on June 1, 2019, and B is a member of the X group starting June 2, 2019. See § 1.1502-76(b). As of June 1, 2019, Equipment #5 remains eligible property.

(ii) Analysis—(A) Application of the Consolidated Asset Acquisition Rule. B was a member of the Parent group when it acquired Equipment #5. Because S, another member of the Parent group, had a depreciable interest in Equipment #5 while a member of the group within the lookback period, B would be treated as having a prior depreciable interest in Equipment #5 under the Group Prior Use Rule and B's acquisition of Equipment #5 would not satisfy the No Prior Use Requirement. However, B's acquisition of Equipment #5 satisfies the requirements of the Consolidated Asset Acquisition Rule in paragraph (c)(1)(ii) of this section. First, B's acquisition of Equipment #5 meets the requirements of § 1.168(k)-2(b)(3)(iii)(A) without regard to the related-party tests under section 179(d)(2)(A) or (B) and § 1.179-4(c)(1)(ii) or (iii) or the Group Prior Use Rule. Second, as part of the same series of related transactions that includes B's acquisition of Equipment #5, B ceases to be a member of the Parent group and ceases to be Related to S. Third, Equipment #5 continues to be eligible property on the deconsolidation date (June 1, 2019).

(B) Consequences of the Consolidated Asset Acquisition Rule. Under the Consolidated Asset Acquisition Rule, B is treated for all Federal income tax purposes as transferring Equipment #5 to an unrelated person on June 2, 2019, in exchange for an amount of cash equal to the deemed sale amount and, immediately thereafter, acquiring deemed replacement property (New Equipment #5) from an unrelated person for an amount of cash equal to the deemed sale amount. Accordingly, assuming all other requirements in § 1.168(k)-2 are satisfied, B is eligible to claim the additional first year depreciation for an amount equal to the deemed sale amount for the taxable year in which it places New Equipment #5 in service.

(iii) Distribution of B. The facts are the same as in paragraph (d)(5)(i) of this section, except that, on June 1, 2019, Parent distributes the stock of B to its shareholders (which are not Related to S) in a distribution that qualifies for nonrecognition under section 355(a). Accordingly, the Consolidated Asset Acquisition Rule applies. As in paragraph (d)(5)(ii)(B) of this section, assuming all other requirements in § 1.168(k)-2 are satisfied, B is eligible to claim the additional first year depreciation deduction for an amount equal to the deemed sale amount for the taxable year in which it places New Equipment #5 in service.

(iv) Equipment #5 ceases to be eligible property. The facts are the same as in paragraph (d)(5)(i) of this section, except that, on June 1, 2019, Equipment #5 is no longer eligible property. The Consolidated Asset Acquisition Rule does not apply because B's acquisition of Equipment #5 fails to satisfy the requirement in paragraph (c)(1)(ii)(C) of this section that the acquired eligible property continue to be eligible property on the deconsolidation date. Therefore, B's acquisition of Equipment #5 on January 1, 2019, fails to satisfy the No Prior Use Requirement. Under the Group Prior Use Rule, B is treated as having a prior depreciable interest in Equipment #5 because B is a member of the Parent group and S, while a member of the Parent group, had a depreciable interest in Equipment #5 within the lookback period. Accordingly, B is not eligible to claim the additional first year depreciation deduction with respect to Equipment #5 in 2019.

(6) Example 6: Intercompany sale of member stock for which a section 338(h)(10) election is made followed by sale of B stock as part of a series of related transactions—(i) Facts. S owns all of the stock of T, which has a depreciable interest in Equipment #6. On January 1, 2019, B purchases all of the T stock from S in a qualified stock purchase for which a section 338(h)(10) election is made. On June 1, 2019, as part of the same series of related transactions that includes B's purchase of the T stock, Parent sells all of the stock of B to X. Thus, B and T leave the Parent group at the end of the day on June 1, 2019, and B and T are members of the X group starting June 2, 2019. See § 1.1502-76(b). As of June 1, 2019, Equipment #6 remains eligible property.

(ii) Analysis—(A) Section 338(h)(10) election. Pursuant to the section 338(h)(10) election, Old T is treated as transferring all of its assets, including Equipment #6, to an unrelated person in a single transaction in exchange for consideration at the close of the acquisition date (January 1, 2019), and New T is treated as acquiring all of its assets, including Equipment #6, from an unrelated person in exchange for consideration. Old T is deemed to liquidate following the deemed asset sale. See § 1.338-1(a)(1).

(B) Application of the Consolidated Deemed Acquisition Rule. New T was a member of the Parent group when New T acquired Equipment #6 from an unrelated person. Because Old T, another member of the Parent group, had a depreciable interest in Equipment #6 while a member of the group within the lookback period, New T would be treated as having a prior depreciable interest in Equipment #6 under the Group Prior Use Rule and New T's acquisition of Equipment #6 would not satisfy the No Prior Use Requirement. However, New T's acquisition of Equipment #6 satisfies the requirements of the Consolidated Deemed Acquisition Rule in paragraph (c)(2)(ii) of this section. First, New T's acquisition of Equipment #6 meets the requirements of § 1.168(k)-2(b)(3)(iii)(A) without regard to the Group Prior Use Rule. Second, as part of the same series of related transactions that includes B's qualified stock purchase of the T stock, B and New T cease to be members of the Parent group and cease to be Related to S. Third, Equipment #6 continues to be eligible property on the deconsolidation date (June 1, 2019).

(C) Consequences of the Consolidated Deemed Acquisition Rule. Under the Consolidated Deemed Acquisition Rule, New T is treated for all Federal income tax purposes as transferring Equipment #6 to an unrelated person on June 2, 2019, in exchange for an amount of cash equal to the deemed sale amount and, immediately thereafter, acquiring deemed replacement property (New Equipment #6) from an unrelated person for an amount of cash equal to the deemed sale amount. Accordingly, assuming all other requirements in § 1.168(k)-2 are satisfied, New T is eligible to claim the additional first year depreciation deduction for an amount equal to the deemed sale amount for the taxable year in which it places New Equipment #6 in service.

(iii) T owns multiple assets. The facts are the same as in paragraph (d)(6)(i) of this section, except that, in addition to Equipment #6, T also owns Asset A (depreciable real estate that is not eligible property). With respect to Equipment #6, the results are the same as in paragraph (d)(6)(ii) of this section. However, the Consolidated Deemed Acquisition Rule does not apply to Asset A because it is not eligible property. Accordingly, New T is not treated as transferring Asset A to an unrelated person on June 2, 2019 and then, immediately thereafter, acquiring deemed replacement property for Asset A. If Equipment #6 had ceased to be eligible property as of June 1, 2019, the Consolidated Deemed Acquisition Rule also would not apply to Equipment #6.

(7) Example 7: Section 355 transaction following a section 338(h)(10) transaction pursuant to the same series of related transactions—(i) Facts. T has a depreciable interest in Equipment #7. On January 1, 2019, Parent contributes all of the stock of T to B in exchange for common and non-voting preferred stock of B and sells the non-voting preferred stock of B to U pursuant to a binding commitment entered into prior to the contribution (T Exchange). The non-voting preferred stock is not treated as “stock” for purposes of section 1504(a). See section 1504(a)(4). Parent and B jointly make an election under section 338(h)(10) with respect to the T Exchange. On June 1, 2019, as part of the same series of related transactions that includes the T Exchange, Parent contributes the stock of B and assets comprising an active trade or business (within the meaning of section 355(b)) to Controlled in exchange for Controlled common stock and then distributes the Controlled common stock to Parent's shareholders in a distribution qualifying under section 355(a) (Controlled Distribution). In the Controlled Distribution, T and B cease to be Related to Parent. Equipment #7 remains eligible property on June 1, 2019.

(ii) Section 338(h)(10) election. Immediately after the Controlled Distribution, Parent and B are not related as determined under section 338(h)(3)(A)(iii). Further, B's basis in the T stock is not determined, in whole or in part, by reference to the adjusted basis of the T stock in the hands of Parent, and the stock is not acquired in an exchange to which section 351, 354, 355, or 356 applies. Accordingly, the T Exchange qualifies as a “purchase” within the meaning of section 338(h)(3). Pursuant to the section 338(h)(10) election, Old T is treated as transferring all of its assets, including Equipment #7, to an unrelated person in a single transaction in exchange for consideration at the close of the acquisition date (January 1, 2019), and New T is treated as acquiring all of its assets, including Equipment #7, from an unrelated person in exchange for consideration. Old T is deemed to liquidate following the deemed asset sale. See § 1.338-1(a)(1).

(iii) Application of the Consolidated Deemed Acquisition Rule. New T was a member of the Parent group when New T acquired Equipment #7 from an unrelated person. Because Old T, another member of the Parent group, had a depreciable interest in Equipment #7 while a member of the group within the lookback period, New T would be treated as having a prior depreciable interest in Equipment #7 under the Group Prior Use Rule and New T's acquisition of Equipment #7 would not satisfy the No Prior Use Requirement. However, New T's acquisition of Equipment #7 satisfies the requirements of the Consolidated Deemed Acquisition Rule in paragraph (c)(2)(ii) of this section. Thus, New T is treated for all Federal income tax purposes as transferring Equipment #7 to an unrelated person on June 2, 2019, in exchange for an amount of cash equal to the deemed sale amount and, immediately thereafter, acquiring deemed replacement property (New Equipment #7) from an unrelated person for an amount of cash equal to the deemed sale amount. Accordingly, assuming all other requirements in § 1.168(k)-2 are satisfied, New T is eligible to claim the additional first year depreciation deduction for an amount equal to the deemed sale amount for the taxable year in which it places New Equipment #7 in service.

(e) Applicability dates—(1) In general. Except as provided in paragraph (e)(2) of this section, this section applies to—

(i) Depreciable property acquired after September 27, 2017, by the taxpayer and placed in service by the taxpayer during or after the taxpayer's taxable year that begins on or after January 1, 2021;

(ii) A specified plant for which the taxpayer properly made an election to apply section 168(k)(5) and that is planted, or grafted to a plant that was previously planted, by the taxpayer during or after the taxpayer's taxable year that begins on or after January 1, 2021; and

(iii) Components acquired or self-constructed after September 27, 2017, of larger self-constructed property described in § 1.168(k)-2(c)(2) and placed in service by the taxpayer during or after the taxpayer's taxable year that begins on or after January 1, 2021.

(2) Early application of this section and § 1.168(k)-2—(i) In general. Subject to paragraphs (e)(2)(ii) and (iii) of this section, and provided that all members of a consolidated group consistently apply the same set of rules, a taxpayer may choose to apply both the rules of this section and the rules of § 1.168(k)-2, in their entirety and in a consistent manner, to—

(A) Depreciable property acquired after September 27, 2017, by the taxpayer and placed in service by the taxpayer during a taxable year ending on or after September 28, 2017;

(B) A specified plant for which the taxpayer properly made an election to apply section 168(k)(5) and that is planted, or grafted to a plant that was previously planted, after September 27, 2017, by the taxpayer during a taxable year ending on or after September 28, 2017; and

(C) Components acquired or self-constructed after September 27, 2017, of larger self-constructed property described in § 1.168(k)-2(c)(2) and placed in service by the taxpayer during a taxable year ending on or after September 28, 2017.

(ii) Early application to certain transactions. In the case of property described in paragraph (e)(2)(i) of this section that is acquired in a transaction that satisfies the requirements of paragraph (c)(1)(ii) or (c)(2)(ii) of this section, the taxpayer may apply the rules of this section and the rules of § 1.168(k)-2, in their entirety and in a consistent manner, to such property only if those rules are applied, in their entirety and in a consistent manner, by all parties to the transaction (including the transferor member, the transferee member, and the target, as applicable) and the consolidated groups of which they are members, for the taxable year(s) in which the transaction occurs and the taxable year(s) that includes the day after the deconsolidation date.

(iii) Bound by early application. Once a taxpayer applies the rules of this section and the rules of § 1.168(k)-2, in their entirety, for a taxable year, the taxpayer must continue to apply the rules of this section and the rules of § 1.168(k)-2, in their entirety, for the taxpayer's subsequent taxable years.

[T.D. 9916, 85 FR 71765, Nov. 10, 2020]

16 Administrative Provisions and Other Rules

§ 1.1502-75 Filing of consolidated returns.

(a) Privilege of filing consolidated returns—(1) Exercise of privilege for first consolidated return year. A group which did not file a consolidated return for the immediately preceding taxable year may file a consolidated return in lieu of separate returns for the taxable year, provided that each corporation which has been a member during any part of the taxable year for which the consolidated return is to be filed consents (in the manner provided in paragraph (b) of this section) to the regulations under section 1502. If a group wishes to exercise its privilege of filing a consolidated return, such consolidated return must be filed not later than the last day prescribed by law (including extensions of time) for the filing of the common parent's return. Such consolidated return may not be withdrawn after such last day (but the group may change the basis of its return at any time prior to such last day).

(2) Continued filing requirement. A group which filed (or was required to file) a consolidated return for the immediately preceding taxable year is required to file a consolidated return for the taxable year unless it has an election to discontinue filing consolidated returns under paragraph (c) of this section.

(b) How consent for first consolidated year exercised—(1) General rule. The consent of a corporation referred to in paragraph (a)(1) of this section is made by such corporation joining in the making of the consolidated return for such year. A corporation is deemed to have joined in the making of such return for such year if it files a Form 1122 (or successor form) in the manner specified in paragraph (h)(2) of this section.

(2) Consent under facts and circumstances—(i) In general. If a member of the group fails to file Form 1122 (or successor form), the Commissioner may under the facts and circumstances determine that such member has joined in the making of a consolidated return by such group. The following circumstances, among others, will be taken into account in making this determination—

(A) Whether or not the income and deductions of the member were included in the consolidated return;

(B) Whether or not a separate return was filed by the member for that taxable year; and

(ii) Treatment of member. If the Commissioner determines that the member described in paragraph (b)(1)(i) of this section has joined in the making of the consolidated return, such member is treated as if it had filed a Form 1122 (or successor form) for such year for purposes of paragraph (h)(2) of this section.

(3) Failure to consent due to mistake. If any member has failed to join in the making of a consolidated return under either paragraph (b)(1) or (2) of this section, then the tax liability of each member of the group is determined on the basis of separate returns unless the common parent corporation establishes to the satisfaction of the Commissioner that the failure of such member to join in the making of the consolidated return was due to a mistake of law or fact, or to inadvertence. In such case, such member is treated as if it had filed a Form 1122 (or successor form) for such year for purposes of paragraph (h)(2) of this section, and thus joined in the making of the consolidated return for such year.

(c) Election to discontinue filing consolidated returns—(1) Good cause—(i) In general. Notwithstanding that a consolidated return is required for a taxable year, the Commissioner, upon application by the common parent, may for good cause shown grant permission to a group to discontinue filing consolidated returns. Any such application must be made through a letter ruling request filed not later than the 90th day before the due date of the consolidated return for the taxable year (including extensions). In addition, if an amendment of the Code, or other law affecting the computation of tax liability, is enacted and the enactment is effective for a taxable year ending before or within 90 days after the date of enactment, then application for such a taxable year may be made not later than the 180th day after the date of enactment, and if the application is approved the permission to discontinue filing consolidated returns will apply to such taxable year notwithstanding that a consolidated return has already been filed for such year.

(ii) Substantial adverse change in law affecting tax liability. Ordinarily, the Commissioner will grant a group permission to discontinue filing consolidated returns if the net result of all amendments to the Code or regulations with effective dates commencing within the taxable year has a substantial adverse effect on the consolidated tax liability of the group for such year relative to what the aggregate tax liability would be if the members of the group filed separate returns for such year. Thus, for example, assume P and S filed a consolidated return for the calendar year 1966 and that the provisions of the Code have been amended by a bill which was enacted by Congress in 1966, but which is first effective for taxable years beginning on or after January 1, 1967. Assume further that P makes a timely application to discontinue filing consolidated returns. In order to determine whether the amendments have a substantial adverse effect on the consolidated tax liability for 1967, relative to what the aggregate tax liability would be if the members of the group filed separate returns for 1967, the difference between the tax liability of the group computed on a consolidated basis and taking into account the changes in the law effective for 1967 and the aggregate tax liability of the members of the group computed as if each such member filed separate returns for such year (also taking into account such changes) shall be compared with the difference between the tax liability of such group for 1967 computed on a consolidated basis without regard to the changes in the law effective in such year and the aggregate tax liability of the members of the group computed as if separate returns had been filed by such members for such year without regard to the changes in the law effective in such year.

(iii) Other factors. In addition, the Commissioner will take into account other factors in determining whether good cause exists for granting permission to discontinue filing consolidated returns beginning with the taxable year, including:

(a) Changes in law or circumstances, including changes which do not affect Federal income tax liability,

(b) Changes in law which are first effective in the taxable year and which result in a substantial reduction in the consolidated net operating loss (or consolidated unused investment credit) for such year relative to what the aggregate net operating losses (or investment credits) would be if the members of the group filed separate returns for such year, and

(c) Changes in the Code or regulations which are effective prior to the taxable year but which first have a substantial adverse effect on the filing of a consolidated return relative to the filing of separate returns by members of the group in such year.

(2) Discretion of Commissioner to grant blanket permission—(i)

(i) Permission to all groups. The Commissioner, in the Commissioner's discretion, may grant all groups permission to discontinue filing consolidated returns if any provision of the Code or regulations has been amended and such amendment is of the type which could have a substantial adverse effect on the filing of consolidated returns by substantially all groups, relative to the filing of separate returns. Ordinarily, the permission to discontinue applies with respect to the taxable year of each group which includes the effective date of such an amendment.

(ii) Permission to a class of groups. The Commissioner, in the Commissioner's discretion, may grant a particular class of groups permission to discontinue filing consolidated returns if any provision of the Code or regulations has been amended and such amendment is of the type which could have a substantial adverse effect on the filing of consolidated returns by substantially all such groups relative to the filing of separate returns. Ordinarily, the permission to discontinue applies with respect to the taxable year of each group within the class which includes the effective date of such an amendment.

(3) Time and manner for exercising election. If, under subparagraph (1) or (2) of this paragraph, a group has an election to discontinue filing consolidated returns for any taxable year and such group wishes to exercise such election, then the common parent must file a separate return for such year on or before the last day prescribed by law (including extensions of time) for the filing of the consolidated return for such year. See section 6081 (relating to extensions of time for filing returns).

(d) When a group remains in existence—(1) General rule. A group remains in existence for a tax year if the common parent remains as the common parent and at least one subsidiary that was affiliated with it at the end of the prior year remains affiliated with it at the beginning of the year, whether or not one or more corporations have ceased to be subsidiaries at any time after the group was formed. Thus, for example, assume that corporation P acquires the sole outstanding share of stock of S on January 1, year 1, and that P and S file a consolidated return for the year 1 calendar year. On May 1, year 2, P acquires the sole outstanding share of stock of S1 and, on July 1, year 2, P sells the S share. The group (consisting originally of P and S) remains in existence in year 2 because P remained the common parent and, S, a subsidiary that was affiliated with P at the end of year 1, remained affiliated with P at the beginning of year 2.

(2) Common parent no longer in existence—(i) Mere change in identity. For purposes of this paragraph, the common parent corporation shall remain as the common parent irrespective of a mere change in identity, form, or place of organization of such common parent corporation (see section 368(a)(1)(F)).

(ii) Transfer of assets to subsidiary. The group shall be considered as remaining in existence notwithstanding that the common parent is no longer in existence if the members of the affiliated group succeed to and become the owners of substantially all of the assets of such former parent and there remains one or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation and which was a member of the group prior to the date such former parent ceases to exist. For purposes of applying paragraph (f)(2)(i) of § 1.1502-1 to separate return years ending on or before the date on which the former parent ceases to exist, such former parent, and not the new common parent, shall be considered to be the corporation described in such paragraph.

(iii) Taxable years. If a transfer of assets described in subdivision (ii) of this subparagraph is an acquisition to which section 381(a) applies and if the group files a consolidated return for the taxable year in which the acquisition occurs, then for purposes of section 381:

(a) The former common parent shall not close its taxable year merely because of the acquisition, and all taxable years of such former parent ending on or before the date of acquisition shall be treated as taxable years of the acquiring corporation, and

(b) The corporation acquiring the assets shall close its taxable year as of the date of acquisition, and all taxable years of such corporation ending on or before the date of acquisition shall be treated as taxable years of the transferor corporation.

(iv) Exception. With respect to acquisitions occurring before January 1, 1971, subdivision (iii) of this subparagraph shall not apply if the group, in its income tax return, treats the taxable year of the former common parent as having closed as of the date of acquisition.

(3) Reverse acquisitions—(i) In general. If a corporation (hereinafter referred to as the “first corporation”) or any member of a group of which the first corporation is the common parent acquires after October 1, 1965:

(a) Stock of another corporation (hereinafter referred to as the second corporation), and as a result the second corporation becomes (or would become but for the application of this subparagraph) a member of a group of which the first corporation is the common parent, or

(b) Substantially all the assets of the second corporation,

in exchange (in whole or in part) for stock of the first corporation, and the stockholders (immediately before the acquisition) of the second corporation, as a result of owning stock of the second corporation, own (immediately after the acquisition) more than 50 percent of the fair market value of the outstanding stock of the first corporation, then any group of which the first corporation was the common parent immediately before the acquisition shall cease to exist as of the date of acquisition, and any group of which the second corporation was the common parent immediately before the acquisition shall be treated as remaining in existence (with the first corporation becoming the common parent of the group). Thus, assume that corporations P and S comprised group PS (P being the common parent), that P was merged into corporation T (the common parent of a group composed of T and corporation U), and that the shareholders of P immediately before the merger, as a result of owning stock in P, own 90 percent of the fair market value of T's stock immediately after the merger. The group of which P was the common parent is treated as continuing in existence with T and U being added as members of the group, and T taking the place of P as the common parent.

For purposes of determining under (a) of this subdivision whether the second corporation becomes (or would become) a member of the group of which the first corporation is the common parent, and for purposes of determining whether the former stockholders of the second corporation own more than 50 percent of the outstanding stock of the first corporation, there shall be taken into account any acquisitions or redemptions of the stock of either corporation which are pursuant to a plan of acquisition described in (a) or (b) of this subdivision.

(ii) Prior ownership of stock. For purposes of subdivision (i) of this subparagraph, if the first corporation, and any members of a group of which the first corporation is the common parent, have continuously owned for a period of at least 5 years ending on the date of the acquisition an aggregate of at least 25 percent of the fair market value of the outstanding stock of the second corporation, then the first corporation (and any subsidiary which owns stock of the second corporation immediately before the acquisition) shall, as a result of owning such stock, be treated as owning (immediately after the acquisition) a percentage of the fair market value of the first corporation's outstanding stock which bears the same ratio to (a) the percentage of the fair market value of all the stock of the second corporation owned immediately before the acquisition by the first corporation and its subsidiaries as (b) the fair market value of the total outstanding stock of the second corporation immediately before the acquisition bears to (c) the sum of (1) the fair market value, immediately before the acquisition, of the total outstanding stock of the first corporation, and (2) the fair market value, immediately before the acquisition, of the total outstanding stock of the second corporation (other than any such stock owned by the first corporation and any of its subsidiaries). For example, assume that corporation P owns stock in corporation T having a fair market value of $100,000, that P acquires the remaining stock of T from individuals in exchange for stock of P, that immediately before the acquisition the total outstanding stock of T had a fair market value of $150,000, and that immediately before the acquisition the total outstanding stock of P had a fair market value of $200,000. Assuming P owned at least 25 percent of the fair market value of T's stock for 5 years, then for purposes of this subparagraph, P is treated as owning (immediately after the acquisition) 40 percent of the fair market value of its own outstanding stock, determined as follows:

[$150,000/($200,000 + $50,000)] × 662/3% = 40%.

Thus, if the former individual stockholders of T own, immediately after the acquisition more than 10 percent of the fair market value of the outstanding stock of P as a result of owning stock of T, the group of which T was the common parent is treated as continuing in existence with P as the common parent, and the group of which P was the common parent before the acquisition ceases to exist.

(iii) Election. The provisions of subdivision (ii) of this subparagraph shall not apply to any acquisition occurring in a taxable year ending after October 7, 1969, unless the first corporation elects to have such subdivision apply. The election shall be made by means of a statement, signed by any officer who is duly authorized to act on behalf of the first corporation, stating that the corporation elects to have the provisions of § 1.1502-75(d)(3)(ii) apply and identifying the acquisition to which such provisions will apply. The statement shall be filed, on or before the due date (including extensions of time) of the return for the group's first consolidated return year ending after the date of the acquisition, with the internal revenue officer with whom such return is required to be filed.

(iv) Transfer of assets to subsidiary. This subparagraph shall not apply to a transaction to which subparagraph (2)(ii) of this paragraph applies.

(v) Taxable years. If, in a transaction described in subdivision (i) of this subparagraph, the first corporation files a consolidated return for the first taxable year ending after the date of acquisition, then:

(a) The first corporation, and each corporation which, immediately before the acquisition, is a member of the group of which the first corporation is the common parent, shall close its taxable year as of the date of acquisition, and each such corporation shall, immediately after the acquisition, change to the taxable year of the second corporation, and

(b) If the acquisition is a transaction described in section 381(a)(2), then for purposes of section 381:

(1) All taxable years ending on or before the date of acquisition, of the first corporation and each corporation which, immediately before the acquisition, is a member of the group of which the first corporation is the common parent, shall be treated as taxable years of the transferor corporation, and

(2) The second corporation shall not close its taxable year merely because of such acquisition, and all taxable years ending on or before the date of acquisition, of the second corporation and each corporation which, immediately before the acquisition, is a member of any group of which the second corporation is the common parent, shall be treated as taxable years of the acquiring corporation.

(vi) Exception. With respect to acquisitions occurring before April 17, 1968, subdivision (v) of this subparagraph shall not apply if the parties to the transaction, in their income tax returns, treat subdivision (i) as not affecting the closing of taxable years or the operation of section 381.

(4) [Reserved]

(e) Failure to include subsidiary. If a consolidated return is required for the taxable year under the provisions of paragraph (a)(2) of this section, the tax liability of all members of the group for such year shall be computed on a consolidated basis even though:

(1) Separate returns are filed by one or more members of the group, or

(2) There has been a failure to include in the consolidated return the income of any member of the group.

If subparagraph (1) of this paragraph applies, the amounts assessed or paid upon the basis of separate returns shall be considered as having been assessed or paid upon the basis of a consolidated return.

(f) Inclusion of one or more corporations not members of the group—(1) Method of determining tax liability. If a consolidated return includes the income of a corporation which was not a member of the group at any time during the consolidated return year, the tax liability of such corporation will be determined upon the basis of a separate return (or a consolidated return of another group, if paragraph (a)(2) or (b)(3) of this section applies), and the consolidated return will be considered as including only the income of the corporations which were members of the group during that taxable year. If a consolidated return includes the income of two or more corporations which were not members of the group but which constitute another group, the tax liability of such corporations will be computed in the same manner as if separate returns had been made by such corporations unless the Commissioner upon application approves the making of a consolidated return for the other group or unless under paragraph (a)(2) of this section a consolidated return is required for the other group.

(2) Allocation of tax liability. In any case in which amounts have been assessed and paid upon the basis of a consolidated return and the tax liability of one or more of the corporations included in the consolidated return is to be computed in the manner described in subparagraph (1) of this paragraph, the amounts so paid shall be allocated between the group composed of the corporations properly included in the consolidated return and each of the corporations the tax liability of which is to be computed on a separate basis (or on the basis of a consolidated return of another group) in such manner as the corporations which were included in the consolidated return may, subject to the approval of the Commissioner, agree upon or in the absence of an agreement upon the method used in allocating the tax liability of the members of the group under the provisions of section 1552(a).

(g) Computing periods of limitation—(1) Income incorrectly included in consolidated return. If:

(i) A consolidated return is filed by a group for the taxable year, and

(ii) The tax liability of a corporation whose income is included in such return must be computed on the basis of a separate return (or on the basis of a consolidated return with another group), then for the purpose of computing any period of limitation with respect to such separate return (or such other consolidated return), the filing of such consolidated return by the group shall be considered as the making of a return by such corporation.

(2) Income incorrectly included in separate returns. If a consolidated return is required for the taxable year under the provisions of paragraph (a)(2) of this section, the filing of separate returns by the members of the group for such year shall not be considered as the making of a return for the purpose of computing any period of limitation with respect to such consolidated return unless there is attached to each such separate return a statement setting forth:

(i) The most recent taxable year of the member for which its income was included in a consolidated return, and

(ii) The reasons for the group's belief that a consolidated return is not required for the taxable year.

(h) Method of filing return and forms—(1) Consolidated return made by common parent or agent. The consolidated return must be made on Form 1120, U.S. Corporation Income Tax Return (or any successor form), for the group by the common parent or the agent for the group as provided in § 1.1502-77(c). The consolidated return, with Form 851, Affiliations Schedule (or any successor form), attached, must be filed with the service center with which the common parent would have filed a separate return.

(2) Filing of Form 1122 for first year. If, under the provisions of paragraph (a)(1) of this section, a group wishes to file a consolidated return for a taxable year, then a Form 1122 (Authorization and Consent of Subsidiary Corporation To Be Included in a Consolidated Income Tax Return) (or successor form) must be executed by each subsidiary. The group must attach either executed Forms 1122 (or successor forms) or unsigned copies of the completed Forms 1122 (or successor forms) to the consolidated return. If the group submits unsigned Forms 1122 (or successor forms) with its return, it must retain the signed originals in its records in the manner required by § 1.6001-1(e). Form 1122 (or any successor form) is not required for a taxable year if a consolidated return was filed (or was required to be filed) by the group for the immediately preceding taxable year.

(3) Persons qualified to execute returns and forms. Each return or form required to be made or prepared by a corporation must be executed by the person authorized under section 6062 to execute returns of separate corporations.

(i) [Reserved]

(j) Statements and schedules for subsidiaries. The statement of gross income and deductions and the schedules required by the instructions on the return shall be prepared and filed in columnar form so that the details of the items of gross income, deductions, and credits for each member may be readily audited. Such statements and schedules shall include in columnar form a reconciliation of surplus for each corporation, and a reconciliation of consolidated surplus. Consolidated balance sheets as of the beginning and close of the taxable year of the group, taken from the books of the members, shall accompany the consolidated return and shall be prepared in a form similar to that required for reconciliation of surplus.

(k) Cross-reference. See § 1.338(h)(10)-1(d)(7) for special rules regarding filing consolidated returns when a section 338(h)(10) election is made for a target acquired from a selling consolidated group.

(l) Effective/applicability dates. Paragraph (d)(1) of this section applies to taxable years for which the due date of the original return (without regard to extensions) is on or after September 17, 2008.

[T.D. 6894, 31 FR 11794, Sept. 8, 1966]

Editorial Note:For Federal Register citations affecting § 1.1502-75, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.1502-76 Taxable year of members of group.

(a) Taxable year of members of group. The consolidated return of a group must be filed on the basis of the common parent's taxable year, and each subsidiary must adopt the common parent's annual accounting period for the first consolidated return year for which the subsidiary's income is includible in the consolidated return. If any member is on a 52-53-week taxable year, the rule of the preceding sentence will, with the advance consent of the Commissioner, be deemed satisfied if the taxable years of all members of the group end within the same 7-day period. Any request for such consent must be requested at the time and in the manner that the Commissioner of Internal Revenue may prescribe by Internal Revenue Service forms and instructions or by publication in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter).

(b) Items included in the consolidated return—(1) General rules—(i) In general. A consolidated return must include the common parent's items of income, gain, deduction, loss, and credit for the entire consolidated return year, and each subsidiary's items for the portion of the year for which it is a member. If the consolidated return includes the items of a corporation for only a portion of its tax year determined without taking this section into account, items for the portion of the year not included in the consolidated return must be included in a separate return (including the consolidated return of another group). The rules of this paragraph (b) must be applied to prevent the duplication or elimination of the corporation's items.

(ii) The day a corporation becomes or ceases to be a member—(A) End of the day rule. (1) In general. If a corporation (S), other than one described in paragraph (b)(1)(ii)(A)(2) of this section, becomes or ceases to be a member during a consolidated return year, it becomes or ceases to be a member at the end of the day on which its status as a member changes, and its tax year ends for all Federal income tax purposes at the end of that day. Appropriate adjustments must be made if another provision of the Internal Revenue Code or the regulations thereunder contemplates the event occurring before or after S's change in status. For example, S's items restored under § 1.1502-13 immediately before it becomes a nonmember are taken into account in determining the basis of S's stock under § 1.1502-32. On the other hand, if a section 338(g) election is made in connection with S becoming a member, the deemed asset sale under that section takes place before S becomes a member. See § 1.338-10(a)(5) (deemed sale excluded from purchasing corporation's consolidated return.)

(2) Special rule for former S corporations. If S becomes a member in a transaction other than in a qualified stock purchase for which an election under section 338(g) is made, and immediately before becoming a member an election under section 1362(a) was in effect, then S will become a member at the beginning of the day the termination of its S corporation election is effective. S's tax year ends for all Federal income tax purposes at the end of the preceding day.

(B) Next day rule. If, on the day of S's change in status as a member, a transaction occurs that is properly allocable to the portion of S's day after the event resulting in the change, S and all persons related to S under section 267(b) immediately after the event must treat the transaction for all Federal income tax purposes as occurring at the beginning of the following day. A determination as to whether a transaction is properly allocable to the portion of S's day after the event will be respected if it is reasonable and consistently applied by all affected persons. In determining whether an allocation is reasonable, the following factors are among those to be considered—

(1) Whether income, gain, deduction, loss, and credit are allocated inconsistently (e.g., to maximize a seller's stock basis adjustments under § 1.1502-32);

(2) If the item is from a transaction with respect to S stock, whether it reflects ownership of the stock before or after the event (e.g., if a member transfers encumbered land to nonmember S in exchange for additional S stock in a transaction to which section 351 applies and the exchange results in S becoming a member of the consolidated group, the applicability of section 357(c) to the exchange must be determined under § 1.1502-80(d) by treating the exchange as occurring after the event; on the other hand, if S is a member but has a minority shareholder and becomes a nonmember as a result of its redemption of stock with appreciated property, S's gain under section 311 is treated as from a transaction occurring before the event);

(3) Whether the allocation is inconsistent with other requirements under the Internal Revenue Code and regulations promulgated thereunder (e.g., if a section 338(g) election is made in connection with a group's acquisition of S, the deemed asset sale must take place before S becomes a member and S's gain or loss with respect to its assets must be taken into account by S as a nonmember (but see § 1.338-1(d)), or if S realizes discharge of indebtedness income that is excluded from gross income under section 108(a) on the day it becomes a nonmember, the discharge of indebtedness income must be treated as realized by S as a member (see § 1.1502-28(b)(11))); and

(4) Whether other facts exist, such as a prearranged transaction or multiple changes in S's status, indicating that the transaction is not properly allocable to the portion of S's day after the event resulting in S's change.

(C) Successor corporations. For purposes of this paragraph (b)(1)(ii), any reference to a corporation includes a reference to a successor or predecessor as the context may require. A corporation is a successor if the basis of its assets is determined, directly or indirectly, in whole or in part, by reference to the basis of the assets of another corporation (the predecessor). For example, if a member forms S, S is treated as a member from the beginning of its existence.

(iii) Group structure changes. If the common parent ceases to be the common parent but the group remains in existence, adjustments must be made in accordance with the principles of § 1.1502-75(d)(2) and (3).

(2) Determination of items included in separate and consolidated returns—(i) In general. The returns for the years that end and begin with S becoming (or ceasing to be) a member are separate tax years for all Federal income tax purposes. The returns are subject to the rules of the Internal Revenue Code applicable to short periods, as if S ceased to exist on becoming a member (or first existed on becoming a nonmember). For example, cost recovery deductions under section 168 must be allocated for short periods. On the other hand, annualization under section 443 is not required of S solely because it has a short year as a result of becoming a member. (Similarly, section 443 applies with respect to a consolidated return only to the extent that the group's return is for a short period and section 443 applies without taking this paragraph (b) into account.)

(ii) Ratable allocation of a year's items—(A) Application. Although the periods ending and beginning with S's change in status are different tax years, items (other than extraordinary items) may be ratably allocated between the periods if—

(1) S is not required to change its annual accounting period or its method of accounting as a result of its change in status (e.g., because its stock is sold between consolidated groups that have the same annual accounting periods); and

(2) An irrevocable ratable allocation election is made under paragraph (b)(2)(ii)(D) of this section.

(B) General rule—(1) Allocation within original year. Under a ratable allocation election, paragraph (b)(2) of this section applies by allocating to each day of S's original year (S's tax year determined without taking this section into account) an equal portion of S's items taken into account in the original year, except that extraordinary items must be allocated to the day that they are taken into account. All persons affected by the election must take into account S's extraordinary items and the ratable allocation of S's remaining items in a manner consistent with the election.

(2) Items to be allocated. Under ratable allocation, the items to be allocated and their timing, location, character, and source are generally determined by treating the original year as a single tax year, and the items are not subject to the rules of the Internal Revenue Code applicable to short periods (unless the original year is a short period). However, the years ending and beginning with S's change in status are treated as different tax years (and as short periods) with respect to any item carried to or from these years (e.g., a net operating loss carried under section 172) and with respect to the application of section 481.

(3) Multiple applications. If this paragraph (b) applies more than once with respect to an original year, adjustments must be made in accordance with the principles of this paragraph (b). For example, if S becomes a member of two different consolidated groups during the same original year and ratable allocation is elected with respect to both groups, ratable allocation is generally determined for both groups by treating the original year as a single tax year; however, if ratable allocation is elected only with respect to the first group, the ratable allocation is determined by treating the original year as a short period that does not include the period that S is a member of the second group. Ratable allocation is not a method of accounting, and ratable allocation with respect to one application of this paragraph (b) to S does not require ratable allocation to be subsequently applied with respect to S.

(1) Any item from the disposition or abandonment of a capital asset as defined in section 1221 (determined without the application of any other rules of law);

(2) Any item from the disposition or abandonment of property used in a trade or business as defined in section 1231(b) (determined without the application of any holding period requirement);

(3) Any item from the disposition or abandonment of an asset described in section 1221(1), (3), (4), or (5), if substantially all the assets in the same category from the same trade or business are disposed of or abandoned in one transaction (or series of related transactions);

(4) Any item from assets disposed of in an applicable asset acquisition under section 1060(c);

(5) Any item carried to or from any portion of the original year (e.g., a net operating loss carried under section 172), and any section 481(a) adjustment;

(6) The effects of any change in accounting method initiated by the filing of the appropriate form after S's change in status;

(7) Any item from the discharge or retirement of indebtedness (e.g., cancellation of indebtedness income or a deduction for retirement at a premium);

(8) Any item from the settlement of a tort or similar third-party liability;

(9) Any compensation-related deduction in connection with S's change in status (including, for example, deductions from bonus, severance, and option cancellation payments made in connection with S's change in status);

(10) Any dividend income from a nonmember that S controls within the meaning of section 304 at the time the dividend is taken into account;

(11) Any deemed income inclusion from a foreign corporation, or any deferred tax amount on an excess distribution from a passive foreign investment company under section 1291;

(12) Any interest expense allocable under section 172(h) to a corporate equity reduction transaction causing this paragraph (b) to apply;

(13) Any credit, to the extent it arises from activities or items that are not ratably allocated (e.g., the rehabilitation credit under section 47, which is based on placement in service); and

(14) Any item which, in the opinion of the Commissioner, would, if ratably allocated, result in a substantial distortion of income in any consolidated return or separate return in which the item is included.

(D) Election—(1) Statement. The election to ratably allocate items under this paragraph (b)(2)(ii) must be made in a separate statement entitled, “THIS IS AN ELECTION UNDER § 1.1502-76(b)(2)(ii) TO RATABLY ALLOCATE THE YEAR'S ITEMS OF [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF THE MEMBER].” The election must be filed by including a statement on or with the returns including the items for the years ending and beginning with S's change in status. If two or more members of the same consolidated group, as a consequence of the same plan or arrangement, cease to be members of that group and remain affiliated as members of another consolidated group, an election under this paragraph (b)(2)(ii)(D)(1) may be made only if it is made by each such member. Each statement must also indicate that an agreement, as described in paragraph (b)(2)(ii)(D)(2) of this section, has been entered into. Each party signing the agreement must retain either the original or a copy of the agreement as part of its records. See § 1.6001-1(e).

(2) Agreement. For each election under this paragraph (b)(2)(ii), the member and the common parent of each affected group must sign and date an agreement. The agreement must—

(i) Identify the extraordinary items, their amounts, and the separate or consolidated returns in which they are included;

(ii) Identify the aggregate amount to be ratably allocated, and the portion of the amount included in the separate and consolidated returns; and

(iii) Include the name and employer identification number of the common parent (if any) of each group that must take the items into account.

(iii) Ratable allocation of a month's items. If ratable allocation under paragraph (b)(2)(ii) of this section is not elected (e.g., because S is required to change its annual accounting period), this paragraph (b)(2)(iii) may be applied to ratably allocate only S's items taken into account in the month of its change in status, but only if the allocation is consistently applied by all affected persons. The ratable allocation is made by applying the principles of paragraph (b)(2)(ii) of this section under any reasonable method. For example, S may close its books both at the end of the preceding month and at the end of the month of the change, and allocate only its items (other than extraordinary items) from the month of the change. See paragraph (b)(1)(ii)(B) of this section for factors to be considered in determining whether the method is reasonable.

(iv) Taxes. To the extent properly taken into account during the member's tax year (determined without the application of this paragraph (b)), Federal, state, local, and foreign taxes are allocated under paragraph (b)(2) of this section on the basis of the items or activities to which the taxes relate. Thus, income tax is allocated based on the inclusion of the income (determined under the principles of this paragraph (b)) to which the tax relates. For example, if a calendar-year domestic corporation has $100 of foreign source dividend income (determined in accordance with United States tax accounting principles but without taking this paragraph (b) into account) that is passive income for purposes of section 904, and $60 of the income is allocated under this paragraph (b) to the period of the calendar year after it becomes a member of a consolidated group, then 60% of the corporation's deemed paid foreign tax credit associated with its dividend income for the calendar year is taken into account in computing the group's passive basket consolidated foreign tax credit. Similarly, property taxes relate to the ownership of property and are allocated over the period that the property is owned. This paragraph (b)(2)(iv) applies without regard to any determination or allocation by another taxing jurisdiction.

(v) Acquisition of S corporation. If a corporation is acquired in a transaction to which paragraph (b)(1)(ii)(A)(2) of this section applies, then paragraphs (b)(2)(ii) and (iii) of this section do not apply and items of income, gain, loss, deduction, and credit are assigned to each short taxable year on the basis of the corporation's normal method of accounting as determined under section 446.

(vi) Passthrough entities—(A) In general. If S is a partner in a partnership or an owner of a similar interest with respect to which items of the entity are taken into account by S, S is treated, solely for purposes of determining the year to which the entity's items are allocated under paragraph (b)(2) of this section, as selling or exchanging its entire interest in the entity immediately before S's change in status.

(B) Treatment as a conduit. For purposes of this paragraph (b)(2), if a member (together with other members) would be treated under section 318(a)(2) as owning an aggregate of at least 50% of any stock owned by the passthrough entity, the method that is used to determine the inclusion of the entity's items in the consolidated or separate return must be the same method that is used to determine the inclusion of the member's items in the consolidated or separate return.

(C) Exception for certain foreign entities. This paragraph (b)(2)(v) does not apply to any foreign corporation generating the deemed inclusion of income, or to any passive foreign investment company generating a deferred tax amount on an excess distribution under section 1291.

(3) Anti-avoidance rule. If any person acts with a principal purpose contrary to the purposes of this paragraph (b), to substantially reduce the Federal income tax liability of any person, adjustments must be made as necessary to carry out the purposes of this section.

(4) Determination of due date for separate return. Paragraph (c) of this section contains rules for the filing of the separate return referred to in this paragraph (b). In applying paragraph (c) of this section, the due date for the filing of S's separate return shall also be determined without regard to the ending of the tax year under paragraph (b)(1)(ii) of this section or the deemed cessation of its existence under paragraph (b)(2)(i) of this section.

(5) Examples. For purposes of the examples in this paragraph (b), unless otherwise stated, P and X are common parents of calendar-year consolidated groups, P owns all of the only class of T's stock, T owns no stock of lower-tier members, all persons use the accrual method of accounting, the facts set forth the only corporate activity, all transactions are between unrelated persons, tax liabilities are disregarded, and any election required under paragraph (b)(2) of this section is properly made. The principles of this paragraph (b) are illustrated by the following examples.

Example 1. Items allocated between consolidated and separate returns. (a) Facts. P and S are the only members of the P group. P sells all of S's stock to individual A on June 30, and therefore S becomes a nonmember on July 1 of Year 2.

(b) Analysis. Under paragraph (b)(1) of this section, the P group's consolidated return for Year 2 includes P's income for the entire tax year and S's income for the period from January 1 to June 30, and S must file a separate return for the period from July 1 to December 31.

(c) Acquisition of another subsidiary before end of tax year. The facts are the same as in paragraph (a) of this Example 1, except that on July 31 P acquires all the stock of T (which filed a separate return for its year ending on November 30 of Year 1) and T therefore becomes a member on August 1 of Year 2. Under § 1.1502-75(d) and paragraph (b)(1) of this section, the P group's consolidated return for Year 2 includes P's income for the entire year, S's income from January 1 to June 30, and T's income from August 1 to December 31. S must file a separate return that includes its income from July 1 to December 31, and T must file a separate return that includes its income from December 1 of Year 1 to July 31 of Year 2. (If P had acquired T after December 31, the P group that included S is a different group from the P group that includes T, and, for example, the P group that includes T must make a separate election under section 1501 and § 1.1502-75 if consolidated returns are to be filed.)

Example 2. Group structure change. (a) Facts. P owns all of the stock of S and T. Shortly after the beginning of Year 1, P merges into T in a reorganization described in section 368(a)(1)(A) (and in section 368(a)(1)(D)), and P's shareholders receive T's stock in exchange for all of P's stock. The P group is treated under § 1.1502-75(d)(2)(ii) as remaining in existence with T as its common parent.

(b) Analysis. Under paragraph (b)(1) of this section, the P group's return must include the common parent's items for the entire consolidated return year and, if the common parent ceases to be the common parent but the group remains in existence, appropriate adjustments must be made. Consequently, although P did not exist for all of Year 1, P's items for the portion of Year 1 ending with the merger are treated as the items of the common parent that must be included in the P group's return for Year 1.

(c) Reverse acquisition. Assume instead that X acquires all of P's assets in exchange for more than 50% of X's stock in a reorganization described in section 368(a)(1)(D). The reorganization constitutes a reverse acquisition under § 1.1502-75(d)(3), with the X group terminating and the P group surviving with X as its common parent. Consequently, P's items for the portion of Year 1 ending with the acquisition are treated as the items of the common parent that must be included in the P group's return for Year 1, and X's items are treated for purposes of paragraph (b)(1) of this section as the items of a subsidiary included in the P group's return for the portion of Year 1 for which X is a member.

Example 3. Ratable allocation. (a) Facts. P sells all of T's stock to X, and T becomes a nonmember on July 1 of Year 1. T engages in the production and sale of merchandise throughout Year 1 and is required to use inventories. The sale is treated as causing T's tax year to end on June 30, and the periods beginning and ending with the sale are treated as two tax years for Federal income tax purposes.

(b) Analysis. If ratable allocation under paragraph (b)(2)(ii) of this section is not elected, T must perform an inventory valuation as of the acquisition and also as of the end of Year 1. If ratable allocation is elected, T must perform an inventory valuation only as of the close of Year 1, and T's income from inventory is ratably allocated, along with T's other items that are not extraordinary items, between the P and X consolidated returns.

(c) Merger into nonmember. Assume instead that T merges into a wholly owned subsidiary of X in a reorganization described in section 368(a)(2)(D), and P receives 10% of X's stock in exchange for all of T's stock. Under paragraph (b)(2)(ii)(B) of this section, because T's tax year ends on June 30 under section 381(b)(1), T's original year determined without taking paragraph (b) of this section into account also ends on June 30. Consequently, a ratable allocation under paragraph (b)(2)(ii) of this section is the same as an allocation based on closing the books.

Example 4. Net operating loss.P sells all of T's stock to X, T becomes a nonmember on June 30 of Year 1, and ratable allocation under paragraph (b)(2)(ii) of this section is elected. Under ratable allocation, the X group has a $100 consolidated net operating loss for Year 1, all of which is attributable to T. However, because of extraordinary items, T has $100 of income for the portion of Year 1 that T is a member of the P group. Under paragraph (b)(2)(ii)(B)(2) of this section, T's loss may be carried back from the X group to the portion of Year 1 that T was a member of the P group. See also section 172 and § 1.1502-21(b). Under paragraph (b)(2)(ii)(C)(5) of this section, any item carried to or from any portion of the original year is an extraordinary item, and the loss therefore is not taken into account again in determining the ratable allocation under paragraph (b)(2)(ii) of this section.

Example 5. Employee benefit plans. (a) Facts. P sells all of T's stock to X, and T becomes a nonmember on June 30 of Year 1. On March 15 of Year 2, T contributes $100 to its retirement plan, which is a qualified plan under section 401(a). T is not required to make quarterly contributions to the plan for Year 1 under section 412(m). The contribution is made on account of T's taxable period beginning on July 1 of Year 1, and is deemed in accordance with section 404(a)(6) to have been made on the last day of T's taxable period beginning on July 1 of Year 1. Ratable allocation under paragraph (b)(2)(ii) of this section is not elected.

(b) Analysis. Under paragraph (b) of this section, the sale is treated as causing T's tax year to end on June 30, and the period beginning on July 1 is treated as a separate annual accounting period for all Federal income tax purposes. T's income from January 1 to June 30 is included in the P group's Year 1 return, and T's income from July 1 to December 31 is included in the X group's Year 1 return. Thus, the $100 contribution is deductible by T for the period of Year 1 that it is a member of the X group, subject to the applicable limitations of section 404, if a contribution on the last day of that period would otherwise be deductible.

(c) The facts are the same as in paragraph (a) of this Example 5, except that, in accordance with section 404(a)(6), $40 of the $100 contribution is made on account of T's taxable period beginning on January 1 of Year 1 and is deemed to be made on the last day of T's taxable period beginning on January 1 of Year 1. The remaining $60 is made on account of T's taxable period beginning on July 1 of Year 1 and is deemed to be made on the last day of T's taxable period beginning on July 1 of Year 1. As in paragraph (b) of this Example 5, under paragraph (b) of this section, the sale is treated as causing T's tax year to end on June 30, and the period beginning on July 1 is treated as a separate annual accounting period for all Federal income tax purposes. The $40 portion of the contribution is deductible by T for the period of Year 1 that it is a member of the P group, subject to the applicable limitations of section 404 and provided that a $40 contribution on the last day of that period would otherwise be deductible for that period, and the $60 portion is deductible by T for the period of Year 1 that it is a member of the X group, subject to the same conditions.

(d) Ratable allocation. The facts are the same as in paragraph (a) of this Example 5, except that P, T, and X elect ratable allocation under paragraph (b)(2)(ii) of this section and T's deduction for the retirement plan contribution is not an extraordinary item. T's deduction may be ratably allocated, subject to the applicable limitations of section 404, and is allowable only if a contribution on the last day of Year 1 otherwise would be deductible for any period in the year. (The results would be the same if S were an unaffiliated corporation when acquired by X, and the due date of its last separate return (including extensions) were before the pension contribution was made on March 15 of Year 2.)

Example 6. Allocation of partnership items. (a) Facts. P sells all of T's stock to X, and T becomes a nonmember on June 30 of Year 1. T has a 10% interest in the capital and profits of a calendar-year partnership.

(b) Analysis. Under paragraph (b)(2)(vi)(A) of this section, T is treated, solely for purposes of determining T's tax year in which the partnership's items are included, as selling or exchanging its entire interest in the partnership as of P's sale of T's stock. Thus, the deemed disposition is not taken into account under section 708, it does not result in gain or loss being recognized by T, and T's holding period is unaffected. However, under section 706(a), in determining T's income, T is required to include its distributive share of partnership items for the partnership's year ending within or with T's tax year. Under section 706(c)(2), the partnership's tax year is treated as closing with respect to T for this purpose as of P's sale of T's stock. The allocation of T's distributive share of partnership items must be made under § 1.706-1(c)(2)(ii).

(c) Controlled partnership. The facts are the same as in paragraph (a) of this Example 6, except that T has a 75% interest in the capital and profits of the partnership. Under paragraph (b)(2)(vi)(B) of this section, T's distributive share of the partnership items is treated as T's items for purposes of paragraph (b)(2) of this section. Thus, if ratable allocation under paragraph (b)(2)(ii) of this section is not elected, T's distributive share of the partnership's items must be determined under § 1.706-1(c)(2)(ii) by an interim closing of the partnership's books. Similarly, if ratable allocation is elected for T's items that are not extraordinary items, T's distributive share of the partnership's nonextraordinary items must also be ratably allocated under § 1.706-1(c)(2)(ii).

Example 7. Acquisition of S corporation. (a) Facts. Z is a small business corporation for which an election under section 1362(a) was in effect at all times since Year 1. At all times, Z had only 100 shares of stock outstanding, all of which were owned by individual A. On July 1 of Year 3, P acquired all of the Z stock. P does not make an election under section 338(g) with respect to its purchase of the Z stock.

(b) Analysis. As a result of P's acquisition of the Z stock, Z's election under section 1362(a) terminates. See sections 1361(b)(1)(B) and 1362(d)(2). Z is required to join in the filing of the P consolidated return. See § 1.1502-75. Z's tax year ends for all Federal income tax purposes on June 30 of Year 3. If no extension of time is sought, Z must file a separate return for the period from January 1 through June 30 of Year 3 on or before March 15 of Year 4. See paragraph (b)(4) of this section. Z will become a member of the P consolidated group as of July 1 of Year 3. See paragraph (b)(1)(ii)(A)(2) of this section. P group's Year 3 consolidated return will include Z's items from July 1 to December 31 of Year 3.

(6) Applicability date. Except as provided in paragraphs (b)(1)(ii)(A)(2) and (b)(2)(v) of this section, this paragraph (b) applies to corporations becoming or ceasing to be members of consolidated groups on or after January 1, 1995.

(c) Time for making separate returns for periods not included in consolidated return—(1) Consolidated return filed by due date for separate return. If the group has filed a consolidated return on or before the due date for the filing of a subsidiary's separate return (including extensions of time and determined without regard to any change of its taxable year required under paragraph (a) of this section), then the separate return for any portion of the subsidiary's taxable year for which its income is not included in the consolidated return of the group must be filed no later than the due date of such consolidated return (including extensions of time).

(2) Consolidated return not filed by due date for separate return. If the group has not filed a consolidated return on or before the due date for the filing of a subsidiary corporation's separate return (including extensions of time and determined without regard to any change of its taxable year required under paragraph (a) of this section), then on or before such due date such subsidiary shall file a separate return either for the portion of its taxable year for which its income would not be included in a consolidated return if such a return were filed, or for its complete taxable year. However, if a separate return is filed for such portion of its taxable year and the group subsequently does not file a consolidated return, such subsidiary corporation shall file a substituted return for its complete taxable year not later than the due date (including extensions of time) prescribed for the filing of the common parent's return. On the other hand, if the return is filed for the subsidiary's complete taxable year and the group later files a consolidated return, such subsidiary must file an amended return not later than the due date (including extensions of time) for the filing of the consolidated return of the group. Such amended return shall be for that portion of such subsidiary's taxable year which is not included in the consolidated return. If, under this subparagraph, a substituted return must be filed, then the return previously filed shall not be considered a return within the meaning of section 6011. If, under this subparagraph, a substituted or amended return must be filed, then, for purposes of sections 6513(a) and 6601(a), the last date prescribed for payment of tax shall be the due date (not including extensions of time) for the filing of the subsidiary's separate return (determined without regard to this subparagraph and without regard to any change of its taxable year required under paragraph (a) of this section).

(3) Examples. The provisions of this paragraph (c) may be illustrated by the following examples:

(i) Example 1. Corporation P, which filed a separate return for the calendar year 2022, acquires all of the stock of corporation S as of the close of December 31, 2022. Corporation S reports its income on the basis of a fiscal year ending March 31. On July 15, 2023, the due date for the filing of a separate return by S (assuming no extensions of time), a consolidated return has not been filed for the group (P and S). On such date S may either file a return for the period April 1, 2022, through December 31, 2022, or it may file a return for the complete fiscal year ending March 31, 2023. If S files a return for the short period ending December 31, 2022, and if the group elects not to file a consolidated return for the calendar year 2023, S, on or before April 15, 2024 (the due date of P's return, assuming no extensions of time), must file a substituted return for the complete fiscal year ending March 31, 2023, in lieu of the return previously filed for the short period. Interest is computed from July 15, 2023. If, however, S files a return for the complete fiscal year ending March 31, 2023, and the group elects to file a consolidated return for the calendar year 2023, then S must file an amended return covering the period from April 1, 2022, through December 31, 2022, in lieu of the return previously filed for the complete fiscal year. Interest is computed from July 15, 2023.

(ii) Example 2. Assume the same facts as in paragraph (c)(3)(i) of this section (Example 1), except that corporation P acquires all of the stock of corporation S at the close of September 30, 2023, and P files a consolidated return for the group for 2023 on April 15, 2024 (not having obtained any extensions of time). Since a consolidated return has been filed on or before the due date (July 15, 2024) for the filing of the separate return for the taxable year ending March 31, 2024, the return of S for the short taxable year beginning April 1, 2023, and ending September 30, 2023, should be filed no later than April 15, 2024.

(d) Applicability date—(1) Taxable years of members of group applicability date. Paragraph (a) of this section applies to any original consolidated Federal income tax return due (without extensions) after July 20, 2007.

(2) Election to ratably allocate items applicability date. Paragraph (b)(2)(ii)(D) of this section applies to any original consolidated Federal income tax return due (without extensions) after July 20, 2007.

[T.D. 6894, 31 FR 11794, Sept. 8, 1966]

Editorial Note:For Federal Register citations affecting § 1.1502-76, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.1502-77 Agent for the group.

(a) Agent for the group—(1) Sole agent. Except as provided in paragraphs (e) and (f)(2) of this section, one entity (the agent) is the sole agent that is authorized to act in its own name regarding all matters relating to the federal income tax liability for the consolidated return year for each member of the group and any successor or transferee of a member (and any subsequent successors and transferees thereof). The identity of that agent is determined under the rules of paragraph (c) of this section.

(2) Agent for each consolidated return year. Agency for the group is established for each consolidated return year and is not affected by the status or membership of the group in later years. Thus, subject to the rules of paragraph (c) of this section, the agent will generally remain agent for that consolidated return year regardless of whether one or more subsidiaries later cease to be members of the group, whether the group files a consolidated return for any subsequent year, whether the agent ceases to be the agent or a member of the group in any subsequent year, or whether the group continues pursuant to § 1.1502-75(d) with a new common parent in any subsequent year.

(3) Communications under this section. Any designation, notification, objection, request, or other communication made to or by the Commissioner pursuant to paragraphs (c) and (f)(2) of this section must be made in accordance with procedures prescribed by the Commissioner in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter), forms, instructions, or other appropriate guidance.

(b) Definitions. The following definitions apply for purposes of this section only—

(1) Successor. A successor is an individual or entity (including a disregarded entity as defined in paragraph (b)(3) of this section) that is primarily liable, pursuant to applicable law (including, for example, by operation of a state or federal merger statute), for the tax liability of a corporation that was a member of the group but is no longer in existence under applicable law. The determination of tax liability is made without regard to § 1.1502-1(f)(4) or § 1.1502-6(a). (For inclusion of a successor in references to a subsidiary or member, see paragraph (b)(5)(iii) of this section.)

(2) Entity. The term entity includes any corporation, limited liability company, or partnership formed under any state, federal, or foreign jurisdiction. The term entity includes a disregarded entity (as defined in paragraph (b)(3) of this section). The term entity does not include an entity that has terminated even if it is in a winding up period under the law under which it is organized.

(3) Disregarded entity. The term disregarded entity includes any of the following types of entities that are disregarded as separate from their owners—

(i) Qualified real estate investment trust subsidiaries (within the meaning of section 856(i)(2));

(ii) Qualified subchapter S subsidiaries (within the meaning of section 1361(b)(3)(B)); and

(iii) Eligible entities with a single owner (within the meaning of § 301.7701-3 of this chapter).

(4) Default successor. A successor to the agent is the default successor if it is an entity (whether domestic or foreign) that is the sole successor to the agent. A partnership is treated as a sole successor with primary liability notwithstanding that one or more partners may also be primarily liable by virtue of being partners.

(5) Member or subsidiary. All references to a member or subsidiary for a consolidated return year include—

(i) Each corporation that was a member of the group during any part of such year (except that any reference to a subsidiary does not include the common parent);

(ii) Each corporation whose income was included in the consolidated return for such year, notwithstanding that the tax liability of such corporation should have been computed on the basis of a separate return, or as a member of another consolidated group, under the provisions of § 1.1502-75; and

(iii) Except as indicated otherwise, a successor of any of the foregoing corporations.

(6) Completed year. A completed year is a consolidated return year that has ended, or will end at the time of the referenced event.

(7) Current year. A current year is a consolidated return year that is not a completed year.

(c) Identity of the agent—(1) In general. Except as otherwise provided in this section, the agent for a current year is the common parent and the agent for a completed year is the common parent at the close of the completed year or its default successor, if any. Except as specifically provided otherwise in this paragraph (c), any entity that is an agent pursuant to paragraph (c)(3) of this section (agent following group structure change), paragraph (c)(5) of this section (agent designated by agent terminating without default successor), paragraph (c)(6) of this section (agent designated by Commissioner), or paragraph (c)(7) of this section (agent designated by resigning agent), or any entity subsequently serving as agent following such agent, acts as an agent for and under the same terms and conditions that apply to a common parent. For example, such an agent would generally be able to designate an agent if it terminates without a default successor; however, an entity that became agent pursuant to a designation by the Commissioner under paragraphs (c)(6)(i)(A)(2), (3), or (4) of this section is not permitted to designate an agent if it terminates without a default successor. Other special rules described in this paragraph (c) apply.

(2) Purported agent. If any entity files a consolidated return, or takes any other action related to the tax liability for the consolidated return year, purporting to be the agent but is subsequently determined not to have been the agent with respect to the claimed group, that entity is treated, to the extent necessary to avoid prejudice to the Commissioner, as if it were the agent.

(3) New common parent after a group structure change. If the group continues in existence after a group structure change (as described in § 1.1502-33(f)(1)), the former common parent is the agent until the group structure change, and the new common parent becomes the agent after the group structure change. Following the group structure change, the new common parent is the agent with respect to the entire current year (including the period before the group structure change) and the former common parent is no longer the agent for that year. However, actions taken by the former common parent as the agent before the group structure change are not nullified when the new common parent becomes the agent with respect to the entire consolidated return year. Following the group structure change, the new common parent continues as the agent for succeeding years subject to the rules of this section.

(4) Notification by default successor—(i) In general. Failure to provide notice to the Commissioner pursuant to this paragraph (c)(4)(i) does not invalidate an entity's status as the default successor. However, until the Commissioner receives notification in writing that an entity is the default successor—

(A) Any notice of deficiency or other communication mailed to the predecessor agent, even if no longer in existence, is considered as having been properly mailed to the agent; and

(B) The Commissioner is not required to act on any communication (including, for example, a claim for refund) submitted on behalf of the group by any person (including the default successor) other than the predecessor agent.

(ii) Conversions and continuances. For purposes of the notice requirements under paragraph (c)(4)(i) of this section, any entity that results from the agent's conversion or continuance by operation of state law and that qualifies as a default successor under paragraph (b)(4) of this section is treated as a default successor for purposes of the notice provisions of paragraph (c)(4)(i) of this section, even if applicable state or local law may treat the converted or continued entity as not ceasing to exist.

(5) Designation by terminating agent—(i) In general. Prior to the termination of its existence without a default successor, an agent may designate an entity described in paragraph (c)(5)(ii) of this section to act as agent for any completed year. This designation is effective upon the termination of the designating agent's existence. However, this paragraph (c)(5) does not apply to, and no designation can be made by, an agent that was designated by the Commissioner under paragraphs (c)(6)(i)(A)(2), (3), or (4) of this section, or any successor of such an agent; in such a case, the terminating agent should request that the Commissioner designate an agent pursuant to paragraph (c)(6)(i)(B) of this section.

(ii) Permissible agents—(A) The terminating agent may designate as agent a member of the group during any part of the completed year, or an entity (whether domestic or foreign) that is a successor of such a member, including an entity that will become a successor at the time the agent's existence terminates.

(B) The terminating agent may not designate as agent any entity that was previously replaced as agent by the Commissioner pursuant to paragraphs (c)(6)(i)(A)(2), (3), or (4) of this section, or any successor of such an agent. However, the terminating agent may submit a request pursuant to paragraph (c)(6)(i)(B) of this section that the Commissioner designate such an entity as agent.

(iii) Notification of designation. The terminating agent must notify the Commissioner in writing of its designation of an entity as agent pursuant to paragraph (c)(5)(i) of this section and provide a statement executed by the designated entity acknowledging that it will serve as the agent for each specified completed year for which it is designated as the agent. If the designated entity was not itself a member of the group during any specified year (because it is a successor of a member), the notification must include a statement acknowledging that the designated entity is or will be primarily liable for the tax liability for the specified completed year as a successor of a member.

(iv) Failure to designate an agent. If the agent terminates without a default successor, and no agent is designated pursuant to this paragraph (c)(5)—

(A) Any notice of deficiency or other communication mailed to the agent, even if no longer in existence, is considered as having been properly mailed to the agent; and

(B) The Commissioner is not required to act on any communication (including, for example, a claim for refund) submitted on behalf of the group by any person.

(6) Designation by the Commissioner—(i) In general. The Commissioner has the authority to designate an entity to act as the agent under the circumstances prescribed in this paragraph (c)(6)(i). The designated agent for a completed year must be an entity described in paragraph (c)(5)(ii)(A) of this section when the designation becomes effective. The designated agent for a current year must be a member of the group when the designation becomes effective. If, pursuant to this paragraph (c)(6), the Commissioner replaces the common parent or another entity as the agent, the common parent or other entity, or any successor thereof, may not later act as the agent unless so designated by the Commissioner.

(A) On Commissioner's own accord. With or without a request from any member of the group, the Commissioner may designate an entity to act as the agent if—

(1) The agent's existence terminates, other than in a group structure change, without there being a default successor and without any designation made under paragraph (c)(5)(i) of this section;

(2) An agent previously designated by the Commissioner is no longer a member of the group in the current year and does not have a default successor that is a member of the group;

(3) The Commissioner believes that the agent or its default successor exists but such entity has either not timely responded to the Commissioner's notices (sent to the last known address on file for the entity or left at the usual place of business for such entity) or has failed to perform its obligations as agent as prescribed by the Internal Revenue Code (Code) or regulations promulgated thereunder; or

(4) The agent is or becomes a foreign entity as a result of any action or transaction (including, for example, a continuance into a foreign jurisdiction or certain inversion transactions subject to section 7874 in which a foreign parent is treated as a domestic corporation).

(B) Written request from any member. At the request of any member, in a circumstance not described in paragraph (c)(6)(i)(A) of this section, the Commissioner may, but is not required to, replace an agent previously designated under this paragraph (c)(6).

(ii) Notification by Commissioner. The Commissioner will notify the designated entity in writing of the Commissioner's designation of the entity as agent pursuant to paragraph (c)(6)(i) of this section, and the designation will be effective as prescribed by the Commissioner. The designated entity should give notice of the designation by the Commissioner pursuant to paragraph (c)(6)(i) of this section to each member of the group during any part of the consolidated return year. However, a failure by the designated entity to notify any such member of the group does not invalidate the designation by the Commissioner.

(iii) Term and effect of designation. Unless otherwise provided by the Commissioner in the designation, any agent designated by the Commissioner pursuant to paragraph (c)(6)(i) of this section (new agent) is the agent with respect to the entire consolidated return year for which it is designated and successive years, subject to the rules of this section. An agent immediately preceding a new agent (former agent) ceases to be the agent for a particular consolidated return year once the new agent has been designated for that year, but the designation of the new agent does not nullify actions taken on behalf of the group by the former agent while it was agent. If there is more than one new agent designated by the Commissioner for a consolidated return year, the new agent that is designated last in time by the Commissioner is the agent with respect to the entire consolidated return year. A designation pursuant to this paragraph (c)(6) is effective as prescribed by the Commissioner in such designation or the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter), forms, instructions, or other appropriate guidance.

(iv) Request by member of the group where agent previously designated by the Commissioner is no longer a member. If an agent at any time after it is designated as agent by the Commissioner pursuant to paragraph (c)(6)(i) of this section is no longer a member of the group for any current year, and its default successor, if any, is not a member of the group at that time, a member of the group, including the agent that will cease to be a member, should request, in writing, that the Commissioner designate a member of the group to be the new agent pursuant to paragraph (c)(6)(i)(A)(2) of this section. Until such a request is made—

(A) Any notice of deficiency or other communication mailed to the agent, even if no longer a member, is considered as having been properly mailed to the agent; and

(B) The Commissioner is not required to act on any communication (including, for example, a claim for refund) submitted on behalf of the group by any person.

(7) Agent resigns—(i) In general. The agent may resign for a completed year if—

(A) It provides written notice to the Commissioner that it no longer intends to be the agent for that completed year;

(B) An entity described in paragraph (c)(5)(ii)(A) of this section consents, in writing, to be the agent with respect to that completed year;

(D) The Commissioner does not object to the agent's resignation.

(ii) Notification by agent that replaces agent that resigns. If the Commissioner does not object to the agent's resignation, the agent that replaces the agent that resigns should give written notice that it is the new agent to each member of the group for any part of the completed year for which it is designated the agent.

(8) Transactions under the Code. Notwithstanding section 338(a)(2), a target corporation for which an election is made under section 338 is not deemed to terminate for purposes of this section.

(d) Examples of matters subject to agency. With respect to any consolidated return year for which it is the agent—

(1) The agent makes any election (or similar choice of a permissible option) that is available to a subsidiary in the computation of its separate taxable income, and any change in an election (or similar choice of a permissible option) previously made by or for a subsidiary, including, for example, a request to change a subsidiary's method or period of accounting;

(2) All correspondence concerning the income tax liability for the consolidated return year is carried on directly with the agent;

(3) The agent files for all extensions of time, including extensions of time for payment of tax under section 6164, and any extension so filed is considered as having been filed by each member;

(4) The agent gives waivers, gives bonds, and executes closing agreements, offers in compromise, and all other documents, and any waiver or bond so given, or agreement, offer in compromise, or any other document so executed, is considered as having also been given or executed by each member;

(5) The agent files claims for refund, and any refund is made directly to and in the name of the agent and discharges any liability of the Government to any member with respect to such refund;

(6) The agent takes any action on behalf of a member of the group with respect to a foreign corporation including, for example, elections by, and changes to the method of accounting of, a controlled foreign corporation in accordance with § 1.964-1(c)(3);

(7) Notices of claim disallowance are mailed only to the agent, and the mailing to the agent is considered as a mailing to each member;

(8) Notices of deficiencies are mailed only to the agent (except as provided in paragraph (f)(3) of this section), and the mailing to the agent is considered as a mailing to each member;

(9) Notices of final partnership administrative adjustment under section 6223 with respect to any partnership in which a member of the group is a partner may be mailed to the agent, and, if so, the mailing to the agent is considered as a mailing to each member that is a partner entitled to receive such notice (for other rules regarding partnership proceedings, see paragraph (f)(2)(iii) of this section);

(10) The agent files petitions and conducts proceedings before the United States Tax Court, and any such petition is considered as also having been filed by each member;

(11) Any assessment of tax may be made in the name of the agent, and an assessment naming the agent is considered as an assessment with respect to each member; and

(12) Notice and demand for payment of taxes is given only to the agent, and such notice and demand is considered as a notice and demand to each member.

(e) Matters reserved to subsidiaries. Except as provided in this paragraph (e) and paragraph (f)(2) of this section, no subsidiary (unless it is or becomes an agent pursuant to paragraph (c) of this section) has authority to act for or to represent itself in any matter related to the tax liability for the consolidated return year. The following matters, however, are reserved exclusively to each subsidiary—

(1) The making of the consent required by § 1.1502-75(a)(1);

(2) Any action with respect to the subsidiary's liability for a federal tax other than the income tax imposed by chapter 1 of the Code (including, for example, employment taxes under chapters 21 through 25 of the Code, and miscellaneous excise taxes under chapters 31 through 47 of the Code); and

(3) The making of an election to be treated as a Domestic International Sales Corporation under § 1.992-2.

(f) Dealings with members—(1) Identifying members in notice of a lien. Notwithstanding any other provisions of this section, any notice of a lien, any levy, or any other proceeding to collect the amount of any assessment, after the assessment has been made, must name the entity from which such collection is to be made.

(2) Direct dealing with a member—(i) Several liability. The Commissioner may, upon issuing to the agent written notice that expressly invokes the authority of this provision, deal directly with any member of the group with respect to its liability under § 1.1502-6 for the consolidated tax of the group, in which event such member has sole authority to act for itself with respect to that liability. However, if the Commissioner believes or has reason to believe that the existence of the agent has terminated without an agent being identified under this section, the Commissioner may, if the Commissioner deems it advisable, deal directly with any member with respect to that member's liability under § 1.1502-6 without issuing notice to any other entity.

(ii) Information requests. The Commissioner may, upon issuing to the agent written notice, request information relevant to the consolidated tax liability from any member of the group. However, if the Commissioner believes or has reason to believe that the existence of the agent has terminated without an agent being identified under this section, the Commissioner may request such information from any member of the group without issuing notice to any other entity.

(iii) Members as partners in partnerships subject to the provisions of the Code. Except as otherwise provided in this paragraph (f)(2)(iii), the general rule of paragraph (a)(1) of this section applies so that the agent is the agent for any subsidiary member that for any part of the consolidated return year is a partner in a partnership subject to the provisions of sections 6221 through 6234 of the Code (as originally enacted by the Tax Equity and Fiscal Responsibility Act of 1982 and subsequently amended) and the accompanying regulations (TEFRA partnership). However—

(A) Any subsidiary or any disregarded entity owned by a subsidiary that is designated as tax matters partner of a TEFRA partnership will act in its own name and perform its responsibilities under sections 6221 through 6234 and the accompanying regulations without requiring any action by the agent (but see paragraph (d)(9) of this section regarding the mailing of a final partnership administrative adjustment to the agent); and

(B) The Commissioner may at any time communicate directly with a subsidiary or a disregarded entity owned by a subsidiary that is a partner in a TEFRA partnership, without having to deal with each member separately pursuant to paragraph (f)(2)(i) of this section, whenever the Commissioner determines that such direct communication will facilitate the conduct of an examination, appeal, or settlement with respect to the partnership.

(3) Copy of notice of deficiency to entity that has ceased to be a member of the group. A subsidiary that ceases to be a member of the group during or after a consolidated return year may file a written notice of that fact with the Commissioner and request a copy of any notice of deficiency with respect to the tax for a consolidated return year during which it was a member, or a copy of any notice and demand for payment of such deficiency, or both. Such filing does not limit the scope of the agency of the agent provided for in this section. Any failure by the Commissioner to comply with such request does not limit the subsidiary's tax liability under § 1.1502-6.

(g) Examples. Unless otherwise indicated, all entities are domestic and have a calendar year taxable year, and each of P, S, S-1, S-2, S-3, T, U, V, W, W-1, Y, Z, and Z-1 is a corporation. For none of the consolidated return years at issue does the Commissioner exercise the authority under paragraph (f)(2) of this section to deal with any member separately. Any surviving entity in a merger is either a successor as described in paragraph (b)(1) of this section, or a default successor as described in paragraph (b)(4) of this section, as the case may be. Except as otherwise indicated, no agent will be replaced under paragraph (c)(6) of this section or will resign under paragraph (c)(7) of this section, and all communications to and from the Commissioner are made in accordance with procedures prescribed by the Commissioner.

(1) Example 1—Disposition of all group members where the agent remains the agent. (i) Facts. As of January 1 of Year 1, P is the common parent and agent for the P consolidated group, consisting of P and its two subsidiaries, S and S-1. P files consolidated returns for the P group in Years 1 and 2. On December 31 of Year 1, P sells all the stock of S-1 to X. On December 31 of Year 2, P distributes all the stock of S to P's shareholders. P files a separate return for Year 3.

(ii) Analysis. Although the consolidated group terminates after Year 2 under § 1.1502-75(d)(1) and P is no longer the common parent nor the agent for years after Year 2, P remains the agent for the P group for Years 1 and 2 under paragraph (a)(2) of this section. Accordingly, for as long as P remains in existence, P is the agent for the P group under paragraphs (a)(1) and (2) and (c)(1) of this section for Years 1 and 2.

(2) Example 2—Acquisition of the agent by another group where the agent remains the agent. (i) Facts. The facts are the same as in paragraph (g)(1)(i) of this section (Example 1), except on January 1 of Year 3, all of the outstanding stock of P is acquired by Y, which is the common parent and agent of the Y consolidated group. P thereafter joins in the Y group's consolidated return as a member of the Y group.

(ii) Analysis. Although P is a member of the Y group in Year 3 and succeeding years, P remains the agent for the P group for Years 1 and 2 under paragraph (a)(2) of this section. Accordingly, for as long as P remains in existence, P is the agent for the P group under paragraphs (a)(1) and (2) and (c)(1) of this section for Years 1 and 2.

(3) Example 3—Reverse triangular merger of the agent where the agent remains the agent. (i) Facts. As of January 1 of Year 1, P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. P files consolidated returns for the P group in Years 1 and 2. On March 1 of Year 3, W-1, a subsidiary of W, merges into P in a reverse triangular merger qualifying as a reorganization under section 368(a)(1)(A) and (a)(2)(E). P survives the merger with W-1. The transaction constitutes a reverse acquisition under § 1.1502-75(d)(3)(i) because P's shareholders receive more than 50 percent of W's stock in exchange for all of P's stock. The transaction is therefore a group structure change as described in paragraph (c)(3) of this section.

(ii) Analysis. Because the transaction constitutes a reverse acquisition that results in a group structure change, the P group is treated as remaining in existence with W as its common parent and agent. Under paragraphs (a)(1) and (2) and (c)(1) of this section, P remains the agent for the P group for Years 1 and 2 for as long as P remains in existence, even though the P group continues with W as its new common parent pursuant to § 1.1502-75(d)(3)(i). Until the merger of W-1 and P on March 1 of Year 3, P is the agent for the P group for Year 3. From the time of that merger, W, as common parent of the P group, becomes the agent for the P group with respect to all of Year 3 (including the period through March 1) and succeeding consolidated return years. The actions taken by P before the merger as agent for the P group for Year 3 are not nullified by the fact that W becomes the agent for all of Year 3.

(4) Example 4—Reverse triangular merger of the agent—subsequent distribution of agent where the agent remains the agent. (i) Facts. The facts are the same as in paragraph (g)(3)(i) of this section (Example 3), except that on April 1 of Year 4, in a transaction unrelated to the March 1, Year 3 reverse acquisition, P distributes the stock of its subsidiaries S and S-1 to W, and W then distributes the stock of P to the W shareholders.

(ii) Analysis. Although P is no longer a member of the P group after the Year 4 distribution, P remains the agent for the P group under paragraphs (a)(1) and (2) and (c)(1) of this section for Years 1 and 2 for as long as P remains in existence.

(5) Example 5—Agent Resigns. (i) Facts. The facts are the same as in paragraph (g)(4) of this section (Example 4), except that on August 1 of Year 4, P provides written notice to the Commissioner that it resigns as the agent for Years 1 and 2. Included with the written notice is a statement executed by either S or S-1 consenting to be the agent for the P group for Years 1 and 2.

(ii) Analysis. Pursuant to paragraph (c)(7) of this section, because P is not the agent in Year 4, the current year, it will not be the agent immediately after its resignation takes effect. Accordingly, if the Commissioner does not object to P's resignation, P may resign with respect to Years 1 and 2, both of which are completed years, and either S or S-1, each an entity described in paragraph (c)(5)(ii)(A) of this section, can be the agent for the P group for Years 1 and 2 if it consents in writing. W cannot be the agent for the P group for Years 1 and 2 because it is not an entity described in paragraph (c)(5)(ii)(A) of this section with respect to the P group for Years 1 and 2.

(6) Example 6—Qualified stock purchase and section 338 election where the agent remains the agent. (i) Facts. As of January 1 of Year 1, P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. P files consolidated returns for the P group in Years 1 and 2. On March 31 of Year 2, V purchases the stock of P in a qualified stock purchase (within the meaning of section 338(d)(3)), and V makes a timely election pursuant to section 338(g) with respect to P.

(ii) Analysis. Although section 338(a)(2) provides that P is treated as a new corporation as of the beginning of the day after the acquisition date for purposes of subtitle A, paragraph (c)(8) of this section provides that P's existence is not deemed to terminate for purposes of this section notwithstanding the general rule of section 338(a)(2). Accordingly, new P is the agent for the P group for Year 1 and the period ending March 31 of Year 2 regardless of the election under section 338(g).

(7) Example 7—Change in the agent's federal income tax classification to a partnership and the resulting partnership continues as the agent. (i) Facts. P, a State M limited liability partnership with two partners that is formed on January 1 of Year 1, elects pursuant to § 301.7701-3(c) of this chapter to be an association taxable as a corporation for federal income tax purposes effective on the date of formation. P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. P files consolidated returns for the P group in Years 1 through 6. On January 1 of Year 7, P elects pursuant to § 301.7701-3(c) of this chapter to be treated as a partnership. P remains in existence under applicable law.

(ii) Analysis. The P group terminates and P is no longer the common parent of a consolidated group after its election to be treated as a partnership for federal income tax purposes. Because P remains in existence under applicable law, P is the agent for the P group under paragraphs (a)(1) and (2) and (c)(1) of this section for Years 1 through 6. If P merged into a foreign partnership instead of converting to a partnership, the foreign partnership would be P's default successor and agent for the P group for Years 1 through 6. See paragraphs (b)(4) and (c)(1) of this section.

(8) Example 8—Forward triangular merger of agent—successor as default successor. (i) Facts. As of January 1 of Year 1, P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. P files a consolidated return for the P group for Year 1. On January 1 of Year 3, P merges with and into Z-1, a subsidiary of Z, in a forward triangular merger qualifying as a reorganization under section 368(a)(1)(A) and (a)(2)(D). The transaction constitutes a reverse acquisition under § 1.1502-75(d)(3)(i) resulting in a group structure change as described in paragraph (c)(3) of this section because P's shareholders receive more than 50 percent of Z's stock in exchange for all of P's stock. Z-1, the corporation that survives the merger and the successor of P, is the default successor for the P group for Years 1 and 2.

(ii) Analysis. Although Z is the new common parent for the P group (which continues pursuant to § 1.1502-75(d)(3)(i)) for consolidated return years after the merger, and, as a consequence, Z is the new agent as a result of this group structure change, P may not designate an agent for Years 1 or 2 because Z-1 is P's default successor and the agent for the P group for Years 1 and 2. Z-1 must file the P group's consolidated return for Year 2. See paragraphs (b)(4) and (c)(1) of this section.

(9) Example 9—Merger of the agent into a disregarded entity in exchange for stock of owner in a transaction qualifying as a reorganization under the Code where successor is the default successor. (i) Facts. As of January 1 of Year 1, P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. P files a consolidated return for the P group in Year 1. On January 1 of Year 2, the shareholders of P form Y, a State M corporation. On the same date, Y forms Y-1, a State M limited liability company that is a disregarded entity (as defined in paragraph (b)(3) of this section) for federal income tax purposes, and P merges into Y-1 under State M law. In the merger, the P shareholders receive all of the Y stock. Y (through Y-1) is treated as acquiring the assets of P in a transaction qualifying as a reorganization of P into Y under section 368(a)(1)(F), and the P group continues under § 1.1502-75(d)(2) with Y as the common parent and, as a consequence, the transaction is treated as a group structure change as described in paragraph (c)(3) with Y as the P group's agent for Year 2. In Year 4, the Commissioner seeks to extend the period of limitations on assessment with respect to Year 1 of the P group. In Year 5, the Commissioner seeks to extend the period of limitations on assessment with respect to Year 2 of the Y group (formerly the P group).

(ii) Analysis. (A) Year 1 extension. As a result of the January 1, Year 2 merger, Y-1 is the default successor of P, and the agent for the P group for Year 1. See paragraphs (b)(4) and (c)(1) of this section. Therefore, Y-1 is the only party that can sign the extension with respect to the P group for Year 1.

(B) Year 2 extension. Because the January 1, Year 2 merger qualified as a reorganization under section 368(a)(1)(F), the P group remains in existence with Y as the common parent. Therefore, Y, the common parent of the P group after the merger, is the P group's agent for all of Year 2 (see paragraph (c)(3) of this section) and is the only party that can sign the extension with respect to the P group for that year and in succeeding years. See paragraphs (a)(1) and (2) and (c)(1) of this section.

(10) Example 10—Designation of agent where there is no default successor. (i) Facts. P is incorporated under the laws of State X. Fifty percent of its stock is owned at all times by A, an individual, and 50 percent by BCD, a partnership. On January 1 of Year 1, P forms two subsidiaries, S and T, and becomes the common parent of the P group. P files consolidated returns for the P group beginning in Year 1 and is the agent for the P consolidated group beginning on January 1 of Year 1. On November 30 of Year 3, P dissolves under X law. Under X law, A and BCD are primarily liable for the federal income tax liability of dissolved corporation P. State X law allows the officers of a dissolved corporation to perform certain actions incident to the winding up of its affairs after its dissolution, including the filing of tax returns.

(ii) Analysis. Upon P's dissolution, there is no default successor to P, pursuant to paragraph (b)(4) of this section, because there are two successors. Prior to its dissolution on November 30 of Year 3, pursuant to paragraph (c)(5)(i) of this section, P may designate an agent for the P group for Years 1 and 2 and the short taxable year ending on November 30 of Year 3, to be effective upon P's dissolution. P may designate S or T, pursuant to paragraph (c)(5)(ii)(A) of this section (because they are members of the former group), or BCD (because it is an entity that is a successor to P pursuant to paragraph (b)(1) of this section). P cannot designate A pursuant to paragraph (c)(5)(ii) of this section, because A is not an entity. Under paragraph (b)(2) of this section, the officers of P cannot designate an agent for the P group after P dissolves on November 30 of Year 3, notwithstanding the winding up provisions of State X law. Accordingly, P should designate an agent prior to its dissolution to ensure that there is an agent authorized to file the short Year 3 consolidated return. If P does not designate an agent prior to dissolution under paragraph (c)(5)(i) of this section, the Commissioner may designate an agent under paragraph (c)(6)(i)(A)(1) of this section from among S, T, or BCD, upon their request or otherwise. If any of S, T, A, or BCD realizes that P has dissolved without designating an agent, it should request, in writing, a designation of an agent by the Commissioner as soon as possible.

(11) Example 11—Commissioner designates a new agent. (i) Agent fails to fulfill its obligations. (A) Facts. P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S-1 and S-2, each a State Y corporation. P files a consolidated return for the P group in Year 1. In Year 2, S-3, also a State Y corporation, joins the P group. The P group continues as a consolidated group in Years 2, 3, and 4. As of Year 4, P has failed to file the P group consolidated returns for Years 2 and 3.

(B) Analysis. (1) Scope of designation. Because P failed to perform its obligations as agent as prescribed by federal tax law, the Commissioner may, under the authority of paragraph (c)(6)(i)(A)(3) of this section, on the Commissioner's own accord, with or without a written request from a member, designate another entity described in paragraph (c)(6)(i) of this section to act as the agent for not just Years 2 and 3, but any of Years 1 through 4.

(2) Year 1 designation. The Commissioner may designate either S-1 or S-2, both of which are entities described in paragraphs (c)(6)(i) and (c)(5)(ii)(A) of this section, to act as the agent for the P group for Year 1. Because S-3 was not a member of the group in Year 1, it is not an entity described in paragraphs (c)(6)(i) and (c)(5)(ii)(A) of this section for Year 1 and therefore cannot be the agent for Year 1. Unless otherwise provided in the designation, the designation of either S-1 or S-2 will also be effective for Years 2, 3, and 4 and all succeeding consolidated return years of the group.

(3) Year 2 designation. The Commissioner may designate either S-1, S-2, or S-3, all of which are entities described in paragraph (c)(5)(ii)(A) of this section, to act as the agent for the P group for Year 2. Unless otherwise provided in the designation, the designation of either S-1, S-2, or S-3 will also be effective for Years 3 and 4 and all succeeding consolidated return years of the group.

(4) Year 3 designation. The Commissioner may designate any of S-1, S-2, or S-3 as the agent for Year 3. Unless otherwise provided in the designation, the designation of either S-1, S-2, or S-3 will also be effective for Year 4 and all succeeding consolidated return years of the group.

(5) Year 4 designation. The Commissioner may designate any of S-1, S-2, or S-3 as the agent for Year 4. Unless otherwise provided in the designation, the designation of either S-1, S-2, or S-3 will also be effective for all succeeding consolidated return years of the group.

(ii) Member requests replacement of designated agent. (A) Facts. The facts are the same as in paragraph (g)(11)(i)(A) of this section, except that in Year 4 the Commissioner designates S-1 as agent for Years 1 and succeeding years to replace P for P's failure to fulfill its obligations. After receiving notification that S-1 has been designated, S-3 submits a request in Year 4, pursuant to paragraph (c)(6)(i)(B) of this section, that the Commissioner designate S-2 as the agent because S-1 does not have ready access to the group's books and records, which are located in another state and are in the possession of S-2.

(B) Analysis. In light of S-3's request, the Commissioner may, under the authority of paragraph (c)(6)(i)(B) of this section, designate either S-2 (for all or any years) or S-3 (for any year or years other than Year 1) as agent in lieu of the previously designated agent, S-1. However, notwithstanding S-3's request, the Commissioner is not required to replace S-1 as agent for any of the consolidated return years for which S-1 was designated.

(12) Example 12—Designated agent ceases to be a member of the group. (i) Facts. The facts are the same as in paragraph (g)(11)(ii)(A) of this section (Example 11), except that in Year 4 no member requests that the Commissioner replace S-1, which accordingly continues to be the agent for the P group in Year 5 pursuant to paragraph (c)(6)(iii) of this section. On May 2 of Year 5, S-1 converts under State Y law into S-1 LLC, a limited liability company that is an entity that is treated as a disregarded entity (as defined in paragraph (b)(3) of this section) and, as a consequence, is no longer a member of the P group after the conversion.

(ii) Analysis for completed years. S-1 LLC, the disregarded entity resulting from the conversion, becomes S-1's default successor. As such, S-1 LLC is the agent for Years 1-4.

(iii) Analysis for current and succeeding years. S-1 is an agent designated by the Commissioner pursuant to paragraph (c)(6)(i)(A)(3) of this section. Because S-1 is no longer a member of the P group after May 2 of Year 5, S-1 is the agent for the P group for Year 5 only while it remains a member (see paragraphs (c)(6)(i) and (iii) of this section). According to paragraph (c)(6)(i) of this section, although S-1 LLC is S-1's default successor, it is not a member of the group for the current year and therefore cannot be its agent. Furthermore, S-1 cannot designate an agent for Year 5 under paragraph (c)(5)(i) of this section because that paragraph pertains only to designations for completed years for which there is no default successor. In addition, S-1 cannot designate an agent for Year 5 under paragraph (c)(5)(i) of this section because S-1 was previously designated by the Commissioner under paragraph (c)(6)(i)(A)(3) of this section.

(iv) Member's notice to Commissioner for Commissioner to designate a member of the group for a current year. A member of the group in Year 5 should request that the Commissioner designate, pursuant to paragraphs (c)(6)(i)(A)(2) and (c)(6)(iv) of this section, another member of the P group to be the agent of the group for Year 5. The Commissioner may then, pursuant to paragraph (c)(6)(i)(A)(2) of this section, designate either S-2, S-3, or P to be the agent for the P group and, once so designated, that member will be, effective on May 3 of Year 5, the agent for all of Year 5 and for succeeding years (subject to the rules of this section) pursuant to paragraph (c)(6)(iii) of this section. No actions taken by S-1 on behalf of the P group through May 2, Year 5, are nullified by the Commissioner's designation of another agent even though the agent so designated will be the agent for all of Year 5.

(13) Example 13—Fraudulent conveyance of assets. (i) Facts. As of January 1 of Year 1, P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. On April 15 of Year 2, P files a consolidated return that includes the income of S and S-1 for Year 1. On December 1 of Year 2, S-1 transfers assets having a fair market value of $100x to U in exchange for $10x. This transfer of assets for less than fair market value constitutes a fraudulent conveyance under applicable state law. On March 1 of Year 5, P executes a waiver extending to December 31 of Year 6 the period of limitations on assessment with respect to the P group's Year 1 consolidated return. On February 1 of Year 6, the Commissioner issues a notice of deficiency to P asserting a deficiency of $30x for the P group's Year 1 consolidated tax liability. P does not file a petition for redetermination in the Tax Court, and the Commissioner makes a timely assessment against the P group. P, S, and S-1 are all insolvent and are unable to pay the deficiency. On February 1 of Year 8, the Commissioner sends a notice of transferee liability to U, which does not file a petition in the Tax Court. On August 1 of Year 8, the Commissioner assesses the amount of the P group's deficiency against U. Under section 6901(c), the Commissioner may assess U's transferee liability within one year after the expiration of the period of limitations against the transferor, S-1. By operation of section 6213(a) and 6503(a), the issuance of the notice of deficiency to P and the expiration of the 90-day period for filing a petition in the Tax Court have the effect of further extending by 150 days the P group's limitations period on assessment from the previously extended date of December 31 of Year 6 to May 30 of Year 7.

(ii) Analysis. Pursuant to paragraph (a)(1) of this section, the waiver executed by P on March 1 of Year 5 to extend the period of limitations on assessment to December 31 of Year 6 and the further extension of the P group's limitations period to May 30 of Year 7 (by operation of sections 6213(a) and 6503(a)) have the derivative effect of extending the period of limitations on assessment of U's transferee liability to May 30 of Year 8. By operation of section 6901(f), the issuance of the notice of transferee liability to U and the expiration of the 90-day period for filing a petition in the Tax Court have the effect of further extending the limitations period on assessment of U's liability as a transferee by 150 days, from May 30 of Year 8 to October 27 of Year 8. Accordingly, the Commissioner may send a notice of transferee liability to U at any time on or before May 30 of Year 8 and assess the unpaid liability against U at any time on or before October 27 of Year 8. The result would be the same even if S-1 ceased to exist before March 1 of Year 5, the date P executed the waiver.

(14) Example 14—Consent to extend the statute of limitations for a partnership where a member of the consolidated group is a partner of such partnership subject to the provisions of the Code and the tax matters partner is not a member of the group. (i) Facts. P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. The P group has a November 30 fiscal year end and P files consolidated returns for the P group for the years ending November 30, Year 1 and November 30, Year 2. S-1 is a partner in the PRS partnership, which is subject to the provisions of sections 6221 through 6234. PRS has a calendar year end and A, an individual, is the tax matters partner of the PRS partnership. PRS files a partnership return for the year ending December 31, Year 1. On January 10, Year 5, A, as the tax matters partner for the PRS partnership, executes a consent to extend the period for assessment of partnership items of PRS for all partners, and the Commissioner co-executes the consent on the same day for the year ending December 31, Year 1.

(ii) Analysis. A's consent to extend the statute of limitations for the partnership items of PRS partnership for the year ending December 31, Year 1, extends the statute of limitations with respect to the partnership items for all members of the P group, including P, S, and S-1 for the consolidated return year ending November 30, Year 2. This is because S-1 is a partner in the PRS partnership for which A, the tax matters partner for the PRS partnership, consents, pursuant to section 6229(b)(1)(B), to extend the statute of limitations for the year ending December 31, Year 1. However, under paragraph (f)(2)(iii) of this section, such agreement with respect to the statute of limitations for the PRS partnership for the year ending December 31, Year 1 does not obviate the need to obtain a consent from P, the agent for the P consolidated group, to extend the statute of limitations for the P consolidated group for the P group's consolidated return years ending November 30, Year 1 and November 30, Year 2 regarding any items other than partnership items or affected items of the PRS partnership.

(15) Example 15—Contacting subsidiary member in order to facilitate the conduct of an examination, appeal, or settlement where a member of the consolidated group is a partner of a partnership subject to the provisions of the Code. (i) Facts. P is the common parent and agent for the P consolidated group consisting of P and its two subsidiaries, S and S-1. The P group has a November 30 fiscal year end, and P files consolidated returns for the P group for the years ending November 30, Year 1 and November 30, Year 2. S-1 is a partner in the PRS partnership, which is subject to the provisions of sections 6221 through 6234. PRS has a calendar year end and A, an individual, is the tax matters partner of the PRS partnership. PRS files a partnership return for the year ending December 31, Year 1. The Commissioner, on January 10, Year 4, in the course of an examination of the PRS partnership for the year ending December 31, Year 1, seeks to obtain information in the course of that examination to resolve the audit.

(ii) Analysis. Because the direct contact with a subsidiary member of a consolidated group that is a partner in a partnership subject to the provisions under sections 6221 through 6234 may facilitate the conduct of an examination, appeal, or settlement, the Commissioner, under paragraph (f)(2)(iii) of this section, may communicate directly with either S-1, P, or A regarding the PRS partnership without breaking agency pursuant to paragraph (f)(2)(i) of this section. However, if the Commissioner were instead seeking to execute a settlement agreement with respect to S-1 as a partner with respect to its liability as a partner in PRS partnership, P would need to execute such settlement agreement for all members of the group including the partner subsidiary.

(h) Cross-reference. For further rules applicable to groups that include insolvent financial institutions, see § 301.6402-7 of this chapter.

(i) [Reserved]

(j) Effective/applicability date—(1) In general. The rules of this section apply to consolidated return years beginning on or after April 1, 2015. For prior years beginning before June 28, 2002, see § 1.1502-77A. For prior years beginning on or after June 28, 2002, and before April 1, 2015, see § 1.1502-77B.

(2) Application of this section to prior years. Notwithstanding paragraph (j)(1) of this section, an agent may apply the rules of paragraph (c)(7) of this section to resign as agent for a completed year that began before April 1, 2015.

[T.D. 9715, 80 FR 17318, Apr. 1, 2015, as amended at 80 FR 23237, Apr. 27, 2015; T.D. 10018, 89 FR 106876, Dec. 30, 2024]

§ 1.1502-78 Tentative carryback adjustments.

(a) General rule. If a group has a consolidated net operating loss, a consolidated net capital loss, or a consolidated unused business credit for any taxable year, then any application under section 6411 for a tentative carryback adjustment of the taxes for a consolidated return year or years preceding such year shall be made by the common parent corporation for the carryback year (or the agent determined under § 1.1502-77(c) or § 1.1502-77B(d) for the carryback year) to the extent such loss or unused business credit is not apportioned to a corporation for a separate return year pursuant to § 1.1502-21(b), 1.1502-22(b), or 1.1502-79(c). In the case of the portion of a consolidated net operating loss or consolidated net capital loss or consolidated unused business credit to which the preceding sentence does not apply and that is to be carried back to a corporation that was not a member of a consolidated group in the carryback year, the corporation to which such loss or credit is attributable shall make any application under section 6411. In the case of a net capital loss or net operating loss or unused business credit arising in a separate return year that may be carried back to a consolidated return year, after taking into account the application of § 1.1502-21(b)(4) with respect to any net operating loss arising in another consolidated group, the common parent for the carryback year (or the agent determined under § 1.1502-77(c) or § 1.1502-77B(d) for the carryback year) shall make any application under section 6411.

(b) Special rules—(1) Payment of refund. Any refund allowable under an application referred to in paragraph (a) of this section shall be made directly to and in the name of the corporation filing the application, except that in all cases where a loss is deducted from the consolidated taxable income or a credit is allowed in computing the consolidated tax liability for a consolidated return year, any refund shall be made directly to and in the name of the common parent corporation for the carryback year (or the agent determined under § 1.1502-77(c) or § 1.1502-77B(d) for the carryback year). The payment of any such refund shall discharge any liability of the Government with respect to such refund.

(2) Several liability. If a group filed a consolidated return for a taxable year for which there was an adjustment by reason of an application under section 6411, and if a deficiency is assessed against such group under section 6213(b)(3), then each member of such group shall be severally liable for such deficiency including any interest or penalty assessed in connection with such deficiency.

(3) Groups that include insolvent financial institutions. For further rules applicable to groups that include insolvent financial institutions, see § 301.6402-7 of this chapter.

Example 1.Corporations P, S, and S-1 filed a consolidated return for the calendar year 2003. P, S, and S-1 also filed a consolidated return for the calendar year 2006. The group incurred a consolidated net operating loss in 2006 attributable to S-1 which may be carried back to 2003 as a consolidated net operating loss carryback. If a tentative carryback adjustment is desired, P, the common parent for the carryback year, must file an application under section 6411 and any refund will be made to P.

Example 2.Assume the same facts as in example (1) except that P, S, and S-1 filed separate returns for the calendar year 2006, even though they were members of the same group for such year. P incurred a net operating loss in 1969 which may be carried back to 2003. If a tentative carryback adjustment is desired, P must file an application under section 6411 and any refund from such application will be made to P.

Example 3.Corporations X, Y, and Z filed a consolidated return for the calendar year 2003. Z ceased to be a member of the group in 2004. Z filed a separate return for 2005 while X and Y filed a consolidated return for such year. The group incurred a consolidated net operating loss in 2005 attributable to Y, which may be carried back to 2003. Z also incurred a net operating loss for 2005 which may be carried back to 2003. If a tentative carryback adjustment is claimed with respect to the consolidated net operating loss, X, the common parent, must file an application under section 6411. If a tentative carryback adjustment is desired with respect to Z's loss, X must file an application. Any refunds attributable to either application will be made to X. If an assessment is made under section 6213(b)(3) to recover an excessive tentative allowance made with respect to calendar year 2003, X, Y, and Z are severally liable for such assessment.

Example 4.Corporations L and M filed a consolidated return for the calendar year 2003. Corporation N filed a separate return for such year. Later, N became a member of the group and filed a consolidated return with the group for the calendar year 2005. The group incurred a consolidated net operating loss in 2005 attributable to N which may be carried back to N's separate return for 2003. If a tentative carryback adjustment is desired, N must file an application under section 6411 and any refund will be made directly to N.

(d) Adjustments of overpayments of estimated income tax. If a group paid its estimated income tax on a consolidated basis, then any application under section 6425 for an adjustment of overpayment of estimated income tax shall be made by the common parent corporation. If the members of a group paid estimated income taxes on a separate basis, then any application under section 6425 shall be made by the member of the group which claims an overpayment on a separate basis. Any refund allowable under an application under section 6425 shall be made directly to and in the name of the corporation filing the application.

(e) Time for filing application—(1) General rule. The provisions of section 6411(a) apply to the filing of an application for a tentative carryback adjustment by a consolidated group.

(2) Special rule for new members—(i) New member. A new member is a corporation that, in the preceding taxable year, did not qualify as a member, as defined in § 1.1502-1(b), of the consolidated group that it now joins.

(ii) End of taxable year. Solely for the purpose of complying with the twelve-month requirement for making an application for a tentative carryback adjustment under section 6411(a), the separate return year of a qualified new member shall be treated as ending on the same date as the end of the current taxable year of the consolidated group that the qualified new member joins.

(iii) Qualified new member. A new member of a consolidated group qualifies for purposes of the provisions of this paragraph (e)(2) if, immediately prior to becoming a new member, either—

(A) It was the common parent of a consolidated group; or

(B) It was not required to join in the filing of a consolidated return.

(iv) Examples. The provisions of this paragraph (e)(2) may be illustrated by the following examples:

Example 1.Individual A owns 100 percent of the stock of X, a corporation that is not a member of a consolidated group and files separate tax returns on a calendar year basis. On January 31 of year 1, X becomes a member of the Y consolidated group, which also files returns on a calendar year basis. X is a qualified new member as defined in paragraph (e)(2)(iii)(B) of this section because, immediately prior to becoming a new member of the Y consolidated group, X was not required to join in the filing of a consolidated return. As a result of its becoming a new member of Group Y, X's separate return for the short taxable year (January 1 of year 1 through January 31 of year 1) is due September 15 of year 2 (with extensions). See § 1.1502-76(c). Group Y's consolidated return is also due September 15 of year 2 (with extensions). See § 1.1502-76(c). Solely for the purpose of complying with the twelve-month requirement for making an application for a tentative carryback adjustment under section 6411(a), X's taxable year for the separate return year is treated as ending on December 31 of year 1. X's application for a tentative carryback adjustment is therefore due on or before December 31 of year 2.

Example 2.Assume the same facts as in Example 1 except that immediately prior to becoming a new member of Group Y, X was a member of the Z consolidated group. Because X was required to join in the filing of the consolidated return for Group Z, X is not a qualified new member as defined in paragraph (e)(2)(iii) of this section. X's items for the one-month period will be included in the consolidated return for Group Z. Group Z's application for a tentative carryback adjustment, if any, continues to be due within 12 months of the end of its taxable year, which is not affected by X's change in status as a new member of Group Y.

(f) Applicability date. This section applies to taxable years to which a loss or credit may be carried back and for which the due date (without extensions) of the original return is after June 28, 2002, except that the provisions of paragraph (e)(2) of this section apply for applications by new members of consolidated groups for tentative carryback adjustments resulting from net operating losses, net capital losses, or unused business credits arising in separate return years of new members that begin on or after January 1, 2001.

(2) Prior law. For taxable years to which a loss or credit may be carried back and for which the due date (without extensions) of the original return is on or before June 28, 2002, see § 1.1502-78 in effect prior to June 28, 2002, as contained in 26 CFR part 1 revised April 1, 2002.

[T.D. 6894, 31 FR 11794, Sept. 3, 1966, as amended by T.D. 7059, 35 FR 14546, Sept. 17, 1970; T.D. 7246, 38 FR 767, Jan. 4, 1973; T.D. 8387, 56 FR 67489, Dec. 31, 1991; T.D. 8446, 57 FR 53034, Nov. 6, 1992; T.D. 8677, 61 FR 33324, June 27, 1996; T.D. 8823, 64 FR 36100, July 2, 1999; T.D. 8950, 66 FR 33463, June 22, 2001; T.D. 9002, 67 FR 43544, June 28, 2002; 67 FR 77678, Dec. 19, 2002; T.D. 9715, 80 FR 17324, Apr. 1, 2015; T.D. 9977, 88 FR 44216, July 12, 2023; T.D. 10018, 89 FR 106876, Dec. 30, 2024]

§ 1.1502-79 Separate return years.

(a) Carryover and carryback of consolidated net operating losses to separate return years. For rules regarding the carryover and carryback of consolidated net operating losses to separate return years, see § 1.1502-21(b).

(b) Carryover and carryback of consolidated net capital loss to separate return years. For rules regarding the carryover and carryback of consolidated net capital losses to separate return years, see § 1.1502-22(b).

(c) Carryover and carryback of consolidated unused investment credit to separate return years—(1) In general. If a consolidated unused investment credit can be carried under the principles of section 46(b) and paragraph (b) of § 1.1502-3 to a separate return year of a corporation (or could have been so carried if such corporation were in existence) which was a member of the group in the year in which such unused credit arose, then the portion of such consolidated unused credit attributable to such corporation (as determined under subparagraph (2) of this paragraph) shall be apportioned to such corporation (and any successor to such corporation in a transaction to which section 381(a) applies) under the principles of § 1.1502-21(b) (or §§ 1.1502-79A(a)(1) and (2), as appropriate) and shall be an investment credit carryover or carryback to such separate return year.

(2) Portion of consolidated unused investment credit attributable to a member—(i) Investment credit carryback. In the case of a consolidated unused credit which is an investment credit carryback, the portion of such consolidated unused credit attributable to a member of the group is an amount equal to such consolidated unused credit multiplied by a fraction, the numerator of which is the credit earned of such member for the consolidated unused credit year, and the denominator of which is the consolidated credit earned for such unused credit year.

(ii) Investment credit carryover. In the case of a consolidated unused credit which is an investment credit carryover, the portion of such consolidated unused credit attributable to a member of the group is an amount equal to such consolidated unused credit multiplied by a fraction, the numerator of which is the credit earned with respect to any section 38 property placed in service in the consolidated unused credit year and owned by such member (whether or not placed in service by such member) at the close of the last day as of which the taxable income of such member is included in a consolidated return filed by the group, and the denominator of which is the consolidated credit earned for such unused credit year.

(d) Carryover and carryback of consolidated unused foreign tax—(1) In general. If a consolidated unused foreign tax can be carried under the principles of section 904(c) and § 1.1502-4(d) to a separate return year of a corporation (or could have been so carried if such corporation were in existence) that was a member of the group in the year in which the unused foreign tax arose, then the portion of the consolidated unused foreign tax attributable to the corporation (as determined under paragraph (d)(2) of this section) is apportioned to the corporation (and any successor to that corporation in a transaction to which section 381(a) applies) under the principles of § 1.1502-21(b) and is deemed paid or accrued in such separate return year to the extent provided in section 904(c).

(2) Portion of consolidated unused foreign tax attributable to a member. The portion of a consolidated unused foreign tax for any year attributable to a member is an amount equal to the consolidated unused foreign tax multiplied by a fraction. The numerator of the fraction is the foreign taxes paid or accrued by the member for the year (including those taxes deemed paid or accrued, other than by reason of section 904(c)). The denominator of the fraction is the aggregate of all such taxes paid or accrued for the year (including those taxes deemed paid or accrued, other than by reason of section 904(c)) by all members of the group.

(e) Carryover of consolidated excess charitable contributions to separate return years—(1) In general. If the consolidated excess charitable contributions for any taxable year can be carried under the principles of section 170(b)(2) and § 1.1502-24(b) to a separate return year of a corporation (or could have been so carried if such corporation were in existence) which was a member of the group in the year in which such excess contributions arose, then the portion of such consolidated excess charitable contributions attributable to such corporation (as determined under paragraph (e)(2) of this section) is apportioned to such corporation (and any successor to such corporation in a transaction to which section 381(a) applies) under the principles of § 1.1502-21(b) and is a charitable contribution carryover to such separate return year.

(2) Portion of consolidated excess charitable contributions attributable to a member. The portion of the consolidated excess charitable contributions for any year attributable to a member is an amount equal to the consolidated excess contributions multiplied by a fraction. The numerator of the fraction is the charitable contributions paid by the member for the year. The denominator of the fraction is the aggregate of all charitable contributions paid for the year by all members of the group.

(f) Disallowed business interest expense carryforwards. For the treatment of disallowed business interest expense carryforwards (as defined in § 1.163(j)-1(b)(11)) of a member arising in a separate return limitation year, see § 1.163(j)-5(d) and (f).

[T.D. 6894, 31 FR 11794, Sept. 8, 1966, as amended by T.D. 7728, 45 FR 72650, Nov. 3, 1980; T.D. 8294, 55 FR 9438, Mar. 14, 1990; T.D. 8319, 55 FR 49038, Nov. 26, 1990; T.D. 8364, 56 FR 47402, Sept. 19, 1991; T.D. 8597, 60 FR 36710, July 18, 1995; T.D. 8677, 61 FR 33324, 33325, 33334, June 27, 1996; T.D. 8823, 64 FR 36100, July 2, 1999; T.D. 9905, 85 FR 56843, Sept. 14, 2020; T.D. 10018, 89 FR 106876, Dec. 30, 2024]

§ 1.1502-80 Applicability of other provisions of law.

(a) In general—(1) Application of other provisions. The Internal Revenue Code (Code), or other law, shall be applicable to the group to the extent the regulations do not exclude its application. To the extent not excluded, other rules operate in addition to, and may be modified by, these regulations. Thus, for example, in a transaction to which section 381(a) applies, the acquiring corporation will succeed to the tax attributes described in section 381(c). Furthermore, sections 269 and 482 apply for any consolidated return year. However, in a recognition transaction otherwise subject to section 1001, for example, the rules of section 1001 continue to apply, but may be modified by the intercompany transaction regulations under § 1.1502-13.

(2) No duplicative adjustments. Nothing in these regulations shall be interpreted or applied to require an adjustment, inclusion, or other item to the extent it would have the effect of duplicating any other adjustment, inclusion, or other item required under the Code or other rule of law, including other provisions of these regulations.

(3) Application of single-entity principles. If two or more adjustments, inclusions, or other items are subject to paragraph (a)(2) of this section, the determination of which adjustment, inclusion, or other item is treated as applied or taken into account is made by taking into account the purposes of the provisions and applying single-entity principles as appropriate.

(4) Effective/applicability dates. This paragraph (a) is applicable with respect to transactions and determinations on or after September 17, 2008.

(b) Non-applicability of section 304. Section 304 does not apply to any acquisition of stock of a corporation in an intercompany transaction or to any intercompany item from such transaction occurring on or after July 24, 1991.

(c) Deferral of section 165—(1) General rule. Subsidiary stock is not treated as worthless under section 165 until immediately before the earlier of the time—

(i) The stock is worthless within the meaning of § 1.1502-19(c)(1)(iii); or

(ii) The subsidiary for any reason ceases to be a member of the group.

(2) Cross reference. See § 1.1502-36 for additional rules relating to worthlessness of subsidiary stock.

(3) Effective/applicability date. This paragraph (c) applies to taxable years for which the original consolidated Federal income tax return is due (without extensions) after July 18, 2007. However, taxpayers may apply this paragraph (c) to taxable years beginning on or after January 1, 1995.

(d) Non-applicability of section 357(c)—(1) In general—(i) General rule. Section 357(c) does not apply to any transaction to which § 1.1502-13 applies. Notwithstanding the foregoing, for purposes of determining the transferor's basis in property under section 358(a) received in a transfer described in section 351, section 358(d)(2) operates to exclude liabilities described in section 357(c)(3)(A), other than those also described in section 357(c)(3)(B), from the computation of the amount of liabilities assumed that is treated as money received under section 358(d)(1).

(ii) Application. This paragraph (d) does not apply to a transaction if the transferor or transferee becomes a nonmember as part of the same plan or arrangement. The transferor (or transferee) is treated as becoming a nonmember once it is no longer a member of a consolidated group that includes the transferee (or transferor). For purposes of this paragraph (d), any reference to a transferor or transferee includes, as the context may require, a reference to a successor or predecessor.

(2) Tax years beginning before January 1, 1995. If, in a tax year beginning before January 1, 1995, a member's stock with an excess loss account is transferred in a transaction to which § 1.1502-13, § 1.1502-13T, § 1.1502-14, or § 1.1502-14T applies, paragraph (d)(1) of this section applies to the stock transfer to the extent that the income, gain, deduction, or loss (if any) is not taken into account in a tax year beginning before January 1, 1995. For example, if P, S, and T, are members of a consolidated group, T's stock has an excess loss account, and P transfers the T stock to S in 1993 in a transaction to which section 351 and § 1.1502-13 apply, section 357(c) applies to the transfer only to the extent P's gain is taken into account in tax years beginning before January 1, 1995.

(3) Example—(i) Facts. P owns all the stock of S1. S1 has assets with a total fair market value equal to $100 and an aggregate basis of $30. S1 has $40 of liabilities, $5 of which are described in section 357(c)(3)(A) but not section 357(c)(3)(B), and $35 of which are not described in section 357(c)(3)(A). S1 transfers its assets to a newly formed subsidiary, S2, in exchange for stock of S2 and S2's assumption of the $40 of liabilities in a transaction to which section 351 applies. P, S1, and S2 are members of a consolidated group.

(ii) Analysis. Section 357(c) does not apply to cause S1 to recognize gain in connection with the transfer. For purposes of determining S1's basis in the S2 stock it received in the exchange, section 358(d)(2) operates to exclude $5 of the liabilities from the computation of the amount of liabilities assumed that are treated as money received under section 358(d)(1). S1's basis in the S2 stock received in the exchange is a $5 excess loss account (reflecting its $30 basis in the assets transferred reduced by $35, the amount of liabilities assumed that are not described in section 357(c)(3)(A)).

(4) Applicability dates. Paragraphs (d)(1) and (3) of this section apply to transactions occurring in consolidated return years for which the due date of the return (without regard to extensions) is after October 16, 2026. For rules that apply to transactions occurring in earlier taxable years, see § 1.1502-80(d) as contained in 26 CFR part 1, revised April 1, 2026.

(e) Non-applicability of section 163(e)(5). Section 163(e)(5) does not apply to any intercompany obligation (within the meaning of § 1.1502-13(g)) issued in a consolidated return year beginning on or after July 12, 1995.

(f) Non-applicability of section 1031. Section 1031 does not apply to any intercompany transaction occurring in consolidated return years beginning on or after July 12, 1995.

(g) Special rules for liquidations to which section 332 applies. Notwithstanding the general rule of section 381, if multiple members (distributee members) acquire assets of a corporation in a liquidation to which section 332 applies (regardless of whether any single member owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2)), such members succeed to and take into account the items of the liquidating corporation (including items described in section 381(c), but excluding intercompany items under § 1.1502-13) as provided in this paragraph (g) to the extent not otherwise prohibited by any applicable provision of law. This paragraph (g) does not apply to the intercompany items of the liquidating corporation. See § 1.1502-13(j)(2)(ii).

(1) Income offset items and deferred income. Except as otherwise provided in this paragraph (g)(1), each distributee member succeeds to and takes into account the items of the liquidating corporation that could be used to offset the income of the group or any member (including deferred deductions, net operating loss carryovers, and capital loss carryovers) (income offset items) to the extent that such items would have been reflected in investment adjustments to the stock of the liquidating corporation owned by such distributee member under § 1.1502-32(c) if, immediately prior to the liquidation, any stock of the liquidating corporation owned by nonmembers had been redeemed and then such items had been taken into account. However, each distributee member succeeds to the full amount of any deferred deduction or deferred income item attributable to the particular property or business operations distributed to such distributee in the liquidation to the extent that such item is not taken into account in the determination of the income or loss of the liquidating corporation with regard to the liquidation under chapter 1 of the Internal Revenue Code (Code). If the liquidating corporation is not a member of the group at the time of the liquidation, the rules of this paragraph (g)(1) are applied as if the liquidating corporation had been a member of the group.

(2) Accounting for deferred income items. Solely for the purpose of determining whether deferred income items of a liquidating corporation are taken into account under applicable principles of law as a result of a liquidation to which section 332 applies, the transfer of property to, and the assumption of liabilities by, a distributee member that does not own stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of § 1.1502-34 immediately prior to the liquidation is not treated as part of a transaction to which section 381(a) applies. In addition, section 332(a) does not apply in determining the recognition or nonrecognition of any income realized by the distributee member under applicable principles of law on account of consideration received (or deemed received) on the assumption of the liquidating corporation's obligation or liability attributable to any deferred income item.

(3) Credits and earnings and profits. Each distributee member succeeds to and takes into account a percentage of each credit of the liquidating corporation equal to the value of the stock of the liquidating corporation owned by such distributee at the time of the liquidation divided by the total value of all the stock of the liquidating corporation owned by members of the group at the time of the liquidation. Except to the extent that the distributee member's earnings and profits already reflect the liquidating corporation's earnings and profits, each distributee member succeeds to and takes into account under the principles of § 1.1502-32(c) the earnings and profits, or deficit in earnings and profits, of the liquidating corporation (determined after taking into account the amount of earnings and profits properly applicable to distributions to non-member shareholders under § 1.381(c)(2)-1(c)(2)). If the liquidating corporation is not a member of the group at the time of the liquidation, the rules of this paragraph (g)(3) are applied as if the liquidating corporation had been a member of the group.

(4) Other items. With regard to items to which neither paragraph (g)(1) nor (g)(3) of this section applies, a distributee member that, immediately prior to the liquidation, owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of § 1.1502-34 succeeds to the items of the liquidating corporation in accordance with section 381 and other applicable principles. A distributee member that, immediately prior to the liquidation, does not own stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of § 1.1502-34 succeeds to the items of the liquidating corporation to the extent that it would have succeeded to those items if it had purchased, in a taxable transaction, the assets or businesses of the liquidating corporation that it received in the liquidation and had assumed the liabilities that it assumed in the liquidation.

(5) Determination of the items of a liquidating subsidiary. For purposes of this section, the items of a liquidating subsidiary include the amount of any consolidated tax attribute attributable to the liquidating subsidiary that is determined pursuant to the principles of § 1.1502-21(b)(2)(iv). In addition, if the liquidating subsidiary is a member of a separate return limitation year subgroup, the amount of a tax attribute that arose in a separate return limitation year that is attributable to that member shall also be determined pursuant to the principles of § 1.1502-21(b)(2)(iv).

(6) Examples. The following examples illustrate the application of this paragraph (g):

Example 1. Liquidation—80 percent distributee. (i) Facts. X has only common stock outstanding. On January 1 of year 1, X acquired equipment with a 10-year recovery period and elected to depreciate the equipment using the straight-line method of depreciation. On January 1 of year 7, M1 and M2 own 80 percent and 20 percent, respectively, of X's stock. X is a domestic corporation but is not a member of the group that includes M1 and M2. On that date, X distributes all of its assets to M1 and M2 in complete liquidation. The equipment is distributed to M1. Under section 334(b), M1's basis in the equipment is the same as it would be in X's hands. After computing its tax liability for the taxable year that includes the liquidation, X has net operating losses of $100, business credits of $40, and earnings and profits of $80.

(ii) Succession to items described in section 381(c). (A) Losses. Under paragraph (g)(1) of this section, each distributee member succeeds to X's items that could be used to offset the income of the group or any member to the extent that such items would have been reflected in investment adjustments to the stock of X it owned under § 1.1502-32(c) if, immediately prior to the liquidation, such items had been taken into account. Accordingly, M1 and M2 succeed to $80 and $20, respectively, of X's net operating loss.

(B) Credits and earnings and profits. Under paragraph (g)(3) of this section, because, immediately prior to the liquidation, M1 and M2 hold 80 percent and 20 percent, respectively, of the value of the stock of X, M1 and M2 succeed to $32 and $8, respectively, of X's $40 of business credits. In addition, because M1's and M2's earnings and profits do not reflect X's earnings and profits, X's earnings and profits are allocated to M1 and M2 under the principles of § 1.1502-32(c). Therefore, M1 and M2 succeed to $64 and $16, respectively, of X's earnings and profits.

(C) Depreciation of equipment's basis. Under paragraph (g)(4) of this section, because M1 owns stock in X meeting the requirements of section 1504(a)(2) without regard to the application of § 1.1502-34, M1 is required to continue to depreciate the equipment using the straight-line method of depreciation over the remaining recovery period of 4.5 years (assuming X used a half-year convention).

Example 2. Liquidation-no 80 percent distributee. (i) Facts. The facts are the same as in Example 1 except that M1 and M2 own 60 percent and 40 percent, respectively, of X's stock. In addition, on January 1 of year 6, X entered into a long-term contract with Y, an unrelated party. The total contract price is $1000, and X estimates the total allocable contract costs to be $500. At the time of the liquidation, X had received $250 in progress payments under the contract and incurred costs of $125. X accounted for the contract under the percentage of completion method described in section 460(b). In the liquidation, M1 assumes X's contract obligations and rights.

(ii) Succession to items described in section 381(c). (A) Losses. Under paragraph (g)(1) of this section, each distributee member succeeds to X's items that could be used to offset the income of the group or any member to the extent that such items would have been reflected in investment adjustments to the stock of X it owned under § 1.1502-32(c) if, immediately prior to the liquidation, such items had been taken into account. Accordingly, M1 and M2 succeed to $60 and $40, respectively, of X's net operating loss.

(B) Credits and earnings and profits. Under paragraph (g)(3) of this section, because, immediately prior to the liquidation, M1 and M2 hold 60 percent and 40 percent, respectively, of the value of the stock of X, M1 and M2 succeed to $24 and $16, respectively, of X's $40 of business credits. In addition, because M1's and M2's earnings and profits do not reflect X's earnings and profits, X's earnings and profits are allocated to M1 and M2 under the principles of § 1.1502-32(c). Therefore, M1 and M2 succeed to $48 and $32, respectively, of X's earnings and profits.

(C) Depreciation of equipment's basis. Under section 334(a), M1's basis in the equipment is its fair market value at the time of the distribution. Pursuant to section 168(i)(7), to the extent that M1's basis in the equipment does not exceed X's adjusted basis in the equipment at the time of the transfer, M1 is required to continue to depreciate the equipment using the straight-line method of depreciation over the remaining recovery period of 4.5 years (assuming X used a half-year convention). Any portion of M1's basis in the equipment that exceeds X's adjusted basis in the equipment at the time of the transfer is treated as being placed in service by M1 in the year of the transfer. Thus, M1 may choose any applicable depreciation method, recovery period, and convention under section 168 for such excess basis.

(D) Method of accounting for long-term contract. Under paragraph (g)(4) of this section, M1 does not succeed to X's method of accounting for the contract. Rather, under § 1.460-4(k)(2), M1 is treated as having entered into a new contract on the date of the liquidation. Under § 1.460-4(k)(2)(iii), M1 must evaluate whether the new contract should be classified as a long-term contract within the meaning of § 1.460-1(b) and account for the contract under a permissible method of accounting.

Example 3. Liquidation—deferred items. (i) Facts. X has only common stock outstanding, and M1 and M2 (who are members of the same group) own 80 percent and 20 percent, respectively, of X's stock. X operates two divisions, each of which defers prepaid subscription income pursuant to an election under section 455. X distributes all of its assets in complete liquidation. M1 receives all of the assets of Division 1, including prepaid subscription income, and assumes X's liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income received by M1 relates. M2 receives all of the assets of Division 2, including prepaid subscription income, and assumes X's liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income received by M2 relates.

(ii) Acceleration of deferred income items and succession to other deferred items. Under paragraph (g)(1) of this section, M1 succeeds to the full amount of the deferred prepaid subscription income of X attributable to Division 1. Under applicable law, X does not recognize the deferred prepaid subscription income attributable to Division 1 because X's liability to furnish or deliver the newspaper, magazine, or other periodical ends as a result of a transaction to which section 381(a) applies. Under paragraph (g)(2) of this section, solely for purposes of determining whether the deferred income items of X attributable to Division 2 are taken into account as a result of the liquidation, the distribution of property to M2 is not treated as a transaction to which section 381(a) applies. Therefore, under applicable law, X's deferred prepaid subscription income attributable to Division 2 is taken into account in the determination of X's income or loss with regard to the liquidation. Further, under paragraph (g)(2) of this section, section 332(a) does not apply in determining the recognition or nonrecognition of any income that M2 realizes on account of consideration received (or deemed received) on its assumption of X's liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income relates.

(7) Effective/applicability date. This paragraph (g) applies to transactions occurring after April 14, 2008.

(h) Non-applicability of section 362(e)(2)—(1) General rule. Section 362(e)(2) does not apply to any intercompany transaction occurring on or after September 17, 2008. Taxpayers may apply this paragraph (h) to intercompany transactions occurring on or after October 22, 2004, and in such case, any election made under section 362(e)(2)(C) will have no effect. The purpose of this paragraph (h) is to facilitate the application of the consolidated return provisions addressing the duplication of loss between members of a consolidated group.

(2) Anti-abuse rule—(i) General rule. If a taxpayer engages in a transaction to which section 362(e)(2) would apply but for the application of paragraph (h)(1) of this section, and acts with a view to prevent the consolidated return provisions from properly addressing loss duplication, appropriate adjustments will be made to clearly reflect the income of the group.

(ii) Example. The following example illustrates the principle of the anti-abuse rule in this paragraph (h)(2).

Example. (A) Facts. P, the common parent of a consolidated group, owns the four outstanding shares of S stock (Share 1 through Share 4) with an aggregate basis of $0 and value of $80. S owns Asset 1 with a basis of $0 and a value of $80. With a view to prevent the consolidated return provisions from addressing the duplication of loss, P transfers Asset 2 with a basis of $100 and a value of $20 to S in exchange for an additional share of S stock (Share 5) in a transaction to which section 351 applies. P later sells Share 5 to X, an unrelated person, for $20 at a time when S's basis in Asset 2 was still $100. The sale is a transfer of a loss share and therefore subject to § 1.1502-36.

(B) Analysis. Although the sale would be subject to § 1.1502-36, that section would not prevent the stock loss or reduce S's attributes (to prevent duplication of the stock loss) because neither § 1.1502-36(b) nor § 1.1502-36(c) would adjust the basis of the transferred share (because there are no investment adjustments) and § 1.1502-36(d) would not reduce S's attributes (because S's aggregate inside loss is $0). However, because P acted with a view to prevent the consolidated return provisions from addressing the duplication of the loss on Asset 2, P's transfer of Asset 2 to S is subject to the anti-abuse rule in this paragraph (h)(2). Accordingly, effective immediately before the transfer of Share 5 to X, either P's basis in Share 5 or S's basis in Asset 2 must be adjusted to reflect what it would have been had section 362(e)(2) been applied at the time P transferred Asset 2 to S (taking into account the interim facts and circumstances). Accordingly, S must either reduce its basis in Asset 2 by $80 to $20 (eliminating the duplicated loss) or P must reduce its basis in Share 5 by $80 to $20 (eliminating the duplicated loss).

(C) Transfer of all S shares. Assume the same facts as those in paragraph (A) of this Example, except that P sells all five S shares to X. Although P's transfer of Asset 2 to S results in the duplication of an $80 loss, because all the shares are transferred, the transaction does not prevent the consolidated return provisions from properly addressing loss duplication. P's $80 duplicated loss is offset by an $80 duplicated gain, and the group recognizes the offsetting stock gain and loss. Accordingly, this paragraph (h)(2) does not apply to P's transfer of Asset 2 to S.

(i) [Reserved]

(j) Special rules for application of section 951(a)(2)(B) to distributions to which section 959(b) applies—(1) Single United States shareholder treatment. In determining the amount described in section 951(a)(2)(B) that is attributable to distributions to which section 959(b) applies, members of a group are treated as a single United States shareholder (within the meaning of section 951(b) (or section 953(c)(1)(A), if applicable)) for purposes of determining the part of the year during which such shareholder did not own (within the meaning of section 958(a)) the stock described in section 951(a)(2)(A). The purpose of this paragraph (j) is to facilitate the clear reflection of income of a consolidated group by ensuring that the location of ownership of stock of a foreign corporation within the group does not affect the amount of the group's income by reason of sections 951(a)(1)(A) and 951A(a).

(2) Examples. The following examples illustrate the application of paragraph (j)(1) of this section. For purposes of the examples in this paragraph (j)(2): M1 and M2 are members of a consolidated group of which P is the common parent (P group); each of CFC1, CFC2, and CFC3 is a controlled foreign corporation (within the meaning of section 957(a)) with the U.S. dollar as its functional currency (within the meaning of section 985); the taxable year of all entities is the calendar year for Federal income tax purposes; and a reference to stock owned means stock owned within the meaning of section 958(a). These examples do not address common law doctrines or other authorities that might apply to recast a transaction or to otherwise affect the tax treatment of a transaction.

(i) Example 1: Intercompany transfer of stock of a controlled foreign corporation—(A) Facts. Throughout Year 1, M1 directly owns all the stock of CFC1, which directly owns all the stock of CFC2. In Year 1, CFC2 has $100x of subpart F income (as defined in section 952). M1's pro rata share of CFC2's subpart F income for Year 1 is $100x, which M1 includes in its gross income under section 951(a)(1)(A). In Year 2, CFC2 has $80x of subpart F income and distributes $80x to CFC1 (the CFC2 Distribution). Section 959(b) applies to the entire CFC2 Distribution. On December 29, Year 2, M1 transfers all of its CFC1 stock to M2 in an exchange described in section 351(a). As a result, on December 31, Year 2 (the last day of Year 2 on which CFC2 is a controlled foreign corporation), M2 owns 100% of the stock of CFC1, which owns 100% of the stock of CFC2.

(B) Analysis. Under paragraph (j)(1) of this section, in determining the amount described in section 951(a)(2)(B) that is attributable to the CFC2 Distribution, all members of the P group are treated as a single United States shareholder for purposes of determining the part of Year 2 during which such shareholder did not own the stock of CFC2. Thus, the ratio of the number of days in Year 2 that such United States shareholder did not own the stock of CFC2 to the total number of days in Year 2 is 0/365. The amount described in section 951(a)(2)(B) is $0, M2's pro rata share of CFC2's subpart F income for Year 2 is $80x ($80x-$0), and M2 must include $80x in its gross income under section 951(a)(1)(A).

(ii) Example 2: Transfer of stock of a controlled foreign corporation between controlled foreign corporations—(A) Facts. The facts are the same as in paragraph (j)(2)(i)(A) of this section (the facts in Example 1), except that M1 does not transfer its CFC1 stock to M2. Additionally, throughout Year 1 and from January 1, Year 2, to December 29, Year 2, M2 directly owns all 90 shares of the only class of stock of CFC3. Further, on December 29, Year 2, CFC3 acquires all the CFC2 stock from CFC1 in exchange for 10 newly issued shares of the same class of CFC3 stock in a transaction described in section 368(a)(1)(B). As a result, on December 31, Year 2, M1 owns 10% of the stock of CFC2, and M2 owns 90% of the stock of CFC2.

(B) Analysis. Under paragraph (j)(1) of this section, in determining the amount described in section 951(a)(2)(B) that is attributable to the portion of the CFC2 Distribution with respect to each of the CFC2 stock that M1 owns on December 31, Year 2, and the CFC2 stock that M2 owns on that day, all members of the P group are treated as a single United States shareholder for purposes of determining the part of Year 2 during which such shareholder did not own such stock. In each case, the ratio of the number of days in Year 2 that such United States shareholder did not own such stock to the total number of days in Year 2 is 0/365, and the amount described in section 951(a)(2)(B) is $0. M1's and M2's pro rata shares of CFC2's subpart F income for Year 2 are $8x ($8x−$0) and $72x ($72x−$0), respectively, and M1 and M2 must include $8x and $72x in gross income under section 951(a)(1)(A), respectively.

(3) Applicability date. This paragraph (j) applies to taxable years for which the original consolidated Federal income tax return is due (without extensions) after February 23, 2023.

[T.D. 8402, 57 FR 9385, Mar. 18, 1992]

Editorial Note:For Federal Register citations affecting § 1.1502-80, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.1502-90 Table of contents.

The following list contains the major headings in §§ 1.1502-91 through 1.1502-99:

§ 1.1502-91 Application of section 382 with respect to a consolidated group.

(a) Determination and effect of an ownership change.

(1) In general.

(2) Special rule for post-change year that includes the change date.

(3) Cross-reference.

(b) Definitions and nomenclature.

(1) Defined.

(2) Coordination with rule that ends separate tracking.

(3) Example.

(d) Loss subgroup.

(1) Net operating loss carryovers.

(2) Net unrealized built-in loss.

(3) Loss subgroup parent.

(4) Election to treat loss subgroup parent requirement as satisfied.

(5) Principal purpose of avoiding a limitation.

(6) Special rules.

(7) Examples.

(e) Pre-change consolidated attribute.

(1) Defined.

(2) Example.

(f) Pre-change subgroup attribute.

(1) Defined.

(2) Example.

(g) Net unrealized built-in gain and loss.

(1) In general.

(2) Members included.

(i) Consolidated group with a net operating loss.

(ii) Determination whether a consolidated group has a net unrealized built-in loss.

(iii) Loss subgroup with net operating loss carryovers.

(iv) Determination whether subgroup has a net unrealized built-in loss.

(v) Separate determination of section 382 limitation for recognized built-in losses and net operating losses.

(3) Coordination with rule that ends separate tracking.

(4) Acquisitions of built-in gain or loss assets.

(5) Indirect ownership.

(6) Common parent not common parent for five years.

(h) Recognized built-in gain or loss.

(1) In general. [Reserved]

(2) Disposition of stock or an intercompany obligation of a member.

(3) Intercompany transactions.

(4) Exchanged basis property.

(i) [Reserved]

(j) Predecessor and successor corporations.

§ 1.1502-92 Ownership change of a loss group or a loss subgroup.

(a) Scope.

(b) Determination of an ownership change.

(1) Parent change method.

(i) Loss group.

(ii) Loss subgroup.

(iii) Special rule if election regarding section 1504(a)(1) relationship is made.

(2) Examples.

(3) Special adjustments.

(i) Common parent succeeded by a new common parent.

(ii) Newly created loss subgroup parent.

(iii) Examples.

(4) End of separate tracking of certain losses.

(1) Scope.

(2) Cause for applying supplemental rule.

(3) Operating rules.

(4) Supplemental ownership change rules.

(i) Additional testing dates for the common parent (or loss subgroup parent).

(ii) Treatment of subsidiary stock as stock of the common parent (or loss subgroup parent).

(iii) Different testing periods.

(iv) Disaffiliation of a subsidiary.

(v) Subsidiary stock acquired first.

(vi) Anti-duplication rule.

(5) Examples.

(d) Testing period following ownership change under this section.

(e) Information statements.

(1) Common parent of a loss group.

(2) Abbreviated statement with respect to loss subgroups.

§ 1.1502-93 Consolidated section 382 limitation (or subgroup section 382 limitation).

(a) Determination of the consolidated section 382 limitation (or subgroup section 382 limitation).

(1) In general.

(2) Coordination with apportionment rule.

(b) Value of the loss group (or loss subgroup).

(1) Stock value immediately before ownership change.

(2) Adjustment to value.

(i) In general.

(ii) Anti-duplication.

(3) Examples.

(1) In general.

(2) Adjustments.

(d) Continuity of business.

(1) In general.

(2) Example.

(e) Limitations of losses under other rules.

§ 1.1502-94 Coordination with section 382 and the regulations thereunder when a corporation becomes a member of a consolidated group.

(a) Scope.

(1) In general.

(2) Successor corporation as new loss member.

(3) Coordination in the case of a loss subgroup.

(4) End of separate tracking of certain losses.

(5) Cross-reference.

(b) Application of section 382 to a new loss member.

(1) In general.

(2) Adjustment to value.

(3) Pre-change separate attribute defined.

(4) Examples.

(d) Information statements.

§ 1.1502-95 Rules on ceasing to be a member of a consolidated group (or loss subgroup).

(a) In general.

(1) Consolidated group.

(2) Election by common parent.

(3) Coordination with §§ 1.1502-91 through 1.1502-93.

(b) Separate application of section 382 when a member leaves a consolidated group.

(1) In general.

(2) Effect of a prior ownership change of the group.

(3) Application in the case of a loss subgroup.

(4) Examples.

(1) In general.

(2) Amount which may be apportioned.

(i) Consolidated section 382 limitation.

(ii) Net unrealized built-in gain.

(3) Effect of apportionment on the consolidated group.

(i) Consolidated section 382 limitation.

(ii) Net unrealized built-in gain.

(4) Effect on corporations to which an apportionment is made.

(i) Consolidated section 382 limitation.

(ii) Net unrealized built-in gain.

(5) Deemed apportionment when loss group terminates.

(6) Appropriate adjustments when former member leaves during the year.

(7) Examples.

(d) Rules pertaining to ceasing to be a member of a loss subgroup.

(1) In general.

(2) Exceptions.

(3) Examples.

(e) Allocation of net unrealized built-in loss.

(1) In general.

(2) Amount of allocation.

(i) In general.

(ii) Transferred basis property and deferred gain or loss.

(iii) Assets for which gain or loss has been recognized.

(iv) Exchanged basis property.

(v) Two or more members depart during the same year.

(vi) Anti-abuse rule.

(3) Effect of the allocation on the consolidated group.

(4) Effect on corporations to which the allocation is made.

(5) Subgroup principles.

(6) Apportionment of consolidated section 382 limitation (or subgroup section 382 limitation).

(i) In general.

(ii) Special rule for former members that become members of the same consolidated group.

(7) Examples.

(8) Reporting requirements.

(i) Common parent.

(ii) Former member.

(iii) Exception.

(f) Filing the election to apportion the section 382 limitation and net unrealized built-in gain.

(1) Form of the election to apportion.

(i) Statement.

(ii) Agreement.

(2) Signing the agreement.

(3) Filing the election.

(i) Filing by the common parent.

(ii) Filing by the former member.

(4) Revocation of election.

(g) Effective/applicability date.

§ 1.1502-96 Miscellaneous rules.

(a) End of separate tracking of losses.

(1) Application.

(2) Effect of end of separate tracking.

(i) Net operating loss carryovers.

(ii) Net unrealized built-in losses.

(iii) Common parent not common parent for five years.

(3) Continuing effect of end of separate tracking.

(i) In general.

(ii) Example.

(4) Special rule for testing period.

(5) Limits on effects of end of separate tracking.

(b) Ownership change of subsidiary.

(1) Ownership change of a subsidiary because of options or plan or arrangement.

(2) Effect of the ownership change.

(i) In general.

(ii) Pre-change losses.

(3) Coordination with §§ 1.1502-91, 1.1502-92, and 1.1502-94.

(4) Example.

(d) Losses reattributed under § 1.1502-36(d)(6).

(1) In general.

(2) Deemed section 381(a) transaction.

(3) Rules relating to owner shifts.

(i) In general.

(ii) Examples.

(4) Rules relating to the section 382 limitation.

(i) Reattributed loss is a pre-change separate attribute of a new loss member.

(ii) Reattributed loss is a pre-change subgroup attribute.

(iii) Potential application of section 382(l)(1).

(iv) Duplication or omission of value.

(v) Special rule for continuity of business requirement.

(5) Election to reattribute section 382 limitation.

(i) Effect of election.

(ii) Examples.

(e) Time and manner of making election under § 1.1502-91(d)(4).

(1) In general.

(2) Election statement.

§ 1.1502-97 Special rules under section 382 for members under the jurisdiction of a court in a title 11 or similar case. [Reserved] § 1.1502-98 Coordination with sections 383 and 163(j). § 1.1502-99 Effective/applicability dates.

(a) In general.

(b) Reattribution of losses under § 1.1502-36(d)(6).

(1) Sections 1.382-2 and 1.382-5.

(2) Sections 1.382-6 and 1.383-1.

[T.D. 8824, 64 FR 36128, July 2, 1999, as amended by T.D. 9304, 71 FR 76907, Dec. 22, 2006; T.D. 9329, 72 FR 32805, June 14, 2007; T.D. 9424, 73 FR 53986, Sept. 17, 2008; T.D. 9905, 85 FR 56843, Sept. 14, 2020; T.D. 10018, 89 FR 106877, Dec. 30, 2024]

§ 1.1502-91 Application of section 382 with respect to a consolidated group.

(a) Determination and effect of an ownership change—(1) In general. This section and §§ 1.1502-92 and 1.1502-93 set forth the rules for determining an ownership change under section 382 for members of consolidated groups and the section 382 limitations with respect to attributes described in paragraphs (e) and (f) of this section. These rules generally provide that an ownership change and the section 382 limitation are determined with respect to these attributes for the group (or loss subgroup) on a single entity basis and not for its members separately. Following an ownership change of a loss group (or a loss subgroup) under § 1.1502-92, the amount of consolidated taxable income for any post-change year which may be offset by pre-change consolidated attributes (or pre-change subgroup attributes) shall not exceed the consolidated section 382 limitation (or subgroup section 382 limitation) for such year as determined under § 1.1502-93.

(2) Special rule for post-change year that includes the change date. If the post-change year includes the change date, section 382(b)(3)(A) is applied so that the consolidated section 382 limitation (or subgroup section 382 limitation) does not apply to the portion of consolidated taxable income that is allocable to the period in the year on or before the change date. See generally § 1.382-6 (relating to the allocation of income and loss). The allocation of consolidated taxable income for the post-change year that includes the change date must be made before taking into account any consolidated net operating loss deduction (as defined in § 1.1502-21(a)).

(3) Cross-reference. See §§ 1.1502-94 and 1.1502-95 for rules that apply section 382 to a corporation that becomes or ceases to be a member of a group or loss subgroup.

(b) Definitions and nomenclature. For purposes of this section and §§ 1.1502-92 through 1.1502-99, unless otherwise stated:

(1) The definitions and nomenclature contained in section 382 and the regulations thereunder (including the nomenclature and assumptions relating to the examples in § 1.382-2T(b)) and this section and §§ 1.1502-92 through 1.1502-99 apply.

(2) In all examples, all groups file consolidated returns, all corporations file their income tax returns on a calendar year basis, the only 5-percent shareholder of a corporation is a public group, the facts set forth the only owner shifts during the testing period, no election is made under paragraph (d)(4) of this section, and each asset of a corporation has a value equal to its adjusted basis.

(i) Is entitled to use a net operating loss carryover to the taxable year that did not arise (and is not treated under § 1.1502-21(c) as arising) in a SRLY;

(ii) Has a consolidated net operating loss for the taxable year in which a testing date of the common parent occurs (determined by treating the common parent as a loss corporation); or

(iii) Has a net unrealized built-in loss (determined under paragraph (g) of this section by treating the date on which the determination is made as though it were a change date).

(2) Coordination with rule that ends separate tracking. A consolidated group may be a loss group because a member's losses that arose in (or are treated as arising in) a SRLY are treated as described in paragraph (c)(1)(i) of this section. See § 1.1502-96(a).

(3) Example. The following example illustrates the principles of this paragraph (c):

Example. Loss group.(i) L and L1 file separate returns and each has a net operating loss carryover arising in Year 1 that is carried over to Year 2. A owns 40 shares and L owns 60 shares of the 100 outstanding shares of L1 stock. At the close of Year 1, L buys the 40 shares of L1 stock from A. For Year 2, L and L1 file a consolidated return. The following is a graphic illustration of these facts: (ii) L and L1 become a loss group at the beginning of Year 2 because the group is entitled to use the Year 1 net operating loss carryover of L, the common parent, which did not arise (and is not treated under § 1.1502-21(c) as arising) in a SRLY. See § 1.1502-94 for rules relating to the application of section 382 with respect to L1's net operating loss carryover from Year 1 which did arise in a SRLY.

(d) Loss subgroup—(1) Net operating loss carryovers. Two or more corporations that become members of a consolidated group (the current group) compose a loss subgroup if—

(i) They were affiliated with each other in another group (the former group), whether or not the group was a consolidated group;

(ii) They bear the relationship described in section 1504(a)(1) to each other through a loss subgroup parent immediately after they become members of the current group (or are deemed to bear that relationship as a result of an election described in paragraph (d)(4) of this section); and

(iii) At least one of the members carries over a net operating loss that did not arise (and is not treated under § 1.1502-21(c) as arising) in a SRLY with respect to the former group.

(2) Net unrealized built-in loss. Two or more corporations that become members of a consolidated group compose a loss subgroup if they—

(i) Have been continuously affiliated with each other for the 5 consecutive year period ending immediately before they become members of the group;

(ii) Bear the relationship described in section 1504(a)(1) to each other through a loss subgroup parent immediately after they become members of the current group (or are deemed to bear that relationship as a result of an election described in paragraph (d)(4) of this section); and

(iii) Have a net unrealized built-in loss (determined under paragraph (g) of this section on the day they become members of the group by treating that day as though it were a change date).

(3) Loss subgroup parent. A loss subgroup parent is the corporation that bears the same relationship to the other members of the loss subgroup as a common parent bears to the members of a group.

(4) Election to treat loss subgroup parent requirement as satisfied—(i) In general. Solely for purposes of paragraphs (d)(1)(i) and (2)(ii) of this section, two or more corporations that become members of a consolidated group at the same time and that were affiliated with each other immediately before becoming members of the group are deemed to bear a section 1504(a)(1) relationship to each other immediately after they become members of the group if the common parent of that group makes an election under this paragraph (d)(4) with respect to those members. See § 1.1502-96(e) for the time and manner of making the election.

(ii) Members included. An election under this paragraph (d)(4) includes all corporations that become members of the current group at the same time and that were affiliated with each other immediately before they become members of the current group.

(iii) Each member included treated as loss subgroup parent. If the members to which this election applies are a loss subgroup described in paragraph (d)(1) or (2) of this section, then each member is treated as a loss subgroup parent. See § 1.1502-92(b)(1)(iii) for special rules relating to an ownership change of a loss subgroup if the election under this paragraph (d)(4) is made.

(5) Principal purpose of avoiding a limitation. The corporations described in paragraphs (d)(1) or (2) of this section do not compose a loss subgroup if any one of them is formed, acquired, or availed of with a principal purpose of avoiding the application of, or increasing any limitation under, section 382. Instead, § 1.1502-94 applies with respect to the attributes of each such corporation. Any member excluded from a loss subgroup, if excluded with a principal purpose of so avoiding or increasing any section 382 limitation, is treated as included in the loss subgroup. This paragraph (d)(5) does not apply solely because, in connection with becoming members of the group, the members of a group (or loss subgroup) are rearranged (or, in the case of the preceding sentence, are not rearranged) to bear a relationship to the other members described in section 1504(a)(1).

(6) Special rules. See § 1.1502-95(d) for rules concerning when a corporation ceases to be a member of a loss subgroup, and for certain exceptions that may apply if a member does not continue to satisfy the loss subgroup parent requirement within the current group. See also § 1.1502-96(a) for a special rule regarding the end of separate tracking of SRLY losses of a member that has an ownership change or that has been a member of a group for at least 5 consecutive years.

(7) Examples. The following examples illustrate the principles of this paragraph (d):

Example 1. Loss subgroup. (i) P owns all the L stock and L owns all the L1 stock. The P group has a consolidated net operating loss arising in Year 1 that is carried to Year 2. On May 2, Year 2, P sells all the stock of L to A, and L and L1 thereafter file consolidated returns. A portion of the Year 1 consolidated net operating loss is apportioned under § 1.1502-21(b) to each of L and L1, which they carry over to Year 2. The following is a graphic illustration of these facts: (ii) (a) L and L1 compose a loss subgroup within the meaning of paragraph (d)(1) of this section because—

(A) They were affiliated with each other in the P group (the former group);

(B) They bear a relationship described in section 1504(a)(1) to each other through a loss subgroup parent (L) immediately after they became members of the L group; and

(C) At least one of the members (here, both L and L1) carries over a net operating loss to the L group (the current group) that did not arise in a SRLY with respect to the P group.

(b) Under paragraph (d)(3) of this section, L is the loss subgroup parent of the L loss subgroup.

Example 2. Loss subgroup—section 1504(a)(1) relationship.(i) P owns all the stock of L and L1. L owns all the stock of L2. L1 and L2 own 40 percent and 60 percent of the stock of L3, respectively. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. On May 22, Year 2, P sells all the stock of L and L1 to P1, the common parent of another consolidated group. The Year 1 consolidated net operating loss is apportioned under § 1.1502-21(b), and each of L, L1, L2, and L3 carries over a portion of such loss to the first consolidated return year of the P1 group ending after the acquisition. The following is a graphic illustration of these facts: (ii) L and L2 compose a loss subgroup within the meaning of paragraph (d)(1) of this section. Neither L1 nor L3 is included in a loss subgroup because neither bears a relationship described in section 1504(a)(1) through a loss subgroup parent to any other member of the former group immediately after becoming members of the P1 group.

Example 3. Loss subgroup—section 1504(a)(1) relationship. The facts are the same as in Example 2, except that the stock of L1 is transferred to L in connection with the sale of the L stock to P1. L, L1, L2, and L3 compose a loss subgroup within the meaning of paragraph (d)(1) of this section because—

(i) They were affiliated with each other in the P group (the former group);

(ii) They bear a relationship described in section 1504(a)(1) to each other through a loss subgroup parent (L) immediately after they become members of the P1 group; and

(iii) At least one of the members (here, each of L, L1, L2, and L3) carries over a net operating loss to the P1 group (the current group).

Example 4. Loss subgroup—elective section 1504(a)(1) relationship.The facts are the same as in Example 2, except that P1 makes the election under paragraph (d)(4) of this section. The election includes L, L1, L2, and L3 (even though L and L2 would compose a loss subgroup without regard to the election) because they become members of the current group (the P1 group) at the same time and were affiliated with each other in the P group immediately before they became members of the P1 group. As a result of the election, L, L1, L2, and L3 are treated as satisfying the requirement that they bear the relationship described in section 1504(a)(1) to each other through a loss subgroup parent immediately after they become members of the P1 group. L, L1, L2, and L3 compose a loss subgroup within the meaning of paragraph (d)(1) of this section.

(e) Pre-change consolidated attribute—(1) Defined. A pre-change consolidated attribute of a loss group is—

(i) Any loss described in paragraph (c)(1)(i) or (ii) of this section (relating to the definition of loss group) that is allocable to the period ending on or before the change date; and

(ii) Any recognized built-in loss of the loss group.

(2) Example—(i) Facts. The L group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. The L loss group has an ownership change at the beginning of Year 2.

(ii) Analysis. The net operating loss carryover of the L loss group from Year 1 is a pre-change consolidated attribute because the L group was entitled to use the loss in Year 2 and therefore the loss was described in paragraph (c)(1)(i) of this section. Under paragraph (a)(2)(i) of this section, the amount of consolidated taxable income of the L group for Year 2 that may be offset by this loss carryover may not exceed the consolidated section 382 limitation of the L group for that year. See § 1.1502-93 for rules relating to the computation of the consolidated section 382 limitation.

(iii) Business interest expense. The facts are the same as in the Example in paragraph (e)(2)(i) of this section, except that, rather than a consolidated net operating loss, a member of the L group pays or accrues a business interest expense in Year 1 for which a deduction is disallowed in that year under section 163(j) and § 1.163(j)-2(b). The disallowed business interest expense is carried over to Year 2 under section 163(j)(2) and § 1.163(j)-2(c). Thus, the disallowed business interest expense carryforward is a pre-change loss. Under section 163(j), the L loss group is entitled to deduct the carryforward in Year 2; however, the amount of consolidated taxable income of the L group for Year 2 that may be offset by this carryforward may not exceed the consolidated section 382 limitation of the L group for that year. See § 1.1502-98(b) (providing that §§ 1.1502-91 through 1.1502-96 apply section 382 to business interest expense, with appropriate adjustments).

(f) Pre-change subgroup attribute—(1) Defined. A pre-change subgroup attribute of a loss subgroup is—

(i) Any net operating loss carryover described in paragraph (d)(1)(iii) of this section (relating to the definition of loss subgroup); and

(ii) Any recognized built-in loss of the loss subgroup.

(2) Example. The following example illustrates the principle of this paragraph (f):

Pre-change subgroup attribute. (i) P is the common parent of a consolidated group. P owns all the stock of L, and L owns all the stock of L1. L2 is not a member of an affiliated group, and has a net operating loss arising in Year 1 that is carried over to Year 2. On December 11, Year 2, L1 acquires all the stock of L2, causing an ownership change of L2. During Year 2, the P group has a consolidated net operating loss that is carried over to Year 3. On November 2, Year 3, M acquires all the L stock from P. M, L, L1, and L2 thereafter file consolidated returns. All of the P group Year 2 consolidated net operating loss is apportioned under § 1.1502-21(b) to L and L2, which they carry over to the M group.

(ii)(a) L, L1, and L2 compose a loss subgroup because—

(1) They were affiliated with each other in the P group (the former group);

(2) They bear a relationship described in section 1504(a)(1) to each other through a loss subgroup parent (L) immediately after they became members of the L group; and

(3) At least one of the members (here, both L and L2) carries over a net operating loss to the M group (the current group) that is described in paragraph (d)(1)(iii) of this section.

(b) For this purpose, L2's loss from Year 1 that was a SRLY loss with respect to the P group (the former group) is described in paragraph (d)(1)(iii) of this section because L2 had an ownership change on becoming a member of the P group (see § 1.1502-96(a)) on December 11, Year 2. Starting on December 12, Year 2, the P group no longer separately tracked owner shifts of the stock of L1 with respect to the Year 1 loss. M's acquisition results in an ownership change of L, and therefore the L loss subgroup under § 1.1502-92(a)(2). See § 1.1502-93 for rules governing the computation of the subgroup section 382 limitation.

(iii) In the M group, L2's Year 1 loss continues to be subject to a section 382 limitation resulting from the ownership change that occurred on December 11, Year 2. See § 1.1502-96(c).

(g) Net unrealized built-in gain and loss—(1) In general. The determination whether a consolidated group (or loss subgroup) has a net unrealized built-in gain or loss under section 382(h)(3) is based on the aggregate amount of the separately computed net unrealized built-in gains or losses of each member that is included in the group (or loss subgroup) under paragraph (g)(2) of this section, including items of built-in income and deduction described in section 382(h)(6). Thus, for example, amounts deferred under section 267, or under § 1.1502-13 (other than amounts deferred with respect to the stock of a member (or an intercompany obligation) included in the group (or loss subgroup) under paragraph (g)(2) of this section) are built-in items. The threshold requirement under section 382(h)(3)(B) applies on an aggregate basis and not on a member-by-member basis. The separately computed amount of a member included in a group or loss subgroup does not include any unrealized built-in gain or loss on stock (including stock described in section 1504(a)(4) and § 1.382-2T(f)(18)(ii) and (iii)) of another member included in the group or loss subgroup (or an intercompany obligation). However, a member of a group or loss subgroup includes in its separately computed amount the unrealized built-in gain or loss on stock (but not on an intercompany obligation) of another member not included in the group or loss subgroup. If a member is not included in the determination whether a group (or subgroup) has a net unrealized built-in loss under paragraph (g)(2)(ii) or (iv) of this section, that member is not included in the loss group or loss subgroup. See § 1.1502-94(c) (relating to built-in gain or loss of a new loss member) and § 1.1502-96(a) (relating to the end of separate tracking of certain losses).

(2) Members included—(i) Consolidated group with a net operating loss. The members included in the determination whether a consolidated group described in paragraph (c)(1)(i) or (ii) of this section (relating to loss groups with net operating losses) has a net unrealized built-in gain are all members of the consolidated group on the day that the determination is made.

(ii) Determination whether a consolidated group has a net unrealized built-in loss. The members included in the determination whether a consolidated group is a loss group described in paragraph (c)(1)(iii) of this section are—

(A) The common parent and all other members that have been affiliated with the common parent for the 5 consecutive year period ending on the day that the determination is made;

(B) Any other member that has a net unrealized built-in loss determined under paragraph (g)(1) of this section on the date that the determination is made, and that is neither a new loss member described in § 1.1502-94(a)(1)(ii) nor a member of a loss subgroup described in paragraph (d)(2) of this section;

(C) Any new loss member described in § 1.1502-94(a)(1)(ii) that has a net unrealized built-in gain determined under paragraph (g)(1) of this section on the day that the determination is made; and

(D) The members of a loss subgroup described in paragraph (d)(2) of this section if the members of the subgroup have, in the aggregate, a net unrealized built-in gain on the day that the determination is made.

(iii) Loss subgroup with net operating loss carryovers. The members included in the determination whether a loss subgroup described in paragraph (d)(1) of this section (relating to loss subgroups with net operating loss carryovers) has a net unrealized built-in gain are all members of the loss subgroup on the day that the determination is made.

(iv) Determination whether subgroup has a net unrealized built-in loss. The members included in the determination whether a subgroup has a net unrealized built-in loss are those members described in paragraphs (d)(2)(i) and (ii) of this section.

(v) Separate determination of section 382 limitation for recognized built-in losses and net operating losses. In determining whether a loss group described in paragraph (c)(1)(i) or (ii) of this section (relating to loss groups that have net operating loss carryovers) has a net unrealized built-in gain which, if recognized, increases the consolidated section 382 limitation, the group includes, under paragraph (g)(2)(i) of this section, all of its members on the day the determination is made. Under paragraph (g)(2)(ii) of this section, however, for purposes of determining whether a group has a net unrealized built-in loss described in paragraph (c)(1)(iii) of this section, not all members of the consolidated group may be included. Thus, a consolidated group may have recognized built-in gains that increase the amount of consolidated taxable income that may be offset by its pre-change net operating loss carryovers that did not arise (and are not treated as arising) in a SRLY, and also may have recognized built-in losses the absorption of which is limited. Similar results may obtain for loss subgroups under paragraphs (g)(2)(iii) and (iv) of this section. See § 1.1502-93(c)(2) for rules prohibiting the use of recognized built-in gains to increase the amount of consolidated taxable income that can be offset by recognized built-in losses.

(3) Coordination with rule that ends separate tracking. See § 1.1502-96(a) for special rules relating to members (or loss subgroups) that have an ownership change within six months before, on, or after becoming a member of the group.

(4) Acquisitions of built-in gain or loss assets. A member of a consolidated group (or loss subgroup) may not, in determining its separately computed net unrealized built-in gain or loss, include any gain or loss with respect to assets acquired with a principal purpose to affect the amount of its net unrealized built-in gain or loss. A group (or loss subgroup) may not, in determining its net unrealized built-in gain or loss, include any gain or loss of a member acquired with a principal purpose to affect the amount of its net unrealized built-in gain or loss.

(5) Indirect ownership. A member's separately computed net unrealized built-in gain or loss is adjusted to the extent necessary to prevent any duplication of unrealized gain or loss attributable to the member's indirect ownership interest in another member through a nonmember if the member has a 5-percent or greater ownership interest in the nonmember.

(6) Common parent not common parent for five years. If the common parent has become the common parent of an existing group within the previous 5 year period in a transaction described in § 1.1502-75(d)(2)(ii) or (3), appropriate adjustments must be made in applying paragraph (g)(2)(ii)(A) of this section so that corporations that have not been members of the group for five years are not included. In such a case, references to the common parent in paragraph (g)(2)(ii)(A) of this section are to the former common parent. Thus, members of the group remaining in existence (including the new common parent) that have not been affiliated with the former common parent (or that have not been members of that group) for the five consecutive year period ending on the day that the determination is made are not included under paragraph (g)(2)(ii)(A) of this section. See, however, § 1.1502-96(a)(2) for special rules relating to members (or loss subgroups) that have an ownership change within six months before, on, or after the time that the member becomes a member of the group.

(h) Recognized built-in gain or loss—(1) In general. [Reserved]

(2) Disposition of stock or an intercompany obligation of a member. Gain or loss recognized by a member on the disposition of stock (including stock described in section 1504(a)(4) and § 1.382-2T(f)(18)(ii) and (iii)) of another member is treated as a recognized gain or loss for purposes of section 382(h)(2) (unless disallowed) even though gain or loss on such stock was not included in the determination of a net unrealized built-in gain or loss under paragraph (g)(1) of this section. Gain or loss recognized by a member with respect to an intercompany obligation is treated as recognized gain or loss only to the extent (if any) the transaction gives rise to aggregate income or loss within the consolidated group. The first sentence of this paragraph (h)(2) is applicable on or after September 17, 2008.

(3) Intercompany transactions. Gain or loss that is deferred under provisions such as section 267 and § 1.1502-13 is treated as recognized built-in gain or loss only to the extent taken into account by the group during the recognition period. See also § 1.1502-13(c)(7) Example 10.

(4) Exchanged basis property. If the adjusted basis of any asset is determined, directly or indirectly, in whole or in part, by reference to the adjusted basis of another asset held by the member at the beginning of the recognition period, the asset is treated, with appropriate adjustments, as held by the member at the beginning of the recognition period.

(i) [Reserved]

(j) Predecessor and successor corporations. A reference in this section and §§ 1.1502-92 through 1.1502-99 to a corporation, member, common parent, loss subgroup parent, or subsidiary includes, as the context may require, a reference to a predecessor or successor corporation as defined in § 1.1502-1(f)(4). For example, the determination whether a successor satisfies the continuous affiliation requirement of paragraph (d)(2)(i) or (g)(2)(ii) of this section is made by reference to its predecessor.

[T.D. 8824, 64 FR 36129, July 2, 1999, as amended by T.D. 9048, 68 FR 12291, Mar. 14, 2003; T.D. 9187, 70 FR 10326, Mar. 3, 2005; T.D. 9254, 71 FR 13018, Mar. 14, 2006; T.D. 9424, 73 FR 53984, Sept. 17, 2008; T.D. 9905, 85 FR 56844, Sept. 14, 2020; T.D. 10018, 89 FR 106877, Dec. 30, 2024]

§ 1.1502-92 Ownership change of a loss group or a loss subgroup.

(a) Scope. This section provides rules for determining if there is an ownership change for purposes of section 382 with respect to a loss group or a loss subgroup. See § 1.1502-94 for special rules for determining if there is an ownership change with respect to a new loss member and § 1.1502-96(b) for special rules for determining if there is an ownership change of a subsidiary.

(b) Determination of an ownership change—(1) Parent change method—(i) Loss group. A loss group has an ownership change if the loss group's common parent has an ownership change under section 382 and the regulations thereunder. Solely for purposes of determining whether the common parent has an ownership change—

(A) The losses described in § 1.1502-91(c) are treated as net operating losses (or a net unrealized built-in loss) of the common parent; and

(B) The common parent determines the earliest day that its testing period can begin by reference to only the attributes that make the group a loss group under § 1.1502-91(c).

(ii) Loss subgroup. A loss subgroup has an ownership change if the loss subgroup parent has an ownership change under section 382 and the regulations thereunder. The principles of § 1.1502-95(b) (relating to ceasing to be a member of a consolidated group) apply in determining whether the loss subgroup parent has an ownership change. Solely for purposes of determining whether the loss subgroup parent has an ownership change—

(A) The losses described in § 1.1502-91(d) are treated as net operating losses (or a net unrealized built-in loss) of the loss subgroup parent;

(B) The day that the members of the loss subgroup become members of the group (or a loss subgroup) is treated as a testing date within the meaning of § 1.382-2(a)(4); and

(C) The loss subgroup parent determines the earliest day that its testing period can begin under § 1.382-2T(d)(3) by reference to only the attributes that make the members a loss subgroup under § 1.1502-91(d).

(iii) Special rule if election regarding section 1504(a)(1) relationship is made—(A) Ownership change of deemed loss subgroup parent is an ownership change of loss subgroup. If the common parent makes an election under § 1.1502-91(d)(4), each of the members in the loss subgroup is treated as the loss subgroup parent for purposes of determining whether the loss subgroup has an ownership change under section 382 and the regulations thereunder on or after the day the members become members of the group.

(B) Exception. Paragraph (b)(1)(iii)(A) of this section does not apply to cause an ownership change of a loss subgroup if a deemed loss subgroup parent has an ownership change upon (or after) ceasing to be a member of the current group.

(2) Examples. The following examples illustrate the principles of this paragraph (b):

Example 1. Loss group—ownership change of the common parent.(i) A owns all the L stock. L owns 80 percent and B owns 20 percent of the L1 stock. For Year 1, the L group has a consolidated net operating loss that resulted from the operations of L1 and that is carried over to Year 2. The value of the L stock is $1000. The total value of the L1 stock is $600 and the value of the L1 stock held by B is $120. The L group is a loss group under § 1.1502-91(c)(1) because it is entitled to use its net operating loss carryover from Year 1. On August 15, Year 2, A sells 51 percent of the L stock to C. The following is a graphic illustration of these facts: (ii) Under paragraph (b)(1)(i) of this section, section 382 and the regulations thereunder are applied to L to determine whether it (and therefore the L loss group) has an ownership change with respect to its net operating loss carryover from Year 1 attributable to L1 on August 15, Year 2. The sale of the L stock to C causes an ownership change of L under § 1.382-2T and of the L loss group under paragraph (b)(1)(i) of this section. The amount of consolidated taxable income of the L loss group for any post-change taxable year that may be offset by its pre-change consolidated attributes (that is, the net operating loss carryover from Year 1 attributable to L1) may not exceed the consolidated section 382 limitation for the L loss group for the taxable year.

Example 2. Loss group—owner shifts of subsidiaries disregarded.(i) The facts are the same as in Example 1, except that on August 15, Year 2, A sells only 49 percent of the L stock to C and, on December 12, Year 3, in an unrelated transaction, B sells the 20 percent of the L1 stock to D. A's sale of the L stock to C does not cause an ownership change of L under § 1.382-2T nor of the L loss group under paragraph (b)(1)(i) of this section. The following is a graphic illustration of these facts: (ii) B's subsequent sale of L1 stock is not taken into account for purposes of determining whether the L loss group has an ownership change under paragraph (b)(1)(i) of this section, and, accordingly, there is no ownership change of the L loss group. See paragraph (c) of this section, however, for a supplemental ownership change method that would apply to cause an ownership change if the purchases by C and D were pursuant to a plan or arrangement and certain other conditions are satisfied.

Example 3. Loss subgroup—ownership change of loss subgroup parent controls.(i) P owns all the L stock. L owns 80 percent and A owns 20 percent of the L1 stock. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. On September 9, Year 2, P sells 51 percent of the L stock to B, and L1 is apportioned a portion of the Year 1 consolidated net operating loss under § 1.1502-21(b), which it carries over to its next taxable year. L and L1 file a consolidated return for their first taxable year ending after the sale to B. The following is a graphic illustration of these facts: (ii) Under § 1.1502-91(d)(1), L and L1 compose a loss subgroup on September 9, Year 2, the day that they become members of the L group. Under paragraph (b)(1)(ii) of this section, section 382 and the regulations thereunder are applied to L to determine whether it (and therefore the L loss subgroup) has an ownership change with respect to the portion of the Year 1 consolidated net operating loss that is apportioned to L1 on September 9, Year 2. L has an ownership change resulting from P's sale of 51 percent of the L stock to A. Therefore, the L loss subgroup has an ownership change with respect to that loss.

Example 4. Loss group and loss subgroup—contemporaneous ownership changes. (i) A owns all the stock of corporation M, M owns 35 percent and B owns 65 percent of the L stock, and L owns all the L1 stock. The L group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. On May 19, Year 2, B sells 45 percent of the L stock to M for cash. M, L, and L1 thereafter file consolidated returns. L and L1 are each apportioned a portion of the Year 1 consolidated net operating loss, which they carry over to the M group's Year 2 and Year 3 consolidated return years. The M group has a consolidated net operating loss arising in Year 2 that is carried over to Year 3. On June 9, Year 3, A sells 70 percent of the M stock to C. The following is a graphic illustration of these facts: (ii) Under § 1.1502-91(d)(1), L and L1 compose a loss subgroup on May 19, Year 2, the day they become members of the M group. Under paragraph (b)(1)(ii) of this section, section 382 and the regulations thereunder are applied to L to determine whether L (and therefore the L loss subgroup) has an ownership change with respect to the loss carryovers from Year 1 on May 19, Year 2, a testing date because of B's sale of L stock to M. The sale of L stock to M results in only a 45 percentage point increase in A's ownership of L stock. Thus, there is no ownership change of L (or the L loss subgroup) with respect to those loss carryovers under paragraph (b)(1)(ii) of this section on that day.

(iii) June 9, Year 3, is also a testing date with respect to the L loss subgroup because of A's sale of M stock to C. The sale results in a 56 percentage point increase in C's ownership of L stock, and L has an ownership change. Therefore, the L loss subgroup has an ownership change on that day with respect to the loss carryovers from Year 1.

(iv) Paragraph (b)(1)(i) of this section requires that section 382 and the regulations thereunder be applied to M to determine whether M (and therefore the M loss group) has an ownership change with respect to the net operating loss carryover from Year 2 on June 9, Year 3, a testing date because of A's sale of M stock to C. The sale results in a 70 percentage point increase in C's ownership of M stock, and M has an ownership change. Therefore, the M loss group has an ownership change on that day with respect to that loss carryover.

Example 5. Deemed subgroup parent. (i) P owns all the stock of L and L1 and 80 percent of the stock of T. A owns the remaining 20 percent of the stock of T. L1 owns all the stock of L2. P1, which owns 60 percent of the stock of P, acquires, at the beginning of Year 2, the T, L, and L1 stock owned by P, and T, L, L1, and L2 become members of the P1 group. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. L, L1, and L2 are each apportioned a portion of the Year 1 consolidated net operating loss under § 1.1502-21(b), which they carry over to the P1 group's Year 2 and Year 3 consolidated return years. P1 makes the election described in § 1.1502-91(d)(4) to treat T, L, L1 and L2 as meeting the section 1504(a)(1) requirement of § 1.1502-91(d)(1)(ii). As a result of the election, T, L, L1 and L2 compose a loss subgroup and T, L, L1, and L2 are each treated as the loss subgroup parent for purposes of this paragraph (b). Because of P1's indirect ownership of T, L, L1, and L2 prior to P1's acquisition of the T, L, and L1 stock, P1's acquisition does not cause an ownership change of the loss subgroup.

(ii) On February 2, Year 3, L1 sells all of the stock of L2 to B. Although L2 is treated as a loss subgroup parent, the determination whether the loss subgroup comprised of T, L, and L1 has an ownership change under this paragraph (b) is made without regard to the sale of L2 because L2's ownership change occurred upon ceasing to be a member of the P1 group. See § 1.1502-95(b) to determine the application of section 382 to L2 when L2 ceases to be a member of the P1 group and the T, L, L1 and L2 loss subgroup.

(iii) On March 26, Year 3, A sells her 20 percent minority stock interest in T to C . C's purchase, together with the 32 percentage point owner shift effected by P1's acquisition of the T stock at the beginning of Year 2, causes an ownership change of T, and therefore of the loss subgroup comprised of T, L, and L1.

(3) Special adjustments—(i) Common parent succeeded by a new common parent. For purposes of determining if a loss group has an ownership change, if the common parent of a loss group is succeeded or acquired by a new common parent and the loss group remains in existence, the new common parent is treated as a continuation of the former common parent with appropriate adjustments to take into account shifts in ownership of the former common parent during the testing period (including shifts that occur incident to the common parent's becoming the former common parent). A new common parent may be a continuation of the former common parent even if, under § 1.1502-91(g)(2)(ii), the new common parent is not included in determining whether the group has a net unrealized built-in loss.

(ii) Newly created loss subgroup parent. For purposes of determining if a loss subgroup has an ownership change, if the member that is the loss subgroup parent has not been the loss subgroup parent for at least 3 years as of a testing date, appropriate adjustments must be made to take into account owner shifts of members of the loss subgroup so that the structure of the loss subgroup does not have the effect of avoiding an ownership change under section 382. (See paragraph (b)(3)(iii), Example 3 of this section.)

(iii) Examples. The following examples illustrate the principles of this paragraph (b)(3):

(A) Example 1.—New common parent acquires old common parent. (1) A, who owns all the L stock, sells 30 percent of the L stock to B on August 26, Year 1. L owns all the L1 stock. The L group has a consolidated net operating loss arising in Year 1 that is carried over to Year 3. On July 16, Year 2, A and B transfer their L stock to a newly created holding company, HC, in exchange for 70 percent and 30 percent, respectively, of the HC stock. HC, L, and L1 thereafter file consolidated returns. Under the principles of § 1.1502-75(d), the L loss group is treated as remaining in existence, with HC taking the place of L as the new common parent of the loss group. The following is a graphic illustration of these facts:

(2) On November 11, Year 3, A sells 25 percent of the HC stock to B. For purposes of determining if the L loss group has an ownership change under paragraph (b)(1)(i) of this section on November 11, Year 3, HC is treated as a continuation of L under paragraph (b)(4)(i) of this section because it acquired L and became the common parent without terminating the L loss group. Accordingly, HC's testing period commences on January 1, Year 1, the first day of the taxable year of the L loss group in which the consolidated net operating loss that is carried over to Year 3 arose (see § 1.382-2T(d)(3)(i)). Immediately after the close of November 11, Year 3, B's percentage ownership interest in the common parent of the loss group (HC) has increased by 55 percentage points over its lowest percentage ownership during the testing period (zero percent). Accordingly, HC and the L loss group have an ownership change on that day.

(B) Example 2.—New common parent in case in which common parent ceases to exist. (1) A, B, and C each own one-third of the L stock. L owns all the L1 stock. The L group has a consolidated net operating loss arising in Year 2 that is carried over to Year 3. On November 22, Year 3, L is merged into P, a corporation owned by D, and L1 thereafter files consolidated returns with P. A, B, and C, as a result of owning stock of L, own 90 percent of P's stock after the merger. D owns the remaining 10 percent of P's stock. The merger of L into P qualifies as a reverse acquisition of the L group under § 1.1502-75(d)(3)(i), and the L loss group is treated as remaining in existence, with P taking the place of L as the new common parent of the L group. The following is a graphic illustration of these facts:

(2) For purposes of determining if the L loss group has an ownership change on November 22, Year 3, the day of the merger, P is treated as a continuation of L so that the testing period for P begins on January 1, Year 2, the first day of the taxable year of the L loss group in which the consolidated net operating loss that is carried over to Year 3 arose. Immediately after the close of November 22, Year 3, D is the only 5-percent shareholder that has increased its ownership interest in P during the testing period (from zero to 10 percentage points).

(3) The facts are the same as in paragraph (b)(3)(iii)(B)(1) of this section (Example 2), except that A has held 23 1/3 shares (23 1/3 percent) of L's stock for five years, and A purchased an additional 10 shares of L stock from E two years before the merger. Immediately after the close of the day of the merger (a testing date), A's ownership interest in P, the common parent of the L loss group, has increased by 6 2/3 percentage points over A's lowest percentage ownership during the testing period (23 1/3 percent to 30 percent).

(4) The facts are the same as in paragraph (b)(3)(iii)(B)(1) of this section (Example 2), except that P has a net operating loss arising in Year 1 that is carried to the first consolidated return year ending after the day of the merger. Solely for purposes of determining whether the L loss group has an ownership change under paragraph (b)(1)(i) of this section, the testing period for P commences on January 1, Year 2. P does not determine the earliest day for its testing period by reference to its net operating loss carryover from Year 1, which §§ 1.1502-1(f)(3) and 1.1502-75(d)(3)(i) treat as arising in a SRLY. See § 1.1502-94 to determine the application of section 382 with respect to P's net operating loss carryover.

(C) Example 3.—Newly acquired loss subgroup parent. (1) P owns all the L stock and L owns all the L1 stock. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 3. On January 19, Year 2, L issues a 20 percent stock interest to B. On February 5, Year 3, P contributes its L stock to a newly formed subsidiary, HC, in exchange for all the HC stock, and distributes the HC stock to its sole shareholder A. HC, L, and L1 thereafter file consolidated returns. A portion of the P group's Year 1 consolidated net operating loss is apportioned to L and L1 under § 1.1502-21(b) and is carried over to the HC group's year ending after February 5, Year 3. HC, L, and L1 compose a loss subgroup within the meaning of § 1.1502-91(d) with respect to the net operating loss carryovers from Year 1. The following is a graphic illustration of these facts:

(2) February 5, Year 3, is a testing date for HC as the loss subgroup parent with respect to the net operating loss carryovers of L and L1 from Year 1. See paragraph (b)(1)(ii)(B) of this section. For purposes of determining whether HC has an ownership change on the testing date, appropriate adjustments must be made with respect to the changes in the percentage ownership of the stock of HC because HC was not the loss subgroup parent for at least 3 years prior to the day on which it became a member of the HC loss subgroup (a testing date). The appropriate adjustments include adjustments so that HC succeeds to the owner shifts of other members of the former group. Thus, HC succeeds to the owner shift of L that resulted from the sale of the 20 percent interest to B in determining whether the HC loss subgroup has an ownership change on February 5, Year 3, and on any subsequent testing date that includes January 19, Year 2.

(4) End of separate tracking of certain losses. If § 1.1502-96(a) (relating to the end of separate tracking of attributes) applies to a loss subgroup, then, while one or more members that were included in the loss subgroup remain members of the consolidated group, there is an ownership change with respect to their attributes described in § 1.1502-96(a)(2) only if the consolidated group is a loss group and has an ownership change under paragraph (b)(1)(i) of this section (or such a member has an ownership change under § 1.1502-96(b) (relating to ownership changes of subsidiaries)). If, however, the loss subgroup has had an ownership change before § 1.1502-96(a) applies, see § 1.1502-96(c) for the continuing application of the subgroup's section 382 limitation with respect to its pre-change subgroup attributes.

(1) Scope. This paragraph (c) contains a supplemental rule for determining whether there is an ownership change of a loss group (or loss subgroup). It applies in addition to, and not instead of, the rules of paragraph (b) of this section. Thus, for example, if the common parent of the loss group has an ownership change under paragraph (b) of this section, the loss group has an ownership change even if, by applying this paragraph (c), the common parent would not have an ownership change. This paragraph (c) does not apply in determining an ownership change of a loss subgroup for which an election under § 1.1502-91(d)(4) is made.

(2) Cause for applying supplemental rule. This paragraph (c) applies to a loss group (or loss subgroup) if—

(i) Any 5-percent shareholder of the common parent (or loss subgroup parent) increases its percentage ownership interest in the stock of both—

(A) A subsidiary of the loss group (or loss subgroup) other than by a direct or indirect acquisition of stock of the common parent (or loss subgroup parent); and

(B) The common parent (or loss subgroup parent);

(ii) Those increases occur within a 3 year period ending on any day of a consolidated return year or, if shorter, the period beginning on the first day following the most recent ownership change of the loss group (or loss subgroup); and

(iii) Either—

(A) The common parent (or loss subgroup parent) has actual knowledge of the increase in the 5-percent shareholder's ownership interest in the stock of the subsidiary (or has actual knowledge of the plan or arrangement described in paragraph (c)(3)(i) of this section) before the date that the group's income tax return is filed for the taxable year that includes the date of that increase; or

(B) At any time during the period described in paragraph (c)(2)(ii) of this section, the 5-percent shareholder of the common parent is also a 5-percent shareholder of the subsidiary (determined without regard to paragraph (c)(3)(i) of this section) whose percentage increase in the ownership of the stock of the subsidiary would be taken into account in determining if the subsidiary has an ownership change (determined as if the subsidiary was a loss corporation and applying the principles of § 1.382-2T(k), including the principles relating to duty to inquire).

(3) Operating rules. Solely for purposes of this paragraph (c)—

(i) A 5-percent shareholder of the common parent (or loss subgroup parent) is treated as increasing its ownership interest in the stock of a subsidiary to the extent, if any, that another person or persons increases its percentage ownership interest in the stock of a subsidiary pursuant to a plan or arrangement under which the 5-percent shareholder increases its percentage ownership interest in the common parent (or loss subgroup parent);

(ii) The rules in section 382(l)(3) and §§ 1.382-2T(h) and 1.382-4(d) (relating to constructive ownership) apply with respect to the stock of the subsidiary by treating such stock as stock of a loss corporation; and

(iii) In the case of a loss subgroup, a subsidiary includes any member of the loss subgroup other than the loss subgroup parent. (A loss subgroup parent is, however, a subsidiary of the loss group of which it is a member.)

(4) Supplemental ownership change rules. The determination whether the common parent (or loss subgroup parent) has an ownership change is made by applying paragraph (b)(1) of this section as modified by the following additional rules:

(i) Additional testing dates for the common parent (or loss subgroup parent). A testing date for the common parent (or loss subgroup parent) also includes—

(A) Each day on which there is an increase in the percentage ownership of stock of a subsidiary as described in paragraph (c)(2) of this section; and

(B) The first day of the first consolidated return year for which the group is a loss group (or the members compose a loss subgroup).

(ii) Treatment of subsidiary stock as stock of the common parent (or loss subgroup parent). The common parent (or loss subgroup parent) is treated as though it had issued to the person acquiring (or deemed to acquire) the subsidiary stock an amount of its own stock (by value) that equals the value of the subsidiary stock represented by the percentage increase in that person's ownership of the subsidiary (determined on a separate entity basis). Similar principles apply if the increase in percentage ownership interest is effected by a redemption or similar transaction.

(iii) Different testing periods. Stock treated as issued under paragraph (c)(4)(ii) of this section on a testing date is not treated as so issued for purposes of applying the ownership change rules of this paragraph (c) and paragraph (b)(1) of this section in a testing period that does not include that testing date.

(iv) Disaffiliation of a subsidiary. If a deemed issuance of stock under paragraph (c)(4)(ii) of this section would not cause the loss group (or loss subgroup) to have an ownership change before the day (if any) on which the subsidiary ceases to be a member of the loss group (or subgroup), then paragraph (c)(4) of this section shall not apply.

(v) Subsidiary stock acquired first. If an increase of subsidiary stock described in paragraph (c)(2)(i)(A) of this section occurs before the date that the 5-percent shareholder increases its percentage ownership interest in the stock of the common parent (or loss subgroup parent), then the deemed issuance of stock is treated as occurring on that later date, but in an amount equal to the value of the subsidiary stock on the date it was acquired.

(vi) Anti-duplication rule. If two or more 5-percent shareholders are treated as increasing their percentage ownership interests pursuant to the same plan or arrangement described in paragraph (c)(3)(i) of this section, appropriate adjustments must be made so that the amount of stock treated as issued is not taken into account more than once.

(5) Examples. The following examples illustrate the principles of this paragraph (c):

Example 1. Stock of the common parent under supplemental rules. (i) A owns all the L stock. L is not a member of an affiliated group and has a net operating loss carryover arising in Year 1 that is carried over to Year 6. On September 20, Year 6, L transfers all of its assets and liabilities to a newly created subsidiary, S, in exchange for S stock. L and S thereafter file consolidated returns. On November 23, Year 6, B contributes cash to L in exchange for a 45 percent ownership interest in L and contributes cash to S for a 20 percent ownership interest in S.

(ii) During the 3 year period ending on November 23, Year 6, B is a 5% shareholder of L and of S that increases its ownership interest in L and S during that period. Under paragraph (c)(4)(ii) of this section, the determination whether L (the common parent of a loss group) has an ownership change on November 23, Year 6 (or, subject to paragraph (c)(4)(iv) of this section, on any testing date in the testing period which includes November 23, Year 6), is made by applying paragraph (b)(1)(i) of this section and by treating the value of B's 20 percent ownership interest in S as if it were L stock issued to B. Because B is a 5% shareholder of both L and S during the 3 year period ending on November 23, Year 6, and B's increase in its percentage ownership in the stock of S would be taken into account in determining if S (if it were a loss corporation) had an ownership change, it is not relevant whether L has actual knowledge of B's acquisition of S stock.

Example 2. Plan or arrangement—public offering of subsidiary stock. (i) A owns all the stock of L and L owns all the stock of L1. The L group has a consolidated net operating loss arising in Year 1 that resulted from the operations of L1 and that is carried over to Year 2. On October 7, Year 2, A sells 49 percent of the L stock to B. As part of a plan that includes the sale of L stock, A causes a public offering of L1 stock on November 6, Year 2. L has actual knowledge of the plan. The following is a graphic illustration of these facts: (ii) A's sale of the L stock to B does not cause an ownership change of the L loss group on October 7, Year 2, under the rules of § 1.382-2T and paragraph (b)(1)(i) of this section.

(iii) Because the issuance of L1 stock to the public occurs as part of the same plan as B's acquisition of L stock, and L has knowledge of the plan, paragraph (c)(4) of this section applies to determine whether the L loss group has an ownership change on November 6, Year 2 (or, subject to paragraph (c)(4)(iv) of this section, on any testing date for which the testing period includes November 6, Year 2).

(d) Testing period following ownership change under this section. If a loss group (or a loss subgroup) has had an ownership change under this section, the testing period for determining a subsequent ownership change with respect to pre-change consolidated attributes (or pre-change subgroup attributes) begins no earlier than the first day following the loss group's (or loss subgroup's) most recent change date.

(e) Information statements—(1) Common parent of a loss group. The common parent of a loss group must file the information statement required by § 1.382-11(a) for a consolidated return year because of any owner shift, equity structure shift, or other transaction described in § 1.382-2T(a)(2)(i)—

(i) With respect to the common parent and with respect to any subsidiary stock subject to paragraph (c) of this section; and

(ii) With respect to an ownership change described in § 1.1502-96(b) (relating to ownership changes of subsidiaries).

(2) Abbreviated statement with respect to loss subgroups. The common parent of a consolidated group that has a loss subgroup during a consolidated return year must file the information statement required by § 1.382-11(a) because of any owner shift, equity structure shift, or other transaction described in § 1.382-2T(a)(2)(i) with respect to the loss subgroup parent and with respect to any subsidiary stock subject to paragraph (c) of this section. Instead of filing a separate statement for each loss subgroup parent, the common parent (which is treated as a loss corporation) may file the single statement described in paragraph (e)(1) of this section. In addition to the information concerning stock ownership of the common parent, the single statement must identify each loss subgroup parent and state which loss subgroups, if any, have had ownership changes during the consolidated return year. The loss subgroup parent is, however, still required to maintain the records necessary to determine if the loss subgroup has an ownership change. This paragraph (e)(2) applies with respect to the attributes of a loss subgroup until, under § 1.1502-96(a), the attributes are no longer treated as described in § 1.1502-91(d) (relating to the definition of loss subgroup). After that time, the information statement described in paragraph (e)(1) of this section must be filed with respect to those attributes.

[T.D. 8824, 64 FR 36137, July 2, 1999, as amended by T.D. 9264, 71 FR 30608, May 30, 2006; T.D. 9329, 72 FR 32807, June 14, 2007; T.D. 10018, 89 FR 106877, Dec. 30, 2024]

§ 1.1502-93 Consolidated section 382 limitation (or subgroup section 382 limitation).

(a) Determination of the consolidated section 382 limitation (or subgroup section 382 limitation)—(1) In general. Following an ownership change, the consolidated section 382 limitation (or subgroup section 382 limitation) for any post-change year is an amount equal to the value of the loss group (or loss subgroup), as defined in paragraph (b) of this section, multiplied by the long-term tax-exempt rate that applies with respect to the ownership change, and adjusted as required by section 382 and the regulations thereunder. See, for example, section 382(b)(2) (relating to the carryforward of unused section 382 limitation), section 382(b)(3)(B) (relating to the section 382 limitation for the post-change year that includes the change date), section 382(h) (relating to recognized built-in gains and section 338 gains), and section 382(m)(2) (relating to short taxable years). For special rules relating to the recognized built-in gains of a loss group (or loss subgroup), see paragraph (c)(2) of this section.

(2) Coordination with apportionment rule. For special rules relating to apportionment of a consolidated section 382 limitation (or a subgroup section 382 limitation) or net unrealized built-in gain when one or more corporations cease to be members of a loss group (or a loss subgroup) and to aggregation of amounts so apportioned, see § 1.1502-95(c).

(b) Value of the loss group (or loss subgroup)—(1) Stock value immediately before ownership change. Subject to any adjustment under paragraph (b)(2) of this section, the value of the loss group (or loss subgroup) is the value, immediately before the ownership change, of the stock of each member, other than stock that is owned directly or indirectly by another member. For this purpose—

(i) Ownership is determined under § 1.382-2T;

(ii) A member is considered to indirectly own stock of another member through a nonmember only if the member has a 5-percent or greater ownership interest in the nonmember; and

(iii) Stock includes stock described in section 1504(a)(4) and § 1.382-2T(f)(18)(ii) and (iii).

(2) Adjustment to value—(i) In general. The value of the loss group (or loss subgroup), as determined under paragraph (b)(1) of this section, is adjusted under any rule in section 382 or the regulations thereunder requiring an adjustment to such value for purposes of computing the amount of the section 382 limitation. See, for example, section 382(e)(2) (redemptions and corporate contractions), section 382(l)(1) (certain capital contributions) and section 382(l)(4) (ownership of substantial nonbusiness assets). For purposes of section 382(e)(2), redemptions and corporate contractions that do not effect a transfer of value outside of the loss group (or loss subgroup) are disregarded. For purposes of section 382(l)(1), capital contributions between members of the loss group (or loss subgroup) (or a contribution of stock to a member made solely to satisfy the loss subgroup parent requirement of paragraph (d)(1)(ii) or (2)(ii) of this section), are not taken into account. Also, the substantial nonbusiness asset test of section 382(l)(4) is applied on a group (or subgroup) basis, and is not applied separately to its members.

(ii) Anti-duplication. Appropriate adjustments must be made to the extent necessary to prevent any duplication of the value of the stock of a member, even though corporations that do not file consolidated returns may not be required to make such an adjustment. In making these adjustments, the group (or loss subgroup) may apply the principles of § 1.382-8 (relating to controlled groups of corporations) in determining the value of a loss group (or loss subgroup) even if that section would not apply if separate returns were filed. Also, the principles of § 1.382-5(d) (relating to successive ownership changes and absorption of a section 382 limitation) may apply to adjust the consolidated section 382 limitation (or subgroup section 382 limitation) of a loss group (or loss subgroup) to avoid a duplication of value if there are simultaneous (rather than successive) ownership changes.

(3) Examples. The following examples illustrate the principles of this paragraph (b):

Example 1. Basic case. (i) L, L1, and L2 compose a loss group. L has outstanding common stock, the value of which is $100. L1 has outstanding common stock and preferred stock that is described in section 1504(a)(4). L owns 90 percent of the L1 common stock, and A owns the remaining 10 percent of the L1 common stock plus all the preferred stock. The value of the L1 common stock is $40, and the value of the L1 preferred stock is $30. L2 has outstanding common stock, 50 percent of which is owned by L and 50 percent by L1. The L group has an ownership change. The following is a graphic illustration of these facts: (ii) Under paragraph (b)(1) of this section, the L group does not include the value of the stock of any member that is owned directly or indirectly by another member in computing its consolidated section 382 limitation. Accordingly, the value of the stock of the loss group is $134, the sum of the value of—

(a) The common stock of L ($100);

(b) The 10 percent of the L1 common stock ($4) owned by A; and

Example 2. Indirect ownership. (i) L and L1 compose a consolidated group. L's stock has a value of $100. L owns 80 shares (worth $80) and corporation M owns 20 shares (worth $20) of the L1 stock. L also owns 79 percent of the stock of corporation M. The L group has an ownership change. The following is a graphic illustration of these facts: (ii) Under paragraph (b)(1) of this section, because of L's more than 5 percent ownership interest in M, a nonmember, L is considered to indirectly own 15.8 shares of the L1 stock held by M (79% × 20 shares). The value of the L loss group is $104.20, the sum of the values of—

(a) The L stock ($100); and

(b) The L1 stock not owned directly or indirectly by L (21% × $20, or $4.20).

(c) Recognized built-in gain of a loss group or loss subgroup—(1) In general. If a loss group (or loss subgroup) has a net unrealized built-in gain, any recognized built-in gain of the loss group (or loss subgroup) is taken into account under section 382(h) in determining the consolidated section 382 limitation (or subgroup section 382 limitation).

(2) Adjustments. Appropriate adjustments must be made so that any recognized built-in gain of a member that increases more than one section 382 limitation (whether consolidated, subgroup, or separate) does not effect a duplication in the amount of consolidated taxable income that can be offset by pre-change net operating losses. For example, a consolidated section 382 limitation that is increased by recognized built-in gains is reduced to the extent that pre-change net operating losses of a loss subgroup absorb additional consolidated taxable income because the same recognized built-in gains caused an increase in that loss subgroup's section 382 limitation. In addition, recognized built-in gain may not increase the amount of consolidated taxable income that can be offset by recognized built-in losses.

(d) Continuity of business—(1) In general. A loss group (or a loss subgroup) is treated as a single entity for purposes of determining whether it satisfies the continuity of business enterprise requirement of section 382(c)(1).

(2) Example. The following example illustrates the principle of this paragraph (d):

Example. Continuity of business enterprise.L owns all the stock of two subsidiaries, L1 and L2. The L group has an ownership change. It has pre-change consolidated attributes attributable to L2. Each of the members has historically conducted a separate line of business. Each line of business is approximately equal in value. One year after the ownership change, L discontinues its separate business and the business of L2. The separate business of L1 is continued for the remainder of the 2 year period following the ownership change. The continuity of business enterprise requirement of section 382(c)(1) is met even though the separate businesses of L and L2 are discontinued.

(e) Limitations of losses under other rules. If a section 382 limitation for a post-change year exceeds the consolidated taxable income that may be offset by pre-change attributes for any reason, including the application of the limitation of § 1.1502-21(c), the amount of the excess is carried forward under section 382(b)(2) (relating to the carryforward of unused section 382 limitation).

[T.D. 8824, 64 FR 36153, July 2, 1999]

§ 1.1502-94 Coordination with section 382 and the regulations thereunder when a corporation becomes a member of a consolidated group.

(a) Scope—(1) In general. This section applies section 382 and the regulations thereunder to a corporation that is a new loss member of a consolidated group. A corporation is a new loss member if it—

(i) Carries over a net operating loss that arose (or is treated under § 1.1502-21(c) as arising) in a SRLY with respect to the current group, and that is not described in § 1.1502-91(d)(1); or

(ii) Has a net unrealized built-in loss (determined under paragraph (c) of this section immediately before it becomes a member of the current group by treating that day as a change date) that is not taken into account under § 1.1502-91(d)(2) in determining whether two or more corporations compose a loss subgroup.

(2) Successor corporation as new loss member. A new loss member also includes any successor to a corporation that has a net operating loss carryover arising in a SRLY and that is treated as remaining in existence under § 1.382-2(a)(1)(ii) following a transaction described in section 381(a).

(3) Coordination in the case of a loss subgroup. For rules regarding the determination of whether there is an ownership change of a loss subgroup with respect to a net operating loss or a net unrealized built-in loss described in § 1.1502-91(d) (relating to the definition of loss subgroup) and the computation of a subgroup section 382 limitation following such an ownership change, see §§ 1.1502-92 and 1.1502-93.

(4) End of separate tracking of certain losses. If § 1.1502-96(a) (relating to the end of separate tracking of attributes) applies to a new loss member, then, while that member remains a member of the consolidated group, there is an ownership change with respect to its attributes described in § 1.1502-96(a)(2) only if the consolidated group is a loss group and has an ownership change under § 1.1502-92(b)(1)(i) (or that member has an ownership change under § 1.1502-96(b) (relating to ownership changes of subsidiaries)). If, however, the new loss member has had an ownership change before § 1.1502-96(a) applies, see § 1.1502-96(c) for the continuing application of the section 382 limitation with respect to the member's pre-change losses.

(5) Cross-reference. See section 382(a) and § 1.1502-96(c) for the continuing effect of an ownership change after a corporation becomes or ceases to be a member.

(b) Application of section 382 to a new loss member—(1) In general. Section 382 and the regulations thereunder apply to a new loss member to determine, on a separate entity basis, whether and to what extent a section 382 limitation applies to limit the amount of consolidated taxable income that may be offset by the new loss member's pre-change separate attributes. For example, if an ownership change with respect to the new loss member occurs under section 382 and the regulations thereunder, the amount of consolidated taxable income for any post-change year that may be offset by the new loss member's pre-change separate attributes shall not exceed the section 382 limitation as determined separately under section 382(b) with respect to that member for such year. If the post-change year includes the change date, section 382(b)(3)(A) is applied so that the section 382 limitation of the new loss member does not apply to the portion of the taxable income for such year that is allocable to the period in such year on or before the change date. See generally § 1.382-6 (relating to the allocation of income and loss).

(2) Adjustment to value. Appropriate adjustments must be made to the extent necessary to prevent any duplication of the value of the stock of a member, even though corporations that do not file consolidated returns may not be required to make such an adjustment. For example, the principles of § 1.1502-93(b)(2)(ii) (relating to adjustments to value) apply in determining the value of a new loss member.

(3) Pre-change separate attribute defined. A pre-change separate attribute of a new loss member is—

(i) Any net operating loss carryover of the new loss member described in paragraph (a)(1) of this section; and

(ii) Any recognized built-in loss of the new loss member.

(4) Examples. The following examples illustrate the principles of this paragraph (b):

Example 1. Basic case. (i) A and P each own 50 percent of the L stock. On December 19, Year 6, P purchases 30 percent of the L stock from A for cash. L has net operating losses arising in Year 1 and Year 2 that it carries over to Year 6 and Year 7. The following is a graphic illustration of these facts: (ii) L is a new loss member because it has net operating loss carryovers that arose in a SRLY with respect to the P group and L is not a member of a loss subgroup under § 1.1502-91(d). Under section 382 and the regulations thereunder, L is a loss corporation on December 19, Year 6, that day is a testing date for L, and the testing period for L commences on December 20, Year 3.

(iii) P's purchase of L stock does not cause an ownership change of L on December 19, Year 6, with respect to the net operating loss carryovers from Year 1 and Year 2 under section 382 and § 1.382-2T. The use of the loss carryovers, however, is subject to limitation under § 1.1502-21(c).

Example 2. Multiple new loss members. (i) The facts are the same as in Example 1, and, on December 31, Year 6, L purchases all the stock of L1 from B for cash. L1 has a net operating loss of $40 arising in Year 3 that it carries over to Year 7. The following is a graphic illustration of these facts: (ii) L1 is a new loss member because it has a net operating loss carryover from Year 3 that arose in a SRLY with respect to the P group and L1 is not a member of a loss subgroup under § 1.1502-91(d)(1).

(iii) L's purchase of all the stock of L1 causes an ownership change of L1 on December 31, Year 6, under section 382 and § 1.382-2T. Accordingly, a section 382 limitation based on the value of the L1 stock immediately before the ownership change limits the amount of consolidated taxable income of the P group for any post-change year that may be offset by L1's loss from Year 3.

(iv) L1's ownership change upon becoming a member of the P group is an ownership change described in § 1.1502-96(a). Thus, starting on January 1, Year 7, the P group no longer separately tracks owner shifts of the stock of L1 with respect to L1's loss from Year 3, and the P group is a loss group because L1's Year 3 loss is treated as a loss described in § 1.1502-91(c).

Example 3. Ownership changes of new loss members. (i) The facts are the same as in Example 2, and, on July 30, Year 7, C purchases all the stock of P for cash.

(ii) L is a new loss member on July 30, Year 7, because its Year 1 and Year 2 losses arose in SRLYs with respect to the P group and it is not a member of a loss subgroup under § 1.1502-91(d)(1). The testing period for L commences on August 1, Year 4. C's purchase of all the P stock causes an ownership change of L on July 30, Year 7, under section 382 and § 1.382-2T with respect to its Year 1 and Year 2 losses. Accordingly, a section 382 limitation based on the value of the L stock immediately before the ownership change limits the amount of consolidated taxable income of the P group for any post-change year that may be offset by L's Year 1 and Year 2 losses. See § 1.1502-21(c) for rules relating to an additional limitation.

(iii) The P group is a loss group on July 30, Year 7, because it is entitled to use L1's loss from Year 3, and such loss is no longer treated as a loss of a new loss member starting the day after L1's ownership change on December 31, Year 6. See §§ 1.1502-96(a) and 1.1502-91(c)(2). C's purchase of all the P stock causes an ownership change of P, and therefore the P loss group, on July 30, Year 7, with respect to L1's Year 3 loss. Accordingly, a consolidated section 382 limitation based on the value of the P stock immediately before the ownership change limits the amount of consolidated taxable income of the P group for any post-change year that may be offset by L1's Year 3 loss.

(c) Built-in gains and losses. As the context may require, the principles of §§ 1.1502-91(g) and (h) and 1.1502-93(c) (relating to built-in gains and losses) apply to a new loss member on a separate entity basis. See § 1.1502-91(g)(4). See § 1.1502-13 (including Example 10 of § 1.1502-13(c)(7)) for rules relating to the treatment of intercompany transactions.

(d) Information statements. The common parent of a consolidated group that has a new loss member subject to paragraph (b)(1) of this section during a consolidated return year must file the information statement required by § 1.382-11(a) because of any owner shift, equity structure shift, or other transaction described in § 1.382-2T(a)(2)(i). Instead of filing a separate statement for each new loss member, the common parent may file a single statement described in § 1.382-11(a) with respect to the stock ownership of the common parent (which is treated as a loss corporation). In addition to the information concerning stock ownership of the common parent, the single statement must identify each new loss member and state which new loss members, if any, have had ownership changes during the consolidated return year. The new loss member is, however, required to maintain the records necessary to determine if it has an ownership change. This paragraph (d) applies with respect to the attributes of a new loss member until an event occurs which ends separate tracking under § 1.1502-96(a). After that time, the information statement described in § 1.1502-92(e)(1) must be filed with respect to these attributes.

[T.D. 8824, 64 FR 36155, July 2, 1999, as amended by T.D. 9264, 71 FR 30608, May 30, 2006; T.D. 9329, 72 FR 32807, June 14, 2007]

§ 1.1502-95 Rules on ceasing to be a member of a consolidated group (or loss subgroup).

(a) In general—(1) Consolidated group. This section provides rules for applying section 382 on or after the day that a member ceases to be a member of a consolidated group (or loss subgroup). The rules concern how to determine whether an ownership change occurs with respect to losses of the member, and how a consolidated section 382 limitation (or subgroup section 382 limitation) and a loss group's (or loss subgroup's) net unrealized built-in gain or loss is apportioned to the member. As the context requires, a reference in this section to a loss group, a member, or a corporation also includes a reference to a loss subgroup, and a reference to a consolidated section 382 limitation also includes a reference to a subgroup section 382 limitation.

(2) Election by common parent. Only the common parent (not the loss subgroup parent) may make the election under paragraph (c) of this section to apportion a consolidated section 382 limitation (or subgroup section 382 limitation) or a loss group's (or loss subgroup's) net unrealized built-in gain.

(3) Coordination with §§ 1.1502-91 through 1.1502-93. For rules regarding the determination of whether there is an ownership change of a loss subgroup and the computation of a subgroup section 382 limitation following such an ownership change, see §§ 1.1502-91 through 1.1502-93.

(b) Separate application of section 382 when a member leaves a consolidated group—(1) In general. Except as provided in §§ 1.1502-91 through 1.1502-93 (relating to rules applicable to loss groups and loss subgroups), section 382 and the regulations thereunder apply to a corporation on a separate entity basis after it ceases to be a member of a consolidated group (or loss subgroup). Solely for purposes of determining whether a corporation has an ownership change—

(i) Any portion of a consolidated net operating loss that is apportioned to the corporation under § 1.1502-21(b) is treated as a net operating loss of the corporation beginning on the first day of the taxable year in which the loss arose;

(ii) The testing period may include the period during which (or before which) the corporation was a member of the group (or loss subgroup); and

(iii) Except to the extent provided in § 1.1502-96(d) (relating to reattributed losses), the day it ceases to be a member of a consolidated group is treated as a testing date of the corporation within the meaning of § 1.382-2(a)(4).

(2) Effect of a prior ownership change of the group. If a loss group has had an ownership change under § 1.1502-92 before a corporation ceases to be a member of a consolidated group (the former member)—

(i) Any pre-change consolidated attribute that is subject to a consolidated section 382 limitation continues to be treated as a pre-change loss with respect to the former member after it is apportioned to the former member and, if any net unrealized built-in loss is allocated to the former member under paragraph (e) of this section, any recognized built-in loss of the former member is a pre-change loss of the member;

(ii) The section 382 limitation with respect to such pre-change attribute is zero unless the common parent, under paragraph (c) of this section, apportions to the former member all or part of the consolidated section 382 limitation applicable to such attribute. The limitation applicable to a pre-change attribute other than a recognized built-in loss may be increased to the extent that the common parent has apportioned all or part of the loss group's net unrealized built-in gain to the former member, and the former member recognizes built-in gain during the recognition period;

(iii) The testing period for determining a subsequent ownership change with respect to such pre-change attribute (or such net unrealized built-in loss, if any) begins no earlier than the first day following the loss group's most recent change date; and

(iv) As generally provided under section 382, an ownership change of the former member that occurs on or after the day it ceases to be a member of a loss group may result in an additional, lesser limitation amount with respect to such losses.

(3) Application in the case of a loss subgroup. If two or more former members are included in the same loss subgroup immediately after they cease to be members of a consolidated group, the principles of paragraphs (b), (c) and (e) of this section apply to the loss subgroup. Therefore, for example, an apportionment by the common parent under paragraph (c) of this section is made to the loss subgroup rather than separately to its members. If the common parent of the consolidated group apportions all or part of a limitation (or net unrealized built-in gain) separately to one or more former members that are included in a loss subgroup because the common parent of the acquiring group makes an election under § 1.1502-91(d)(4) with respect to those members, the aggregate of those separate amounts is treated as the amount apportioned to the loss subgroup. Such separate apportionment may occur, for example, because the election under § 1.1502-91(d)(4) has not been filed at the time that the election of apportionment is made under paragraph (f) of this section.

(4) Examples. The following examples illustrate the principles of this paragraph (b):

(i) Example 1: Treatment of departing member as a separate corporation throughout the testing period. (A) A owns all the L stock. L owns all the stock of L1 and L2. The L group has a consolidated net operating loss arising in Year 1 that is carried over to Year 3. On January 12, Year 2, A sells 30 percent of the L stock to B. On February 7, Year 3, L sells 40 percent of the L2 stock to C, and L2 ceases to be a member of the group. A portion of the Year 1 consolidated net operating loss is apportioned to L2 under § 1.1502-21(b) and is carried to L2's first separate return year, which ends December 31, Year 3. The following is a graphic illustration of these facts:

(B) Under paragraph (b)(1) of this section, L2 is a loss corporation on February 7, Year 3. Under paragraph (b)(1)(iii) of this section, February 7, Year 3, is a testing date. Under paragraph (b)(1)(ii) of this section, the testing period for L2 with respect to this testing date commences on January 1, Year 1, the first day of the taxable year in which the portion of the consolidated net operating loss apportioned to L2 arose. Therefore, in determining whether L2 has an ownership change on February 7, Year 3, B's purchase of 30 percent of the L stock and C's purchase of 40 percent of the L2 stock are each owner shifts. L2 has an ownership change under section 382(g) and § 1.382-2T because B and C have increased their ownership interests in L2 by 18 and 40 percentage points, respectively, during the testing period.

(ii) Example 2: Effect of prior ownership change of loss group. (A) L owns all the L1 stock and L1 owns all the L2 stock. The L loss group had an ownership change under § 1.1502-92 in Year 2 with respect to a consolidated net operating loss arising in Year 1 and carried over to Year 2 and Year 3. The consolidated section 382 limitation computed solely on the basis of the value of the stock of L is $100. On December 31, Year 2, L1 sells 25 percent of the stock of L2 to B. L2 is apportioned a portion of the Year 1 consolidated net operating loss which it carries over to its first separate return year ending after December 31, Year 2. L2's separate section 382 limitation with respect to this loss is zero unless L elects to apportion all or a part of the consolidated section 382 limitation to L2. (See paragraph (c) of this section for rules regarding the apportionment of a consolidated section 382 limitation.) L apportions $50 of the consolidated section 382 limitation to L2, and the remaining $50 of the consolidated section 382 limitation stays with the loss group composed of L and L1.

(B) On December 31, Year 3, L1 sells its remaining 75 percent stock interest in L2 to C, resulting in an ownership change of L2. L2's section 382 limitation computed on the change date with respect to the value of its stock is $30. Accordingly, L2's section 382 limitation for post-change years ending after December 31, Year 3, with respect to its pre-change losses, including the consolidated net operating losses apportioned to it from the L group, is $30, adjusted for a short taxable year, carryforward of unused limitation, or any other adjustment required under section 382. The analysis would be similar if the L loss group had an ownership change under § 1.1502-92 in Year 2 with respect to disallowed business interest expense paid or accrued by L2 in Year 1 and carried forward under section 163(j)(2) to Year 2 and Year 3. See § 1.1502-98(b) (providing that §§ 1.1502-91 through 1.1502-96 apply section 382 to business interest expense, with appropriate adjustments).

(c) Apportionment of a consolidated section 382 limitation—(1) In general. The common parent may elect to apportion all or any part of a consolidated section 382 limitation to a former member (or loss subgroup). The common parent also may elect to apportion all or any part of the loss group's net unrealized built-in gain to a former member (or loss subgroup).

(2) Amount which may be apportioned—(i) Consolidated section 382 limitation. The common parent may apportion all or part of each element of the consolidated section 382 limitation determined under § 1.1502-93. For this purpose, the consolidated section 382 limitation consists of two elements—

(A) The value element, which is the element of the limitation determined under section 382(b)(1) (relating to value multiplied by the long-term tax-exempt rate) without regard to such adjustments as those described in section 382(b)(2) (relating to the carryforward of unused section 382 limitation), section 382(b)(3)(B)(relating to the section 382 limitation for the post-change year that includes the change date), section 382(h)(relating to built-in gains and section 338 gains), and section 382(m)(2)(relating to short taxable years); and

(B) The adjustment element, which is so much (if any) of the limitation for the taxable year during which the former member ceases to be a member of the consolidated group that is attributable to a carryover of unused limitation under section 382(b)(2) or to recognized built-in gains under 382(h).

(ii) Net unrealized built-in gain. The aggregate amount of the loss group's net unrealized built-in gain that may be apportioned to one or more former members that cease to be members during the same consolidated return year cannot exceed the loss group's excess, immediately after the close of that year, of net unrealized built-in gain over recognized built-in gain, determined under section 382(h)(1)(A)(ii) (relating to a limitation on recognized built-in gain). For this purpose, net unrealized built-in gain apportioned to former members in prior consolidated return years is treated as recognized built-in gain in those years.

(3) Effect of apportionment on the consolidated group—(i) Consolidated section 382 limitation. The value element of the consolidated section 382 limitation for any post-change year ending after the day that a former member (or loss subgroup) ceases to be a member(s) is reduced to the extent that it is apportioned under this paragraph (c). The consolidated section 382 limitation for the post-change year in which the former member (or loss subgroup) ceases to be a member(s) is also reduced to the extent that the adjustment element for that year is apportioned under this paragraph (c).

(ii) Net unrealized built-in gain. The amount of the loss group's net unrealized built-in gain that is apportioned to the former member (or loss subgroup) is treated as recognized built-in gain for a prior taxable year ending in the recognition period for purposes of applying the limitation of section 382(h)(1)(A)(ii) to the loss group's recognition period taxable years beginning after the consolidated return year in which the former member (or loss subgroup) ceases to be a member.

(4) Effect on corporations to which an apportionment is made—(i) Consolidated section 382 limitation. The amount of the value element that is apportioned to a former member (or loss subgroup) is treated as the amount determined under section 382(b)(1) for purposes of determining the amount of that corporation's (or loss subgroup's) section 382 limitation for any taxable year ending after the former member (or loss subgroup) ceases to be a member(s). Appropriate adjustments must be made to the limitation based on the value element so apportioned for a short taxable year, carryforward of unused limitation, or any other adjustment required under section 382. The adjustment element apportioned to a former member (or loss subgroup) is treated as an adjustment under section 382(b)(2) or section 382(h), as appropriate, for the first taxable year after the member (or members) ceases to be a member (or members).

(ii) Net unrealized built-in gain. For purposes of determining the amount by which the former member's (or loss subgroup's) section 382 limitation for any taxable year beginning after the former member (or loss subgroup) ceases to be a member(s) is increased by its recognized built-in gain—

(A) The amount of net unrealized built-in gain apportioned to a former member (or loss subgroup) is treated as if it were an amount of net unrealized built-in gain determined under section 382(h)(1)(A)(i)(without regard to the threshold of section 382(h)(3)(B)) with respect to such member or loss subgroup, and that amount is not reduced under section 382(h)(1)(A)(ii) by the loss group's recognized built-in gain;

(B) The former member's (or loss subgroup's) 5 year recognition period begins on the loss group's change date;

(C) In applying section 382(h)(1)(A)(ii), the former member (or loss subgroup) takes into account only its prior taxable years that begin after it ceases to be a member of the loss group; and

(D) The former member's (or loss subgroup's) recognized built-in gain on the disposition of an asset is determined under section 382(h)(2)(A), treating references to the change date in that section as references to the loss group's change date.

(5) Deemed apportionment when loss group terminates. If a loss group terminates, to the extent the consolidated section 382 limitation or net unrealized built-in gain is not apportioned under paragraph (c)(1) of this section, the consolidated section 382 limitation or net unrealized built-in gain is deemed to be apportioned to the loss subgroup that includes the common parent, or, if there is no loss subgroup that includes the common parent immediately after the loss group terminates, to the common parent. A loss group terminates on the first day of the first taxable year that is a separate return year with respect to each member of the former loss group.

(6) Appropriate adjustments when former member leaves during the year. Appropriate adjustments are made to the consolidated section 382 limitation for the consolidated return year during which the former member (or loss subgroup) ceases to be a member(s) to reflect the inclusion of the former member in the loss group for a portion of that year.

(7) Examples. The following examples illustrate the principles of this paragraph (c):

Example 1. Consequence of apportionment. (i) L owns all the L1 stock and L1 owns all the L2 stock. The L group has a $200 consolidated net operating loss arising in Year 1 that is carried over to Year 2. At the close of December 31, Year 1, the group has an ownership change under § 1.1502-92. The ownership change results in a consolidated section 382 limitation of $10 based on the value of the stock of the group. On August 29, Year 2, L1 sells 30 percent of the stock of L2 to A. L2 is apportioned $90 of the group's $200 consolidated net operating loss under § 1.1502-21(b). L, the common parent, elects to apportion $6 of the consolidated section 382 limitation to L2. The following is a graphic illustration of these facts: (ii) For its separate return years ending after December 31, Year 2, L2's section 382 limitation with respect to the $90 of the group's net operating loss apportioned to it is $6, adjusted, as appropriate, for any short taxable year, unused section 382 limitation, or other adjustment. For its consolidated return year ending December 31, Year 2 the L group's consolidated section 382 limitation with respect to the remaining $110 of pre-change consolidated attribute is $4 ($10 minus the $6 value element apportioned to L2), adjusted, as appropriate, for any short taxable year, unused section 382 limitation, or other adjustment.

(iii) For the L group's consolidated return year ending December 31, Year 2, the value element of its consolidated section 382 limitation is increased by $4 (rounded to the nearest dollar), to account for the period during which L2 was a member of the L group ($6, the consolidated section 382 limitation apportioned to L2, times 241/365, the ratio of the number of days during Year 2 that L2 is a member of the group to the number of days in the group's consolidated return year). See paragraph (c)(6) of this section. Therefore, the value element of the consolidated section 382 limitation for Year 2 of the L group is $8 (rounded to the nearest dollar).

(iv) The section 382 limitation for L2's short taxable year ending December 31, Year 2, is $2 (rounded to the nearest dollar), which is the amount that bears the same relationship to $6, the value element of the consolidated section 382 limitation apportioned to L2, as the number of days during that short taxable year, 124 days, bears to 365. See § 1.382-5(c).

Example 2. Consequence of no apportionment.The facts are the same as in Example 1, except that L does not elect to apportion any portion of the consolidated section 382 limitation to L2. For its separate return years ending after August 29, Year 2, L2's section 382 limitation with respect to the $90 of the group's pre-change consolidated attribute apportioned to L2 is zero under paragraph (b)(2)(ii) of this section. Thus, the $90 consolidated net operating loss apportioned to L2 cannot offset L2's taxable income in any of its separate return years ending after August 29, Year 2. For its consolidated return years ending after August 29, Year 2, the L group's consolidated section 382 limitation with respect to the remaining $110 of pre-change consolidated attribute is $10, adjusted, as appropriate, for any short taxable year, unused section 382 limitation, or other adjustment.

Example 3. Apportionment of adjustment element.The facts are the same as in Example 1, except that L2 ceases to be a member of the L group on August 29, Year 3, and the L group has a $4 carryforward of an unused consolidated section 382 limitation (under section 382(b)(2)) to the Year 3 consolidated return year. The carryover of unused limitation increases the consolidated section 382 limitation for the Year 3 consolidated return year from $10 to $14. L may elect to apportion all or any portion of the $10 value element and all or any portion of the $4 adjustment element to L2.

(d) Rules pertaining to ceasing to be a member of a loss subgroup—(1) In general. A corporation ceases to be a member of a loss subgroup on the earlier of—

(i) The first day of the first taxable year for which it files a separate return; or

(ii) The first day that it ceases to bear a relationship described in section 1504(a)(1) to the loss subgroup parent (treating for this purpose the loss subgroup parent as the common parent described in section 1504(a)(1)(A)).

(2) Exceptions. Paragraph (d)(1)(ii) of this section does not apply to a member of a loss subgroup while that member remains a member of the current group—

(i) If an election under § 1.1502-91(d)(4)(relating to treating the subgroup parent requirement as satisfied) applies to the members of the loss subgroup;

(ii) Starting on the day after the change date (but not earlier than the date the loss subgroup becomes a member of the group), if there is an ownership change of the loss subgroup within six months before, on, or after becoming members of the group; or

(iii) Starting the day after the period of 5 consecutive years following the day that the loss subgroup become members of the group during which the loss subgroup has not had an ownership change.

(3) Examples. The principles of this paragraph (d) are illustrated by the following examples:

Example 1. Basic case.(i) P owns all the L stock, L owns all the L1 stock and L1 owns all the L2 stock. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. On December 11, Year 2, P sells all the stock of L to corporation M. Each of L, L1, and L2 is apportioned a portion of the Year 1 consolidated net operating loss, and thereafter each joins with M in filing consolidated returns. Under § 1.1502-92, the L loss subgroup has an ownership change on December 11, Year 2. The L loss subgroup has a subgroup section 382 limitation of $100. The following is a graphic illustration of these facts: (ii) On May 22, Year 3, L1 sells 40 percent of the L2 stock to A. L2 carries over a portion of the P group's net operating loss from Year 1 to its separate return year ending December 31, Year 3. Under paragraph (d)(1) of this section, L2 ceases to be a member of the L loss subgroup on May 22, Year 3, which is both (1) the first day of the first taxable year for which it files a separate return and (2) the day it ceases to bear a relationship described in section 1504(a)(1) to the loss subgroup parent, L. The net operating loss of L2 that is carried over from the P group is treated as a pre-change loss of L2 for its separate return years ending after May 22, Year 3. Under paragraphs (a)(2) and (b)(2) of this section, the separate section 382 limitation with respect to this loss is zero unless M elects to apportion all or a part of the subgroup section 382 limitation of the L loss subgroup to L2.

Example 2. Formation of a new loss subgroup.The facts are the same as in Example 1, except that A purchases 40 percent of the L1 stock from L rather than purchasing L2 stock from L1. L1 and L2 file a consolidated return for their first taxable year ending after May 22, Year 3, and each of L1 and L2 carries over a part of the net operating loss of the P group that arose in Year 1. Under paragraph (d)(1) of this section, L1 and L2 cease to be members of the L loss subgroup on May 22, Year 3. The net operating losses carried over from the P group are treated as pre-change subgroup attributes of the loss subgroup composed of L1 and L2. The subgroup section 382 limitation with respect to those losses is zero unless M elects to apportion all or part of the subgroup section 382 limitation of the L loss subgroup to the L1 loss subgroup. The following is a graphic illustration of these facts:

Example 3. Ownership change upon becoming members of the group. (i) A owns all the stock of P, and P owns all the stock of L1 and L2. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 3 and Year 4. Corporation M acquires all the stock of P on November 11, Year 3, and P, L1, and L2 thereafter file consolidated returns with M. M's acquisition results in an ownership change of the P loss subgroup under § 1.1502-92(b)(1)(ii).

(ii) P distributes the L2 stock to M on October 7, Year 4, and L2 ceases to bear the relationship described in section 1504(a)(1) to P, the P loss subgroup parent. However, under paragraph (d)(2) of this section, L2 does not cease to be a member of the P loss subgroup because the P loss subgroup had an ownership change upon becoming members of the M group and L2 remains in the M group.

Example 4. Ceasing to bear a section 1504 (a)(1) to the loss subgroup parent. (i) A owns all the stock of P, and P owns all the stock of L1 and L2. The P group has a consolidated net operating loss arising in Year 1 that is carried over to Year 7. At the close of Year 2, X acquires all of the stock of P, causing an ownership change of the loss subgroup composed of P, L1 and L2 under § 1.1502-92(b)(1)(ii). In Year 4, M, which is owned by the same person that owns X, acquires all of the stock of P, and the M acquisition does not cause a second ownership change of the P loss subgroup.

(ii) P distributes the L2 stock to M on February 3, Year 6 (less than 5 years after the P loss subgroup became members of the M group) and L2 ceases to bear the relationship described in section 1504(a)(1) to P, the loss subgroup parent. Thus, the section 382 limitation from the Year 2 ownership change that applies with respect to the pre-change attributes attributable to L2 is zero except to the extent M elects to apportion all or part of the P loss subgroup section 382 limitation to L2.

Example 5. Relationship through a successor.The facts are the same as in Example 3, except that M's acquisition of the P stock does not result in an ownership change of the P loss subgroup, and, instead of P's distributing the stock of L2, L2 merges into L1 on October 7, Year 4. L1 (as successor to L2 in the merger within the meaning of § 1.1502-1(f)(4)) continues to bear a relationship described in section 1504(a)(1) to P, the loss subgroup parent. Thus, L2 does not cease to be a member of the P loss subgroup as a result of the merger.

Example 6. Reattribution of net operating loss carryover under § 1.1502-36(d)(6).The facts are the same as in Example 3, except that, instead of distributing the L2 stock to M, P sells that stock to B, and, under § 1.1502-36(d)(6), M reattributes $10 of L2's net operating loss carryover to itself. Under § 1.1502-36(d)(6)(iv)(A), M succeeds to the reattributed loss as if the loss were succeeded to in a transaction to which section 381(a) applies. M, as successor to L2, does not cease to be a member of the P loss subgroup.

(e) Allocation of net unrealized built-in loss—(1) In general. This paragraph (e) provides rules for the allocation of a loss group's (or loss subgroup's) net unrealized built-in loss if a member ceases to be a member of a loss group (or loss subgroup). This paragraph (e) applies if—

(i) A loss group (or loss subgroup) has a net unrealized built-in loss on a change date; and

(ii) Immediately after the close of the consolidated return year in which the departing member ceases to be a member, the amount of the loss group's (or loss subgroup's) excess of net unrealized built-in loss over recognized built-in loss, determined under section 382(h)(1)(B)(ii) (relating to a limitation on recognized built-in loss), is greater than zero. (The amount of such excess is referred to as the remaining NUBIL balance.) In applying section 382(h)(1)(B)(ii) for this purpose, net unrealized built-in loss allocated to departing members in prior consolidated return years is treated as recognized built-in loss in those years.

(2) Amount of allocation—(i) In general. The amount of net unrealized built-in loss allocated to a departing member is equal to the remaining NUBIL balance, multiplied by a fraction. The numerator of the fraction is the amount of the built-in loss, taken into account on the change date under § 1.1502-91(g), in the assets held by the departing member immediately after the member ceases to be a member of the loss group (or loss subgroup). The denominator of the fraction is the sum of the numerator, plus the amount of the built-in loss, taken into account under § 1.1502-91(g) on the change date, in the assets held by the loss group (or loss subgroup) immediately after the close of the taxable year in which the departing member ceases to be a member. (Fluctuations in value of the assets between the change date and the date that the member ceases to be a member of the group (or loss subgroup), or the close of the taxable year in which the member ceases to be a member of the loss group, are disregarded.) Because the amount of built-in loss on the change date with respect to a departing member's assets is taken into account (rather than that member's separately computed net unrealized built-in loss on the change date), a departing member can be apportioned all or part of the loss group's net unrealized built-in loss, even if the departing member had a separately computed net unrealized built-in gain on the change date. Amounts taken into account under section 382(h)(6)(C) (relating to certain deduction items) are treated as if they were assets in determining the numerator and denominator of the fraction.

(ii) Transferred basis property and deferred gain or loss. For purposes of paragraph (b)(2)(i) of this section, assets held by the departing member immediately after it ceases to be a member of the group (or by other members immediately after the close of the taxable year) include—

(A) Assets held at that time that are transferred basis property that was held by any member of the group (or loss subgroup) on the change date; and

(B) Assets held at that time by any member of the consolidated group with respect to which gain or loss of the group member or loss subgroup member at issue has been deferred in an intercompany transaction and has not been taken into account.

(iii) Assets for which gain or loss has been recognized. For purposes of paragraph (b)(2)(i) of this section, assets held by the departing member immediately after it ceases to be a member of the group (or by other members immediately after the close of the taxable year) do not include assets with respect to which gain or loss has previously been recognized and taken into account during the recognition period (including gain or loss recognized in an intercompany transaction and taken into account immediately before the member leaves the group). Appropriate adjustments must be made if gain or loss on an asset has been only partially recognized and taken into account.

(iv) Exchanged basis property. The rules of § 1.1502-91(h) apply for purposes of this paragraph (e) (disregarding stock received from the departing member or another member that is a member immediately after the close of the taxable year).

(v) Two or more members depart during the same year. If two or more members cease to be members during the same consolidated return year, appropriate adjustments must be made to the denominator of the fraction for each departing member by treating the other departing members as if they had not ceased to be members during that year and as if the assets held by those other departing members immediately after they cease to be members of the group (or loss subgroup) are assets held by the group immediately after the close of the taxable year.

(vi) Anti-abuse rule. If assets are transferred between members or a member ceases to be a member with a principal purpose of causing or affecting the allocation of amounts under this paragraph (e), appropriate adjustments must be made to eliminate any benefit of such acquisition, disposition, or allocation.

(3) Effect of allocation on the consolidated group. The amount of the net unrealized built-in loss that is allocated to the former member is treated as recognized built-in loss for a prior taxable year ending in the recognition period for purposes applying the limitation of section 382(h)(1)(B)(ii) to a loss group's (or loss subgroup's) recognition period taxable years beginning after the consolidated return year in which the former member ceases to be a member.

(4) Effect on corporations to which the allocation is made. For purposes of determining the amount of the former member's recognized built-in losses in any taxable year beginning after the former member ceases to be a member—

(i) The amount of the loss group's (or loss subgroup's) net unrealized built-in loss that is allocated to the former member is treated as if it were an amount of net unrealized built-in loss determined under section 382(h)(1)(B)(i)(without regard to the threshold of section 382(h)(3)(B)) with respect to such member or loss subgroup, and that amount is not reduced under section 382(h)(1)(B)(ii) by the loss group's (or loss subgroup's) recognized built-in losses;

(ii) The former member's 5 year recognition period begins on the loss group's (or loss subgroup's) change date;

(iii) In applying section 382(h)(1)(B)(ii), the former member takes into account only its prior taxable years that begin after it ceases to be a member of the loss group (or loss subgroup); and

(iv) The former member's recognized built-in loss on the disposition of an asset is determined under section 382(h)(2)(B), treating references to the change date in that section as references to the loss group's (or loss subgroup's) change date.

(5) Subgroup principles. If two or more former members are members of the same consolidated group (the second group) immediately after they cease to be members of the current group, the principles of paragraphs (e)(1), (2) and (4) of this section apply to those former members on an aggregate basis. Thus, for example, the amount of net unrealized built-in loss allocated to those members is based on the assets held by those members immediately after they cease to be members of the current group and the limitation of section 382(h)(1)(B)(ii) on recognized built-in losses is applied by taking into account the aggregate amount of net unrealized built-in loss allocated to the former members and the aggregate recognized losses of those members in taxable years beginning after they cease to be members of the current group. If one or more of such members cease to be members of the second group, the principles of this paragraph (e) are applied with respect to those members to allocate to them all or part of any remaining unrecognized amount of net unrealized built-in loss allocated to the members that became members of the second group.

(6) Apportionment of consolidated section 382 limitation (or subgroup section 382 limitation)—(i) In general. For rules relating to the apportionment of a consolidated section 382 limitation (or subgroup section 382 limitation) to a former member, see paragraph (c) of this section.

(ii) Special rule for former members that become members of the same consolidated group. If recognized built-in losses of one or more former members would be subject to a consolidated section 382 limitation (or subgroup section 382 limitation) if recognized immediately before the member (or members) cease to be members of the group, an apportionment of that limitation may be made, under paragraph (c) of this section, to a loss subgroup that includes such member (or members), and the recognized built-in losses (if any) of that member (or members) will be subject to that apportioned limitation. If two or more of such former members are not included in a loss subgroup immediately after they cease to be members of the group (for example, because they do not have net operating loss carryovers or, in the aggregate, a net unrealized built-in loss), but are members of the same consolidated group, an apportionment of the consolidated section 382 limitation (or subgroup section 382 limitation) may be made to them as if they were a loss subgroup.

(7) Examples. The following examples illustrate the principles of this paragraph (e):

Example 1. Basic allocation case. (i) P owns all of the stock of L1 and L2. On September 4, Year 1, A purchases all of the P stock, causing an ownership change of the P group. On that date P has two assets (other than the L1 and L2 stock), asset 1 with an adjusted basis of $40 and a fair market value of $15 and asset 2 with an adjusted basis of $50 and a fair market value of $100. L1 has two assets, asset 3 , with a fair market value of $50 and an adjusted basis of $100, and asset 4, with an adjusted basis of $125 and a fair market value of $75. L2 has two assets, asset 5, with a fair market value of $150 and an adjusted basis of $100, and asset 6, with an adjusted basis of $90 and a fair market value of $40. Thus, the P loss group has a net unrealized built-in loss of $75.

(ii) On March 19, Year 3, P sells all of the L2 stock to M. At that time, asset 5, which has appreciated in value, has a fair market value of $250 and an adjusted basis of $100. Asset 6, which has declined in value, has an adjusted basis of $90 and a fair market value of $10.

(iii) On April 8, Year 3, P sells asset 1, and has a recognized built-in loss of $25 that is subject to the P group's section 382 limitation. On November 11, Year 4, L2 sells asset 6 for its then fair market value, $10, recognizing a loss of $80. On June 3, Year 5, L1 sells asset 4, recognizing a loss of $50.

(iv) Immediately after the close of Year 3, the P loss group's remaining NUBIL balance is $50 ($75 net unrealized built-in loss reduced by the $25 recognized built-in loss of P). The portion of the remaining NUBIL balance that is allocated to L2 is $17 (rounded to the nearest dollar). Seventeen dollars is the product obtained by multiplying $50 (the remaining NUBIL balance) by $50/$150. The numerator of the fraction ($50) is the amount of built-in loss in asset 6, taken into account on the change date under § 1.1502-91(g). The denominator ($150) is the sum of the numerator ($50) and the amount of built-in loss in assets 3 and 4, taken into account on the change date under § 1.1502-91(g) ($100). The built-in loss in asset 1 is not included in the denominator of the fraction because it is not held by the P group immediately after the close of Year 3.

(v) Seventeen dollars of L2's $80 loss on the sale of asset 6 is a recognized built-in loss and subject to a section 382 limitation of zero, unless P apportions some or all of the P group's consolidated section 382 limitation to L2 (adjusted for a short taxable year, carryover of unused limitation, or any other adjustment required under section 382).

(vi) Thirty-three dollars of L1's $50 loss on the sale of asset 4 is subject to the P group's consolidated section 382 limitation, reduced by the amount of such limitation apportioned to L2, and adjusted for any short taxable year, a carryforward of unused limitation, or other adjustment. (In applying section 382(h)(1)(B)(ii) with respect to Year 5, the P group's net unrealized built-in loss is reduced by P's $25 recognized built-in loss in Year 3 and the $17 of net unrealized built-in loss allocated to L2, thus limiting the P group's recognized built-in loss in Year 5 to $33.)

Example 2. Two members depart in the same year.The facts are the same as in Example 1, except that P sells all of the stock of L1 to C on November 1, Year 3. The amount of net unrealized built-in loss apportioned to L2 (rounded to the nearest dollar) is $17 ($50 remaining NUBIL balance × $50/$150). The amount of net unrealized built-in loss apportioned to L1 (rounded to the nearest dollar) is $33 ($50 remaining NUBIL balance × $100/$150).

(8) Reporting requirements—(i) Common Parent. Except as provided in paragraph (e)(8)(iii) of this section, if a net unrealized built-in loss is allocated under paragraph (e) of this section, the common parent must include a statement entitled, “STATEMENT OF NET UNREALIZED BUILT-IN LOSS ALLOCATION PURSUANT TO § 1.1502-95(e),” on or with its income tax return for the taxable year in which the former member(s) (or a new loss subgroup that includes that member) ceases to be a member. The statement must include—

(A) The name and employer identification number of the departing member;

(B) The amount of the remaining NUBIL balance for the taxable year in which the member departs;

(D) A representation that the common parent has delivered a copy of the statement to the former member (or the common parent of the group of which the former member is a member) on or before the day the group files its income tax return for the consolidated return year that the former member ceases to be a member.

(ii) Former member. Except as provided in paragraph (e)(8)(iii) of this section, the former member must include a statement on or with its first income tax return (or the first return in which the former member joins) that is filed after the close of the consolidated return year of the group of which the former member (or a new loss subgroup that includes that member) ceases to be a member. The statement will be identical to the statement filed by the common parent under paragraph (e)(8)(i) of this section except that instead of including the information described in paragraph (e)(8)(i)(A) of this section the former member must provide the name, employer identification number and tax year of the former common parent, and instead of the representation described in paragraph (e)(8)(i)(D) of this section the former member must represent that it has received and retained the copy of the statement delivered by the common parent as part of its records. See § 1.6001-1(e).

(iii) Exception. This paragraph (e)(8) does not apply if the required information (other than the amount of the remaining NUBIL balance) is included in a statement of election under paragraph (f) of this section (relating to apportioning a section 382 limitation).

(f) Filing the election to apportion the section 382 limitation and net unrealized built-in gain—(1) Form of the election to apportion—(i) Statement. An election under paragraph (c) of this section must be made in the form set forth in this paragraph (f)(1)(i). The election must be made by the common parent and the party described in paragraph (f)(2) of this section. It must be filed in accordance with paragraph (f)(3) of this section and be entitled, “THIS IS AN ELECTION UNDER § 1.1502-95 TO APPORTION ALL OR PART OF THE [INSERT THE CONSOLIDATED SECTION 382 LIMITATION, THE SUBGROUP SECTION 382 LIMITATION, THE LOSS GROUP'S NET UNREALIZED BUILT-IN GAIN, OR THE LOSS SUBGROUP'S NET UNREALIZED BUILT-IN GAIN, AS APPROPRIATE] IN THE AMOUNT OF [INSERT THE AMOUNT OF THE LOSS LIMITATION OR NET UNREALIZED BUILT-IN GAIN] TO [INSERT NAME(S) AND EMPLOYER IDENTIFICATION NUMBER(S) OF THE CORPORATION (OR THE CORPORATIONS THAT COMPOSE A NEW LOSS SUBGROUP) TO WHICH ALLOCATION IS MADE].” The statement must also indicate that an agreement, as described in paragraph (f)(1)(ii) of this section, has been entered into.

(ii) Agreement. Both the common parent and the party described in paragraph (f)(2) of this section must sign and date the agreement. The agreement must include, as appropriate—

(A) The date of the ownership change that resulted in the consolidated section 382 limitation (or subgroup section 382 limitation) or the loss group's (or loss subgroup's) net unrealized built-in gain;

(B) The amount of the departing member's (or loss subgroup's) pre-change net operating loss carryovers and the taxable years in which they arose that will be subject to the limitation that is being apportioned to that member (or loss subgroup);

(C) The amount of any net unrealized built-in loss allocated to the departing member (or loss subgroup) under paragraph (e) of this section, which, if recognized, can be a pre-change attribute subject to the limitation that is being apportioned;

(D) If a consolidated section 382 limitation (or subgroup section 382 limitation) is being apportioned, the amount of the consolidated section 382 limitation (or subgroup section 382 limitation) for the taxable year during which the former member (or new loss subgroup) ceases to be a member of the consolidated group (determined without regard to any apportionment under this section);

(E) If any net unrealized built-in gain is being apportioned, the amount of the loss group's (or loss subgroup's) net unrealized built-in gain (as determined under paragraph (c)(2)(ii) of this section) that may be apportioned to members that ceased to be members during the consolidated return year;

(F) The amount of the value element and adjustment element of the consolidated section 382 limitation (or subgroup section 382 limitation) that is apportioned to the former member (or new loss subgroup) pursuant to paragraph (c) of this section;

(G) The amount of the loss group's (or loss subgroup's) net unrealized built-in gain that is apportioned to the former member (or new loss subgroup) pursuant to paragraph (c) of this section;

(H) If the former member is allocated any net unrealized built-in loss under paragraph (e) of this section, the amount of any adjustment element apportioned to the former member that is attributable to recognized built-in gains (determined in a manner that will enable both the group and the former member to apply the principles of § 1.1502-93(c)); and

(1) The name and employer identification number of the common parent making the apportionment.

(2) Signing the agreement. The agreement must be signed by both the common parent and the former member (or, in the case of a loss subgroup, the common parent and the loss subgroup parent) by persons authorized to sign their respective income tax returns. If the allocation is made to a loss subgroup for which an election under § 1.1502-91(d)(4) is made, and not separately to its members, the agreement under this paragraph (f) must be signed by the common parent and any member of the new loss subgroup by persons authorized to sign their respective income tax returns. Each party signing the agreement must retain either the original or a copy of the agreement as part of its records. See § 1.6001-1(e).

(3) Filing of the election—(i) Filing by the common parent. The election must be filed by the common parent of the group that is apportioning the consolidated section 382 limitation (or the subgroup section 382 limitation) or the loss group's net unrealized built-in gain (or loss subgroup's net unrealized built-in gain) by including the statement on or with its income tax return for the taxable year in which the former member (or new loss subgroup) ceases to be a member.

(ii) Filing by the former member. An identical statement must be included on or with the first return of the former member (or the first return in which the former member, or the members of a new loss subgroup, join) that is filed after the close of the consolidated return year of the group of which the former member (or the members of a new loss subgroup) ceases to be a member.

(4) Revocation of election. An election statement made under paragraph (c) of this section is revocable only with the consent of the Commissioner.

(g) Effective/applicability date. Paragraphs (e)(8) and (f) of this section apply to any original consolidated Federal income tax return due (without extensions) after June 14, 2007. For original consolidated Federal income tax returns due (without extensions) after May 30, 2006, and on or before June 14, 2007, see § 1.1502-95T as contained in 26 CFR part 1 in effect on April 1, 2007. For original consolidated Federal income tax returns due (without extensions) on or before May 30, 2006, see § 1.1502-95 as contained in 26 CFR part 1 in effect on April 1, 2006.

[T.D. 8824, 64 FR 36159, July 2, 1999, as amended by T.D. 9264, 71 FR 30604, 30608, May 30, 2006; T.D. 9329, 72 FR 32805, 32807, June 14, 2007; T.D. 9424, 73 FR 53985, Sept. 17, 2008; T.D. 9905, 85 FR 56844, Sept. 14, 2020]

§ 1.1502-96 Miscellaneous rules.

(a) End of separate tracking of losses—(1) Application. This paragraph (a) applies to a member (or a loss subgroup) with a net operating loss carryover that arose (or is treated under § 1.1502-21(c) as arising) in a SRLY, or a member (or loss subgroup) with a net unrealized built-in loss determined at the time that the member (or loss subgroup) becomes a member of the consolidated group if there is—

(i) An ownership change of the member (or loss subgroup) within six months before, on, or after becoming a member of the group; or

(ii) A period of 5 consecutive years following the day that the member (or loss subgroup) becomes a member of a group during which the member (or loss subgroup) has not had an ownership change.

(2) Effect of end of separate tracking—(i) Net operating loss carryovers. If this paragraph (a) applies with respect to a member (or loss subgroup) with a net operating loss carryover, then, starting on the day after the earlier of the change date (but not earlier than the day the member (or loss subgroup) becomes a member of the consolidated group) or the last day of the 5 consecutive year period described in paragraph (a)(1)(ii) of this section, such loss carryover is treated as described in § 1.1502-91(c)(1)(i). The preceding sentence also applies for purposes of determining whether there is an ownership change with respect to such loss carryover following such change date or 5 consecutive year period. Thus, for example, starting the day after the change date (but not earlier than the day the member (or loss subgroup) becomes a member of the consolidated group) or the end of the 5 consecutive year period—

(A) The consolidated group which includes the new loss member or loss subgroup is no longer required to separately track owner shifts of the stock of the new loss member or subgroup parent to determine if an ownership change occurs with respect to the loss carryover of the new loss member or members included in the loss subgroup;

(B) The group is a loss group because the member's loss carryover is treated as a loss described in § 1.1502-91(c)(1)(i);

(D) If the group has an ownership change, such loss carryover is a pre-change consolidated attribute subject to the loss group's consolidated section 382 limitation.

(ii) Net unrealized built-in losses. If this paragraph (a) applies with respect to a new loss member described in § 1.1502-94(a)(1)(ii) (or a loss subgroup described in § 1.1502-91(d)(2)) then, starting on the day after the earlier of the change date (but not earlier than the day the member (or loss subgroup) becomes a member of the group) or the last day of the 5 consecutive year period described in paragraph (a)(1)(ii) of this section, the member (or members of the loss subgroup) are treated, for purposes of applying § 1.1502-91(g)(2)(ii), as if they have been affiliated with the common parent for 5 consecutive years. Starting on that day, the member's (or the members of the loss subgroup's) separately computed net unrealized built-in loss is included in the determination whether the group has a net unrealized built-in loss, and there is an ownership change with respect to the member's separately computed net unrealized built-in loss only if the group (including the member) has a net unrealized built-in loss and has an ownership change. Thus, for example, starting the day after the change date (but not earlier than the day the member (or loss subgroup) becomes a member of the consolidated group), or the end of the 5 consecutive period

(A) The consolidated group which includes the new loss member or loss subgroup is no longer required to separately track owner shifts of the stock of the new loss member or subgroup parent to determine if an ownership change occurs with respect to the net unrealized built-in loss of the new loss member or members of the loss subgroup;

(B) The group includes the member's (or the loss subgroup members') separately computed net unrealized built-in loss in determining whether it is a loss group under § 1.1502-91(c)(1)(iii);

(C) There is an ownership change with respect to such net unrealized built-in loss only if the group is a loss group and has an ownership change; and

(D) If the group has an ownership change, the member's separately computed net unrealized built-in loss and its assets are taken into account in determining the group's pre-change consolidated attributes described in § 1.1502-91(e)(1) (relating to recognized built-in losses) that are subject to the group's consolidated section 382 limitation.

(iii) Common parent not common parent for five years. If the common parent has become the common parent of an existing group within the previous 5-year period in a transaction described in § 1.1502-75(d)(2)(ii) or (3), appropriate adjustments must be made in applying paragraphs (a)(2)(ii) and (3) of this section. In such a case, as the context requires, references to the common parent are to the former common parent.

(3) Continuing effect of end of separate tracking—(i) In general. As the context may require, a current group determines which of its members are included in a loss subgroup on any testing date by taking into account the application of this section in the former group. See the example in § 1.1502-91(f)(2). For this purpose, corporations that are treated under paragraph (a)(2)(ii) of this section as having been affiliated with the common parent of the former group for 5 consecutive years are also treated as having been affiliated with any other members that have been (or are treated as having been) affiliated with the common parent. The corporations are treated as having been affiliated with such other members for the same period of time that those members have been (or are treated as having been) affiliated with the common parent. If two or more corporations become members of the group at the same time, but paragraph (a)(1) of this section does not apply to every such corporation, then immediately after the corporations become members of the group, the corporations to which paragraph (a)(1) of this section applied are treated as not having been previously affiliated, for purposes of applying this paragraph (a)(3), with the corporations to which paragraph (a)(2)(ii) of this section did not apply.

(ii) Example. The following example illustrates the principles of this paragraph (a)(3):

Example. (i) L has owned all the stock of L1 for three years. At the close of December 31, Year 1, the M group purchases all the L stock, and L and L1 become members of the M group. Other than the stock of L1, L has one asset (the L loss asset) with a net unrealized built-in loss of $200 on this date. L1 has one asset with a net unrealized built-in gain of $50 (the L1 gain asset). L and L1 do not compose a loss subgroup because they do not meet the five year affiliation requirement of § 1.1502-91(d)(2)(i). L is a new loss member, and M's purchase of L causes an ownership change of L. At the close of December 31, Year 4, at a time when L1 has been affiliated with the M group for three years and has been affiliated with L for six years, the S group purchases all the M stock. On this date, the L loss asset has a net unrealized built-in loss of $300, the L1 gain asset has a net unrealized built-in gain of $80, and M, the common parent of the M group, has one asset with a net unrealized built-in gain of $200.

(ii) Paragraph (a)(1) of this section applies to L because L is a new loss member described in § 1.1502-94(a)(1)(ii) that has an ownership change upon becoming a member of the M group on December 31, Year 1. Accordingly, L is treated as having been affiliated with M for 5 consecutive years, and the L loss asset with a net unrealized built-in loss of $300 is included in the determination whether the M group has a net unrealized built-in loss.

(iii) The S group determines which of its members are included in a loss subgroup by taking into account application of paragraph (a) of this section in the M group. For this purpose, application of paragraph (a) of this section causes L to be treated as having been affiliated with M (or as having been a member of the M group) for 5 consecutive years as of January 1, Year 2. Therefore, the S group includes L in the determination whether the M subgroup acquired by S on December 31, Year 4, has a net unrealized built-in loss.

(iv) Because paragraph (a)(1) of this section applied to L when L became a member of the M group, but did not apply to L1, L is treated as not having been affiliated with L1 before L and L1 joined the M group. Also, L1 is not included in the determination whether the M subgroup has a net unrealized built-in loss because L1 has not been continuously affiliated with members of the M group for the five consecutive year period ending immediately before they become members of the S group. See § 1.1502-91(g)(2).

(4) Special rule for testing period. For purposes of determining the beginning of the testing period for a loss group, the member's (or loss subgroup's) net operating loss carryovers (or net unrealized built-in loss) described in paragraph (a)(2) of this section are considered to arise—

(i) In a case described in paragraph (a)(1)(i) of this section, in a taxable year that begins not earlier than the later of the day following the change date or the day that the member becomes a member of the group; and

(ii) In a case described in paragraph (a)(1)(ii) of this section, in a taxable year that begins 3 years before the end of the 5 consecutive year period.

(5) Limits on effects of end of separate tracking. The rule contained in this paragraph (a) applies solely for purposes of §§ 1.1502-91 through 1.1502-95 and this section (other than paragraph (b)(2)(ii)(B) of this section (relating to the definition of pre-change attributes of a subsidiary)) and § 1.1502-98, and not for purposes of other provisions of the consolidated return regulations. However, the rule contained in this paragraph (a) does apply in §§ 1.1502-15(g), 1.1502-21(g) and 1.1502-22(g) for purposes of determining the composition of loss subgroups defined in § 1.1502-91(d). See also paragraph (c) of this section for the continuing effect of an ownership change with respect to pre-change attributes.

(b) Ownership change of subsidiary—(1) Ownership change of a subsidiary because of options or plan or arrangement. Notwithstanding § 1.1502-92, a subsidiary may have an ownership change for purposes of section 382 with respect to its attributes which a group or loss subgroup includes in making a determination under § 1.1502-91(c)(1) (relating to the definition of loss group) or § 1.1502-91(d) (relating to the definition of loss subgroup). The subsidiary has such an ownership change if it has an ownership change under the principles of § 1.1502-95(b) and section 382 and the regulations thereunder (determined on a separate entity basis by treating the subsidiary as not being a member of a consolidated group) in the event of—

(i) The deemed exercise under § 1.382-4(d) of an option or options (other than an option with respect to stock of the common parent) held by a person (or persons acting pursuant to a plan or arrangement) to acquire more than 20 percent of the stock of the subsidiary; or

(ii) An increase by 1 or more 5-percent shareholders, acting pursuant to a plan or arrangement to avoid an ownership change of a subsidiary, in their percentage ownership interest in the subsidiary by more than 50 percentage points during the testing period of the subsidiary through the acquisition (or deemed acquisition pursuant to § 1.382-4(d)) of ownership interests in the subsidiary and in higher-tier members with respect to the subsidiary.

(2) Effect of the ownership change—(i) In general. If a subsidiary has an ownership change under paragraph (b)(1) of this section, the amount of consolidated taxable income for any post-change year that may be offset by the pre-change losses of the subsidiary shall not exceed the section 382 limitation for the subsidiary. For purposes of this limitation, the value of the subsidiary is determined solely by reference to the value of the subsidiary's stock.

(ii) Pre-change losses. The pre-change losses of a subsidiary are—

(A) Its allocable part of any consolidated net operating loss which is attributable to it under § 1.1502-21(b) (determined on the last day of the consolidated return year that includes the change date) that is not carried back and absorbed in a taxable year prior to the year including the change date;

(B) Its net operating loss carryovers that arose (or are treated under § 1.1502-21(c) as having arisen) in a SRLY; and

(C) Its recognized built-in loss with respect to its separately computed net unrealized built-in loss, if any, determined on the change date.

(3) Coordination with §§ 1.1502-91, 1.1502-92, and 1.1502-94. If an increase in percentage ownership interest causes an ownership change with respect to an attribute under this paragraph (b) and under § 1.1502-92 on the same day, the ownership change is considered to occur only under § 1.1502-92 and not under this paragraph (b). See § 1.1502-94 for anti-duplication rules relating to value.

(4) Example. The following example illustrates paragraph (b)(1)(ii) of this section:

Example. Plan to avoid an ownership change of a subsidiary. (i) L owns all the stock of L1, L1 owns all the stock of L2, L2 owns all the stock of L3, and L3 owns all the stock of L4. The L group has a consolidated net operating loss arising in Year 1 that is carried over to Year 2. L has assets other than its L1 stock with a value of $900. L1, L2, and L3 own no assets other than their L2, L3, and L4 stock. L4 has assets with a value of $100. During Year 2, A, B, C, and D, acting pursuant to a plan to avoid an ownership change of L4, acquire the following ownership interests in the members of the L loss group: (A) on September 11, Year 2, A acquires 20 percent of the L1 stock from L and B acquires 20 percent of the L2 stock from L1; and (B) on September 20, Year 2, C acquires 20 percent of the stock of L3 from L2 and D acquires 20 percent of the stock of L4 from L3.

(ii) The acquisitions by A, B, C, and D pursuant to the plan have increased their respective percentage ownership interests in L4 by approximately 10, 13, 16, and 20 percentage points, for a total of approximately 59 percentage points during the testing period. This more than 50 percentage point increase in the percentage ownership interest in L4 causes an ownership change of L4 under paragraph (b)(2) of this section.

(c) Continuing effect of an ownership change. A loss corporation (or loss subgroup) that is subject to a limitation under section 382 with respect to its pre-change losses continues to be subject to the limitation regardless of whether it becomes a member or ceases to be a member of a consolidated group. See § 1.382-5(d) (relating to successive ownership changes and absorption of a section 382 limitation).

(d) Losses reattributed under § 1.1502-36(d)(6)—(1) In general. This paragraph (d) contains rules relating to net operating carryovers, capital loss carryovers, and deferred deductions (collectively, loss or losses) that are reattributed to the common parent under § 1.1502-36(d)(6). References in this paragraph (d) to a subsidiary are references to the subsidiary (or lower-tier subsidiary) whose loss is reattributed to the common parent.

(2) Deemed section 381(a) transaction. Under § 1.1502-36(d)(6)(iv)(A), the common parent succeeds to the reattributed losses as if the losses were succeeded to in a transaction to which section 381(a) applies. In general, §§ 1.1502-91 through 1.1502-95, this section, and § 1.1502-98 are applied to the reattributed losses in accordance with that characterization. See generally, § 1.382-2(a)(1)(ii) (relating to distributor or transferor loss corporations in transactions under section 381), § 1.1502-1(f)(4) (relating to the definition of predecessor and successor) and § 1.1502-91(j) (relating to predecessor and successor corporations). For example, if the reattributed loss is a pre-change attribute subject to a section 382 limitation, it remains subject to that limitation following the reattribution. In certain cases, the limitation applicable to the reattributed loss is zero unless the common parent apportions all or part of the limitation to itself. (See paragraph (d)(4) of this section.)

(3) Rules relating to owner shifts—(i) In general. Any owner shift of the subsidiary (including any deemed owner shift resulting from section 382(g)(4)(D) or 382(l)(3)) in connection with the disposition of the stock of the subsidiary is not taken into account in determining whether there is an ownership change with respect to the reattributed loss. However, any owner shift with respect to the successor corporation that is treated as continuing in existence under § 1.382-2(a)(1)(ii) must be taken into account for such purpose if such owner shift is effected by the reattribution and an owner shift of the stock of the subsidiary not held directly or indirectly by the common parent would have been taken into account if such shift had occurred immediately before the reattribution. See paragraph (d)(3)(ii) Example 2 of this section.

(ii) Examples. The following examples illustrate the principles of this paragraph (d)(3):

Example 1. No owner shift for reattributed loss. (i) Facts. P, the common parent of a consolidated group, owns 60% of the stock of L, and B owns the remaining 40%. L has a net operating loss carryover of $100 from year 1 that it carries over to years 2, 3, and 4. At the beginning of year 2, P purchases 40% of the L stock from B, which does not cause an ownership change of L. On December 31, year 3, P sells all of the L stock to M. Pursuant to § 1.1502-36(d)(6), P reattributes $10 of L's $100 net operating loss carryover to itself, and L carries $90 of its net operating loss carryover to its year 4.

(ii) Analysis. The sale of the L stock to M does not cause an owner shift that is taken into account in determining if there is an ownership change with respect to the $10 reattributed loss. Following the reattribution, § 1.1502-94(b) continues to apply to determine if there is an ownership change with respect to the $10 reattributed loss, until, under paragraph (a) of this section, the loss is treated as described in § 1.1502-91(c)(1)(i). In applying § 1.1502-94(b), the 40 percentage point increase by the P shareholders prior to the reattribution is taken into account. The sale of the L stock to M does cause an ownership change of L with respect to the $90 of its net operating loss that it carries over to year 4.

Example 2. Owner shift for reattributed loss.The facts are the same as in Example 1, except that P only purchases 20% of the L stock from B and sells 80% of the L stock to M. L is a new loss member, and, under § 1.1502-94(b)(1), an owner shift of the stock of L not held directly or indirectly by the common parent (the 20% of L stock still held by B) would have been taken into account if such shift had occurred immediately before the reattribution. Following the reattribution, § 1.1502-94(b) continues to apply to determine if there is an ownership change with respect to the $10 reattributed loss, until, under paragraph (a) of this section, the loss is treated as described in § 1.1502-91(c)(1)(i). With respect to the $10 reattributed loss, the P shareholders have increased their percentage ownership interest by 40 percentage points. The P shareholders have increased their ownership interests by 20 percentage points as a result of P's purchase of stock from B, and, under § 1.382-2(a)(1)(ii), are treated as increasing their interests by an additional 20 percentage points as a result of the reattribution. (The acquisition of the L stock by M does not, however, effect an owner shift for the $10 of reattributed loss.) The sale of the L stock to M causes an ownership change of L with respect to the $90 of net operating loss that L carries over to Year 4.

(4) Rules relating to the section 382 limitation—(i) Reattributed loss is a pre-change separate attribute of a new loss member. If the reattributed loss is a pre-change separate attribute of a new loss member that is subject to a separate section 382 limitation prior to the disposition of subsidiary stock, the common parent's limitation with respect to that loss is zero, except to the extent that the common parent apportions to itself, under paragraph (d)(5) of this section, all or part of such limitation. A separate section 382 limitation is the limitation described in § 1.1502-94(b) that applies to a pre-change separate attribute.

(ii) Reattributed loss is a pre-change subgroup attribute. If the reattributed loss is a pre-change subgroup attribute subject to a subgroup section 382 limitation prior to the disposition of subsidiary stock, and, immediately after the reattribution, the common parent is not a member of the loss subgroup, the section 382 limitation with respect to that loss is zero, except to the extent that the common parent apportions to itself, under paragraph (d)(5) of this section, all or part of the subgroup section 382 limitation. See, however, § 1.1502-95(d)(3) Example 6, for an illustration of a case where the common parent, as successor to the subsidiary, is a member of the loss subgroup immediately after the reattribution.

(iii) Potential application of section 382(l)(1). In general, the value of the stock of the common parent is used to determine the section 382 limitation for an ownership change with respect to the reattributed loss that occurs at the time of, or after, the reattribution. For example, if the loss is a pre-change consolidated attribute, the value of the stock of the common parent is used to determine the section 382 limitation, and no adjustment to that value is required because of the deemed section 381(a) transaction. However, if the loss is a pre-change separate attribute of a new loss member (or is a pre-change attribute of a loss subgroup member and the common parent was not the loss subgroup parent immediately before the reattribution), the deemed section 381(a) transaction is considered to constitute a capital contribution with respect to the new loss member (or loss subgroup member) for purposes of section 382(l)(1). Accordingly, if that section applies because the deemed capital contribution is (or is considered under section 382(l)(1)(B) to be) part of a plan described in section 382(l)(1)(A), the value of the stock of the common parent after the deemed section 381(a) transaction must be adjusted to reflect the capital contribution. Ordinarily, this will require the value of the stock of the common parent to be reduced to an amount that represents the value of the stock of the subsidiary (or loss subgroup of which the subsidiary was a member) when the reattribution occurred.

(iv) Duplication or omission of value. In determining any section 382 limitation with respect to the reattributed loss and with respect to other pre-change losses, appropriate adjustments must be made so that value is not improperly omitted or duplicated as a result of the reattribution. For example, if the subsidiary has an ownership change upon its departure, and the common parent (as successor) has an ownership change with respect to the reattributed pre-change separate attribute upon its reattribution under paragraph (d)(3)(i) of this section, proper adjustments must be made so that the value of the subsidiary is not taken into account more than once in determining the section 382 limitation for the reattributed loss and the loss that is not reattributed.

(v) Special rule for continuity of business requirement. If the reattributed loss is a pre-change attribute of new loss member and the reattribution occurs within the two-year period beginning on the change date, then, starting immediately after the reattribution, the continuity of business requirement of section 382(c)(1) is applied with respect to the business enterprise of the common parent. Similar principles apply if the reattributed loss is a pre-change subgroup attribute and, on the day after the reattribution, the common parent is not a member of the loss subgroup.

(5) Election to reattribute section 382 limitation—(i) Effect of election. The common parent may elect to apportion to itself all or part of any separate section 382 limitation or subgroup section 382 limitation to which the loss is subject immediately before the reattribution. However, no net unrealized built-in gain of the member (or loss subgroup) whose loss is reattributed can be apportioned to the common parent. The principles of § 1.1502-95(c) apply to the apportionment, treating, as the context requires, references to the former member as references to the common parent, and references to the consolidated section 382 limitation as references to the separate section 382 limitation (or subgroup section 382 limitation) that is being apportioned. Thus, for example, the common parent can reattribute to itself all or part of the value element or adjustment element of the limitation, and any part of such element that is apportioned requires a corresponding reduction in such element of the separate section 382 limitation of the subsidiary whose loss is reattributed (or in the subgroup section 382 limitation if the reattributed loss is a pre-change subgroup attribute). Appropriate adjustments must be made to the separate section 382 limitation (or subgroup section 382 limitation) for the consolidated return year in which the reattribution is made to reflect that the reattributed loss is an attribute acquired by the common parent during the year in a transaction to which section 381(a) applies. The election is made by the common parent as part of the election to reattribute the loss. See § 1.1502-36(e)(5)(x) for the time and manner of making the election.

(ii) Examples. The following examples illustrate the principles of this paragraph (d)(5):

Example 1. Consequence of apportionment. (i) Facts. P, the common parent of a consolidated group, purchases all of the stock of L on December 31, year 1. L carries over a net operating loss arising in year 1 to each of the next 5 taxable years. The purchase of the L stock causes an ownership change of L, and results in a separate section 382 limitation of $10 for L's net operating loss carryover based on the value of the L stock. On July 2, year 3, P sells 30% of the L stock to A. Under § 1.1502-36(d)(6), P elects to reattribute to itself $110 of L's $200 net operating loss carryover. P also elects to apportion to itself $6 of the $10 value element of the separate section 382 limitation.

(ii) Analysis. (A) P's separate section 382 limitation. For the consolidated return years ending after December 31, year 3, P's separate section 382 limitation with respect to the reattributed net operating loss carryover is $6, adjusted as appropriate for any short taxable year, unused section 382 limitation, or other adjustment. For the P group's consolidated return year ending December 31, year 3, the separate section 382 limitation for L's net operating loss carryover is $8, the sum of $5 and $3. Five dollars of the limitation is the amount that bears the same relationship to $10 as the number of days in the period ending with the deemed section 381(a) transaction, 183 days, bears to 365. Three dollars of the limitation is the amount that bears the same relationship to $6 as the number of days in the period between July 3 and December 31, 182, bears to 365.

(B) L's separate section 382 limitation. For L's taxable years ending after December 31, year 3, L's separate section 382 limitation for its $90 of net operating loss carryover that was not reattributed to P is $4, adjusted as appropriate for any short taxable year, unused section 382 limitation, or other adjustment. For L's short taxable year ending December 31, year 3, the section 382 limitation for its $90 of net operating loss carryover is $2, the amount that bears the same relationship to $4 (the portion of the value element that was not apportioned to P), as the number of days during the short taxable year, 182 days, bears to 365. See § 1.382-5(c).

Example 2. No apportionment required for consolidated pre-change attribute. (i) Facts. P, the common parent of a consolidated group, forms L. For year 1, L has an operating loss of $70 that is not absorbed and is included in the group's consolidated net operating loss that is carried over to subsequent years. On January 1 of year 3, A buys all of the P stock and the P group has an ownership change. The consolidated section 382 limitation based on the value of the P stock is $10.

(ii) Analysis. On April 13 of year 4, P sells all of the stock of L to B and, under § 1.1502-36(d)(6), elects to reattribute to itself $45 of L's net operating loss carryover. Following the reattribution, the $45 portion of the year 1 net operating loss carryover retains its character as a pre-change consolidated attribute, and remains subject to so much of the $10 consolidated section 382 limitation as P does not elect to apportion to L under § 1.1502-95(c).

(e) Time and manner of making election under § 1.1502-91(d)(4)—(1) In general. This paragraph (e) prescribes the time and manner of making the election under § 1.1502-91(d)(4), relating to treating two or more corporations as treating the section 1504(a)(1) requirement of § 1.1502-91(d)(1)(ii) and (d)(2)(ii) as satisfied.

(2) Election statement. An election under § 1.1502-91(d)(4) must be made by the common parent. The election must be made in the form of the following statement: “THIS IS AN ELECTION UNDER § 1.1502-91(d)(4) TO TREAT THE FOLLOWING CORPORATIONS AS MEETING THE REQUIREMENTS OF § 1.1502-91 (d)(1)(ii) AND (d)(2)(ii) IMMEDIATELY AFTER THEY BECAME MEMBERS OF THE GROUP.” [List separately the name of each corporation, its E.I.N., and the date that it became a member of the group]. If separate elections are being made for corporations that became members at different times or that were acquired from different affiliated groups, provide a separate statement and list for each election.

(3) The election statement must be filed by the common parent with its income tax return for the consolidated return year in which the members with respect to which the election is made become members of the group. Such election must be filed on or before the due date for such income tax return, including extensions.

(4) An election made under this paragraph (e) is irrevocable.

[T.D. 8824, 64 FR 36170, July 2, 1999, as amended by T.D. 9424, 73 FR 53985, Sept. 17, 2008]

§ 1.1502-97 Special rules under section 382 for members under the jurisdiction of a court in a title 11 or similar case. [Reserved]

§ 1.1502-98 Coordination with sections 383 and 163(j).

(a) Coordination with section 383. The rules contained in §§ 1.1502-91 through 1.1502-96 also apply for purposes of section 383, with appropriate adjustments to reflect that section 383 applies to credits and net capital losses. For example, subgroups with respect to the carryover of general business credits, minimum tax credits, unused foreign tax, and net capital loss are determined by applying the principles of § 1.1502-91(d)(1). Similarly, in the case of net capital losses, general business credits, and excess foreign taxes that are pre-change attributes, § 1.383-1 applies the principles of §§ 1.1502-91 through 1.1502-96. For example, if a loss group has an ownership change under § 1.1502-92 and has a carryover of unused general business credits from a pre-change consolidated return year to a post-change consolidated return year, the amount of the group's regular tax liability for the post-change year that can be offset by the carryover cannot exceed the consolidated section 383 credit limitation for that post-change year, determined by applying the principles of §§ 1.383-1(c)(6) and 1.1502-93 (relating to the computation of the consolidated section 382 limitation).

(b) Application to section 163(j)—(1) In general. The regulations in this part under sections 163(j), 382, and 383 of the Code contain rules governing the application of section 382 to interest expense governed by section 163(j) and the regulations in this part under section 163(j) of the Code. See, for example, §§ 1.163(j)-11(c), 1.382-2, 1.382-6, 1.382-7, and 1.383-1. The rules contained in §§ 1.1502-91 through 1.1502-96 apply these rules to members of a consolidated group, or corporations that join or leave a consolidated group, with appropriate adjustments. For example, for purposes of §§ 1.1502-91 through 1.1502-96, the term loss group includes a consolidated group in which any member is entitled to use a disallowed business interest expense carryforward, as defined in § 1.163(j)-1(b)(11), that did not arise, and is not treated as arising, in a SRLY with regard to that group. Additionally, a reference to net operating loss carryovers in §§ 1.1502-91 through 1.1502-96 generally includes a reference to disallowed business interest expense carryforwards. References to a loss or losses in §§ 1.1502-91 through 1.1502-96 include references to disallowed business interest expense carryforwards or section 382 disallowed business interest carryforwards, within the meaning of § 1.382-2(a)(7), as appropriate.

(2) Appropriate adjustments. For purposes of applying the rules in §§ 1.1502-91 through 1.1502-96 to current-year business interest expense (as defined in § 1.163(j)-1(b)(9)), disallowed business interest expense carryforwards, and section 382 disallowed business interest carryforwards, appropriate adjustments are required.

[T.D. 8824, 64 FR 36174, July 2, 1999, as amended by T.D. 8884, 65 FR 33760, May 25, 2000; T.D. 9905, 85 FR 56844, Sept. 14, 2020]

§ 1.1502-99 Effective/applicability dates.

(a) In general. Sections 1.1502-91 through 1.1502-96 and § 1.1502-98 apply to any testing date that is on or after June 25, 1999. Sections 1.1502-94 through 1.1502-96 also apply to a corporation that becomes a member of a group or ceases to be a member of a group (or loss subgroup) on or after June 25, 1999.

(b) Reattribution of losses under § 1.1502-36(d)(6). Section 1.1502-96(d) applies to reattributions of net operating loss carryovers, capital loss carryovers, and deferred deductions in connection with a transfer of stock to which § 1.1502-36 applies, and the election under § 1.1502-96(d)(5) (relating to an election to reattribute section 382 limitation) can be made with an election under § 1.1502-36(d)(6) to reattribute a loss to the common parent that is filed at the time and in the manner provided in § 1.1502-36(e)(5)(x).

(c) Application to section 163(j)—(1) Sections 1.382-2 and 1.382-5. To the extent the rules of §§ 1.1502-91 through 1.1502-99 effectuate the rules of §§ 1.382-2 and 1.382-5, the provisions apply with respect to ownership changes occurring on or after November 13, 2020. For loss corporations that have ownership changes occurring before November 13, 2020, see §§ 1.1502-91 through 1.1502-99 as contained in 26 CFR part 1, revised April 1, 2019. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of §§ 1.1502-91 through 1.1502-99 to the extent they apply the rules of §§ 1.382-2 and 1.382-5, to ownership changes occurring during a taxable year beginning after December 31, 2017, as well as consistently applying the rules of the §§ 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§ 1.382-6 and 1.383-1), the section 163(j) regulations (as defined in § 1.163(j)-1(b)(37)), and, if applicable, §§ 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-7, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79, and 1.1504-4, to that taxable year.

(2) Sections 1.382-6 and 1.383-1. To the extent the rules of §§ 1.1502-91 through 1.1502-98 effectuate the rules of §§ 1.382-6 and 1.383-1, the provisions apply with respect to ownership changes occurring during a taxable year beginning on or after November 13, 2020. For the application of these rules to an ownership change with respect to an ownership change occurring during a taxable year beginning before November 13, 2020, see §§ 1.1502-91 through 1.1502-99 as contained in 26 CFR part 1, revised April 1, 2019. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of §§ 1.1502-91 through 1.1502-99 (to the extent that those rules effectuate the rules of §§ 1.382-6 and 1.383-1), to ownership changes occurring during a taxable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of 1.1502-91 through 1.1502-99 (to the extent that those rules effectuate the rules of §§ 1.382-2 and 1.382-5), the section 163(j) regulations (as defined in § 1.163(j)-1(b)(37)), and, if applicable, §§ 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-7, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, and 1.1504-4, to a taxable year beginning after December 31, 2017.

[T.D. 8824, 64 FR 36174, July 2, 1999, as amended by T.D. 9424, 73 FR 53986, Sept. 17, 2008; T.D. 9905, 85 FR 56844, Sept. 14, 2020; T.D. 10018, 89 FR 106877, Dec. 30, 2024]

§ 1.1502-100 Corporations exempt from tax.

(a) In general—(1) Computation of tax liability. The tax liability for a consolidated return year of a group of two or more corporations described in section 1504(e) which are exempt from taxation under section 501 (hereinafter referred to in this section as “exempt group”) shall be determined on a consolidated basis by applying the provisions of subchapter F of chapter 1 of the code in the manner provided in this section. See section 1504(e) for tax-exempt corporations eligible to file a consolidated return.

(2) Applicability of other consolidated return provisions. The provisions of the consolidated return regulations are applicable to an exempt group to the extent they are not inconsistent with the provisions of this section or the provisions of subchapter F of chapter 1 of the Code. For purposes of applying the provisions of the consolidated return regulations to an exempt group, the following substitutions must be made—

(i) The term “exempt group” is substituted for the term “group”;

(ii) The terms “unrelated business taxable income”, “separate unrelated business taxable income”, and “consolidated unrelated business taxable income” are substituted for the terms “taxable income”, “separate taxable income”, and “consolidated taxable income”; and

(iii) The term consolidated liability for tax determined under § 1.1502-2 (or an equivalent term) means the consolidated liability for tax of an exempt group determined under paragraph (b) of this section.

(b) The tax liability for a consolidated return year of an exempt group is the tax imposed by section 511(a) on the consolidated unrelated taxable income for the year (determined under paragraph (c) of this section), and by allowing the credits provided in § 1.1502-2(b).

(c) Consolidated unrelated business taxable income. The consolidated unrelated business taxable income for a consolidated return year shall be determined by taking into account:

(1) The separate unrelated business taxable income of each member of the exempt group (determined under paragraph (d) of this section);

(2) Any consolidated net operating loss deduction (determined under § 1.1502-21) subject to the limitations provided in section 512(b)(6);

(3) Any consolidated charitable contribution deduction (determined under § 1.1502-24) subject to the limitations provided in section 512(b)(10); and

(4) Any consolidated net gain or net loss from the disposition of debt-financed property (as defined in section 514(b)) taken into account as provided by section 514(a), or from the cutting of timber to which section 631 applies.

(d) Separate unrelated business taxable income—(1) In general. The separate unrelated business taxable income of a member of an exempt group must be computed in accordance with the provisions of section 512 covering the determination of unrelated business taxable income of separate corporations, except that:

(i) The provisions of paragraphs (a) through (d), (f) through (k), and (o) of § 1.1502-12 apply; and

(ii) No charitable contributions deduction is taken into account under section 512(b)(10).

(2) Section 501(c)(2) organizations. See sections 511(c) and 512(a)(3)(C) for special rules applicable to organizations described in section 501(c)(2). .

See sections 511(c) and 512(a)(3)(C) for special rules applicable to organizations described in section 501(c)(2).

[T.D. 7595, 44 FR 10382, Feb. 20, 1979, as amended by T.D. 8677, 61 FR 33325, June 27, 1996; T.D. 8823, 64 FR 36101, July 2, 1999; T.D. 9885, 84 FR 67044, Dec. 6, 2019; T.D. 10018, 89 FR 106878, Dec. 30, 2024]

§ 1.1503-1 Computation and payment of tax.

(a) General rule. In any case in which a consolidated return is filed or required to be filed, the tax shall be determined, computed, assessed, collected, and adjusted in accordance with the regulations prescribed under section 1502 promulgated prior to the last date prescribed by law for the filing of such return.

(b) Limitation. If the affiliated group includes one or more Western Hemisphere trade corporations (as defined in section 921) or one or more regulated public utilities (as defined in section 1503 (c)), the increase in tax described in section 1503 (a) shall be applied in a manner provided in the regulations under section 1502.

[T.D. 6500, 25 FR 12105, Nov. 26, 1960, as amended by T.D. 7244, 37 FR 28897, Dec. 30, 1972]

§ 1.1503(d)-0 Table of contents.

This section lists the captions contained in §§ 1.1503(d)-1 through 1.1503(d)-8.

§ 1.1503(d)-1 Definitions and special rules for filings under section 1503(d).

(a) In general.

(b) Definitions.

(1) Domestic corporation.

(2) Dual resident corporation.

(3) Hybrid entity.

(4) Separate unit.

(i) In general.

(ii) Separate unit combination rule.

(iii) Business operations that do not constitute a permanent establishment.

(iv) Foreign branch separate units held by dual resident corporations or hybrid entities in the same foreign country.

(5) Dual consolidated loss.

(6) Subject to tax.

(7) Foreign country.

(8) Consolidated group.

(9) Domestic owner.

(10) Affiliated dual resident corporation and affiliated domestic owner.

(11) Unaffiliated dual resident corporation, unaffiliated domestic corporation, and unaffiliated domestic owner.

(12) Domestic affiliate.

(13) Domestic use.

(14) Foreign use.

(15) Grantor trust.

(16) Transparent entity.

(i) In general.

(ii) Example.

(17) Disregarded entity.

(18) Partnership.

(19) Indirectly.

(20) Certification period.

(1) Reasonable cause exception.

(2) Requirements for reasonable cause relief.

(i) Time of submission.

(ii) Notice requirement.

(3) Signature requirement.

§ 1.1503(d)-2 Domestic use. § 1.1503(d)-3 Foreign use.

(a) Foreign use.

(1) In general.

(2) Indirect use.

(i) General rule.

(ii) Exception.

(iii) Examples.

(3) Deemed use.

(b) Available for use.

(1) In general.

(2) Election or merger required to enable foreign use.

(3) Presumed use where no foreign country rule for determining use.

(4) Certain interests in partnerships or grantor trusts.

(i) General rule.

(ii) Combined separate unit.

(iii) Reduction in interest.

(5) De minimis reduction of an interest in a separate unit.

(i) General rule.

(ii) Limitations.

(iii) Reduction in interest.

(iv) Examples and coordination with exceptions to other triggering events.

(6) Certain asset basis carryovers.

(7) Assumption of certain liabilities.

(i) In general.

(ii) Ordinary course limitation.

(8) Multiple-party events.

(9) Additional guidance.

(d) Ordering rules for determining the foreign use of losses.

(e) Mirror legislation rule.

(1) In general.

(2) Stand-alone exception.

(i) In general.

(ii) Stand-alone domestic use agreement.

(iii) Termination of stand-alone domestic use agreement.

§ 1.1503(d)-4 Domestic use limitation and related operating rules.

(a) Scope.

(b) Limitation on domestic use of a dual consolidated loss.

(c) Effect of a dual consolidated loss on a consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner.

(1) Dual resident corporation.

(2) Separate unit.

(3) SRLY limitation.

(4) Items of a dual consolidated loss used in other taxable years.

(5) Reconstituted net operating losses.

(d) Elimination of a dual consolidated loss after certain transactions.

(1) General rule.

(i) Transactions described in section 381(a).

(ii) Cessation of separate unit status.

(2) Exceptions.

(i) Certain section 368(a)(1)(F) reorganizations.

(ii) Acquisition of a dual resident corporation by another dual resident corporation.

(iii) Acquisition of a separate unit by a domestic corporation.

(A) Acquisition by a corporation that is not a member of the same consolidated group.

(B) Acquisition by a member of the same consolidated group.

(iv) Special rules for foreign insurance companies.

(e) Special rule denying the use of a dual consolidated loss to offset tainted income.

(1) In general.

(2) Tainted income.

(i) Definition.

(ii) Income presumed to be derived from holding tainted assets.

(3) Tainted assets defined.

(4) Exceptions.

(f) Computation of foreign tax credit limitation.

§ 1.1503(d)-5 Attribution of items and basis adjustments.

(a) In general.

(b) Determination of amount of income or dual consolidated loss of a dual resident corporation.

(1) In general.

(2) Exceptions.

(c) Determination of amount of income or dual consolidated loss attributable to a separate unit, and income or loss attributable to an interest in a transparent entity.

(1) In general.

(i) Scope and purpose.

(ii) Only items of domestic owner taken into account.

(iii) Separate application.

(2) Foreign branch separate unit.

(i) In general.

(ii) Principles of § 1.882-5.

(iii) Exception where foreign country attributes interest expense solely by reference to books and records.

(3) Hybrid entity separate unit and an interest in a transparent entity.

(i) General rule.

(ii) Interests in certain disregarded entities, partnerships, and grantor trusts owned by a hybrid entity or transparent entity.

(4) Special rules.

(i) Allocation of items between certain tiered separate units and interests in transparent entities.

(A) Foreign branch separate unit.

(B) Hybrid entity separate unit or interest in a transparent entity.

(ii) Combined separate unit.

(iii) Gain or loss on the direct or indirect disposition of a separate unit or an interest in a transparent entity.

(A) In general.

(B) Multiple separate units or interests in transparent entities.

(iv) Inclusions on stock.

(v) Foreign currency gain or loss recognized under section 987.

(vi) Recapture of dual consolidated loss.

(d) Foreign tax treatment disregarded.

(e) Items generated or incurred while a dual resident corporation, a separate unit, or a transparent entity.

(f) Assets and liabilities of a separate unit or an interest in a transparent entity.

(g) Basis adjustments.

(1) Affiliated dual resident corporation or affiliated domestic owner.

(2) Interests in hybrid entities that are partnerships or interests in partnerships through which a separate unit is owned indirectly.

(i) Scope.

(ii) Determination of basis of partner's interest.

(3) Combined separate units.

§ 1.1503(d)-6 Exceptions to the domestic use limitation rule.

(a) In general.

(1) Scope and purpose.

(2) Absence of foreign affiliate or foreign consolidation regime.

(3) Foreign insurance companies treated as domestic corporations.

(b) Elective agreement in place between the United States and a foreign country.

(1) In general.

(2) Application to combined separate units.

(1) In general.

(2) Statement.

(d) Domestic use election.

(1) In general.

(2) No domestic use election available if there is a triggering event in the year the dual consolidated loss is incurred.

(e) Triggering events requiring the recapture of a dual consolidated loss.

(1) Events.

(i) Foreign use.

(ii) Disaffiliation.

(iii) Affiliation.

(iv) Transfer of assets.

(v) Transfer of an interest in a separate unit.

(vi) Conversion to a foreign corporation.

(vii) Conversion to a regulated investment company, a real estate investment trust, or an S corporation.

(viii) Failure to certify.

(ix) Cessation of stand-alone status.

(2) Rebuttal.

(i) General rule.

(ii) Certain asset transfers.

(iii) Reporting.

(iv) Examples.

(f) Triggering event exceptions.

(1) Continuing ownership of assets or interests.

(i) Disaffiliation as a result of a transaction described in section 381.

(ii) Continuing ownership by consolidated group.

(iii) Continuing ownership by unaffiliated dual resident corporation or unaffiliated domestic owner.

(2) Transactions requiring a new domestic use agreement.

(i) Multiple-party events.

(ii) Events resulting in a single consolidated group.

(iii) Requirements.

(A) New domestic use agreement.

(B) Statement filed by original elector.

(3) Certain transfers qualifying for the de minimis exception to foreign use.

(4) Deemed transactions as a result of certain transfers that do not result in a foreign use.

(5) Compulsory transfers.

(6) Subsequent triggering events.

(g) Annual certification reporting requirement.

(h) Recapture of dual consolidated loss and interest charge.

(1) Presumptive rules.

(i) Amount of recapture.

(ii) Interest charge.

(2) Reduction of presumptive recapture amount and presumptive interest charge.

(i) Amount of recapture.

(ii) Interest charge.

(3) Rules regarding multiple-party event exceptions to triggering events.

(i) Scope.

(ii) Original elector and prior subsequent electors not subject to recapture or interest charge.

(iii) Recapture tax amount and required statement.

(A) In general.

(B) Recapture tax amount.

(iv) Tax assessment and collection procedures.

(A) In general.

(B) Collection from original elector and prior subsequent electors; joint and several liability.

(D) Refund.

(v) Definition of income tax liability.

(vi) Example.

(4) Computation of taxable income in year of recapture.

(i) Presumptive rule.

(ii) Exception to presumptive rule.

(5) Character and source of recapture income.

(6) Reconstituted net operating loss.

(i) General rule.

(ii) Exception.

(iii) Special rule for recapture following multiple-party event exception to a triggering event.

(i) [Reserved]

(j) Termination of domestic use agreement and annual certifications.

(1) Rebuttals, exceptions to triggering events, and recapture.

(2) Termination of ability for foreign use.

(i) In general.

(ii) Statement.

(3) Agreements filed in connection with stand-alone exception.

§ 1.1503(d)-7 Examples.

(a) In general.

(b) Presumed facts for examples.

§ 1.1503(d)-8 Effective dates.

(a) General rule.

(b) Special rules.

(1) Reduction of term of agreements filed under §§ 1.1503-2A(c)(3), 1.1503-2A(d)(3), 1.1503-2(g)(2)(i), or 1.1503-2T(g)(2)(i).

(2) Reduction of term of agreements filed under §§ 1.1503-2(g)(2)(iv)(B)(2)(i) (1992), 1.1503-2(g)(2)(iv)(B)(3)(i), or Rev. Proc. 2000-42.

(3) Relief for untimely filings.

(i) General rule.

(ii) Closing agreements.

(iii) Pending requests for relief.

(4) Multiple-party event exception to triggering events.

(5) Basis adjustment rules.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007; 72 FR 20424, Apr. 23, 2007]

§ 1.1503(d)-1 Definitions, special rules, and filings.

(a) In general. This section and §§ 1.1503(d)-2 through 1.1503(d)-8 provide rules concerning the determination and use of dual consolidated losses pursuant to section 1503(d). Paragraph (b) of this section provides definitions that apply for purposes of this section and §§ 1.1503(d)-2 through 1.1503(d)-8. Paragraph (c) of this section provides rules for a domestic consenting corporation. Paragraph (d) of this section provides rules for disregarded payment losses. Paragraph (e) of this section provides relief for certain compliance failures due to reasonable cause, and a signature requirement for filings. Paragraph (f) of this section provides an anti-avoidance rule.

(b) Definitions. The following definitions apply for purposes of this section and §§ 1.1503(d)-2 through 1.1503(d)-8:

(1) Domestic corporation means an entity classified as a domestic corporation under section 7701(a)(3) and (4) or otherwise treated as a domestic corporation by the Internal Revenue Code, including, but not limited to, sections 269B, 953(d), 1504(d), and 7874. However, solely for purposes of section 1503(d), the term domestic corporation shall not include a regulated investment company as defined in section 851, a real estate investment trust as defined in section 856, or an S corporation as defined in section 1361.

(2) Dual resident corporation means—

(i) A domestic corporation that is subject to an income tax of a foreign country on its worldwide income or on a residence basis. A corporation is taxed on a residence basis if it is taxed as a resident under the laws of the foreign country;

(ii) A foreign insurance company that makes an election to be treated as a domestic corporation pursuant to section 953(d) and is treated as a member of an affiliated group for purposes of chapter 6, even if such company is not subject to an income tax of a foreign country on its worldwide income or on a residence basis. See section 953(d)(3); and

(iii) A domestic consenting corporation (as defined in § 301.7701-3(c)(3)(i) of this chapter), as provided in paragraph (c)(1) of this section. See § 1.1503(d)-7(c)(41) for an example illustrating the application of section 1503(d) to a domestic consenting corporation.

(3) Hybrid entity means an entity that is not taxable as an association for Federal tax purposes, but is subject to an income tax of a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis.

(4) Separate unit—(i) In general. The term separate unit means either of the following that is carried on or owned, as applicable, directly or indirectly, by a domestic corporation (including a dual resident corporation):

(A) Except to the extent provided in paragraph (b)(4)(iii) of this section, a business operation outside the United States that, if carried on by a U.S. person, would constitute a foreign branch as defined in § 1.367(a)-6T(g)(1) (foreign branch separate unit).

(B) An interest in a hybrid entity (hybrid entity separate unit).

(ii) Separate unit combination rule. Except as otherwise provided in this paragraph, if a domestic owner, or two or more domestic owners that are members of the same consolidated group, have two or more separate units (individual separate units), then all such individual separate units that are located (in the case of a foreign branch separate unit) or subject to an income tax either on their worldwide income or on a residence basis (in the case of a hybrid entity an interest in which is a hybrid entity separate unit) in the same foreign country shall be treated as one separate unit (combined separate unit). See § 1.1503(d)-7(c) Example 1. Separate units of a foreign insurance company that is a dual resident corporation under paragraph (b)(2)(ii) of this section, however, shall not be combined with separate units of any other domestic corporation. Except as specifically provided in this section or §§ 1.1503(d)-2 through 1.1503(d)-8, any individual separate unit composing a combined separate unit loses its character as an individual separate unit.

(iii) Business operations that do not constitute a permanent establishment. A business operation carried on by a domestic corporation that is not a dual resident corporation shall not constitute a foreign branch separate unit, provided the business operation:

(A) Is not carried on indirectly through a hybrid entity or a transparent entity; and

(B) Is conducted in a country with which the United States has entered into an income tax convention and is not treated as a permanent establishment pursuant to that convention, or is not otherwise subject to tax on a net basis under that convention. See § 1.1503(d)-7(c) Example 2.

(iv) Foreign branch separate units held by dual resident corporations or hybrid entities in the same foreign country. A foreign branch separate unit may be owned by a dual resident corporation, or through a hybrid entity (an interest in which is a separate unit), even where the foreign branch is located in the same foreign country that subjects such dual resident corporation or hybrid entity to tax on its worldwide income or on a residence basis. But see the rule under paragraph (b)(4)(ii) of this section that combines certain same-country hybrid entity separate units and foreign branch separate units. See also § 1.1503(d)-7(c) Example 1.

(5) Dual consolidated loss means—

(i) In the case of a dual resident corporation, and except to the extent provided in § 1.1503(d)-5(b), the net operating loss (as defined in section 172(c) and the related regulations) incurred in a year in which the corporation is a dual resident corporation; and

(ii) In the case of a separate unit, the net loss attributable to the separate unit under § 1.1503(d)-5(c) through (e).

(6) Subject to tax. For purposes of determining whether a domestic corporation or another entity is subject to an income tax of a foreign country on its income, the fact that it has no actual income tax liability to the foreign country for a particular taxable year shall not be taken into account.

(7) Foreign country includes any U.S. territory (as defined in § 1.1502-1(l)).

(8) Consolidated group has the meaning provided in § 1.1502-1(h).

(9) Domestic owner means—

(i) A domestic corporation (including a dual resident corporation) that has one or more separate units or interests in a transparent entity; and

(ii) In the case of a combined separate unit, a domestic corporation (including a dual resident corporation) that has one or more individual separate units that are treated as part of the combined separate unit under paragraph (b)(4)(ii) of this section.

(10) Affiliated dual resident corporation and affiliated domestic owner mean a dual resident corporation and a domestic owner, respectively, that is a member of a consolidated group.

(11) Unaffiliated dual resident corporation, unaffiliated domestic corporation, and unaffiliated domestic owner mean a dual resident corporation, domestic corporation, and domestic owner, respectively, that is not a member of a consolidated group.

(12) Domestic affiliate means—

(i) A member of an affiliated group, without regard to the exceptions contained in section 1504(b) (other than section 1504(b)(3)) relating to includible corporations;

(ii) A domestic owner;

(iii) A separate unit; or

(iv) An interest in a transparent entity, as defined in paragraph (b)(16) of this section.

(13) Domestic use. See § 1.1503(d)-2.

(14) Foreign use. See § 1.1503(d)-3.

(15) Grantor trust means a trust, any portion of which is treated as being owned by the grantor or another person under subpart E of subchapter J of this chapter.

(16) Transparent entity—(i) In general. The term transparent entity means an entity described in this paragraph (b)(16) where all or a portion of its interests are owned, directly or indirectly, by a domestic corporation. An entity is described in this paragraph (b)(16) if the entity—

(A) Is not taxable as an association for Federal tax purposes;

(B) Is not subject to income tax in a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis; and

(C) Is not a pass-through entity under the laws of the applicable foreign country. For purposes of applying the preceding sentence, the applicable foreign country is the foreign country in which the relevant foreign branch separate unit is located, or the foreign country that subjects the relevant hybrid entity (an interest in which is a separate unit) or dual resident corporation to an income tax either on its worldwide income or on a residence basis.

(ii) Example. A U.S. limited liability company (LLC) does not elect to be taxed as an association for Federal tax purposes and is not subject to income tax in a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis. The LLC is owned by a hybrid entity (an interest in which is a separate unit) that is the relevant hybrid entity. Provided the LLC is not treated as a pass-through entity by the applicable foreign country that subjects the relevant hybrid entity to an income tax either on its worldwide income or on a residence basis, the LLC would qualify as a transparent entity. See also § 1.1503(d)-7(c) Example 26.

(17) Disregarded entity means an entity that is disregarded as an entity separate from its owner, under §§ 301.7701-1 through 301.7701-3 of this chapter, for Federal tax purposes.

(18) Partnership means an entity that is classified as a partnership, under §§ 301.7701-1 through 301.7701-3 of this chapter, for Federal tax purposes.

(19) Indirectly, when used in reference to ownership, means ownership through a partnership, a disregarded entity, or a grantor trust, regardless of whether the partnership, disregarded entity, or grantor trust is a U.S. person.

(20) Certification period means the period of time up to and including the fifth taxable year following the year in which the dual consolidated loss that is the subject of a domestic use agreement (as described in § 1.1503(d)-6(d)(1)) was incurred.

(c) Treatment of domestic consenting corporation as a dual resident corporation—(1) Rule. A domestic consenting corporation is treated as a dual resident corporation under paragraph (b)(2)(iii) of this section for a taxable year if, on any day during the taxable year, the following requirements are satisfied:

(i) Under the tax law of a foreign country where a specified foreign tax resident is tax resident, the specified foreign tax resident derives or incurs (or would derive or incur) items of income, gain, deduction, or loss of the domestic consenting corporation (because, for example, the domestic consenting corporation is fiscally transparent under such tax law).

(ii) The specified foreign tax resident bears a relationship to the domestic consenting corporation that is described in section 267(b) or 707(b). See § 1.1503(d)-7(c)(41) for an example illustrating the application of paragraph (c) of this section.

(2) Definitions. The following definitions apply for purposes of this paragraph (c).

(i) The term fiscally transparent means, with respect to a domestic consenting corporation or an intermediate entity, fiscally transparent as determined under the principles of § 1.894-1(d)(3)(ii) and (iii), without regard to whether a specified foreign tax resident is a resident of a country that has an income tax treaty with the United States.

(ii) The term specified foreign tax resident means a body corporate or other entity or body of persons liable to tax under the tax law of a foreign country as a resident.

(d) Disregarded payment loss (DPL) rules—(1) In general. The disregarded payment loss rules of this paragraph (d) only apply to a domestic corporation (including a dual resident corporation) that directly or indirectly owns an interest in a disregarded entity, regardless of whether the disregarded entity is domestic or foreign (such a domestic corporation, a disregarded payment entity owner, or DPE owner). If these rules apply to a DPE owner, then the DPE owner determines disregarded payment income or disregarded payment loss of its disregarded payment entities (if any) described in paragraph (d)(5)(i)(A), (B), (C), or (D) of this section in accordance with paragraph (d)(5)(ii) of this section and, in the case of a disregarded payment loss for which a triggering event occurs under paragraph (d)(3) of this section, includes an amount equal to the DPL inclusion amount in gross income and establishes a suspended deduction in accordance with paragraph (d)(2) of this section. The inclusion required under this paragraph (d)(1) and paragraph (d)(2)(i) of this section is included in the taxable year of the DPE owner in which the triggering event occurs, and the corresponding suspended deduction under this paragraph (d)(1) and paragraph (d)(2)(ii) of this section is established in the subsequent taxable year of the DPE owner. See § 1.1503(d)-7(c)(42) for an example illustrating the application of the disregarded payment loss rules.

(2) DPL amounts—(i) DPL inclusion amount. A DPL inclusion amount means, with respect to a disregarded payment loss as to which a triggering event occurs during the DPL certification period, an amount equal to the disregarded payment loss. Such amount is reduced (but not below zero) to the extent of the balance in the DPL cumulative register of the disregarded payment entity if the certification requirement under paragraph (d)(4)(iii) of this section is satisfied.

(ii) Suspended deduction. With respect to a DPL inclusion amount, a DPE owner establishes a suspended deduction in an amount equal to the DPL inclusion amount. The suspended deduction is allowed as a deduction under the principles of § 1.1503(d)-6(h)(6) by treating the suspended deduction as if it were a reconstituted net operating loss that becomes deductible only to the extent of disregarded payment income derived in the taxable year in which the suspended deduction is established or subsequent taxable years (as measured by the disregarded payment entity's DPL cumulative register), provided that the certification requirement under paragraph (d)(4)(iv) of this section is satisfied.

(iii) DPL cumulative register. The term DPL cumulative register means, with respect to the disregarded payment entity, an account the balance of which is computed at the end of each foreign taxable year of the entity, and which is—

(A) Increased by the amount of disregarded payment income of the entity for the foreign taxable year, and then, after determining the DPL inclusion amount for the year,

(B) Decreased by the amount of the cumulative register balance that is used under paragraph (d)(2)(i) or (ii) of this section.

(iv) Character and source—(A) DPL inclusion amount. A DPE owner's income inclusion for a DPL inclusion amount is, for all U.S. tax purposes, treated as ordinary income, and characterized and sourced, including for purposes of sections 904(d) and 907, in the same manner as if the disregarded payment entity were a foreign corporation and the amount were interest or royalty income paid by the foreign corporation (taking into account, for example, section 904(d)(3) if such foreign corporation would be a controlled foreign corporation). For these purposes, the DPL inclusion amount is considered comprised of interest or royalty income based on the proportion of interest or royalty deductions taken into account, respectively, in computing the disregarded payment loss relative to all the deductions taken into account in computing the disregarded payment loss. Further, for these purposes, a deduction attributable to a structured payment or a deduction with respect to equity is treated as an interest deduction.

(B) Suspended deduction. A DPE owner's deduction with respect to a suspended deduction is, for all U.S. tax purposes, characterized and sourced in the same manner as the income for the DPL inclusion amount to which it relates. If the income from the DPL inclusion amount is assigned to multiple statutory and residual groupings, the deduction is allocated and apportioned to each grouping in the same proportions as the DPL inclusion amount.

(3) Triggering events. An event described in paragraph (d)(3)(i) or (ii) of this section is a triggering event with respect to a disregarded payment loss of a disregarded payment entity.

(i) Foreign use. A foreign use of the disregarded payment loss. For this purpose, a foreign use is determined under the principles of § 1.1503(d)-3 (including the exceptions in § 1.1503(d)-3(c)), by treating the disregarded payment loss as a dual consolidated loss, treating the disregarded payment entity as a separate unit (or, in the case of a disregarded payment entity that is a dual resident corporation, by treating the disregarded payment entity as a dual resident corporation), and, in § 1.1503(d)-3(a)(1)(i) and (ii), only taking into account a person that is related to the DPE owner of the disregarded payment entity. Thus, for example, a foreign use of a disregarded payment loss occurs if, under a relevant foreign tax law, any portion of the foreign law deduction taken into account in computing the disregarded payment loss is made available (including by reason of a foreign consolidation regime or similar regime, or a sale, merger, or similar transaction) to offset an item of income that, for U.S. tax purposes, is an item of a foreign corporation, but only if such foreign corporation is related to the DPE owner of the disregarded payment entity. When applying the principles of the deemed ordering rule in § 1.1503(d)-3(c)(3), items of income or gain are taken into account only to the extent such items are described in paragraph (d)(5)(ii)(D) of this section; thus, for example, such items include items of income that are or would be taken into account in determining the amount of disregarded payment loss or disregarded payment income, and exclude items that are regarded for U.S. tax purposes.

(ii) Failure to comply with certification requirements. A failure by the DPE owner of the disregarded payment entity to comply with the certification requirements of paragraphs (d)(4)(i) and (ii) of this section.

(4) Certification requirements. Except as otherwise provided in publications, forms, instructions, or other guidance, a DPE owner of a disregarded payment entity is subject to the certification requirements of this paragraph (d)(4) with respect to a disregarded payment loss of the disregarded payment entity.

(i) For its taxable year that includes the date on which the foreign taxable year in which a disregarded payment loss is incurred ends, the DPE owner must attach with its timely filed tax return a certification labeled “Initial Disregarded Payment Loss Certification Under Section 1503(d),” which must contain—

(A) The information set forth in § 1.1503(d)-6(c)(2)(ii) (determined by substituting the phrase “disregarded payment entity” for the phrase “separate unit”);

(B) A statement of the amount of the disregarded payment loss; and

(ii) During the DPL certification period, for each of its taxable years after the taxable year described in paragraph (d)(4)(i) of this section that includes a date on which a foreign taxable year ends, the DPE owner must attach with its timely filed tax return a certification labeled “Annual Disregarded Payment Loss Certification Under Section 1503(d)” and satisfying the requirements of this paragraph (d)(4)(ii). Certifications with respect to multiple disregarded payment losses may be combined in a single certification, but each disregarded payment loss must be separately identified. To satisfy the requirements of this paragraph (d)(4)(ii), the certification must—

(A) Identify the disregarded payment loss to which it pertains by setting forth the foreign taxable year in which the disregarded payment loss was incurred and the amount of such disregarded payment loss;

(B) State that there has been no foreign use of the disregarded payment loss; and

(C) Warrant that arrangements have been made to ensure that there will be no foreign use of the disregarded payment loss and that the DPE owner will be informed of any such foreign use.

(iii) If a disregarded payment entity has a balance in its DPL cumulative register upon a DPL triggering event and the DPE owner includes in gross income a DPL inclusion amount that is less than the amount of the disregarded payment loss, the DPE owner of the disregarded payment entity must attach a statement labeled “Reduction of Disregarded Payment Loss Amount Under Section 1503(d)” to its income tax return for the taxable year in which the triggering event occurs and provide any other information as requested by the Commissioner. The statement must show the disregarded payment income or disregarded payment loss of the disregarded payment entity for each foreign taxable year (other than a foreign taxable year where the entity or branch is not a disregarded payment entity) up to and including the foreign taxable year with respect to which the triggering event occurs.

(iv) If a DPE owner claims an allowed deduction with respect to a suspended deduction, the DPE owner must attach a statement labeled “Release of Suspended Deduction Under Section 1503(d)” to the income tax return for the taxable year in which the deduction is allowed and provide any other information as requested by the Commissioner, including in regulations, forms, instructions or other guidance. The statement must describe the DPE owner's DPL inclusion amount to which the suspended deduction relates and show the disregarded payment income or disregarded payment loss of the disregarded payment entity for each foreign taxable year up to and including the foreign taxable year during which the deduction is allowed.

(5) Definitions. The following definitions apply for purposes of this paragraph (d).

(i) The term disregarded payment entity means, with respect to a DPE owner, any entity, foreign branch, or dual resident corporation described in paragraph (d)(5)(i)(A), (B), (C) or (D) of this section.

(A) A disregarded entity that is a foreign tax resident and related to the DPE owner, provided that the DPE owner directly or indirectly owns interests in the disregarded entity.

(B) A foreign branch of the DPE owner and a foreign branch of an entity that is related to the DPE owner and in which the DPE owner directly or indirectly owns an interest.

(C) An entity that is treated as a partnership for U.S. tax purposes that is a foreign tax resident and related to the DPE owner, provided that the DPE owner directly or indirectly owns an interest in the entity.

(D) The DPE owner itself if it is a dual resident corporation.

(ii) The terms disregarded payment income and disregarded payment loss have the meanings set forth in this paragraph (d)(5)(ii). For purposes of computing the disregarded payment income or disregarded payment loss of a disregarded payment entity, a DPE owner takes into account the disregarded payment income or disregarded payments loss of each disregarded payment entity for each foreign taxable year that ends with or within its U.S. taxable year and an item is taken into account only if it gives rise to income or a deduction under the relevant foreign tax law during the portion of the foreign taxable year in which the entity or foreign branch is a disregarded payment entity; for purposes of allocating an item to a period, the principles of § 1.1502-76(b) apply. Thus, for example, if a DPE owner with a calendar U.S. taxable year becomes subject to the disregarded payment loss rules for the U.S. taxable year beginning on January 1, 2026, the disregarded payment income or disregarded payment loss of a disregarded payment entity of the DPE owner with a foreign taxable year ending on June 30, 2026, excludes items allocated (under the principles of § 1.1502-76(b)) to the pre-January 1, 2026, portion of that foreign taxable year. Items taken into account in computing disregarded payment income or disregarded payment loss are calculated in the currency used to determine tax under the relevant foreign tax law. See § 1.1503(d)-7(c)(46) for an example illustrating items that are taken into account in determining disregarded payment income or disregarded payment loss.

(A) Disregarded payment income. Disregarded payment income means, with respect to a disregarded payment entity and a foreign taxable year of the entity, the excess (if any) of the sum of the items described in paragraph (d)(5)(ii)(D) of this section over the sum of the items described in paragraph (d)(5)(ii)(C) of this section.

(B) Disregarded payment loss. Subject to the de minimis rule set forth in paragraph (d)(6)(vii) of this section, a disregarded payment loss means, with respect to a disregarded payment entity and a foreign taxable year of the entity, the excess (if any) of the sum of the items described in paragraph (d)(5)(ii)(C) of this section over the sum of the items described in paragraph (d)(5)(ii)(D) of this section.

(C) Items of deduction. With respect to a disregarded payment entity and a foreign taxable year of the entity, an item is described in this paragraph (d)(5)(ii)(C) to the extent that it satisfies all of the requirements set forth in paragraphs (d)(5)(ii)(C)(1) through (3) of this section. In addition, an item of a disregarded payment entity described in paragraph (d)(5)(i)(A) of this section is described in this paragraph (d)(5)(ii)(C) if, under the relevant foreign tax law, it is a deduction with respect to equity (including deemed equity) allowed to the entity in such taxable year (for example, a notional interest deduction) or a deduction for an imputed interest payment with respect to a debt instrument (such as a deduction for an imputed interest payment with respect to an interest-free loan).

(1) Under the relevant foreign tax law, the disregarded payment entity is allowed a deduction in such taxable year for the item.

(2) The payment, accrual, or other transaction giving rise to the item is disregarded for U.S. tax purposes as a transaction between a disregarded entity and its tax owner or between disregarded entities with the same tax owner (for example, a payment by a disregarded entity to its tax owner or to another disregarded entity owned by its tax owner, a payment from a dual resident corporation or partnership to a disregarded entity it owns, or a payment from the home office of a foreign branch to a disregarded entity the home office owns that is attributable to the foreign branch).

(3) If the payment, accrual, or other transaction were regarded for U.S. tax purposes, it would be interest, a structured payment, or a royalty within the meaning of § 1.267A-5(a)(12), (b)(5)(ii), or (a)(16), respectively.

(D) Items of income. With respect to a disregarded payment entity and a foreign taxable year of the entity, an item is described in this paragraph (d)(5)(ii)(D) to the extent that it satisfies all of the requirements set forth in paragraphs (d)(5)(ii)(D)(1) through (3) of this section.

(1) Under the relevant foreign tax law, the disregarded payment entity includes the item in income in such taxable year.

(2) The payment, accrual, or other transaction giving rise to the item is disregarded for U.S. tax purposes as a transaction between a disregarded entity and its tax owner or between disregarded entities with the same tax owner (for example, because it is a payment to a disregarded entity from the disregarded entity's tax owner or from another disregarded entity of its tax owner, a payment to a dual resident corporation or partnership from a disregarded entity it owns, or a payment from a disregarded entity to the home office of a foreign branch that is attributable to the foreign branch).

(3) If the payment, accrual, or other transaction were regarded for U.S. tax purposes, it would be interest, a structured payment, or a royalty with the meaning of § 1.267A-5(a)(12), (b)(5)(ii), or (a)(16), respectively.

(E) Translation into U.S. dollars. The amount of disregarded payment income or disregarded payment loss with respect to a foreign taxable year of a disregarded payment entity is translated into U.S. dollars using the yearly average exchange rate (within the meaning of § 1.987-1(c)(2)) for that foreign taxable year.

(F) Royalties under pre-August 6, 2024 licenses excluded. Royalties paid or accrued pursuant to a license agreement entered into before August 6, 2024, are not taken into account when determining the amount of disregarded payment income or disregarded payment loss. The preceding sentence ceases to apply with respect to any such agreement upon the significant modification of any terms of the agreement, such as a change in the licensor or licensee or a significant modification of the rights in consideration for which the royalties are paid. In such case, any amounts paid or accrued on or after the date of the significant modification are taken into account when determining the amount of disregarded payment income or disregarded payment loss. Termination of a license agreement and re-entry into a license agreement between the same parties and with the same terms (other than the term governing the period covered by the agreement), an extension of the period covered by a license agreement without modification of other terms, or an alteration of a legal right or obligation that occurs by operation of the terms of the license agreement (for example, where the license agreement provides for updating the royalty based on updated transfer pricing studies), will not be considered a significant modification of the first license agreement. For purposes of this paragraph (d)(5)(ii)(F), a combined disregarded payment entity is treated as a single licensor or licensee, as the case may be.

(iii) The term DPL certification period includes, with respect to a disregarded payment loss, the foreign taxable year in which the disregarded payment loss is incurred, any prior foreign taxable years, and, except as provided in paragraph (d)(6)(iii) of this section, the 60-month period following the foreign taxable year in which the disregarded payment loss is incurred.

(iv) The term foreign branch means a branch (within the meaning of § 1.267A-5(a)(2)) that gives rise to a taxable presence under the tax law of the foreign country where the branch is located.

(v) The term foreign taxable year means, with respect to a disregarded payment entity, the entity's taxable year for purposes of a relevant foreign tax law.

(vi) The term foreign tax resident means a tax resident (within the meaning of § 1.267A-5(a)(23)(i)) of a foreign country.

(vii) The term related has the meaning provided in this paragraph (d)(5)(vii). A person is related to a DPE owner if the person is a related person within the meaning of section 954(d)(3) and the regulations thereunder, determined by treating the person as the “controlled foreign corporation” referred to in that section. In addition, for purposes of determining relatedness, a disregarded entity is treated as a corporation.

(viii) The term relevant foreign tax law means, with respect to a disregarded payment entity, any tax law of a foreign country of which the entity is a tax resident (within the meaning of § 1.267A-5(a)(23)(i)) or, in the case of a disregarded payment entity that is a foreign branch, the tax law of the foreign country where the branch is located.

(ix) The term DPE owner has the meaning provided in paragraph (d)(1) of this section, and includes any successor to the corporation described paragraph (d)(1) of this section.

(6) Special rules—(i) Disregarded payment entity combination rule. For purposes of this paragraph (d), disregarded payment entities for which the relevant foreign tax law is the same (for example, because the entities are tax residents of the same foreign country) are combined and treated as a combined disregarded payment entity under the principles of paragraph (b)(4)(ii) of this section, provided that the entities have the same foreign taxable year and are owned, or interests in which are directly or indirectly owned, either by the same DPE owner or by DPE owners that are members of the same consolidated group. However, this paragraph (d)(6)(i) does not apply with respect to a dual resident corporation treated as a disregarded payment entity pursuant to paragraph (d)(5)(i)(D) of this section. In determining the disregarded payment income or disregarded payment loss of a combined disregarded payment entity, the principles of § 1.1503(d)-5(c)(4)(ii) apply. Thus, for example, if multiple individual disregarded payment entities are treated as a combined disregarded payment entity pursuant to this paragraph (d)(6)(i), then the combined disregarded payment entity has either a single amount of disregarded payment income or a single amount of disregarded payment loss.

(ii) Partial ownership of disregarded payment entity. If a DPE owner of a disregarded payment entity indirectly owns through a partnership less than all the interests in that disregarded payment entity, then the rules of this paragraph (d) are applied based on the DPE owner's proportionate interest in the disregarded payment entity. In such a case, as to the DPE owner, only a proportionate share of the disregarded payment entity's items of deduction or income are taken into account in computing disregarded payment income or disregarded payment loss of the entity. In addition, with respect to the disregarded payment loss as so computed, the DPE owner must comply with the certification requirements of paragraph (d)(4) of this section and, upon a triggering event, directly include in gross income an amount equal to the DPL inclusion amount.

(iii) Termination of DPL certification period. With respect to a disregarded payment loss of a disregarded payment entity, the DPL certification period does not include any date after the end of the DPE owner's taxable year during which the DPE owner, or a person related to the DPE owner, no longer owns directly or indirectly any of the interests in the disregarded payment entity, or, in the case of a disregarded payment entity that is a foreign branch, substantially all of the assets of the foreign branch. In such a case, the DPE owner ceases to be subject to the rules of paragraph (d) of this section with respect to the disregarded payment loss; thus, for example, after the end of such taxable year the DPE owner is not subject to the certification requirements of paragraph (d)(4)(ii) of this section with respect to the loss, and will not be required to include in gross income the DPL inclusion amount with respect to such loss. The DPL certification period will also terminate with respect to a disregarded payment loss upon a DPE owner's inclusion of the DPL inclusion amount attributable to the disregarded payment loss.

(iv) Agent for a consolidated group. If a DPE owner is a member of a consolidated group, see § 1.1502-77 for agent of the group rules (generally treating the common parent as the agent of its consolidated group).

(v) Coordination with foreign hybrid mismatch rules. Whether a disregarded payment entity is allowed a deduction under a relevant foreign tax law is determined with regard to hybrid mismatch rules, if any, under the relevant foreign tax law. Thus, for example, if a relevant foreign tax law denies a deduction for an item to prevent a deduction/no-inclusion outcome (that is, a payment that is deductible for the payer jurisdiction and is not included in the ordinary income of the payee), the item is not taken into account for purposes of computing the amount of disregarded payment income or disregarded payment loss. For this purpose, the term hybrid mismatch rules has the meaning provided in § 1.267A-5(a)(10).

(vi) DPL inclusion amount and suspended deduction not taken into account for dual consolidated loss purposes. A DPL inclusion amount included in the gross income of a DPE owner, and any allowed amount of a suspended deduction attributable to a DPL inclusion amount, are not taken into account for purposes of determining the income or dual consolidated loss of the dual resident corporation, or the income or dual consolidated loss attributable to the separate unit, under § 1.1503(d)-5(b) or (c).

(vii) De minimis rule. A disregarded payment entity will be deemed to have no disregarded payment loss with respect to a foreign taxable year in which the conditions in paragraphs (d)(6)(vii)(A) and (B) of this section are satisfied.

(A) The items that compose the disregarded payment loss are incurred in connection with the conduct of an active trade or business (within the meaning of § 1.367(a)-2(d)(2) and (3), but for this purpose treating the disregarded payment entity as the foreign corporation referenced therein) carried on by the disregarded payment entity. For purposes of the preceding sentence, the determination of whether items are incurred in connection with an active trade or business is made under § 1.367(a)-2(d)(5), but for this purpose by treating the property received by the disregarded payment entity pursuant to the arrangement that gave rise to the item (such as cash or the rights to use the intangible property) as the property described in such section.

(B) The amount of the disregarded payment loss is less than the lesser of $3 million or 10 percent of the aggregate amount of all the items of the disregarded payment entity for the foreign taxable year that satisfy the condition described in paragraph (d)(5)(ii)(C)(1) of this section. For this purpose, the items of the disregarded payment entity may include, for example, items that are regarded for both U.S. and foreign tax purposes, or foreign law items that if regarded for U.S. tax purposes would not be treated as interest, a structured payment, or a royalty within the meaning of § 1.267A-5(a)(12), (b)(5)(ii), or (a)(16), respectively.

(e) Special rules for filings.—(1) Reasonable cause exception. A person that is permitted or required to file an election, agreement, statement, rebuttal, computation, or other information pursuant to this section and §§ 1.1503(d)-2 through 1.1503(d)-8, that fails to make such filing in a timely manner, shall be considered to have satisfied the timeliness requirement with respect to such filing if the person is able to demonstrate, to the Area Director, Field Examination, Small Business/Self Employed or the Director of Field Operations, Large and Mid-Size Business (Director) having jurisdiction of the taxpayer's tax return for the taxable year, that such failure was due to reasonable cause and not willful neglect. In determining whether the taxpayer has reasonable cause, the Director shall consider whether the taxpayer acted reasonably and in good faith. In general, the taxpayer must demonstrate that it exercised ordinary care and prudence in meeting its tax obligations but nonetheless did not comply with the prescribed duty within the prescribed time. Whether the taxpayer acted reasonably and in good faith will be determined after considering all the facts and circumstances. The Director shall notify the person in writing within 120 days of the filing if it is determined that the failure to comply was not due to reasonable cause, or if additional time will be needed to make such determination. For this purpose, the 120-day period shall begin on the date the taxpayer is notified in writing that the request has been received and assigned for review. If, once such period commences, the taxpayer is not again notified within 120 days, then the taxpayer shall be deemed to have established reasonable cause. The reasonable cause exception of this paragraph (d) shall only apply if, once the person becomes aware of its failure to file the election, agreement, statement, rebuttal, computation or other information in a timely manner, the person complies with the requirements of paragraph (d)(2) of this section.

(2) Requirements for reasonable cause relief—(i) Time of submission. Requests for reasonable cause relief will only be considered if once the person becomes aware of the failure to file the election, agreement, statement, rebuttal, computation or other information, the person attaches all the documents that should have been filed, as well as a written statement setting forth the reasons for the failure to timely comply, to an amended return that amends the return to which the documents should have been attached pursuant to the rules of this section and §§ 1.1503(d)-2 through 1.1503(d)-8.

(ii) Notice requirement. In addition to the requirements of paragraph (d)(2)(i) of this section, the taxpayer must provide a copy of the amended return and all required attachments to the Director as follows:

(A) If the taxpayer is under examination for any taxable year when the taxpayer requests relief, the taxpayer must provide a copy of the amended return and attachments to the personnel conducting the examination.

(B) If the taxpayer is not under examination for any taxable year when the taxpayer requests relief, the taxpayer must provide a copy of the amended return and attachments to the Director having jurisdiction of the taxpayer's return.

(3) Signature requirement. When an election, agreement, statement, rebuttal, computation, or other information is required pursuant to this section and §§ 1.1503(d)-2 through 1.1503(d)-8 to be attached to and filed by the due date (including extensions) of a U.S. tax return and signed under penalties of perjury by the person who signs the return, the attachment and filing of an unsigned copy is considered to satisfy such requirement, provided the taxpayer retains the original in its records in the manner specified by § 1.6001-1(e).

(f) Anti-avoidance rule—(1) In general. Except to the extent provided in paragraph (f)(2) of this section, if a transaction, series of transactions, plan, or arrangement is engaged in with a view to avoid the purposes of the rules in this section and §§ 1.1503(d)-2 through 1.1503(d)-8, then appropriate adjustments will be made. A transaction, series of transactions, plan, or arrangement (including an arrangement to reflect, or not reflect, items on books and records) is engaged in with a view to avoid the purposes of this section and §§ 1.1503(d)-2 through 1.1503(d)-8 only if it results in a double deduction or similar outcome (for example, by putting an item of deduction or loss that composes (or would compose) a dual consolidated loss to both a domestic use and a foreign use (determined under §§ 1.1503(d)-2 and 1.1503(d)-3, respectively) or putting a foreign law item of deduction or loss that is disregarded for U.S. tax purposes to a foreign use). The appropriate adjustments may include adjustments to disregard the transaction, series of transactions, plan, or arrangement, or adjustments to modify the items that are taken into account for purposes of determining the income or dual consolidated loss of or attributable to a dual resident corporation or a separate unit, or for purposes of determining income or loss of an interest in a transparent entity under § 1.1503(d)-5. See § 1.1503(d)-7(c)(43) through (45) for examples illustrating the application of this paragraph (f).

(2) Exceptions. The anti-avoidance rule in paragraph (f)(1) of this section does not apply to a reduction or elimination of a dual consolidated loss solely by reason of intercompany transactions as described in § 1.1502-13, items of income arising from the ownership of stock and taken into account under § 1.1503(d)-5(b)(1) or (c)(4)(iv), or the attribution to a hybrid entity separate unit or an interest in a transparent entity of items that have not been and will not be reflected on the entity's books and records. The anti-avoidance rule in paragraph (f)(1) of this section also does not apply with respect to the application of the dual consolidated loss rules to the GloBE Model Rules, or to cause a foreign use of a dual consolidated loss to occur solely in a period before the taxable year in which such loss was incurred.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007, as amended by T.D. 9896, 85 FR 19855, Apr. 8, 2020; T.D. 10018, 89 FR 106878, Dec. 30, 2024; T.D. 10026, 90 FR 3014, Jan. 14, 2025]

§ 1.1503(d)-2 Domestic use.

A domestic use of a dual consolidated loss shall be deemed to occur when the dual consolidated loss is made available to offset, directly or indirectly, the income of a domestic affiliate (other than the dual resident corporation or separate unit that, in each case, incurred the dual consolidated loss) in the taxable year in which the dual consolidated loss is recognized, or in any other taxable year, regardless of whether the dual consolidated loss offsets income under the income tax laws of a foreign country and regardless of whether any income that the dual consolidated loss may offset in the foreign country is, has been, or will be subject to tax in the United States. A domestic use shall be deemed to occur in the year the dual consolidated loss is included in the computation of the taxable income of a consolidated group, unaffiliated dual resident corporation, or an unaffiliated domestic owner, as applicable, even if no tax benefit results from such inclusion in that year. See § 1.1503(d)-7(c) Examples 2 through 4.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007]

§ 1.1503(d)-3 Foreign use.

(a) Foreign use—(1) In general. Except as provided in paragraph (c) of this section, a foreign use of a dual consolidated loss shall be deemed to occur when any portion of a deduction or loss taken into account in computing the dual consolidated loss is made available under the income tax laws of a foreign country to offset or reduce, directly or indirectly, any item that is recognized as income or gain under such laws and that is, or would be, considered under U.S. tax principles to be an item of—

(i) A foreign corporation as defined in section 7701(a)(3) and (a)(5); or

(ii) A direct or indirect owner of an interest in a hybrid entity, provided such interest is not a separate unit. See § 1.1503(d)-7(c) Examples 5 through 10 and 37.

(2) Indirect use—(i) General rule. Except to the extent provided in paragraph (a)(2)(ii) of this section, an item of deduction or loss shall be deemed to be made available indirectly if—

(A) One or more items are taken into account as deductions or losses for foreign tax purposes, but do not give rise to corresponding items of income or gain for U.S. tax purposes; and

(B) The item or items described in paragraph (a)(2)(i)(A) of this section have the effect of making an item of deduction or loss composing the dual consolidated loss available for a foreign use as described in paragraph (a)(1) of this section.

(ii) Exception. The general rule provided in paragraph (a)(2)(i) of this section shall not apply if the consolidated group, unaffiliated domestic owner, or unaffiliated dual resident corporation demonstrates, to the satisfaction of the Commissioner, that the item or items described in paragraph (a)(2)(i)(A) of this section that gave rise to the indirect foreign use—

(A) Were not incurred, or taken into account, with a principal purpose of avoiding the provisions of section 1503(d). For purposes of this paragraph (a)(2)(ii), an item incurred or taken into account as interest for foreign tax purposes, but disregarded for U.S. tax purposes, shall be deemed to have been incurred, or taken into account, with a principal purpose of avoiding the provisions of section 1503(d). Similarly, for purposes of this paragraph (a)(2)(ii), an item incurred or taken into account as the result of an instrument that is treated as debt for foreign tax purposes and equity for U.S. tax purposes, shall be deemed to have been incurred, or taken into account, with a principal purpose of avoiding the provisions of section 1503(d); and

(B) Were incurred, or taken into account, in the ordinary course of the dual resident corporation's or separate unit's trade or business.

(iii) Examples. See § 1.1503(d)-7(c) Examples 6 through 8.

(3) Deemed use. See paragraph (e) of this section for a deemed foreign use pursuant to the mirror legislation rule.

(b) Available for use. A foreign use shall be deemed to occur in the year in which any portion of a deduction or loss taken into account in computing the dual consolidated loss is made available for an offset described in paragraph (a) of this section, regardless of whether it actually offsets or reduces any items of income or gain under the income tax laws of the foreign country in such year, and regardless of whether any of the items that may be so offset or reduced are regarded as income under U.S. tax principles.

(c) Exceptions—(1) In general. Paragraphs (c)(2) through (9) of this section provide exceptions to the general definition of foreign use set forth in paragraphs (a) and (b) of this section. These exceptions only apply to a foreign use that occurs solely as a result of the conditions or circumstances described therein, and do not apply if a foreign use occurs in any other case or by any other means. For example, the exception under paragraph (c)(4) of this section (regarding certain interests in partnerships or grantor trusts) shall not apply where the item of deduction or loss is made available through a foreign consolidation regime (or similar method). In addition, these exceptions do not apply when attempting to demonstrate that no foreign use of a dual consolidated loss can occur in any other year by any means under § 1.1503(d)-6(c), (e)(2)(i), or (j)(2). But see § 1.1503(d)-6(e)(2)(ii), which takes into account the exception under paragraph (c)(7) of this section for purposes of rebutting certain asset transfers.

(2) Election or merger required to enable foreign use. Where the laws of a foreign country provide an election that would enable a foreign use, a foreign use shall be considered to occur only if the election is made. Similarly, where the laws of a foreign country would enable a foreign use through a sale, merger, or similar transaction, a foreign use shall be considered to occur only if the sale, merger, or similar transaction occurs.

(3) Deemed ordering rule—(i) In general. This paragraph (c)(3) applies if the losses or deductions composing the dual consolidated loss are made available under the laws of a foreign country both in part to offset income or gain that would constitute a foreign use and in part to offset income or gain that would not constitute a foreign use. In such a case, the losses or deductions shall be deemed to be made available to offset the income or gain that does not constitute a foreign use, to the extent of such income or gain, before being considered to be made available to offset the income or gain that does constitute a foreign use. See § 1.1503(d)-7(c)(11) (Example 11).

(ii) Limitation. For purposes of applying this paragraph (c)(3), items of income or gain are taken into account only to the extent such items are or would be taken into account in determining the amount of income or dual consolidated loss under § 1.1503(d)-5(b) or (c). Thus, for example, this paragraph does not apply with respect to items of income or gain that are otherwise disregarded for U.S. tax purposes. But see § 1.1503(d)-1(d)(3)(i), which provides that when applying the principles of this rule for purposes of the disregarded payment loss rules, the only relevant items are those that are or would be taken into account for purposes of determining a disregarded payment loss or disregarded payment income.

(4) Certain interests in partnerships or grantor trusts—(i) General rule. Except to the extent provided in paragraph (c)(4)(iii) of this section, this paragraph (c)(4)(i) applies to a dual consolidated loss attributable to an interest in a hybrid entity partnership or a hybrid entity grantor trust, or to a separate unit owned indirectly through a partnership or grantor trust. In such a case, a foreign use will not be considered to occur if the foreign use is solely the result of another person's ownership of an interest in the partnership or grantor trust, as applicable, and the allocation or carry forward of an item of deduction or loss composing such dual consolidated loss as a result of such ownership. See § 1.1503(d)-7(c) Example 13.

(ii) Combined separate unit. This paragraph applies to a dual consolidated loss attributable to a combined separate unit that includes an individual separate unit to which paragraph (c)(4)(i) of this section would apply, but for the application of the separate unit combination rule provided under § 1.1503(d)-1(b)(4)(ii). In such a case, paragraph (c)(4)(i) of this section shall apply to the portion of the dual consolidated loss of such combined separate unit that is attributable, as provided under § 1.1503(d)-5(c) through (e), to the individual separate unit (otherwise described in paragraph (c)(4)(i) of this section) that is a component of the combined separate unit. See § 1.1503(d)-7(c) Example 14.

(iii) Reduction in interest. The exception under paragraph (c)(4)(i) of this section shall not apply if, at any time following the year in which the dual consolidated loss is incurred, there is more than a de minimis reduction in the domestic owner's percentage interest in the partnership or grantor trust, as applicable, as described in paragraph (c)(5) of this section. In such a case, a foreign use shall be deemed to occur at the time the reduction in interest exceeds the de minimis amount. See § 1.1503(d)-7(c) Example 13.

(5) De minimis reduction of an interest in a separate unit—(i) General rule. This paragraph applies to a de minimis reduction of a domestic owner's interest in a separate unit (including an interest described in paragraph (c)(4)(i) of this section). Except to the extent provided in paragraph (c)(5)(ii) of this section, no foreign use shall be considered to occur with respect to a dual consolidated loss as a result of an item of deduction or loss composing such dual consolidated loss being made available solely as a result of a reduction in the domestic owner's interest in the separate unit, as provided under paragraph (c)(5)(iii) of this section. See § 1.1503(d)-7(c) Example 5.

(ii) Limitations. The exception provided in paragraph (c)(5)(i) of this section shall not apply if—

(A) During any 12-month period the domestic owner's percentage interest in the separate unit is reduced by 10 percent or more, as determined by reference to the domestic owner's interest at the beginning of the 12-month period; or

(B) At any time the domestic owner's percentage interest in the separate unit is reduced by 30 percent or more, as determined by reference to the domestic owner's interest at the end of the taxable year in which the dual consolidated loss was incurred.

(iii) Reduction in interest. The following rules apply for purposes of paragraphs (c)(4) and (5) of this section. A reduction of a domestic owner's interest in a separate unit shall include a reduction resulting from another person acquiring through sale, exchange, contribution, or other means, an interest in the foreign branch or hybrid entity, as applicable. A reduction may occur either directly or indirectly, including through an interest in a partnership, a disregarded entity, or a grantor trust through which a separate unit is carried on or owned. In the case of an interest in a hybrid entity partnership or a separate unit all or a portion of which is carried on or owned through a partnership, an interest in such separate unit (or portion of such separate unit) is determined by reference to the owner's interest in the profits or the capital in the separate unit. In the case of an interest in a hybrid entity grantor trust or a separate unit all or a portion of which is carried on or owned through a grantor trust, an interest in such separate unit (or portion of such separate unit) is determined by reference to the domestic owner's share of the assets and liabilities of the separate unit.

(iv) Examples and coordination with exceptions to other triggering events. See § 1.1503(d)-7(c) Examples 5, 13, and 14. See also § 1.1503(d)-6(f)(3) and (f)(5) for rules that coordinate the de minimis exception to foreign use with exceptions to other triggering events described in § 1.1503(d)-6(e)(1), and provide an exception to foreign use following certain compulsory transfers.

(6) Certain asset basis carryovers. No foreign use shall be considered to occur with respect to a dual consolidated loss solely as a result of items of deduction or loss composing such dual consolidated loss being made available as a result of the transfer of assets of a dual resident corporation or separate unit, provided—

(i) Such items of loss and deduction are made available solely as a result of the basis of the transferred assets being determined, under foreign law, in whole or in part by reference to the basis of the assets in the hands of the dual resident corporation or separate unit;

(ii) The aggregate adjusted basis, as determined under U.S. tax principles, of all the assets so transferred during any 12-month period is less than 10 percent of the aggregate adjusted basis, as determined under U.S. tax principles, of all the dual resident corporation's or separate unit's assets, determined by reference to the assets held at the beginning of such 12-month period; and

(iii) The aggregate adjusted basis, as determined under U.S. tax principles, of all the assets so transferred at any time is less than 30 percent of the aggregate adjusted basis, as determined under U.S. tax principles, of all the dual resident corporation's or separate unit's assets, determined by reference to the assets held at the end of the taxable year in which the dual consolidated loss was generated. See § 1.1503(d)-7(c) Example 15.

(7) Assumption of certain liabilities—(i) In general. Except to the extent provided in paragraph (c)(7)(ii) of this section, no foreign use shall be considered to occur with respect to any dual consolidated loss solely as a result of an item of deduction or loss composing such dual consolidated loss being made available following the assumption of liabilities of a dual resident corporation or separate unit, provided such availability arises solely as the result of an item of deduction or loss incurred with respect to, or as a result of, such liabilities. See § 1.1503(d)-7(c) Example 16.

(ii) Ordinary course limitation. Paragraph (c)(7)(i) of this section shall apply only to the extent the liabilities assumed were incurred in the ordinary course of the dual resident corporation's, or separate unit's, trade or business. For purposes of this paragraph, liabilities incurred in the ordinary course of a trade or business shall include debt incurred to finance the trade or business of the dual resident corporation or separate unit.

(8) Multiple-party events. This paragraph applies to a transaction that qualifies for the triggering event exception described in § 1.1503(d)-6(f)(2)(i)(B) where the acquiring unaffiliated domestic corporation or consolidated group owns, directly or indirectly, more than 90 percent, but less than 100 percent, of the transferred assets or interests immediately after the transaction. In such a case, no foreign use shall be considered to occur with respect to a dual consolidated loss of the dual resident corporation or separate unit whose assets or interests were acquired, solely as a result of the less than 10 percent direct or indirect ownership of the acquired assets or interests by persons other than the acquiring unaffiliated domestic corporation or consolidated group, as applicable, immediately after the transaction. See § 1.1503(d)-7(c) Example 37.

(9) Additional guidance. The Commissioner may provide, by guidance published in the Internal Revenue Bulletin, that certain events or transactions do or do not result in a foreign use. Such guidance may also modify the triggering events and rebuttals described in § 1.1503(d)-6(e), and the exceptions thereto under § 1.1503(d)-6(f), as appropriate.

(d) Ordering rules for determining the foreign use of losses. If the laws of a foreign country provide for the foreign use of losses of a dual resident corporation or a separate unit, but do not provide applicable rules for determining the order in which such losses are used in a taxable year, the following rules shall apply:

(1) Any net loss, or net income, that the dual resident corporation or separate unit has in a taxable year shall first be used to offset net income, or loss, recognized by its affiliates in the same taxable year before any carry over of its losses is considered to be used to offset any income from the taxable year.

(2) If under the laws of the foreign country the dual resident corporation or separate unit has losses from different taxable years, it shall be deemed to use first the losses which would not constitute a triggering event that would result in the recapture of a dual consolidated loss pursuant to § 1.1503(d)-6(h). Thereafter, it shall be deemed to use first the losses from the most recent taxable year from which a loss may be carried forward or back for foreign law purposes.

(3) Where different losses or deductions (for example, capital losses and ordinary losses) of a dual resident corporation or separate unit incurred in the same taxable year are available for foreign use, the different losses shall be deemed to be used on a pro rata basis. See § 1.1503(d)-7(c) Example 12.

(e) Mirror legislation rule—(1) In general. Except as provided in paragraph (e)(2) or (3) of this section and § 1.1503(d)-6(b) (relating to agreements entered into between the United States and a foreign country), a foreign use shall be deemed to occur if the income tax laws of a foreign country would deny any opportunity for the foreign use of the dual consolidated loss in the year in which the dual consolidated loss is incurred (mirror legislation), determined by assuming that such foreign country had recognized the dual consolidated loss in such year, for any of the following reasons:

(i) The dual resident corporation or separate unit that incurred the loss is subject to income taxation by another country (for example, the United States) on its worldwide income or on a residence basis.

(ii) The loss may be available to offset income (other than income of the dual resident corporation or separate unit) under the laws of another country (for example, the United States).

(iii) The deductibility of any portion of a deduction or loss taken into account in computing the dual consolidated loss depends on whether such amount is deductible under the laws of another country (for example, the United States). See § 1.1503(d)-7(c) Examples 17 through 19.

(2) Stand-alone exception—(i) In general. This paragraph (e)(2) applies if, in the absence of the mirror legislation described in paragraph (e)(1) of this section, no item of deduction or loss composing the dual consolidated loss of such dual resident corporation or separate unit would otherwise be available for a foreign use in the taxable year in which such dual consolidated loss is incurred. This determination is made without regard to whether such availability is limited by election (or other similar procedure). However, for purposes of this paragraph (e)(2)(i), no item of deduction or loss composing the dual consolidated loss of a dual resident corporation or separate unit is considered to be made available for foreign use solely because the laws of a foreign country would enable a foreign use through a sale, merger, or similar transaction (provided no such sale, merger, or similar transaction actually occurs). In such a case, no foreign use shall be considered to occur pursuant to paragraph (e)(1) of this section with respect to the dual consolidated loss, provided the requirements of paragraph (e)(2)(ii) of this section are satisfied. See § 1.1503(d)-7(c) Examples 17 through 19.

(ii) Stand-alone domestic use agreement. In order to qualify for the exception under paragraph (e)(2)(i) of this section, the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be, must enter into a domestic use agreement in accordance with the provisions of § 1.1503(d)-6(d) and, in addition, must include the following items in such domestic use agreement:

(A) A statement that the document is also being submitted under the provisions of paragraph (e)(2) of this section.

(B) A certification that the conditions of paragraph (e)(2)(i) of this section are satisfied during the taxable year in which the dual consolidated loss is incurred.

(C) An agreement to include with each annual certification required under § 1.1503(d)-6(g), a certification that the conditions described in paragraph (e)(2)(i) of this section are satisfied during the taxable year of each such certification.

(iii) Termination of stand-alone domestic use agreement. This paragraph (e)(2)(iii) applies to a consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be, that entered into a domestic use agreement pursuant to paragraph (e)(2)(ii) of this section, with respect to a dual consolidated loss, and which subsequently makes an election pursuant to § 1.1503(d)-6(b) (relating to agreements entered into between the United States and a foreign country) with respect to such dual consolidated loss. In such a case, the dual consolidated loss shall be subject to the election under § 1.1503(d)-6(b) (and any related agreements, representations and conditions), and the domestic use agreement entered into pursuant to paragraph (e)(2)(ii) of this section shall terminate and have no further effect.

(3) Exception for domestic consenting corporations. Paragraph (e)(1) of this section will not apply so as to deem a foreign use of a dual consolidated loss incurred by a domestic consenting corporation that is a dual resident corporation under § 1.1503(d)-1(b)(2)(iii).

(4) Exception for disregarded payment losses. Paragraph (e)(1) of this section will not apply so as to deem a foreign use of a disregarded payment loss (within the meaning of § 1.1503(d)-1(d)(5)(ii)(B)).

[T.D. 9315, 72 FR 12914, Mar. 19, 2007, as amended by T.D. 9896, 85 FR 19855, Apr. 8, 2020; T.D. 10026, 90 FR 3018, Jan. 14, 2025]

§ 1.1503(d)-4 Domestic use limitation and related operating rules.

(a) Scope. This section prescribes rules that apply when the general limitation on the domestic use of a dual consolidated loss under paragraph (b) of this section applies. Thus, the rules of this section do not apply when an exception to the domestic use limitation applies (for example, as a result of a domestic use election under § 1.1503(d)-6(d)). In general, when the domestic use limitation applies, the dual consolidated loss of a dual resident corporation or separate unit is subject to the separate return limitation year (SRLY) provisions of § 1.1502-21(c), as modified under this section. Paragraph (c) of this section provides rules that determine the effect of a dual consolidated loss on a consolidated group, an unaffiliated dual resident corporation, or an unaffiliated domestic owner. Paragraph (d) of this section provides rules that eliminate dual consolidated losses following certain transactions or events. Paragraph (e) of this section contains provisions that prevent dual consolidated losses from offsetting tainted income. Finally, paragraph (f) of this section provides rules for computing foreign tax credits.

(b) Limitation on domestic use of a dual consolidated loss. Except as provided in § 1.1503(d)-6, the domestic use of a dual consolidated loss is not permitted. See § 1.1503(d)-2 for the definition of a domestic use. See also § 1.1503(d)-7(c) Examples 2 through 4.

(c) Effect of a dual consolidated loss on a consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner. For any taxable year in which a dual resident corporation or separate unit has a dual consolidated loss that is subject to the domestic use limitation of paragraph (b) of this section, the following rules shall apply:

(1) Dual resident corporation. This paragraph (c)(1) applies to a dual consolidated loss of a dual resident corporation. The unaffiliated dual resident corporation, or consolidated group that includes the dual resident corporation, shall compute its taxable income (or loss), or consolidated taxable income (or loss), respectively, without taking into account those items of deduction and loss that compose the dual resident corporation's dual consolidated loss. For this purpose, the dual consolidated loss shall be treated as composed of a pro rata portion of each item of deduction and loss of the dual resident corporation taken into account in calculating the dual consolidated loss. The dual consolidated loss is subject to the limitations on its use contained in paragraph (c)(3) of this section and, subject to such limitations, may be carried over or back for use in other taxable years as a separate net operating loss carryover or carryback of the dual resident corporation arising in the year incurred. If the dual resident corporation owns a separate unit or an interest in a transparent entity, the limitations contained in paragraph (c)(3) of this section shall apply to the dual resident corporation as if the separate unit or interest in a transparent entity were a separate domestic corporation that filed a consolidated return with the unaffiliated dual resident corporation, or with the consolidated group of the affiliated dual resident corporation, as applicable.

(2) Separate unit. This paragraph (c)(2) applies to a dual consolidated loss that is attributable to a separate unit. The unaffiliated domestic owner of a separate unit, or the consolidated group of an affiliated domestic owner of a separate unit, shall compute its taxable income (or loss) or consolidated taxable income (or loss), respectively, without taking into account those items of deduction and loss that compose the separate unit's dual consolidated loss. For this purpose, the dual consolidated loss shall be treated as composed of a pro rata portion of each item of deduction and loss of the separate unit taken into account in calculating the dual consolidated loss. The dual consolidated loss is subject to the limitations contained in paragraph (c)(3) of this section as if the separate unit to which the dual consolidated loss is attributable were a separate domestic corporation that filed a consolidated return with its unaffiliated domestic owner or with the consolidated group of its affiliated domestic owner, as applicable. Subject to such limitations, the dual consolidated loss may be carried over or back for use in other taxable years as a separate net operating loss carryover or carryback of the separate unit arising in the year incurred. See § 1.1503(d)-7(c) Examples 29 and 38.

(3) SRLY limitation. The dual consolidated loss shall be treated as a loss incurred by the dual resident corporation or separate unit in a separate return limitation year and shall be subject to all of the limitations of § 1.1502-21(c) (SRLY limitation), subject to the following modifications—

(i) Notwithstanding § 1.1502-1(f)(2)(i), the SRLY limitation is applied to any dual consolidated loss of a common parent that is a dual resident corporation, or any dual consolidated loss attributable to a separate unit of a common parent;

(ii) The SRLY limitation is applied without regard to § 1.1502-21(c)(2) (SRLY subgroup limitation) and 1.1502-21(g) (overlap with section 382);

(iii) For purposes of calculating the general SRLY limitation under § 1.1502-21(c)(1)(i), the calculation of aggregate consolidated taxable income shall only include items of income, gain, deduction, and loss generated—

(A) In the case of a hybrid entity separate unit, in years in which the hybrid entity (an interest in which is a separate unit) is taxed as a corporation (or otherwise at the entity level) either on its worldwide income or as a resident in the same foreign country in which it was so taxed during the year in which the dual consolidated loss was generated; and

(B) In the case of a foreign branch separate unit, in years in which the foreign branch qualified as a separate unit in the same foreign country in which it so qualified during the year in which the dual consolidated loss was generated;

(iv) For purposes of calculating the general SRLY limitation under § 1.1502-21(c)(1)(i), the calculation of aggregate consolidated taxable income shall not include any amount included in income pursuant to § 1.1503(d)-6(h) (relating to the recapture of a dual consolidated loss).

(v) The SRLY limitation is applied without regard to § 1.1502-21(c)(1)(i)(E) (section 172(a) limitation applicable to a SRLY member).

(4) Items of a dual consolidated loss used in other taxable years. A pro rata portion of each item of deduction or loss that composes the dual consolidated loss shall be considered to be used when the dual consolidated loss is used in other taxable years. See § 1.1503(d)-7(c) Examples 29 and 38.

(5) Reconstituted net operating losses. For additional rules and limitations that apply to reconstituted net operating losses, see § 1.1503(d)-6(h)(6).

(d) Elimination of a dual consolidated loss after certain transactions—(1) General rule. In general, a dual resident corporation has a net operating loss (and, therefore, a dual consolidated loss) only if it sustains such loss, or succeeds to such loss as a result of acquiring the assets of a corporation that sustained the loss in a transaction described in section 381(a). Similarly, a net loss generally is attributable to a separate unit of a domestic owner (and therefore is a dual consolidated loss) only if the domestic owner incurs the deductions or losses, or succeeds to such deductions or losses in a transaction described in section 381(a). Except as provided in § 1.1503(d)-6(h)(6)(iii), section 1503(d) and these regulations do not alter these general rules. Thus, the provisions of §§ 1.1503(d)-1 through 1.1503(d)-8 generally do not cause a corporation to have a dual consolidated loss if it did not sustain (or inherit) the loss. Instead, these regulations either eliminate a dual consolidated loss that a corporation sustained (or inherited), or prevent the carryover of a dual consolidated loss under section 381 that would ordinarily occur, as a result of certain transactions.

(i) Transactions described in section 381(a). This paragraph (d)(1)(i) applies to a dual consolidated loss of a dual resident corporation, or of a domestic owner attributable to a separate unit, that is subject to the domestic use limitation rule of paragraph (b) of this section. In such a case, and except as provided in paragraph (d)(2) of this section, the dual consolidated loss shall not carry over to another corporation in a transaction described in section 381(a) and, as a result, shall be eliminated. See § 1.1503(d)-7(c) Example 20.

(ii) Cessation of separate unit status. This paragraph (d)(1)(ii) applies when a separate unit of an unaffiliated domestic owner ceases to be a separate unit of its domestic owner, or when a separate unit of an affiliated domestic owner ceases to be a separate unit with respect to its domestic owner and all other members of the affiliated domestic owner's consolidated group. In such a case, and except as provided in paragraph (d)(2)(iii) of this section, a dual consolidated loss of the domestic owner attributable to such separate unit, that is subject to the domestic use limitation of paragraph (b) of this section, shall be eliminated. For purposes of this paragraph (d)(1)(ii), a separate unit may cease to be a separate unit if, for example, such separate unit is terminated, dissolved, liquidated, sold, or otherwise disposed of. See § 1.1503(d)-7(c) Example 21.

(2) Exceptions—(i) Certain section 368(a)(1)(F) reorganizations. Paragraph (d)(1)(i) of this section (relating to transactions described in section 381(a)) shall not apply to a dual consolidated loss of a dual resident corporation that undergoes a reorganization described in section 368(a)(1)(F) in which the resulting corporation is a domestic corporation. In such a case, the dual consolidated loss of the resulting corporation continues to be subject to the limitations of paragraphs (b) and (c) of this section, applied as if the resulting corporation incurred the dual consolidated loss.

(ii) Acquisition of a dual resident corporation by another dual resident corporation. If a dual resident corporation transfers its assets to another dual resident corporation in a transaction described in section 381(a), and the transferee corporation is a resident of (or is taxed on its worldwide income by) the same foreign country of which the transferor was a resident (or was taxed on its worldwide income), then paragraph (d)(1)(i) of this section shall not apply with respect to dual consolidated losses of the dual resident corporation, and income generated by the transferee may be offset by the carryover dual consolidated losses of the transferor, subject to the limitations of paragraphs (b) and (c) of this section applied as if the transferee incurred the dual consolidated loss. Dual consolidated losses of the transferor dual resident corporation may not, however, be used to offset income attributable to separate units or interests in transparent entities owned by the transferee because they constitute domestic affiliates under § 1.1503(d)-1(b)(12)(iii) and (iv), respectively.

(iii) Acquisition of a separate unit by a domestic corporation. This paragraph (d)(2)(iii) provides exceptions to the general rules in paragraphs (d)(1)(i) and (ii) of this section that eliminate the dual consolidated loss of a domestic owner that is attributable to a separate unit following certain transactions or events. The exceptions set forth in this paragraph (d)(2)(iii) shall only apply where a domestic owner transfers its assets to a domestic corporation (transferee corporation) in a transaction described in section 381(a).

(A) Acquisition by a corporation that is not a member of the same consolidated group—(1) General rule. If a domestic owner transfers either an individual separate unit or a combined separate unit to a transferee corporation that is not a member of its consolidated group in a transaction described in section 381(a), and the transferee corporation, or a member of the transferee's consolidated group, is a domestic owner of the transferred separate unit immediately after the transaction, then paragraphs (d)(1)(i) and (ii) of this section shall not apply to such transfer. In addition, income of the transferee, or a member of the transferee's consolidated group, that is attributable to the transferred separate unit may be offset by the carryover dual consolidated losses of the transferor domestic owner that were attributable to the transferred separate unit, subject to the limitations of paragraphs (b) and (c) of this section applied as if the transferee incurred the dual consolidated losses and such losses were attributable to the separate unit. See § 1.1503(d)-7(c) Example 21.

(2) Combination with separate units of the transferee. This paragraph (d)(2)(iii)(A)(2) applies to a transaction described in paragraph (d)(2)(iii)(A)(1) of this section where the transferred separate unit is combined with another separate unit of the transferee, or another member of the transferee's consolidated group, immediately after the transfer as provided under § 1.1503(d)-1(b)(4)(ii). In such a case, income generated by the transferee, or another member of the transferee's consolidated group, that is attributable to the combined separate unit may be offset by the carryover dual consolidated losses that were attributable to the transferred separate unit, subject to the limitations of paragraphs (b) and (c) of this section, applied as if the transferee incurred the dual consolidated losses and such losses were attributable to the combined separate unit.

(B) Acquisition by a member of the same consolidated group. If an affiliated domestic owner transfers its assets to another member of its consolidated group in a transaction described in section 381(a), and the transferee corporation or another member of such consolidated group is a domestic owner of the separate unit to which the dual consolidated loss was attributable, then paragraphs (d)(1)(i) and (ii) of this section shall not apply. In addition, income generated by the transferee that is attributable to the transferred separate unit may be offset by the carryover dual consolidated losses that were attributable to the transferred separate unit, subject to the limitations of paragraphs (b) and (c) of this section, applied as if the transferee incurred the dual consolidated losses and such losses were attributable to the separate unit. See § 1.1503(d)-7(c) Example 21.

(iv) Special rules for foreign insurance companies. See § 1.1503(d)-6(a) for additional limitations that apply where the transferor is a foreign insurance company that is a dual resident corporation under § 1.1503(d)-1(b)(2)(ii).

(e) Special rule denying the use of a dual consolidated loss to offset tainted income—(1) In general. Dual consolidated losses incurred by a dual resident corporation that are subject to the domestic use limitation rule under paragraph (b) of this section shall not be used to offset income it earns after it ceases to be a dual resident corporation to the extent that such income is tainted income.

(2) Tainted income—(i) Definition. For purposes of paragraph (e)(1) of this section, the term tainted income means—

(A) Income or gain recognized on the sale or other disposition of tainted assets; and

(B) Income derived as a result of holding tainted assets.

(ii) Income presumed to be derived from holding tainted assets. In the absence of evidence establishing the actual amount of income that is attributable to holding tainted assets, the portion of a corporation's income in a particular taxable year that is treated as tainted income derived as a result of holding tainted assets shall be an amount equal to the corporation's taxable income for the year (other than income described in paragraph (e)(2)(i)(A) of this section) multiplied by a fraction, the numerator of which is the fair market value of all tainted assets acquired by the corporation (determined at the time such assets were so acquired) and the denominator of which is the fair market value of the total assets owned by the corporation at the end of such taxable year. To establish the actual amount of income that is attributable to holding tainted assets, documentation must be attached to, and filed by the due date (including extensions) of, the domestic corporation's tax return or the consolidated tax return of an affiliated group of which it is a member, as the case may be, for the taxable year in which the income is generated. See § 1.1503(d)-7(c) Example 22.

(3) Tainted assets defined. For purposes of paragraph (e)(2) of this section, tainted assets are any assets acquired by a domestic corporation in a nonrecognition transaction, as defined in section 7701(a)(45), any assets otherwise transferred to the corporation as a contribution to capital, or any assets otherwise received from a separate unit or a transparent entity owned by such domestic corporation, at any time during the three taxable years immediately preceding the taxable year in which the corporation ceases to be a dual resident corporation or at any time thereafter.

(4) Exceptions. Income derived from assets acquired by a domestic corporation shall not be subject to the limitation described in paragraph (e)(1) of this section, and in addition shall not be treated as tainted assets as defined in paragraph (e)(3) of this section, if—

(i) For the taxable year in which the assets were acquired, the corporation did not have a dual consolidated loss (or a carryforward of a dual consolidated loss to such year); or

(ii) The assets were acquired as replacement property in the ordinary course of business.

(f) Computation of foreign tax credit limitation. If a dual consolidated loss is subject to the domestic use limitation rule under paragraph (b) of this section, the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner shall compute its foreign tax credit limitation by applying the limitations of paragraph (c) of this section. Thus, the items constituting the dual consolidated loss are not taken into account until the year in which such items are absorbed.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007, as amended by T.D. 9927, 85 FR 67988, Oct. 27, 2020]

Editorial Note:By T.D. 9927, 85 FR 67988, Oct. 27, 2020, § 1.1503(d)-4 was amended; however, a portion of the amendment could not be incorporated due to inaccurate amendatory instruction.

§ 1.1503(d)-5 Attribution of items and basis adjustments.

(a) In general. This section provides rules for determining the amount of income or dual consolidated loss of a dual resident corporation. This section also provides rules for determining the income or dual consolidated loss attributable to a separate unit, as well as the income or loss attributable to an interest in a transparent entity. Paragraph (b) of this section provides rules with respect to dual resident corporations. Paragraph (c) of this section provides rules with respect to separate units and interests in transparent entities. These determinations are required for various purposes under section 1503(d). For example, it is necessary for purposes of applying the domestic use limitation rule under § 1.1503(d)-4(b) to a dual consolidated loss, and for determining the extent to which a dual consolidated loss is available to offset income as provided under § 1.1503(d)-4(c). These determinations are also necessary for purposes of determining whether the amount subject to recapture may be reduced pursuant to § 1.1503(d)-6(h)(2). Paragraph (d) of this section provides rules with respect to the foreign tax treatment of items. Paragraph (e) of this section provides rules regarding the treatment of items where a dual resident corporation, separate unit, or transparent entity only qualified as such during a portion of a taxable year. Paragraph (f) of this section provides rules for determining the assets and liabilities of a separate unit. Finally, paragraph (g) of this section provides rules for making basis adjustments to stock of certain members of a consolidated group and to certain interests in partnerships. The rules in this section apply for purposes of §§ 1.1503(d)-1 through 1.1503(d)-7.

(b) Determination of amount of income or dual consolidated loss of a dual resident corporation—(1) In general. For purposes of determining whether a dual resident corporation has income or a dual consolidated loss for the taxable year, and except as provided in paragraph (b)(2) of this section, the dual resident corporation shall compute its income or dual consolidated loss taking into account only those items of income, gain, deduction, and loss from such year (including any items recognized by such corporation as a result of an election under section 338). In the case of an affiliated dual resident corporation, such calculation shall be made in accordance with the rules set forth in the regulations under section 1502 governing the computation of consolidated taxable income. See also paragraphs (d) and (e) of this section.

(2) Exceptions. For purposes of determining the income or dual consolidated loss of a dual resident corporation, the following shall not be taken into account—

(i) Any net capital loss of the dual resident corporation;

(ii) Any carryover or carryback losses; or

(iii) Any items of income, gain, deduction, and loss that are attributable to a separate unit or an interest in a transparent entity of the dual resident corporation.

(c) Determination of amount of income or dual consolidated loss attributable to a separate unit, and income or loss attributable to an interest in a transparent entity—(1) In general—(i) Scope and purpose. Paragraphs (c) through (e) of this section apply for purposes of determining the income or dual consolidated loss attributable to a separate unit, and the income or loss attributable to an interest in a transparent entity, for the taxable year. In the case of an affiliated domestic owner, this determination shall be made in accordance with the rules set forth in the regulations under section 1502 governing the computation of consolidated taxable income. These rules apply solely for purposes of section 1503(d).

(ii) Only items of domestic owner taken into account. The computation made under paragraphs (c) through (e) of this section shall be made using only those existing items of income, gain, deduction, and loss of the separate unit's or transparent entity's domestic owner (or owners, in the case of certain combined separate units), as determined for U.S. tax purposes. These items must be translated into U.S. dollars (if necessary) at the appropriate exchange rate provided under section 989(b), as modified by regulations. The computation shall be made as if the separate unit or interest in a transparent entity were a domestic corporation, using items that are attributable to the separate unit or interest in a transparent entity. However, for purposes of making this computation, net capital losses, and carryover or carryback losses, of the domestic owner shall not be taken into account. Items of income, gain, deduction, and loss that are otherwise disregarded for U.S. tax purposes shall not be regarded or taken into account for purposes of this section. See § 1.1503(d)-7(c) Examples 6 and 23 through 25.

(iii) Separate application. The attribution rules of this section shall apply separately to each separate unit or interest in a transparent entity. Thus, an item of income, gain, deduction, or loss shall not be considered attributable to more than one separate unit or interest in a transparent entity. In addition, for purposes of this section items of income, gain, deduction, and loss attributable to a separate unit or an interest in a transparent entity shall not offset items of income, gain, deduction, and loss of another separate unit or interest in a transparent entity. See § 1.1503(d)-7(c) Example 24. See also the separate unit combination rule in § 1.1503(d)-1(b)(4)(ii).

(2) Foreign branch separate unit—(i) In general. Except to the extent provided in paragraph (c)(4) of this section, for purposes of determining the items of income, gain, deduction (other than interest), and loss of a domestic owner that are attributable to the domestic owner's foreign branch separate unit, the principles of section 864(c)(2), (c)(4), and (c)(5), as set forth in § 1.864-4(c), and §§ 1.864-5 through 1.864-7, shall apply. The principles apply without regard to limitations imposed on the effectively connected treatment of income, gain, or loss under the trade or business safe harbors in section 864(b) and the limitations for treating foreign source income as effectively connected under section 864(c)(4)(D). Except as provided in paragraph (c)(2)(iii) of this section, for purposes of determining the domestic owner's interest expense that is attributable to a foreign branch separate unit, the principles of § 1.882-5, as modified in paragraph (c)(2)(ii) of this section, shall apply. When applying the principles of section 864(c) (as modified by this paragraph) and § 1.882-5 (as modified in paragraph (c)(2)(ii) of this section), the foreign branch separate unit's domestic owner shall be treated as a foreign corporation, the foreign branch separate unit shall be treated as a trade or business within the United States, and the other assets of the domestic owner shall be treated as assets that are not U.S. assets.

(ii) Principles of § 1.882-5. For purposes of paragraph (c)(2)(i) of this section, the principles of § 1.882-5 shall be applied, subject to the following modifications—

(A) Except as otherwise provided in this section, only the assets, liabilities, and interest expense of the domestic owner shall be taken into account in the § 1.882-5 formula;

(B) Except as provided under paragraph (c)(2)(ii)(C) of this section, a taxpayer may use the alternative tax book value method under § 1.861-9(i) for purposes of determining the value of its U.S. assets pursuant to § 1.882-5(b)(2) and its worldwide assets pursuant to § 1.882-5(c)(2);

(C) For purposes of determining the value of a U.S. asset pursuant to § 1.882-5(b)(2), and worldwide assets pursuant to § 1.882-5(c)(2), the taxpayer must use the same methodology under § 1.861-9T(g) (that is, tax book value, alternative tax book value, or fair market value) that the taxpayer uses for purposes of allocating and apportioning interest expense for the taxable year under section 864(e);

(D) Asset values shall be determined pursuant to § 1.861-9T(g)(2); and

(E) For purposes of determining the step-two U.S. connected liabilities, the amounts of worldwide assets and liabilities under § 1.882-5(c)(2)(iii) and (iv) must be determined in accordance with U.S. tax principles, rather than substantially in accordance with U.S. tax principles.

(iii) Exception where foreign country attributes interest expense solely by reference to books and records. The principles of § 1.882-5 shall not apply if the foreign country in which the foreign branch separate unit is located determines, for purposes of computing taxable income (or loss) of a permanent establishment or branch of a nonresident corporation under the laws of the foreign country, the interest expense of the foreign branch separate unit by taking into account only the items of interest expense reflected on the foreign branch separate unit's books and records. In such a case, only those items of the domestic owner's interest expense reflected on the foreign branch separate unit's books and records (as provided in paragraph (c)(3)(i) of this section), adjusted to conform to U.S. tax principles, shall be attributable to the foreign branch separate unit. This paragraph shall not apply where the foreign country does not use a method of attributing interest based solely on the interest that is reflected on the books and records. For example, this paragraph does not apply if the foreign country uses a method for attributing interest expense similar to § 1.882-5 or that set forth in the Organization for Economic Co-operation and Development Report on the Attribution of Profits to Permanent Establishments, Part II (Banks), December 2006. See http://www.oecd.org.

(3) Hybrid entity separate unit and an interest in a transparent entity—(i) General rule. This paragraph (c)(3) applies to determine the items of income, gain, deduction, and loss of a domestic owner that are attributable to a hybrid entity separate unit, or an interest in a transparent entity, of such domestic owner. Except to the extent provided in paragraph (c)(4) of this section, the domestic owner's items of income, gain, deduction, and loss are attributable to the extent they are reflected on the books and records of the hybrid entity or transparent entity, as applicable, as adjusted to conform to U.S. tax principles. See § 1.1503(d)-7(c) Examples 23 through 26. For purposes of this paragraph (c)(3), the term “books and records” has the meaning provided under § 1.989(a)-1(d). The treatment of items for foreign tax purposes, including under any type of foreign anti-deferral regime, is not relevant for purposes of determining whether items are reflected on the books and records of the entity, or for purposes of making adjustments to such items to conform to U.S. tax principles. The method described in the second sentence of this paragraph shall not apply to the extent that the Commissioner determines that booking practices are employed with a principal purpose of avoiding the principles of section 1503(d), including inconsistently treating the same or similar items of income, gain, deduction, and loss. In such a case, the Commissioner may reallocate the items of income, gain, deduction, and loss between or among a domestic owner, its hybrid entities, its transparent entities (and interests therein), its separate units, or any other entity, as applicable, in a manner consistent with the principles of section 1503(d) and which properly reflects income (or loss).

(ii) Interests in certain disregarded entities, partnerships, and grantor trusts owned by a hybrid entity or transparent entity. This paragraph (c)(3)(ii) applies if a hybrid entity or transparent entity to which paragraph (c)(3)(i) of this section applies owns, directly or indirectly (other than through a hybrid entity or transparent entity), an interest in an entity that is treated as a disregarded entity, partnership, or grantor trust for U.S. tax purposes, but is not a hybrid entity or a transparent entity. For example, the rules of this paragraph would apply when a hybrid entity holds an interest in a limited partnership created in the United States and, for both U.S. and foreign tax purposes the entity is considered a partnership. In such a case, and except to the extent provided in paragraph (c)(4) of this section, items of income, gain, deduction, and loss that are reflected on the books and records of such disregarded entity, partnership or grantor trust, as determined under paragraph (c)(3)(i) of this section, shall be treated as being reflected on the books and records of the hybrid entity or transparent entity for purposes of applying paragraph (c)(3)(i) of this section. See § 1.1503(d)-7(c) Example 26.

(4) Special rules. The following special rules shall apply for purposes of attributing items to separate units or interests in transparent entities under this section:

(i) Allocation of items between certain tiered separate units and interests in transparent entities—(A) Foreign branch separate unit. This paragraph (c)(4)(i) applies where a hybrid entity or transparent entity owns directly or indirectly (other than through a hybrid entity or a transparent entity), a foreign branch separate unit. For purposes of determining items of income, gain, deduction, and loss of the domestic owner that are attributable to the domestic owner's foreign branch separate unit described in the preceding sentence, only items of income, gain, deduction, and loss that are attributable to the domestic owner's interest in the hybrid entity, or transparent entity, as provided in paragraph (c)(3) of this section, shall be taken into account. Further, only assets, liabilities, and activities of the domestic owner's interest in the hybrid entity or the transparent entity shall be taken into account under paragraph (c)(2) of this section when applying the principles of 864(c)(2), (c)(4), (c)(5) (as set forth in § 1.864-4(c), and §§ 1.864-5 through 1.864-7), and § 1.882-5 (as modified in paragraph (c)(2)(ii) of this section). See § 1.1503(d)-7(c) Examples 25 and 26.

(B) Hybrid entity separate unit or interest in a transparent entity. For purposes of determining items of income, gain, deduction, and loss that are attributable to a hybrid entity separate unit or an interest in a transparent entity described in paragraph (c)(3) of this section, such items shall not be taken into account to the extent they are attributable to a foreign branch separate unit pursuant to paragraph (c)(4)(i)(A) of this section. See § 1.1503(d)-7(c) Examples 25 and 26.

(ii) Combined separate unit. If two or more individual separate units defined in § 1.1503(d)-1(b)(4)(i) are treated as one combined separate unit pursuant to § 1.1503(d)-1(b)(4)(ii), the items of income, gain, deduction, and loss that are attributable to the combined separate unit shall be determined as follows:

(A) Items of income, gain, deduction, and loss are first attributed to each individual separate unit without regard to § 1.1503(d)-1(b)(4)(ii), pursuant to the rules of paragraphs (c) through (e) of this section.

(B) The combined separate unit then takes into account all of the items of income, gain, deduction, and loss attributable to its individual separate units pursuant to paragraph (c)(4)(ii)(A) of this section. See § 1.1503(d)-7(c) Examples 25 and 26.

(iii) Gain or loss on the direct or indirect disposition of a separate unit or an interest in a transparent entity—(A) In general. This paragraph (c)(4)(iii) applies for purposes of attributing items of income, gain, deduction, and loss that are recognized on the sale, exchange, or other disposition of a separate unit or an interest in a transparent entity (or an interest in a disregarded entity, partnership, or grantor trust that owns, directly or indirectly, a separate unit or an interest in a transparent entity). For purposes of this paragraph (c)(4)(iii), items taken into account on the sale, exchange, or other disposition include loss recapture income or gain under section 367(a)(3)(C) or 904(f)(3), and gain or loss recognized by the domestic owner as the result of an election under section 338. In cases where this paragraph (c)(4)(iii)(A) applies, items taken into account on the sale, exchange, or other disposition shall be attributable to the separate unit or the interest in the transparent entity to the extent of gain or loss that would have been recognized had the separate unit or transparent entity sold all its assets (as determined in paragraph (f) of this section) in a taxable exchange, immediately before the sale, exchange, or other disposition (deemed sale). For purposes of a deemed sale described in this paragraph (c)(4)(iii), the assets are treated as being sold for an amount equal to their fair market value, plus the assumption of the liabilities of the separate unit or interest in a transparent entity (as determined in paragraph (f) of this section). See § 1.1503(d)-7(c) Example 27.

(B) Multiple separate units or interests in transparent entities. This paragraph (c)(4)(iii)(B) applies to a sale, exchange, or other disposition described in paragraph (c)(4)(iii)(A) of this section that results in more than one separate unit or interest in a transparent entity being, directly or indirectly, disposed of. In such a case, items of income, gain, deduction, and loss recognized on such sale, exchange, or other disposition are allocated and attributed to each separate unit or interest in a transparent entity, based on the relative gain or loss that would have been recognized by each separate unit or interest in a transparent entity pursuant to a deemed sale of their assets. See § 1.1503(d)-7(c) Example 28.

(iv) Inclusions on stock. Any amount included in income of a domestic owner arising from ownership of stock in a foreign corporation (for example, under sections 78, 951, or 986(c)) through a separate unit, or interest in a transparent entity, shall be attributable to the separate unit or interest in a transparent entity, if an actual dividend from such foreign corporation would have been so attributed. See § 1.1503(d)-7(c) Example 24.

(v) Foreign currency gain or loss recognized under section 987. Foreign currency gain or loss of a domestic owner recognized under section 987 as a result of a transfer or remittance shall not be attributable to a separate unit or an interest in a transparent entity.

(vi) Recapture of dual consolidated loss. If all or a portion of a dual consolidated loss that was attributable to a separate unit is included in the gross income of a domestic owner under the recapture provisions of § 1.1503(d)-6(h), such amount shall be attributable to the separate unit that incurred the dual consolidated loss being recaptured. See § 1.1503(d)-7(c) Examples 38 and 40.

(d) Foreign tax treatment disregarded. The fact that a particular item taken into account in computing the income or dual consolidated loss of a dual resident corporation or a separate unit, or the income or loss of an interest in a transparent entity, is not taken into account in computing income (or loss) subject to a foreign country's income tax shall not cause such item to be excluded from being taken into account under paragraph (b), (c), or (e) of this section.

(e) Items generated or incurred while a dual resident corporation, a separate unit, or a transparent entity. For purposes of determining the amount of the dual consolidated loss of a dual resident corporation for the taxable year, only the items of income, gain, deduction, and loss generated or incurred during the period the dual resident corporation qualified as such shall be taken into account. For purposes of determining the amount of income of a dual resident corporation for the taxable year, all the items of income, gain, deduction, and loss generated or incurred during the year shall be taken into account. For purposes of determining the amount of the income or dual consolidated loss attributable to a separate unit, or the income or loss attributable to an interest in a transparent entity, for the taxable year, only the items of income, gain, deduction, and loss generated or incurred during the period the separate unit or the interest in the transparent entity qualified as such shall be taken into account. For purposes of this paragraph (e), the allocation of items to periods shall be made under the principles of § 1.1502-76(b).

(f) Assets and liabilities of a separate unit or an interest in a transparent entity. A separate unit or an interest in a transparent entity shall be treated as owning assets to the extent items of income, gain, deduction, and loss from such assets would be attributable to the separate unit or interest in the transparent entity under paragraphs (c) through (e) of this section. Similarly, liabilities shall be treated as liabilities of a separate unit, or an interest in a transparent entity, to the extent interest expense incurred on such liabilities would be attributable to the separate unit, or the interest in a transparent entity, under paragraphs (c) through (e) of this section.

(g) Basis adjustments—(1) Affiliated dual resident corporation or affiliated domestic owner. If a member of a consolidated group owns stock in an affiliated dual resident corporation or an affiliated domestic owner that is a member of the same consolidated group, the member shall adjust the basis of the stock in accordance with the provisions of § 1.1502-32. Corresponding adjustments shall be made to the stock of other members in accordance with the provisions of § 1.1502-32. In the case where two or more individual separate units are treated as a combined separate unit pursuant to § 1.1503(d)-1(b)(4)(ii), see paragraph (g)(3) of this section.

(2) Interests in hybrid entities that are partnerships or interests in partnerships through which a separate unit is owned indirectly—(i) Scope. This paragraph (g)(2) applies for purposes of determining the adjusted basis of an interest in—

(A) A hybrid entity that is a partnership; and

(B) A partnership through which a domestic owner indirectly owns a separate unit.

(ii) Determination of basis of partner's interest. The adjusted basis of an interest described in paragraph (g)(2)(i) of this section shall be adjusted in accordance with section 705 and this paragraph (g)(2). The adjusted basis shall not be decreased for any amount of a dual consolidated loss that is attributable to the partnership interest, or separate unit owned indirectly through the partnership interest, as applicable, that is not absorbed as a result of the application of § 1.1503(d)-4(b) and (c). The adjusted basis shall, however, be decreased for the amount of such dual consolidated loss that is absorbed in a carryover or carryback taxable year. The adjusted basis shall be increased for any amount included in income pursuant to § 1.1503(d)-6(h) as a result of the recapture of a dual consolidated loss that was attributable to the interest in the hybrid partnership, or separate unit owned indirectly through the partnership interest, as applicable.

(3) Combined separate units. This paragraph (g)(3) applies where two or more individual separate units of one or more affiliated domestic owners are treated as one combined separate unit pursuant to § 1.1503(d)-1(b)(4)(ii). In such a case, a member owning stock in an affiliated domestic owner of the combined separate unit shall adjust the basis in the stock of such domestic owner as provided in paragraph (g)(1) of this section, and an affiliated domestic owner shall adjust its basis in a partnership, as provided in paragraph (g)(2) of this section, taking into account only those items of income, gain, deduction, or loss attributable to each individual separate unit, prior to combination. For purposes of this rule, if the dual consolidated loss attributable to a combined separate unit is subject to the domestic use limitation of § 1.1503(d)-4(b), then for purposes of this paragraph (g) and § 1.1502-32, the dual consolidated loss shall be allocated to an individual separate unit to the extent such individual separate unit contributed items of deduction or loss giving rise to the dual consolidated loss. In addition, if one or more affiliated domestic owners are required to recapture all or a portion of a dual consolidated loss pursuant to paragraph (h) of this section, such recapture amount shall be allocated to the affiliated domestic owner of the individual separate units composing the combined separate unit, to the extent such individual separate units contributed items of deduction or loss giving rise to the recaptured dual consolidated loss.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007; 72 FR 20424, Apr. 25, 2007]

§ 1.1503(d)-6 Exceptions to the domestic use limitation rule.

(a) In general—(1) Scope and purpose. This section provides certain exceptions to the domestic use limitation rule of § 1.1503(d)-4(b). Paragraph (b) of this section provides an exception for bilateral elective agreements. Paragraph (c) of this section provides rules regarding an exception that applies when there is no possibility of a foreign use. Paragraphs (d) through (h) of this section provide rules for an exception where a domestic use election is made. Paragraph (e) of this section provides rules with respect to triggering events, and paragraph (f) of this section provides rules regarding exceptions to triggering events. Paragraph (g) of this section provides rules with respect to the annual certification reporting requirement. Paragraph (h) of this section provides rules regarding the recapture of dual consolidated losses. Finally, paragraph (j) of this section provides rules regarding the termination of domestic use agreements and the annual certification requirement.

(2) Absence of foreign affiliate or foreign consolidation regime. The absence of a foreign affiliate or a foreign consolidation regime alone does not constitute an exception to the domestic use limitation rule. This is the case because it is still possible that all or a portion of the dual consolidated loss may be put to a foreign use. For example, there may be a foreign use with respect to an affiliate acquired in a year subsequent to the year in which the dual consolidated loss was incurred. In addition, a foreign use may occur in the absence of a foreign consolidation regime through a sale, merger, or similar transaction. See § 1.1503(d)-7(c) Example 2.

(3) Foreign insurance companies treated as domestic corporations. The exceptions contained in this section shall not apply to losses of a foreign insurance company that is a dual resident corporation under § 1.1503(d)-1(b)(2)(ii), or to losses attributable to any separate unit of such foreign insurance company. In addition, these exceptions shall not apply to losses described in the preceding sentence that, subject to the rules of § 1.1503(d)-4(d), carry over to a domestic corporation pursuant to a transaction described in section 381(a).

(b) Elective agreement in place between the United States and a foreign country—(1) In general. The domestic use limitation rule of § 1.1503(d)-4(b) shall not apply to a dual consolidated loss to the extent the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be, elects to deduct the loss in the United States pursuant to an agreement entered into between the United States and a foreign country that puts into place an elective procedure through which losses in a particular year may be used to offset income in only one country. This exception shall apply only if all the terms and conditions required under such agreement are satisfied, including any reporting or filing requirements. See § 1.1503(d)-3(e)(2)(iii) for the effect of an agreement described in this paragraph on a stand-alone domestic use agreement.

(2) Application to combined separate units. This paragraph (b)(2) applies where two or more individual separate units are treated as one combined separate unit pursuant to § 1.1503(d)-1(b)(4)(ii), and an agreement described in paragraph (b)(1) of this section would apply to at least one of the individual separate units. In such a case, and except to the extent provided in the agreement, the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be, may apply the agreement to the individual separate units, as applicable, provided the terms and conditions of the agreement are otherwise satisfied. See § 1.1503(d)-7(c) Example 19.

(c) No possibility of foreign use—(1) In general. The domestic use limitation rule of § 1.1503(d)-4(b) shall not apply to a dual consolidated loss if the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be—

(i) Demonstrates, to the satisfaction of the Commissioner, that no foreign use (as defined in § 1.1503(d)-3) of the dual consolidated loss occurred in the year in which it was incurred, and that no foreign use can occur in any other year by any means; and

(ii) Prepares a statement described in paragraph (c)(2) of this section that is attached to, and filed by the due date (including extensions) of, its U.S. income tax return for the taxable year in which the dual consolidated loss is incurred. See § 1.1503(d)-7(c) Examples 2, 30, and 31.

(2) Statement. The statement described in this paragraph (c)(2) must be signed under penalties of perjury by the person who signs the tax return. The statement must be labeled “No Possibility of Foreign Use of Dual Consolidated Loss Statement” at the top of the page and must include the following items, in paragraphs labeled to correspond with the items set forth in paragraphs (c)(2)(i) through (iv) of this section:

(i) A statement that the document is submitted under the provisions of paragraph (c) of this section.

(ii) The name, address, taxpayer identification number, and place and date of incorporation of the dual resident corporation, and the country or countries that tax the dual resident corporation on its worldwide income or on a residence basis, or, in the case of a separate unit, identification of the separate unit, including the name under which it conducts business, its principal activity, and the country in which its principal place of business is located. In the case of a combined separate unit, such information must be provided for each individual separate unit that is treated as part of the combined separate unit under § 1.1503(d)-1(b)(4)(ii).

(iii) A statement of the amount of the dual consolidated loss at issue.

(iv) An analysis, in reasonable detail and specificity, of the treatment of the losses and deductions composing the dual consolidated loss under the relevant facts. The analysis must include the reasons supporting the conclusion that no foreign use of the dual consolidated loss can occur as described in paragraph (c)(1)(i) of this section. The analysis must be supported with official or certified English translations of the relevant provisions of foreign law. The analysis may, for example, be based on the taxpayer's interpretation of foreign law, on advice received from local tax advisers in an opinion, or on a ruling from local country tax authorities. In all cases, however, the determination must be made to the satisfaction of the Commissioner.

(d) Domestic use election—(1) In general. The domestic use limitation rule of § 1.1503(d)-4(b) shall not apply to a dual consolidated loss if an election to be bound by the provisions of paragraphs (d) through (j) of this section is made by the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be (elector). In order to elect such relief, an agreement described in this paragraph (d)(1) (domestic use agreement) must be attached to, and filed by the due date (including extensions) of, the U.S. income tax return of the elector for the taxable year in which the dual consolidated loss is incurred. The domestic use agreement must be signed under penalties of perjury by the person who signs the return. If dual consolidated losses of more than one dual resident corporation or separate unit requires the filing of domestic use agreements by the same elector, the agreements may be combined in a single document, but the information required by paragraphs (d)(1)(ii) and (iv) of this section must be provided separately with respect to each dual consolidated loss. The domestic use agreement must be labeled “Domestic Use Election and Agreement” at the top of the page and must include the following items, in paragraphs labeled to correspond with the following:

(i) A statement that the document submitted is an election and an agreement under the provisions of paragraph (d) of this section.

(ii) The information required by paragraph (c)(2)(ii) of this section.

(iii) An agreement by the elector to comply with all of the provisions of paragraphs (d) through (j) of this section, as applicable.

(iv) A statement of the amount of the dual consolidated loss at issue.

(v) A certification that there has not been, and will not be, a foreign use (as defined in § 1.1503(d)-3) during the certification period (as defined in § 1.1503(d)-1(b)(20)).

(vi) A certification that arrangements have been made to ensure that there will be no foreign use of the dual consolidated loss during the certification period, and that the elector will be informed of any such foreign use of the dual consolidated loss during such period.

(vii) If applicable, a notification that an excepted triggering event under paragraph (f)(2) of this section has occurred with respect to the dual consolidated loss within the taxable year in which the loss is incurred. See paragraph (g) of this section for notification of excepted triggering events occurring during the certification period.

(2) No domestic use election available if there is a triggering event in the year the dual consolidated loss is incurred. Except as otherwise provided in this section, if a dual resident corporation or separate unit incurs a dual consolidated loss in a taxable year and a triggering event, as described in paragraph (e)(1) of this section, occurs (and no exception applies) with respect to the dual consolidated loss in such taxable year, then the consolidated group, unaffiliated dual resident corporation, or unaffiliated domestic owner, as the case may be, may not make a domestic use election with respect to such dual consolidated loss and the loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b). See § 1.1503(d)-7(c) Examples 5 through 7. See also § 1.1503(d)-4(d) for rules that eliminate a dual consolidated loss after certain transactions.

(e) Triggering events requiring the recapture of a dual consolidated loss—(1) Events. Except as provided under paragraphs (e)(2) (rebuttal of triggering events) and (f) (exceptions to triggering events) of this section, if there is a triggering event described in this paragraph (e)(1) with respect to a dual consolidated loss of a dual resident corporation or a separate unit during the certification period (as defined in § 1.1503(d)-1(b)(20)), the elector will recapture and report as ordinary income the amount of such dual consolidated loss as provided in paragraph (h) of this section on its tax return for the taxable year in which the triggering event occurs (or, when the triggering event is a foreign use of the dual consolidated loss, the taxable year that includes the last day of the foreign taxable year during which such use occurs). In addition, the elector must pay any applicable interest charge required by paragraph (h) of this section. For purposes of this section, any of the following events shall constitute a triggering event:

(i) Foreign use. A foreign use (as defined in § 1.1503(d)-3) of the dual consolidated loss. See § 1.1503(d)-3(c) for exceptions to foreign use.

(ii) Disaffiliation. An affiliated dual resident corporation or affiliated domestic owner that incurred directly or through a separate unit, respectively, a dual consolidated loss that is subject to a domestic use election, ceases to be a member of the consolidated group that made the domestic use election. For purposes of this paragraph (e)(1)(ii), an affiliated dual resident corporation or affiliated domestic owner shall be considered to cease to be a member of the consolidated group if it is no longer a member of the group within the meaning of § 1.1502-1(b), or if the group ceases to exist (for example, when the group no longer files a consolidated return). See § 1.1503(d)-7(c) Example 34. Any consequences resulting from this triggering event (for example, recapture of a dual consolidated loss) shall be taken into account on the tax return of the consolidated group for the taxable year that includes the date on which the affiliated dual resident corporation or affiliated domestic owner ceases to be a member of the consolidated group. This paragraph (e)(1)(ii) shall not apply to an acquisition described in § 1.1502-75(d)(3) where the consolidated group that includes the affiliated dual resident corporation or affiliated domestic owner, as applicable, is treated as remaining in existence.

(iii) Affiliation. An unaffiliated dual resident corporation or unaffiliated domestic owner becomes a member of a consolidated group. Any consequences resulting from this triggering event (for example, recapture of a dual consolidated loss) shall be taken into account on the tax return of the unaffiliated dual resident corporation or unaffiliated domestic owner for the taxable year that ends at the end of the day on which such corporation becomes a member of the consolidated group.

(iv) Transfer of assets. Fifty percent or more of the dual resident corporation's or separate unit's gross assets (measured by the fair market value of the assets at the time of such transaction or, for multiple transactions, at the time of the first transaction) is sold or otherwise disposed of in either a single transaction or a series of transactions within a twelve-month period. See § 1.1503(d)-7(c) Examples 5 and 35 through 37. In determining whether fifty percent or more of such assets is sold or otherwise disposed of, any dispositions occurring in the ordinary course of the dual resident corporation's or separate unit's trade or business shall be disregarded. In addition, for purposes of this paragraph (e)(1)(iv), an interest in another separate unit and the shares of a dual resident corporation shall not be treated as assets of a separate unit or a dual resident corporation.

(v) Transfer of an interest in a separate unit. Fifty percent or more of the interest in a separate unit (measured by voting power or value at the time of such transaction, or for multiple transactions, at the time of the first transaction) of the domestic owner, as determined by reference to such domestic owner's percentage interest on the last day of the taxable year in which the dual consolidated loss was incurred, is sold or otherwise disposed of either in a single transaction or a series of transactions within a twelve-month period. See § 1.1503(d)-7(c) Examples 5 and 35 through 37.

(vi) Conversion to a foreign corporation. An unaffiliated dual resident corporation, unaffiliated domestic owner, or hybrid entity an interest in which is a separate unit, that incurred the dual consolidated loss, becomes a foreign corporation (for example, as a result of a reorganization or an election to be classified as a corporation under § 301.7701-3(c) of this chapter).

(vii) Conversion to a regulated investment company, a real estate investment trust, or an S corporation. An unaffiliated dual resident corporation or unaffiliated domestic owner elects to be a regulated investment company pursuant to section 851(b)(1), a real estate investment trust pursuant to section 856(c)(1), or an S corporation pursuant to section 1362(a).

(viii) Failure to certify. The elector fails to file a certification with respect to a dual consolidated loss as required under paragraph (g) of this section.

(ix) Cessation of stand-alone status. In the case of a dual consolidated loss that is subject to the stand-alone exception described in § 1.1503(d)-3(e)(2), the conditions described in § 1.1503(d)-3(e)(2)(i) are no longer satisfied. See § 1.1503(d)-7(c) Example 18.

(2) Rebuttal—(i) General rule. An event described in paragraph (e)(1) of this section shall not constitute a triggering event if the elector demonstrates, to the satisfaction of the Commissioner, that there can be no foreign use (as defined in § 1.1503(d)-3) of the dual consolidated loss during the remaining certification period by any means. See paragraph (j)(1) of this section for rules regarding the termination of domestic use agreements and annual certifications following rebuttals under this general rule.

(ii) Certain asset transfers. An event described in paragraph (e)(1)(iv) of this section shall not constitute a triggering event if the elector demonstrates, to the satisfaction of the Commissioner, that the transfer of assets did not result in a carryover under foreign law of the dual resident corporation's, or separate unit's, losses, expenses, or deductions to the transferee of the assets. For purposes of this determination, the exception to foreign use in § 1.1503(d)-3(c)(7) shall be taken into account. Following rebuttal under this paragraph (e)(2)(ii), the domestic use agreement continues in effect.

(iii) Reporting. In order to satisfy the requirements of paragraph (e)(2)(i) or (ii) of this section, the elector must prepare a statement, labeled “Rebuttal of Triggering Event” at the top of the page, that indicates that it is submitted under the provisions of this paragraph (e)(2). The statement must include the information described in paragraphs (c)(2)(ii) and (iii) of this section. The statement must also include the information described in paragraph (c)(2)(iv) of this section that supports the conclusions under paragraph (e)(2)(i) or (ii) of this section, as applicable. The statement must be attached to, and filed by the due date (including extensions) of, the elector's income tax return for the taxable year in which the presumed triggering event occurs.

(iv) Examples. See § 1.1503(d)-7(c) Examples 32 and 33.

(f) Triggering event exceptions—(1) Continuing ownership of assets or interests. The following events shall not constitute triggering events, requiring the recapture of the dual consolidated loss under paragraph (h) of this section:

(i) Disaffiliation as a result of a transaction described in section 381. An affiliated dual resident corporation or affiliated domestic owner ceases to be a member of a consolidated group solely by reason of a transaction in which a member of the same consolidated group succeeds to the tax attributes of the dual resident corporation or domestic owner under the provisions of section 381.

(ii) Continuing ownership by consolidated group. This paragraph (f)(1)(ii) applies when assets of an affiliated dual resident corporation, or assets of, or interests in, a separate unit of an affiliated domestic owner are sold or otherwise disposed of. In such a case, the sale or disposition shall not be treated as a triggering event to the extent the assets or interests are acquired by one or more members of the consolidated group that includes the affiliated dual resident corporation or affiliated domestic owner, or by a partnership or a grantor trust, but only if immediately after the acquisition more than 90 percent of the partnership's or grantor trust's interests is owned, directly or indirectly, by members of such consolidated group.

(iii) Continuing ownership by unaffiliated dual resident corporation or unaffiliated domestic owner. This paragraph (f)(1)(iii) applies when assets of an unaffiliated dual resident corporation, or assets of, or interests in, a separate unit of an unaffiliated domestic owner, are sold or otherwise disposed of. In such a case, the sale or disposition shall not be a triggering event to the extent such assets or interests are acquired by the unaffiliated dual resident corporation, or unaffiliated domestic owner, as applicable, or by a partnership or grantor trust, but only if immediately after the acquisition more than 90 percent of the partnership's or grantor trust's interests is owned, directly or indirectly, by the unaffiliated dual resident corporation or unaffiliated domestic owner. For example, this paragraph (f)(1)(iii) applies when an unaffiliated domestic owner acquires direct ownership of the assets of a separate unit that it had immediately before owned indirectly through a partnership.

(2) Transactions requiring a new domestic use agreement—(i) Multiple-party events. If all the requirements of paragraph (f)(2)(iii) of this section are satisfied, the following events shall not constitute triggering events requiring the recapture of the dual consolidated loss under paragraph (h) of this section:

(A) An affiliated dual resident corporation or affiliated domestic owner becomes an unaffiliated domestic corporation or a member of a new consolidated group (other than in a transaction described in paragraph (f)(2)(ii)(B) of this section).

(B) Assets of a dual resident corporation or assets of, or interests in, a separate unit, are sold or otherwise disposed of in a transaction in which such assets or interests are acquired by an unaffiliated domestic corporation, one or more members of a new consolidated group, or by a partnership or grantor trust, but only if immediately after the sale or disposition more than 90 percent of the partnership's or grantor trust's interests is owned, directly or indirectly, by the unaffiliated domestic owner or by members of a new consolidated group, as applicable. See the related exception to foreign use provided under § 1.1503(d)-3(c)(8). See also § 1.1503(d)-7(c) Examples 36 and 37.

(ii) Events resulting in a single consolidated group. If the requirements of paragraph (f)(2)(iii)(A) of this section are satisfied, the following events shall not constitute triggering events requiring the recapture of the dual consolidated loss under paragraph (h) of this section:

(A) An unaffiliated dual resident corporation or unaffiliated domestic owner becomes a member of a consolidated group.

(B) A consolidated group ceases to exist as a result of a transaction described in § 1.1502-13(j)(5)(i) (relating to acquisitions of the common parent of the consolidated group), other than a transaction in which any member of the terminating group, or the successor-in-interest of such member, is not a member of the surviving group immediately after the terminating group ceases to exist. See § 1.1503(d)-7(c) Example 34.

(iii) Requirements—(A) New domestic use agreement. The unaffiliated domestic corporation or new consolidated group (subsequent elector) must file an agreement described in paragraph (d)(1) of this section (new domestic use agreement). The new domestic use agreement must be labeled “New Domestic Use Agreement” at the top of the page, and must be attached to and filed by the due date (including extensions) of, the subsequent elector's income tax return for the taxable year in which the event described in paragraph (f)(2)(i) or (f)(2)(ii) of this section occurs. The new domestic use agreement must be signed under penalties of perjury by the person who signs the return and must include the following items:

(1) A statement that the document submitted is an election and agreement under the provisions of paragraph (f)(2) of this section.

(2) An agreement to assume the same obligations with respect to the dual consolidated loss as the unaffiliated dual resident corporation, unaffiliated domestic owner, or consolidated group, as applicable, that filed the original domestic use agreement (original elector) with respect to that loss. In such a case, obligations of an elector provided under this section shall also be considered to be obligations of a subsequent elector.

(3) In the event of a transaction described in section 384(a) involving the subsequent elector, an agreement to treat any potential recapture amount under paragraph (h) of this section with respect to the dual consolidated loss as unrealized built-in gain for purposes of section 384(a), subject to any applicable exceptions (for example, the threshold requirements under section 382(h)(3)(B)). The potential recapture amount treated as unrealized built-in gain under this paragraph (f)(2)(iii)(A)(3) may be reduced to the extent permitted by paragraph (h)(2)(i) of this section.

(4) In the case of a multiple-party event described in paragraph (f)(2)(i) of this section, an agreement to be subject to the rules provided in paragraph (h)(3) of this section.

(5) The name, U.S. taxpayer identification number, and address of the original elector and prior subsequent electors, if any, with respect to the dual consolidated loss.

(B) Statement filed by original elector. In the case of a multiple-party event described in paragraph (f)(2)(i) of this section, the original elector must file a statement that is attached to and filed by the due date (including extensions) of its income tax return for the taxable year in which the event occurs. The statement must be labeled “Original Elector Statement” at the top of the page, must be signed under penalties of perjury by the person who signs the tax return, and must include the following items:

(1) A statement that the document submitted is an election and agreement under the provisions of paragraph (f)(2) of this section.

(2) An agreement to be subject to the rules provided in paragraph (h)(3) of this section.

(3) The name, U.S. taxpayer identification number, and address of the subsequent elector.

(3) Certain transfers qualifying for the de minimis exception to foreign use. If a transaction or event qualifies for the de minimis exception to foreign use described in § 1.1503(d)-3(c)(5), the transaction or event shall not constitute a triggering event under paragraph (e)(1)(iv) (transfers of assets) or (v) (transfers of an interest in a separate unit) of this section. For purposes of the preceding sentence, the transaction or event shall include deemed transfers that occur as a result of the transaction or event. See, for example, deemed transfers occurring pursuant to Rev. Rul. 99-5 (1999-1 CB 434), see § 601.601(d)(2)(ii)(b), and section 708 and the related regulations. See also § 1.1503(d)-7 Example 5. This paragraph (f)(3) only applies if the entire transaction or event qualifies for the de minimis exception to foreign use. For example, if a domestic owner sells five percent of a separate unit to a foreign corporation, which would qualify for the de minimis exception to foreign use if it were the only transfer, but pursuant to the same transaction also sells 70 percent of the same separate unit to another corporation in a manner that results in a triggering event under paragraph (e)(1)(v) of this section, this paragraph shall not apply to prevent the transaction from resulting in a triggering event.

(4) Deemed transactions as a result of certain transfers that do not result in a foreign use. The rules in this paragraph (f)(4) apply where the assets of, or the interests in, a separate unit are transferred in a transaction that would not result in a foreign use and, but for resulting deemed transactions or events, would not result in a triggering event described in paragraph (e)(1) of this section. For purposes of this paragraph (f)(4), deemed transactions or events shall include transactions or events that are deemed to occur pursuant to Rev. Rul. 99-5 and section 708 and the related regulations. In such a case, the deemed transactions shall not result in a triggering event under paragraph (e)(1)(iv) (transfers of assets) or (v) (transfers of an interest in a separate unit) of this section. See also § 1.1503(d)-7 Example 35.

(5) Compulsory transfers. Transfers of the assets or stock of a dual resident corporation, or of the assets or interests in a separate unit, shall not constitute a triggering event (including a foreign use that occurs as a result of, or following, the transfer) if such transfers are—

(i) Legally required by a government of a country as a necessary condition of doing business in the country;

(ii) Compelled by a genuine threat of immediate expropriation by a government of a country; or

(iii) The result of the expropriation of assets by a government of a country.

(6) Subsequent triggering events. Any triggering event described in paragraph (e) of this section that occurs subsequent to one of the transactions described in this paragraph (f), and that itself does not meet any of the exceptions provided in this paragraph (f), shall require recapture under paragraph (h) of this section by the elector or subsequent elector, as applicable.

(g) Annual certification reporting requirement. Unless and until the domestic use agreement is terminated pursuant to paragraph (j) of this section, the elector must file a certification, labeled “Certification of Dual Consolidated Loss” at the top of the page, that is attached to, and filed by the due date (including extensions) of, its income tax return for each taxable year during the certification period. The certification must provide that there has been no foreign use of the dual consolidated loss. The certification must identify the dual consolidated loss to which it pertains by setting forth the elector's year in which the loss was incurred and the amount of such loss. In addition, the certification must warrant that arrangements have been made to ensure that there will be no foreign use of the dual consolidated loss and that the elector will be informed of any such foreign use. If applicable, the certification must include a notification that an excepted triggering event under paragraph (f)(2) of this section has occurred with respect to the dual consolidated loss within the taxable year being certified. If dual consolidated losses of more than one taxable year are subject to the rules of this paragraph (g), the certification for those years may be combined in a single document, but each dual consolidated loss must be separately identified. See § 1.1503(d)-3(e)(2)(ii) for additional certifications required where taxpayers elect the stand-alone exception of § 1.1503(d)-3(e)(2).

(h) Recapture of dual consolidated loss and interest charge—(1) Presumptive rules—(i) Amount of recapture. Except as otherwise provided in this section, upon the occurrence of a triggering event described in paragraph (e) of this section that does not meet any of the exceptions provided in paragraph (f) of this section, the dual resident corporation or domestic owner of the separate unit shall recapture as gross income the total amount of the dual consolidated loss to which the triggering event applies on its income tax return for the taxable year in which the triggering event occurs (or, when the triggering event is a foreign use of the dual consolidated loss, the taxable year that includes the last day of the foreign taxable year during which such foreign use occurs). See § 1.1503(d)-5(c)(4)(vi) for rules with respect to the attribution of recapture income to a separate unit. See also § 1.1503(d)-7 Examples 38 through 40.

(ii) Interest charge. In connection with the recapture, the elector shall pay an interest charge. An interest charge may be due even if the amount of recapture income is reduced to zero pursuant to paragraph (h)(2)(i) of this section. See § 1.1503(d)-7(c) Example 39. Except as otherwise provided in this section, the amount of the interest shall be computed under the rules of section 6601(a) by treating the additional tax resulting from the recapture as though it had been due and unpaid as of the date for payment of the tax for the taxable year in which the taxpayer received a tax benefit from the dual consolidated loss. For purposes of this paragraph (h)(1)(ii), a tax benefit shall be considered to have arisen in a taxable year in which the losses or deductions taken into account in computing the dual consolidated loss reduced U.S. taxable income. For the purpose of computing the interest charge, the additional tax resulting from the recapture is determined by treating the recapture income as the last income earned in the year of recapture. The interest shall be computed to the date for payment of the tax for the year of recapture and the interest thus computed becomes a part of the tax liability for that taxable year. See section 6601 for the computation of interest on a tax liability that it is not paid timely. The recapture interest charge shall be deductible to the same extent as interest under section 6601.

(2) Reduction of presumptive recapture amount and presumptive interest charge—(i) Amount of recapture. The dual resident corporation or domestic owner may recapture an amount less than the total dual consolidated loss if the elector demonstrates, to the satisfaction of the Commissioner, the lesser amount described in this paragraph (h)(2)(i). The reduction in the amount of recapture is the amount by which the dual consolidated loss would have offset other taxable income reported on a timely filed U.S. income tax return for any taxable year up to and including the taxable year of the triggering event (or, when the triggering event is a foreign use of the dual consolidated loss, the taxable year that includes the last day of the foreign taxable year during which such foreign use occurs) if no domestic use election had been made for the loss such that it was subject to the domestic use limitation of § 1.1503(d)-4(b) (and therefore subject to the limitation under § 1.1503(d)-4(c)). For this purpose, the rules for attributing items of income, gain, deduction, and loss under § 1.1503(d)-5 shall apply. An elector using this rebuttal rule must prepare a separate accounting showing the income for each year that would have offset the dual resident corporation's or separate unit's recapture amount if no domestic use election had been made for the dual consolidated loss. The separate accounting must be signed under penalties of perjury by the person who signs the elector's tax return, must be labeled “Reduction of Recapture Amount” at the top of the page, and must indicate that it is submitted under the provisions of this paragraph (h)(2)(i). The accounting must be attached to, and filed by the due date (including extensions) of, the elector's income tax return for the taxable year in which the triggering event occurs. See § 1.1503(d)-7(c) Examples 38 through 40.

(ii) Interest charge. The interest charge imposed under this section may be reduced if the elector demonstrates, to the satisfaction of the Commissioner, that the net interest owed would have been less than that provided in paragraph (h)(1)(ii) of this section if the elector had filed an amended return for the taxable year in which the recaptured dual consolidated loss was incurred, and for any other affected taxable years up to and including the taxable year of recapture, if no domestic use election had been made for the dual consolidated loss such that it had been subject to the restrictions of § 1.1503(d)-4(b) (and therefore subject to the limitations under § 1.1503(d)-4(c)). An elector using this rebuttal rule must prepare a computation demonstrating the reduction in the net interest owed as a result of treating the dual consolidated loss as a loss subject to the restrictions of § 1.1503(d)-4(b) (and therefore subject to the limitations under § 1.1503(d)-4(c)). The computation must be labeled “Reduction of Interest Charge” at the top of the page and must indicate that it is submitted under the provisions of this paragraph (h)(2)(ii). The computation must be signed under penalties of perjury by the person who signs the elector's tax return, and must be attached to, and filed by the due date (including extensions) of, the elector's income tax return for the taxable year in which the triggering event occurs. See § 1.1503(d)-7(c) Examples 39 and 40.

(3) Rules regarding multiple-party event exceptions to triggering events—(i) Scope. The rules of this paragraph (h)(3) apply when, after a triggering event described in paragraph (e) of this section with respect to which the requirements of paragraph (f)(2)(i) of this section were met (excepted event), a triggering event under paragraph (e) of this section occurs, and no exception applies to such triggering event under paragraph (f) of this section (subsequent triggering event). See § 1.1503(d)-7(c) Examples 36 and 37.

(ii) Original elector and prior subsequent electors not subject to recapture or interest charge—(A) Except to the extent otherwise provided in this paragraph (h)(3), neither the original elector nor any prior subsequent elector shall be subject to the rules of this paragraph (h) with respect to dual consolidated losses subject to the original domestic use agreement.

(B) In the case of a dual consolidated loss with respect to which multiple excepted events have occurred, only the subsequent elector that owns the dual resident corporation or separate unit at the time of the subsequent triggering event shall be subject to the recapture rules of this paragraph (h). For purposes of this paragraph (h), the term prior subsequent elector refers to all other subsequent electors.

(iii) Recapture tax amount and required statement—(A) In general. If a subsequent triggering event occurs, the subsequent elector shall take into account the recapture tax amount as determined under paragraph (h)(3)(iii)(B) of this section. The subsequent elector must prepare a statement that computes the recapture tax amount, as provided under paragraph (h)(3)(iii)(B) of this section, with respect to the dual consolidated loss subject to the new domestic use agreement. This statement must be attached to, and filed by the due date (including extensions) of, the subsequent elector's income tax return for the taxable year in which the subsequent triggering event occurs (or, when the subsequent triggering event is a foreign use of the dual consolidated loss, the taxable year that includes the last day of the foreign taxable year during which such foreign use occurs). The statement must be signed under penalties of perjury by the person who signs the return. The statement must be labeled “Statement Identifying Liability” at the top and, in addition to the calculation of the recapture tax amount, must include the following items, in paragraphs labeled to correspond with the items set forth in paragraphs (h)(3)(iii)(A)(1) through (3) of this section:

(1) A statement that the document is submitted under the provisions of § 1.1503(d)-6(h)(3)(iii).

(2) A statement identifying the amount of the dual consolidated losses at issue and the taxable years in which they were used.

(3) The name, address, and taxpayer identification number of the original elector and all prior subsequent electors.

(B) Recapture tax amount. The recapture tax amount equals the excess (if any) of—

(1) The income tax liability of the subsequent elector for the taxable year that includes the amount of recapture and related interest charge with respect to the dual consolidated losses that are recaptured as a result of the subsequent triggering event, as provided under paragraphs (h)(1) and (h)(2) of this section; over

(2) The income tax liability of the subsequent elector for such taxable year, computed by excluding the amount of recapture and related interest charge described in paragraph (h)(3)(iii)(B)(1) of this section.

(iv) Tax assessment and collection procedures—(A) In general—(1) Subsequent elector. An assessment identifying an income tax liability of the subsequent elector is considered an assessment of the recapture tax amount where the recapture tax amount is part of the income tax liability being assessed and the recapture tax amount is reflected in a statement attached to the subsequent elector's income tax return as provided under paragraph (h)(3)(iii) of this section.

(2) Original elector and prior subsequent electors. The assessment of the recapture tax amount as set forth in paragraph (h)(3)(iv)(A)(1) of this section shall be considered as having been properly assessed as an income tax liability of the original elector and of each prior subsequent elector, if any. The date of such assessment shall be the date the income tax liability of the subsequent elector was properly assessed. The Commissioner may collect all or a portion of such recapture tax amount from the original elector and/or the prior subsequent electors under the circumstances set forth in paragraph (h)(3)(iv)(B) of this section.

(B) Collection from original elector and prior subsequent electors; joint and several liability—(1) In general. If the subsequent elector does not pay in full the income tax liability that includes a recapture tax amount, the Commissioner may collect that portion of the unpaid balance of such income tax liability attributable to the recapture tax amount in full or in part from the original elector and/or from any prior subsequent elector, provided that the following conditions are satisfied with respect to such elector:

(i) The Commissioner properly has assessed the recapture tax amount pursuant to paragraph (h)(3)(iv)(A)(1) of this section.

(ii) The Commissioner has issued a notice and demand for payment of the recapture tax amount to the subsequent elector in accordance with § 301.6303-1 of this chapter.

(iii) The subsequent elector has failed to pay all of the recapture tax amount by the date specified in such notice and demand.

(iv) The Commissioner has issued a notice and demand for payment of the unpaid portion of the recapture tax amount to the original elector, or prior subsequent elector (as the case may be), in accordance with § 301.6303-1 of this chapter.

(2) Joint and several liability. The liability imposed under this paragraph (h)(3)(iv)(B) on the original elector and each prior subsequent elector shall be joint and several.

(C) Allocation of partial payments of tax. If the subsequent elector's income tax liability for a taxable period includes a recapture tax amount, and if such income tax liability is satisfied in part by payment, credit, or offset, such payment, credit or offset shall be allocated first to that portion of the income tax liability that is not attributable to the recapture tax amount, and then to that portion of the income tax liability that is attributable to the recapture tax amount.

(D) Refund. If the Commissioner makes a refund of any income tax liability that includes a recapture tax amount, the Commissioner shall allocate and pay the refund to each elector who paid a portion of such income tax liability as follows:

(1) The Commissioner shall first determine the total amount of recapture tax paid by and/or collected from the original elector and from any prior subsequent electors. The Commissioner shall then allocate and pay such refund to the original elector and prior subsequent electors, with each such elector receiving an amount of such refund on a pro rata basis, not to exceed the amount of recapture tax paid by and/or collected from such elector.

(2) The Commissioner shall pay the balance of such refund, if any, to the subsequent elector.

(v) Definition of income tax liability. Solely for purposes of paragraph (h)(3) of this section, the term income tax liability means the income tax liability imposed on a domestic corporation under title 26 of the United States Code for a taxable year, including additions to tax, additional amounts, penalties, and any interest charge related to such income tax liability.

(vi) Example. See § 1.1503(d)-7(c) Example 36.

(4) Computation of taxable income in year of recapture—(i) Presumptive rule. Except to the extent provided in paragraph (h)(4)(ii) of this section, for purposes of computing the taxable income for the year of recapture, no current, carryover or carryback losses may offset and absorb the recapture amount.

(ii) Exception to presumptive rule. The recapture amount included in gross income may be offset and absorbed by that portion of the elector's net operating loss carryover that is attributable to the dual resident corporation or separate unit that incurred the dual consolidated loss being recaptured, if the elector demonstrates, to the satisfaction of the Commissioner, the amount of such portion of the carryover. The principles of § 1.1502-21(b)(2)(iv) shall apply for purposes of determining whether any portion of a net operating loss carryover is attributable to the dual resident corporation or separate unit. In the case of a separate unit, such determination shall be made by treating the separate unit as a domestic corporation and a member of the consolidated group composing its unaffiliated domestic owner, or members of the consolidated group of which its affiliated domestic owner is a member, as appropriate. An elector utilizing this rebuttal rule must prepare a computation demonstrating the amount of net operating loss carryover that, under this paragraph (h)(4)(ii), may absorb the recapture amount included in gross income. Such computation must be signed under penalties of perjury and attached to and filed by the due date (including extensions) of, the income tax return for the taxable year in which the triggering event occurs (or, when the triggering event is a foreign use of the dual consolidated loss, the taxable year that includes the last day of the foreign taxable year during which such foreign use occurs).

(5) Character and source of recapture income. The amount recaptured under this paragraph (h) shall be treated as ordinary income. Except as provided in the prior sentence, such income shall be treated, as applicable, as income from the same source, having the same character, and falling within the same separate category, for all purposes, including sections 904(d) and 907, to which the items of deduction or loss composing the dual consolidated loss were allocated and apportioned, as provided under sections 861(b), 862(b), 863(a), 864(e), 865, and the related regulations. For this determination, the pro rata computation of the items of deduction or loss composing the dual consolidated loss as described in § 1.1503(d)-4(c)(4) shall apply. See § 1.1503(d)-7(c) Example 38.

(6) Reconstituted net operating loss—(i) General rule. Except as provided in paragraphs (h)(6)(ii) and (iii) of this section, commencing in the taxable year immediately following the year in which the dual consolidated loss is recaptured, the dual resident corporation, or the domestic owner of the separate unit, that incurred the dual consolidated loss that is recaptured shall be treated as having a net operating loss (reconstituted net operating loss) in an amount equal to the amount actually recaptured under this paragraph (h). If a domestic corporation (transferee) acquires the assets of the dual resident corporation or domestic owner in a transaction described in section 381(a), the preceding sentence shall be applied by treating the transferee as the dual resident corporation or domestic owner, as applicable. In a case to which this paragraph (h)(6) applies, the transferee corporation shall be treated as having a reconstituted net operating loss in an amount equal to the amount actually recaptured under this paragraph (h). In no event, however, shall more than one corporation be treated as having a reconstituted net operating loss as a result of a single dual consolidated loss being recaptured. A reconstituted net operating loss of a domestic owner shall be attributable under § 1.1503(d)-5 to the separate unit that incurred the dual consolidated loss that was recaptured. Moreover, a reconstituted net operating loss shall be subject to the domestic use limitation of § 1.1503(d)-4(b) (and therefore subject to the limitation under § 1.1503(d)-4(c)), without regard to the exceptions contained in paragraphs (b) through (d) of this section (relating to elective agreements in place between the United States and a foreign country, the ability to demonstrate no possibility of a foreign use, and a domestic use election, respectively). The reconstituted net operating loss shall be available only for carryover, under section 172(b), to taxable years following the taxable year of recapture. For purposes of determining the remaining carryover period, the reconstituted net operating loss shall be treated as if it had been recognized in the taxable year in which the dual consolidated loss that is the basis of the recapture amount was incurred. See § 1.1503(d)-7(c) Examples 36, 38, and 40.

(ii) Exception. Paragraph (h)(6)(i) of this section shall not apply to the extent the dual consolidated loss that is the basis of the recapture amount would have been eliminated pursuant to § 1.1503(d)-4(d) if no domestic use election had been made for such loss. See § 1.1503(d)-7(c) Example 40.

(iii) Special rule for recapture following multiple-party event exception to a triggering event. This paragraph applies to an excepted event described in paragraph (f)(2)(i)(B) of this section that is followed by a subsequent triggering event requiring recapture as described in paragraph (f)(6) of this section. In such a case, the domestic corporation that owns, directly or indirectly, the assets of the dual resident corporation, or the assets of or the interests in a separate unit, immediately following the excepted event shall be treated as if it incurred the dual consolidated loss that is recaptured for purposes of applying paragraph (h)(6)(i) of this section. See § 1.1503(d)-7(c) Example 36.

(i) [Reserved]

(j) Termination of domestic use agreement and annual certifications—(1) Rebuttals, exceptions to triggering events, and recapture. The domestic use agreement filed with respect to a dual consolidated loss shall terminate prior to the end of the certification period and have no further effect if—

(i) An elector is able to rebut the presumption of a triggering event pursuant to the general rule in paragraph (e)(2)(i) of this section;

(ii) An event described in paragraph (e)(1) of this section is not a triggering event as a result of the application of paragraphs (f)(2)(i) or (ii) (relating to events requiring a new domestic use agreement) of this section; this paragraph (j)(1)(ii) does not, however, apply to terminate the new domestic use agreement filed in connection with the event pursuant to paragraph (f)(2)(iii)(A) of this section. See also paragraph (h)(3)(iv) of this section regarding collection from the original elector and prior subsequent electors in certain cases; or

(iii) A dual consolidated loss is recaptured pursuant to paragraph (h) of this section. See § 1.1503(d)-7(c) Examples 32 through 34.

(2) Termination of ability for foreign use—(i) In general. A domestic use agreement filed with respect to a dual consolidated loss shall terminate and have no further effect as of the end of a taxable year if the elector—

(A) Demonstrates, to the satisfaction of the Commissioner, that as of the end of such taxable year no foreign use (as defined in § 1.1503(d)-3) of the dual consolidated loss can occur in any other year by any means; and

(B) Prepares a statement described in paragraph (j)(2)(ii) of this section that is attached to, and filed by the due date (including extensions) of, its U.S. income tax return for such taxable year.

(ii) Statement. The statement described in this paragraph (j)(2)(ii) must be signed under penalties of perjury by the person who signs the return. The statement must be labeled “Termination of Ability for Foreign Use” at the top of the page and must include the following information, in paragraphs labeled to correspond with the following:

(A) A statement that the document is submitted under the provisions of paragraph (j)(2) of this section.

(B) The information required by paragraph (c)(2)(ii) of this section.

(C) A statement of the amount of the dual consolidated loss at issue and the year in which such dual consolidated loss was incurred.

(D) The information described in paragraph (c)(2)(iv) of this section that supports the conclusion that no foreign use can occur as provided in paragraph (j)(2)(i)(A) of this section.

(3) Agreements filed in connection with stand-alone exception. See § 1.1503(d)-3(e)(2)(iii) for the termination of domestic use agreements filed in connection with the stand-alone exception to the mirror legislation rule when a subsequent election is made under paragraph (b) of this section (relating to agreements entered into between the United States and a foreign country).

[T.D. 9315, 72 FR 12914, Mar. 19, 2007, as amended by T.D. 9896, 85 FR 19855, Apr. 8, 2020]

§ 1.1503(d)-7 Examples.

(a) In general. This section provides examples that illustrate the application of §§ 1.1503(d)-1 through 1.1503(d)-6. This section also provides facts that are presumed for such examples.

(b) Presumed facts for examples. For purposes of the examples in this section, unless otherwise indicated, the following facts are presumed:

(1) Each entity has only a single class of equity outstanding, all of which is held by a single owner.

(2) P, a domestic corporation and the common parent of the P consolidated group, owns S, a domestic corporation and a member of the P consolidated group.

(3) DRCX, a domestic corporation, is subject to Country X tax on its worldwide income or on a residence basis, and is a dual resident corporation.

(4) DE1X and DE2X are both Country X entities, subject to Country X tax on their worldwide income or on a residence basis, and disregarded as entities separate from their owners for U.S. tax purposes. DE3Y is a Country Y entity, subject to Country Y tax on its worldwide income or on a residence basis, and disregarded as an entity separate from its owner for U.S. tax purposes. All the interests in DE1X, DE2X, and DE3Y constitute hybrid entity separate units.

(5) FBX is a Country X business operation that, if carried on by a U.S. person, would constitute a foreign branch, as defined in § 1.367(a)-6T(g)(1), and is a Country X foreign branch separate unit.

(6) Neither the assets nor the activities of an entity constitute a foreign branch separate unit.

(7) FSX is a Country X entity that is subject to Country X tax on its worldwide income or on a residence basis and is classified as a foreign corporation for U.S. tax purposes.

(8) The applicable foreign country has a consolidation regime that—

(i) Includes as members of a consolidated group any commonly controlled branches and permanent establishments in such jurisdiction, and entities that are subject to tax in such jurisdiction on their worldwide income or on a residence basis; and

(ii) Allows the losses of members of consolidated groups to offset income of other members.

(9) There is no mirror legislation, within the meaning of § 1.1503(d)-3(e)(1), in the applicable foreign country.

(10) There is no elective agreement described in § 1.1503(d)-6(b) between the United States and the applicable foreign country.

(11) There is no income tax convention between the United States and the applicable foreign country.

(12) If a domestic use election, within the meaning of § 1.1503(d)-6(d), is made, all the necessary filings related to such election are properly completed on a timely basis.

(13) If there is a triggering event requiring recapture of a dual consolidated loss, the amount of recapture is not reduced pursuant to § 1.1503(d)-6(h)(2).

(14) There are no other items of income, gain, deduction, and loss. In addition, the United States and the applicable foreign country recognize the same items of income, gain, deduction, and loss in each taxable year.

(15) All taxpayers use the calendar year as their taxable year.

(1) Example 1. Separate unit combination rule—(i) Facts. P owns DE3Y which, in turn, owns DE1X. DE1X owns FBX. PRS, an entity treated as a partnership for both U.S. and Country X tax purposes, is owned 50 percent by P and 50 percent by an unrelated foreign person. PRS carries on a business operation in Country X that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1). In addition, P owns DRCX, a member of the consolidated group of which P is the parent, which carries on business operations in Country X that constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1). S owns DE2X.

(ii) Result. Pursuant to § 1.1503(d)-1(b)(4)(ii), the interest in DE1X, the interest in DE2X, FBX, P's share of the Country X business operations carried on by PRS (which is owned by P indirectly through its interest in PRS), and DRCX's Country X business operations are combined and treated as a single separate unit of the consolidated group of which P is the parent. This is the case regardless of whether the losses of each individual separate unit are made available to offset the income of the other individual separate units under Country X tax laws. Because DRCX is a dual resident corporation, it is not combined and treated as part of this combined separate unit and, as a result, DRCX's income or dual consolidated loss is not taken into account in determining the income or dual consolidated loss of the combined separate unit. In addition, P's interest in DE3Y is not combined and is another separate unit because it is subject to tax in Country Y, rather than Country X.

(2) Example 2. Definition of a separate unit and application of domestic use limitation—foreign branch separate unit—(i) Facts. P carries on business operations in Country X that constitute a permanent establishment under the U.S.-Country X income tax convention. In year 1, a loss is attributable to P's Country X permanent establishment, as determined under § 1.1503(d)-5.

(ii) Result. Under §§ 1.1503(d)-1(b)(4)(i)(A) and 1.367(a)-6T(g)(1), P's Country X permanent establishment constitutes a foreign branch separate unit. Therefore, the year 1 loss attributable to the foreign branch separate unit constitutes a dual consolidated loss pursuant to § 1.1503(d)-1(b)(5)(ii). The dual consolidated loss rules apply to the dual consolidated loss even though there is no affiliate of the foreign branch separate unit in Country X, because it is still possible that all or a portion of the dual consolidated loss can be put to a foreign use. For example, there may be a foreign use with respect to a Country X affiliate acquired in a year subsequent to the year in which the dual consolidated loss was incurred. See § 1.1503(d)-6(a)(2). Accordingly, unless an exception under § 1.1503(d)-6 applies (such as a domestic use election), the year 1 dual consolidated loss attributable to P's Country X permanent establishment is subject to the domestic use limitation rule of § 1.1503(d)-4(b). As a result, pursuant to § 1.1503(d)-4(c), the year 1 dual consolidated loss cannot offset income of P that is not attributable to its Country X foreign branch separate unit, nor can it offset income of any other domestic affiliate. The loss can, however, offset income of the Country X foreign branch separate unit, subject to the application of § 1.1503(d)-4(c). The result would be the same even if Country X did not have a consolidation regime that includes as members of consolidated groups Country X branches or permanent establishments of nonresident corporations. The dual consolidated loss rules apply even in the absence of a consolidation regime in the foreign country because it is possible that all or a portion of a dual consolidated loss can be put to a foreign use by other means, such as through a sale, merger, or similar transaction. See § 1.1503(d)-6(a)(2).

(iii) Alternative facts. The facts are the same as in paragraph (c)(2)(i) of this section, except that P's Country X business operations constitute a foreign branch as defined in § 1.367(a)-6T(g)(1), but do not constitute a permanent establishment under the U.S.-Country X income tax convention. Although the activities carried on by P in Country X would otherwise constitute a foreign branch separate unit as described in § 1.1503(d)-1(b)(4)(i)(A), the exception under § 1.1503(d)-1(b)(4)(iii) applies because the activities do not constitute a permanent establishment under the U.S.-Country X income tax convention. Thus, the Country X business operations do not constitute a foreign branch separate unit, and the year 1 loss is not subject to the dual consolidated loss rules. If P instead carried on its Country X business operations through DE1X, then the exception under § 1.1503(d)-1(b)(4)(iii) would not apply because P carries on the business operations through a hybrid entity and, as a result, the business operations would constitute a foreign branch separate unit. Thus, in such a case the year 1 loss would be subject to the dual consolidated loss rules.

(3) Example 3. Domestic use limitation—foreign branch separate unit owned through a partnership—(i) Facts. P and S organize a partnership, PRSX, under the laws of Country X. PRSX is treated as a partnership for both U.S. and Country X tax purposes. PRSX owns FBX. PRSX earns U.S. source income that is unconnected with its FBX branch operations, and such income is not subject to tax by Country X. In addition, such U.S. source income is not attributable to FBX under § 1.1503(d)-5.

(ii) Result. Under § 1.1503(d)-1(b)(4)(i)(A), P's and S's shares of FBX owned indirectly through their interests in PRSX are individual foreign branch separate units. Pursuant to § 1.1503(b)-1(b)(4)(ii), these individual separate units are combined and treated as a single separate unit of the consolidated group of which P is the parent. Unless an exception under § 1.1503(d)-6 applies, any dual consolidated loss attributable to FBX cannot offset income of P or S (other than income attributable to FBX, subject to the application of § 1.1503(d)-4(c)), including their distributive share of the U.S. source income earned through their interests in PRSX, nor can it offset income of any other domestic affiliates.

(4) Example 4. Definition of a separate unit and domestic use limitation—interest in hybrid entity partnership and indirectly owned foreign branch separate unit—(i) Facts. HPSX is a Country X entity that is subject to Country X tax on its worldwide income. HPSX is classified as a partnership for Federal tax purposes. P, S, and FSX, are the sole partners of HPSX. For U.S. tax purposes, P, S, and FSX each has an equal interest in each item of HPSX's profit or loss. HPSX carries on operations in Country Y that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1).

(ii) Result. Under § 1.1503(d)-1(b)(4)(i)(B), the partnership interests in HPSX held by P and S are individual hybrid entity separate units. These individual separate units are combined into a single separate unit under § 1.1503(d)-1(b)(4)(ii). In addition, P's and S's share of the Country Y operations owned indirectly through their interests in HPSX are individual foreign branch separate units under § 1.1503(d)-1(b)(4)(i)(B). These individual separate units are also combined into a single separate unit under § 1.1503(d)-1(b)(4)(ii). Unless an exception under § 1.1503(d)-6 applies, dual consolidated losses attributable to P's and S's combined interests in HPSX can only be used to offset income attributable to their combined interests in HPSX (other than income attributable to P's and S's combined interests in the Country Y foreign branch separate unit), subject to the application of § 1.1503(d)-4(c). Similarly, dual consolidated losses attributable to P's and S's combined interests in the Country Y operations of HPSX can only be used to offset income attributable to their combined interests in such Country Y operations, subject to the application of § 1.1503(d)-4(c). Neither FSX's interest in HPSX, nor its share of the Country Y operations owned by HPSX, is a separate unit because FSX is not a domestic corporation.

(5) Example 5. Foreign use—general rule and de minimis reduction exception—(i) Facts. P owns DE1X. DE1X owns FSX. In year 1, there is a $100x loss attributable to P's interest in DE1X that is a dual consolidated loss. Also in year 1, FSX earns $200x of income. DE1X and FSX file a Country X consolidated tax return. For Country X tax purposes, the year 1 $100x loss of DE1X is used to offset $100x of year 1 income generated by FSX. Under Country X tax law, unused losses are carried forward and available to offset income in subsequent taxable years.

(ii) Result. The $100x loss attributable to P's interest in DE1X is available to, and in fact does, offset FSX's income under the laws of Country X. In addition, under U.S. tax principles, such income is considered to be an item of FSX, a foreign corporation. As a result, under § 1.1503(d)-3(a), there has been a foreign use of the year 1 dual consolidated loss attributable to P's interest in DE1X. Therefore, P cannot make a domestic use election with respect to the loss as provided under § 1.1503(d)-6(d)(2), and such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b). The result would be the same even if FSX, under Country X tax law, had no income against which the dual consolidated loss of DE1X could be offset (unless FSX's ability to use the loss under Country X tax law requires an election, and no such election is made).

(iii) Alternative facts. The facts are the same as in paragraph (c)(5)(i) of this section, except that FSX cannot use the loss of DE1X under Country X tax law without an election, and no such election is made. Pursuant to the exception in § 1.1503(d)-3(c)(2), there is no foreign use of the year 1 dual consolidated loss attributable to P's interest in DE1X. In addition, P files a domestic use election with respect to the year 1 dual consolidated loss attributable to its interest in DE1X and, at the beginning of year 3, P sells its interest in DE1X to F, a Country Y entity that is a foreign corporation. The sale of the interest in DE1X to F results in a foreign use triggering event pursuant to § 1.1503(d)-6(e)(1)(i) because, immediately after the sale, the loss attributable to the interest in DE1X carries over under Country X law and, therefore, is available under U.S. tax principles to offset income of the owner of the interest in DE1X which, in the hands of F, is not a separate unit. It is also a foreign use because the loss is available under U.S. tax principles to offset the income of F, a foreign corporation. See § 1.1503(d)-3(a)(1). Finally, the transfer is a triggering event pursuant to § 1.1503(d)-6(e)(1)(iv) and (v).

(iv) Alternative facts. The facts are the same as in paragraph (c)(5)(iii) of this section, except that P only sells 5 percent of its interest in DE1X to F. Pursuant to Rev. Rul. 99-5 (1999-1 CB 434), see § 601.601(d)(2)(ii)(b) of this chapter, the transaction is treated as if P sold 5 percent of its interest in each of DE1X's assets to F, and then immediately thereafter P and F transferred their interests in the assets of DE1X to a partnership in exchange for an ownership interest therein. The sale of the 5 percent interest in DE1X generally results in a foreign use triggering event because a portion of the dual consolidated loss carries over under Country X tax law and is available under U.S. tax principles to offset income of the owner of the interest in DE1X, a hybrid entity, which in the hands of F is not a separate unit. It is also a foreign use because the loss is available under U.S. tax principles to offset the income of F, a foreign corporation. See § 1.1503(d)-3(a)(1). However, pursuant to the exception under § 1.1503(d)-3(c)(5) (relating to a de minimis reduction of an interest in a separate unit), such availability does not result in a foreign use. In addition, pursuant to § 1.1503(d)-6(f)(1) and (3), the deemed transfers pursuant to Rev. Rul. 99-5 as a result of the sale are not treated as triggering events described in § 1.1503(d)-6(e)(1)(iv) or (v).

(6) Example 6. Foreign use and indirect foreign use—foreign reverse hybrid structure and disregarded payments—(i) Facts. P owns DE1X. DE1X owns 99 percent and S owns 1 percent of FRHX, a Country X partnership that elected to be treated as a corporation for U.S. tax purposes. FRHX conducts a trade or business in Country X. In year 1, DE1X incurs interest expense on a third-party loan, which constitutes a dual consolidated loss attributable to P's interest in DE1X. In year 1, for Country X tax purposes, DE1X takes into account its distributive share of income generated by FRHX and offsets such income with its interest expense.

(ii) Result. In year 1, the dual consolidated loss attributable to P's interest in DE1X is available to, and in fact does, offset income recognized in Country X and, under U.S. tax principles, the income is considered to be income of FRHX, a foreign corporation. Accordingly, pursuant to § 1.1503(d)-3(a)(1), there is a foreign use of the dual consolidated loss. Therefore, P cannot make a domestic use election with respect to the year 1 dual consolidated loss attributable to its interest in DE1X, as provided under § 1.1503(d)-6(d)(2), and such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(iii) Alternative facts. (A) The facts are the same as in paragraph (c)(6)(i) of this section, except as follows. Instead of owning DE1X, P owns DE3Y which, in turn, owns DE1X. In addition, DE3Y, rather than DE1X, is the obligor on the third-party loan and therefore incurs the interest expense on such loan. Finally, DE3Y on-lends the loan proceeds from the third-party loan to DE1X, and DE1X pays interest to DE3Y on such loan that is generally disregarded for U.S. tax purposes.

(B) Pursuant to § 1.1503(d)-5(c)(1)(ii), for purposes of calculating income or a dual consolidated loss, DE3Y and DE1X do not take into account interest income or interest expense, respectively, with respect to amounts paid on the disregarded loan from DE3Y to DE1X. But see § 1.1503(d)-1(d), which takes into account certain payments that are otherwise disregarded for purposes of section 1503(d) and the regulations thereunder. As a result, such items neither create a dual consolidated loss with respect to the interest in DE1X, nor do they reduce (or eliminate) the dual consolidated loss attributable to the interest in DE3Y. Thus, in year 1, there is a dual consolidated loss attributable to P's interest in DE3Y, but not to P's indirect interest in DE1X.

(C) In year 1, interest expense paid by DE1X to DE3Y on the disregarded loan is taken into account as a deduction in computing DE1X's taxable income for Country X tax purposes, but does not give rise to a corresponding item of income or gain for U.S. tax purposes (because it is generally disregarded). In addition, such interest has the effect of making an item of deduction or loss composing the dual consolidated loss attributable to P's interest in DE3Y available for a foreign use. This is the case because it may reduce or offset items of deduction or loss composing the dual consolidated loss for foreign tax purposes, and creates another deduction or loss that may reduce or offset income of DE1X for foreign tax purposes that, under U.S. tax principles, is treated as income of FRHX, a foreign corporation. Moreover, because the disregarded item is incurred or taken into account as interest for foreign tax purposes, it is deemed to have been incurred or taken into account with a principal purpose of avoiding the provisions of section 1503(d). Accordingly, there is an indirect foreign use of the year 1 dual consolidated loss attributable to P's interest in DE3Y, and P cannot make a domestic use election with respect to such loss as provided under § 1.1503(d)-6(d)(2). Thus, the loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(7) Example 7. Indirect foreign use—hybrid instrument—(i) Facts. P owns DE1X which, in turn, owns FSX. DE1X borrows cash from an unrelated lender and transfers the cash to FSX in exchange for an instrument (hybrid instrument). The hybrid instrument is treated as equity for U.S. tax purposes and debt for Country X tax purposes. Interest expense on the loan from the unrelated lender results in a dual consolidated loss being attributable to P's interest in DE1X in year 1. DE1X does not elect under Country X law to consolidate with FSX. In year 1, FSX distributes its stock as a payment on the hybrid instrument to DE1X. For U.S. tax purposes, such payment is excluded from P's gross income under section 305. However, for Country X tax purposes, such payment is treated as interest and gives rise to a deduction taken into account in computing FSX's Country X tax liability; the payment also gives rise to interest income to DE1X for Country X tax purposes.

(ii) Result. The payment on the hybrid instrument does not give rise to an item of income or gain for U.S. tax purposes and therefore does not reduce (or eliminate) the dual consolidated loss attributable to P's interest in DE1X. In addition, such payment is taken into account as a deduction in computing FSX's taxable income for Country X tax purposes. Moreover, such payment has the effect of making an item of deduction or loss composing the dual consolidated loss attributable to P's interest in DE1X available for a foreign use. This is the case because it may reduce or offset items of deduction or loss composing the dual consolidated loss for foreign tax purposes, and creates a deduction that reduces or offsets income of FSX for foreign tax purposes that, under U.S. tax principles, is income of a foreign corporation. Further, because the item is incurred, or taken into account, using an instrument that is treated as equity for U.S. tax purposes and debt for foreign tax purposes, it is deemed to have been engaged in with the principal purpose of avoiding the provisions of section 1503(d). As a result, there has been an indirect foreign use of the year 1 dual consolidated loss, and P cannot make a domestic use election with respect to such loss, as provided under § 1.1503(d)-6(d)(2). Thus, the year 1 dual consolidated loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(8) Example 8. No indirect foreign use—transaction entered into in the ordinary course of business—(i) Facts. P owns DE1X and FBY. FBY is a foreign branch separate unit located in Country Y. DE1X owns FBX and FSX. P's interest in DE1X and FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). Under Country X tax laws, DE1X elects to consolidate with FSX. FBY engages in the business of providing services and, in connection with its ordinary course of business, provides services to unrelated third parties and to DE1X. As compensation for services, DE1X makes a payment to FBY. Under Country X tax law, the payment is deductible. However, the payment is generally disregarded for U.S. tax purposes and, pursuant to § 1.1503(d)-5(c)(1)(ii), is not taken into account in calculating the income or dual consolidated loss attributable to the Country X separate unit or FBY. In year 1, the Country X separate unit and FBY each has a dual consolidated loss. The dual consolidated loss attributable to the Country X separate unit is subject to the domestic use limitation under § 1.1503(d)-4(b) because DE1X and FSX elect to consolidate and, as a result, the dual consolidated loss is put to a foreign use.

(ii) Result. The payment made by DE1X to FBY in connection with the performance of services is taken into account as a deduction in computing DE1X's taxable income for Country X tax purposes, but does not give rise to an item of income or gain for U.S. tax purposes. In addition, such payment has the effect of making an item of deduction or loss composing the dual consolidated loss attributable to FBY available for a foreign use. This is the case because it may reduce or offset items of deduction or loss composing the dual consolidated loss of FBY for foreign tax purposes, and creates another deduction that reduces or offsets income of FSX for foreign tax purposes (because DE1X and FSX elect to file a consolidated return) that, under U.S. tax principles, is income of a foreign corporation. However, the transaction between DE1X and FBY was entered into in the ordinary course of FBY's trade or business. As a result, if P can demonstrate to the satisfaction of the Commissioner that the transaction was not entered into with a principal purpose of avoiding the provisions of section 1503(d), FBY's year 1 dual consolidated loss will not be treated as having been made available for an indirect foreign use. In such a case, P would be entitled to make a domestic use election with respect to such loss.

(9) Example 9. Foreign use—dual resident corporation with hybrid entity joint venture—(i) Facts. P owns DRCX, a member of the P consolidated group. DRCX owns 80 percent of HPSX, a Country X entity that is subject to Country X tax on its worldwide income. HPSX is classified as a partnership for U.S. tax purposes. FSX owns the remaining 20 percent of HPSX. In year 1, DRCX generates a $100x net operating loss (without regard to items attributable to DRCX's interest in HPSX). Also in year 1, HPSX generates $100x of income, $80x of which is attributable to DRCX's interest in HPSX. DRCX and HPSX file a consolidated tax return for Country X tax purposes, and HPSX offsets its $100x of income with the $100x loss generated by DRCX.

(ii) Result. DRCX and its interest in HPSX are not combined because DRCX is a dual resident corporation and the combination rule under § 1.1503(d)-1(b)(4)(ii) only applies to separate units. The $100x year 1 net operating loss incurred by DRCX (without regard to items attributable to DRCX's interest in HPSX) is a dual consolidated loss. In addition, HPSX is a hybrid entity and DRCX's interest in HPSX is a hybrid entity separate unit; however, there is no dual consolidated loss attributable to such separate unit in year 1 (instead, there is $80x of income attributable to such separate unit). DRCX's year 1 dual consolidated loss offsets $100x of income for Country X purposes, and $20x of such income is, under U.S. tax principles, income of FSX, which owns an interest in HPSX that is not a separate unit (in addition, FSX is a foreign corporation). As a result, pursuant to § 1.1503(d)-3(a), there is a foreign use of the year 1 dual consolidated loss of DRCX, and P cannot make a domestic use election with respect to such loss pursuant to § 1.1503(d)-6(d)(2). Therefore, such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b). The result would be the same even if HPSX, under Country X laws, had no income against which the dual consolidated loss could be offset (unless the ability to use the loss under Country X laws required an election, and no such election is made).

(10) Example 10. Foreign use—foreign parent corporation—(i) Facts. F1 and F2, nonresident alien individuals, each owns 50 percent of FPX, a Country X entity that is subject to Country X tax on its worldwide income. FPX is classified as a foreign corporation for U.S. tax purposes. FPX owns DRCX. DRCX is the parent of a consolidated group that includes as a member DS, a domestic corporation. In year 1, DRCX incurs a dual consolidated loss of $100x and, for Country X tax purposes, FPX generates $100x of income. In year 1, FPX elects to consolidate with DRCX for Country X tax purposes, and the $100x year 1 loss of DRCX is used to offset the income of FPX under the laws of Country X. For U.S. tax purposes, the items of FPX do not constitute items of income in year 1.

(ii) Result. The year 1 dual consolidated loss of DRCX offsets the income of FPX under the laws of Country X. Pursuant to § 1.1503(d)-3(a), the offset constitutes a foreign use because the items constituting such income are considered under U.S. tax principles to be items of a foreign corporation. This is the case even though the United States does not recognize such items as income in year 1. Therefore, DRCX cannot make a domestic use election with respect to its year 1 dual consolidated loss pursuant to § 1.1503(d)-6(d)(2). As a result, such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(iii) Alternative facts. The facts are the same as in paragraph (c)(10)(i) of this section, except that FPX is classified as a partnership for U.S. tax purposes. The result would be the same as in paragraph (c)(10)(ii) of this section, because the offset of the income generated by FPX is a foreign use pursuant to § 1.1503(d)-3(a). This is the case because the items constituting such income are considered under U.S. tax principles to be items of F1 and F2, the owners of interests in FPX (a hybrid entity), that are not separate units. Moreover, the result would be the same if F1 and F2 owned their interests in FPX indirectly through another partnership.

(11) Example 11. No foreign use—deemed ordering rule.—(i) Facts. P owns DE1X and DRCX. DRCX is a member of the P consolidated group and owns FSX. DE1X owns FBX. P's interest in DE1X and P's indirect interest in FBX are individual separate units that are combined into a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, DRCX incurs a $200x net operating loss and $200x of income is attributable to P's Country X separate unit. The $200x net operating loss incurred by DRCX is a dual consolidated loss. FSX also earns $200x of income in year 1. DRCX, DE1X, and FSX file a Country X consolidated tax return.

(ii) Result. Under § 1.1503(d)-3(c)(3)(i), DRCX's $200x loss shall be treated as having been made available to offset the $200x of income attributable to P's Country X separate unit. P's Country X separate unit is not, under U.S. tax principles, a foreign corporation, and there is no interest in DE1X (which is a hybrid entity) that is not a separate unit. As a result, DRCX's loss being made available to offset the income attributable to P's Country X separate unit is not considered a foreign use of such loss. Therefore, P can make a domestic use election with respect to DRCX's year 1 dual consolidated loss.

(iii) Alternative facts. The facts are the same as in paragraph (c)(11)(i) of this section, except that in year 1 only $150x of income is attributable to P's Country X separate unit. Because only $150x of income is attributed to P's Country X separate unit, $50x of DRCX's year 1 dual consolidated loss is treated as being made available to offset the income of FSX, a foreign corporation, and therefore constitutes a foreign use. As a result, DRCX cannot make a domestic use election with respect to its year 1 dual consolidated loss pursuant to § 1.1503(d)-6(d)(2), and such loss will be subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(12) Example 12. No foreign use—absence of foreign loss usage ordering rules—(i) Facts. (A) P owns DRCX, a member of the P consolidated group. DRCX owns FSX. Under the Country X consolidation regime, a consolidated group may elect in any given year to use all or a portion of the losses of one consolidated group member to offset income of other consolidated group members. If no such election is made in a year in which losses are generated by a consolidated member, such losses carry forward and are available, at the election of the consolidated group, to offset income of consolidated group members in subsequent taxable years. Country X law does not provide ordering rules for determining when a loss from a particular taxable year is used because, under Country X law, losses never expire. In addition, Country X law does not provide ordering rules for determining when a particular type of loss (for example, capital or ordinary) is used.

(B) In year 1, DRCX incurs a capital loss of $80x which, under § 1.1503(d)-5(b)(2), is not a dual consolidated loss. DRCX also incurs a net operating loss of $80x in year 1 which is a dual consolidated loss. FSX generates $60x of capital gain in year 1 which, for Country X purposes, can be offset by capital losses and net operating losses. Under the laws of Country X, DRCX elects to use $60x of its total year 1 loss of $160x to offset the $60x of capital gain generated by FSX in year 1; the remaining $100x of year 1 loss carries forward. In both year 2 and year 3, DRCX incurs a net operating loss of $100x, while FSX incurs no income or loss in years 2 and 3. DRCX's $100x losses incurred in year 2 and year 3 are dual consolidated losses. Because DRCX does not elect under the laws of Country X to use all or a portion of its year 2 or year 3 net operating losses of $100x to offset the income of other members of the Country X consolidated group, P is permitted to make (and in fact does make) a domestic use election with respect to both the year 2 and year 3 dual consolidated losses of DRCX. In year 4, DRCX has a net operating loss of $10x and FSX generates $125x of income. Country X law permits, upon an election, FSX's $125x of income generated in year 4 to be offset by losses (including carryover losses from prior years) of other group members. Accordingly, in year 4, DRCX elects to use $125x of its accumulated losses to offset the $125x of year 4 income generated by FSX.

(ii) Result. (A) Under the ordering rules of § 1.1503(d)-3(d)(3), a pro rata amount of DRCX's year 1 net operating loss ($30x) and capital loss ($30x) is considered to be used to offset FSX's year 1 $60x capital gain. As a result, P cannot make a domestic use election with respect to DRCX's year 1 $80x dual consolidated loss because a portion of such loss is put to a foreign use.

(B) DRCX's $10x year 4 net operating loss is also a dual consolidated loss. Under the ordering rules of § 1.1503(d)-3(d)(1), such loss is considered to be used to offset $10x of FSX's year 4 $125x of income. Consequently, P cannot make a domestic use election with respect to such loss. Under the ordering rules of § 1.1503(d)-3(d)(2), $50x of capital loss carryover and $50x of ordinary loss from year 1 will be considered to offset $100x of FSX's year 4 income because the income is first deemed to have been offset by losses the use of which would not constitute a triggering event that would result in the recapture of a dual consolidated loss. The remaining $15x of FSX's year 4 income is considered to be offset by losses from year 3 because it is the most recent taxable year from which a loss may be carried forward. Thus, a portion of the year 3 dual consolidated loss has been put to a foreign use and the entire year 3 dual consolidated loss is recaptured. However, none of DRCX's $100x year 2 net operating loss will be deemed to offset FSX's year 4 income. As a result, DRCX's year 2 dual consolidated loss will not be recaptured.

(13) Example 13. Exception to foreign use through partnership interest—(i) Facts. (A) P owns 80 percent of HPSX, a Country X entity subject to Country X tax on its worldwide income. FSZ, an unrelated foreign corporation, owns the remaining 20 percent of HPSX. HPSX is classified as a partnership for Federal tax purposes and carries on operations in Country X that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1). P's interest in HPSX and P's indirect interest in the Country X branch are individual separate units that are combined into a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii).

(B) In year 1, HPSX incurs a loss of $100x, $80x of which is attributable to P's Country X separate unit. The $80x of loss attributable to P's Country X separate unit constitutes a dual consolidated loss and P makes a domestic use election with respect to such loss. In year 2, HPSX generates $50x of income, $40x of which is attributable to P's interest in the Country X separate unit. Under Country X income tax laws, the $100x of year 1 loss incurred by HPSX is carried forward and offsets the $50x of income generated by HPSX in year 2; the remaining $50x of loss is carried forward and is available to offset income generated by HPSX in subsequent years. P and FSZ maintain their ownership interests in HPSX throughout years 1 and 2.

(ii) Result. In year 2, under the laws of Country X, the $100x of year 1 loss, which includes the $80x dual consolidated loss attributable to P's Country X separate unit, is made available to offset income of HPSX. Such income is attributable to P's interest in HPSX, which is a separate unit. Such income also is income of FSZ, a foreign corporation that is an owner of an interest in HPSX, which is not a separate unit. However, pursuant to § 1.1503(d)-3(c)(4), there is no foreign use of the year 1 dual consolidated loss in year 2. This is the case because P's interest in HPSX as of the end of year 1 has not been reduced by more than a de minimis amount, and the portion of the $80x dual consolidated loss was made available for a foreign use in year 2 solely as a result of FSZ's ownership in HPSX and the allocation or carry forward of the dual consolidated loss as a result of such ownership.

(iii) Alternative facts. The facts are the same as in paragraph (c)(13)(i) of this section, except that P also owns FSX. In addition, FSX and HPSX elect to file a consolidated return under Country X law. The exception to foreign use under § 1.1503(d)-3(c)(4) does not apply because there is a foreign use other than by reason of the dual consolidated loss being made available as a result of FSZ's ownership in HPSX and the allocation or carry forward of the dual consolidated loss as a result of such ownership. That is, the exception does not apply because there is also a foreign use of the dual consolidated loss as a result of FSX and HPSX filing a consolidated return under Country X law.

(iv) Alternative facts. The facts are the same as in paragraph (c)(13)(i) of this section, except that at the end of year 2, FSZ contributes cash to HPSX in exchange for additional equity of HPSX. As a result of the contribution, FSZ's interest in HPSX increases from 20 percent to 30 percent, and P's interest in HPSX decreases from 80 percent to 70 percent. P's interest in HPSX is reduced within a single 12-month period by 12.5 percent (10/80), as compared to P's interest in HPSX as of the beginning of such 12-month period. Accordingly, pursuant to § 1.1503(d)-3(c)(4)(iii), the exception to foreign use provided under § 1.1503(d)-3(c)(4)(i) does not apply. Therefore, in year 2 there is a foreign use of the $80x year 1 dual consolidated loss attributable to P's Country X separate unit. Such foreign use constitutes a triggering event in year 2 and the $80x year 1 dual consolidated loss is recaptured. Alternatively, if FSZ were a domestic corporation, there would not be a foreign use of the $80x year 1 dual consolidated loss because the loss would not be available to offset income that, under U.S. tax principles, is income of a foreign corporation or a direct or indirect owner of an interest in a hybrid entity that is not a separate unit.

(14) Example 14. Exception to foreign use through partnership interest—combination rule—(i) Facts. (A) P and FSX form PRSX. P and FSX each own 50 percent of PRSX throughout years 1 and 2. PRSX is treated as a partnership for both U.S. and Country X tax purposes. PRSX owns DEY. DEY is a Country Y entity subject to Country Y tax on its worldwide income and disregarded as an entity separate from its owner for U.S. tax purposes. DEY conducts business operations in Country Y that, if carried on by a U.S. person, would constitute a foreign branch as defined in § 1.367(a)-6T(g)(1). P's interest in the Country Y operations conducted by DEY is an individual foreign branch separate unit. P's interest in DEY, owned indirectly through PRSX, is a hybrid entity individual separate unit. P also owns FBY, a Country Y foreign branch individual separate unit. Under § 1.1503(d)-1(b)(4)(ii), FBY and P's indirect interests in DEY and DEY's Country Y business operations are treated as a combined separate unit (Country Y separate unit).

(B) In year 1, there is a $100x loss attributable to the Country Y business operations conducted by DEY. Thus, there is a $50x loss attributable to P's interest in DEY's Country Y business operations in year 1. Also in year 1, there is a $200x loss attributable to FBY. No income or loss is attributable to P's interest in DEY in year 1. Under § 1.1503(d)-5(c)(4)(ii), the dual consolidated loss attributable to P's combined Country Y separate unit is $250x ($50x loss attributable to P's indirect interest in DEY's Country Y operations, plus $200x loss attributable to FBY). In year 2, neither DEY nor DEY's Country Y operations generates income or loss. Under Country Y law, the $100x of year 1 loss incurred by DEY is carried forward and is available to offset income of DEY in year 2.

(ii) Result. As a result of the carryover of the year 1 $100x loss (which includes $50x of the year 1 dual consolidated loss) under Country Y law, a portion of such loss will be available to offset income of DEY that is attributable to P's interest in DEY owned indirectly through PRSX. A portion of such loss will also be available to offset income of DEY that is attributable to FSX's indirect ownership of DEY. Accordingly, under § 1.1503(d)-3(a), there would be a foreign use of a portion of P's $250x year 1 dual consolidated loss because it is available to offset an item of income of the owner of an interest in a hybrid entity, which is not a separate unit (there would also be a foreign use in this case because FSX is a foreign corporation). However, there has not been a reduction of P's interest in DEY, DEY has not consolidated under the laws of Country Y, and there has not been any other foreign use of the dual consolidated losses. As a result, no foreign use occurs as a result of the carryforward pursuant to § 1.1503(d)-3(c)(4)(i) and (ii).

(15) Example 15. No foreign use—asset basis carryover exception—(i) Facts. P owns FBX and FSX. In year 1, there is a dual consolidated loss attributable to FBX. P's items of income, gain, deduction, and loss that are taken into account in calculating FBX's dual consolidated loss include depreciation deductions attributable to FBX's assets. P makes a domestic use election under § 1.1503(d)-6(d) with respect to the year 1 dual consolidated loss of FBX. At the end of year 2, P contributes a portion of FBX's assets to FSX, in exchange for stock in FSX. The aggregate adjusted basis of the assets transferred by P to FSX is less than 10 percent of the aggregate adjusted basis of all of FBX's assets held at the beginning of year 2. In addition, no other assets of FBX are transferred during the certification period. Under Country X law, FSX's basis in the transferred assets is determined by reference to P's basis in such assets. In addition, under Country X law, a portion of the depreciation deductions that were taken into account in year 1 for U.S. tax purposes, are taken into account in year 2 for Country X tax purposes.

(ii) Result. As a result of the transfer of assets from P to FSX, a portion of the year 1 dual consolidated loss is available for a foreign use. This is the case because a portion of the basis in FBX's assets, which gave rise to depreciation deductions that were taken into account in computing the year 1 dual consolidated loss, will give rise to a depreciation deduction under Country X laws that will be available, under U.S. tax principles, to offset the income of FSX, a foreign corporation, in year 2. However, the aggregate adjusted basis of all the assets transferred by P to FSX, within the 12-month period ending at the end of year 2, is less than 10 percent of the aggregate adjusted basis of all of FBX's assets at the beginning of such 12-month period. Moreover, the aggregate adjusted basis of the assets transferred by P to FSX at any time during the certification period is less than 30 percent of the aggregate adjusted basis of FBX's assets held at the end of year 1. In addition, the item of deduction giving rise to the foreign use is being made available solely as a result of the adjusted basis of the transferred assets being determined in whole, or in part, by reference to the adjusted basis of such transferred assets in the hands of FBX. As a result, this transfer will not result in a foreign use pursuant to § 1.1503(d)-3(c)(6).

(16) Example 16. No foreign use—liability assumption exception—(i) Facts. P owns FBX. In year 1, there is a dual consolidated loss attributable to FBX for which P makes a domestic use election under § 1.1503(d)-6(d). The dual consolidated loss includes a deduction for salary expense that was deductible for U.S. tax purposes at the end of year 1, even though it was not paid until year 2. The deduction was incurred in the ordinary course of FBX's trade or business. During year 2, and before the accrued salary expense liability was paid, P sells all the assets of FBX to FSX in exchange for cash and FSX's assumption of the liabilities of the FBX trade or business, including the obligation to pay the accrued salary expense. Under Country X law, the accrued salary expense of FBX is deductible, and is taken into account for purposes of computing the taxable income of FBX, when paid. FBX pays the accrued salary expense after the sale of FBX to FSX.

(ii) Result. (A) As a result of FSX's assumption of the FBX liabilities, including the accrued salary expense, a portion of the dual consolidated loss is available for a foreign use in year 2. This is the case because the deduction that was taken into account in year 1 in computing the dual consolidated loss under U.S. tax principles will, under Country X tax law, be taken into account and will be available to offset the income of FSX, a foreign corporation, in year 2. However, because this item of expense is made available solely as a result of the assumption of a liability of FBX, and such liability was incurred in the ordinary course of FBX's trade or business, there will not be a foreign use of the year 1 dual consolidated loss pursuant to § 1.1503(d)-3(c)(7).

(B) The transfer of all the assets of FBX to FSX is a triggering event under § 1.1503(d)-6(e)(1)(iv), unless P can rebut the triggering event under § 1.1503(d)-6(e)(2). For purposes of determining whether, under § 1.1503(d)-6(e)(2)(ii), the transfer of assets resulted in a carryover under foreign law of FBX's losses, expenses, or deductions, the exception to foreign use for the assumption of liabilities is taken into account. However, the other exceptions to foreign use do not apply for this purpose (or for purposes of demonstrating that no foreign use of a dual consolidated loss can occur in any other year under § 1.1503(d)-6(c), (e)(2)(i) or (j)(2)). See § 1.1503(d)-3(c)(1). Provided the other requirements of § 1.1503(d)-6(e)(2)(ii) and (iii) are satisfied, P may be able to rebut the occurrence of a triggering event upon the transfer of FBX's assets to FSX.

(17) Example 17. Mirror legislation rule—dual resident corporation and hybrid entity separate unit—(i) Facts. P owns DRCX, a member of the P consolidated group. DRCX owns FSX. In year 1, DRCX incurs a $100x net operating loss that is a dual consolidated loss. To prevent corporations like DRCX from offsetting losses both against income of affiliates in Country X and against income of foreign affiliates under the tax laws of another country, Country X mirror legislation prevents a corporation that is subject to the income tax of another country on its worldwide income or on a residence basis from using the Country X form of consolidation. Accordingly, the Country X mirror legislation prevents the loss of DRCX from being made available to offset income of FSX.

(ii) Result. Under § 1.1503(d)-3(e), because the losses of DRCX are subject to Country X's mirror legislation, there is a deemed foreign use of DRCX's year 1 dual consolidated loss. The stand-alone exception to the mirror rule in § 1.1503(d)-3(e)(2) does not apply because, absent the mirror legislation, DRCX's year 1 dual consolidated loss would be available for a foreign use (as defined in § 1.1503(d)-3), without regard to whether such availability is limited by election or similar procedure. That is, absent the mirror legislation, all or a portion of the dual consolidated loss would be available to offset the income of FSX under the Country X consolidation regime. This is the case even if Country X did not recognize DRCX as having a loss in year 1. Therefore, P may not make a domestic use election with respect to DRCX's year 1 dual consolidated loss pursuant to § 1.1503(d)-3(d)(2).

(iii) Alternative facts. The facts are the same as in paragraph (c)(17)(i) of this section, except that P owns DE1X (rather than DRCX) and, in year 1, there is a $100 dual consolidated loss attributable to P's interest in DE1X (rather than of DRCX). The Country X mirror legislation only applies to Country X dual resident corporations and, therefore, does not apply to losses attributable to P's interest in DE1X. As a result, the mirror legislation rule under § 1.1503(d)-3(e) would not deny the opportunity of such loss from being put to a foreign use (for example, by offsetting the income of FSX through the Country X consolidation regime). Therefore, a domestic use election can be made with respect to the dual consolidated loss (provided the conditions for such an election are otherwise satisfied).

(18) Example 18. Mirror legislation rule—standalone foreign branch separate unit—(i) Facts. P owns FBX. In year 1, there is a $100x dual consolidated loss attributable to FBX. Country X enacted mirror legislation to prevent Country X branches and permanent establishments of nonresident corporations from offsetting losses both against income of Country X affiliates and against other income of its owner (or foreign affiliates thereof) under the tax laws of another country. The Country X mirror legislation prevents a Country X branch or permanent establishment of a nonresident corporation from offsetting its losses against the income of Country X affiliates if such losses may be deductible against income (other than income of the Country X branch or permanent establishment) under the laws of another country.

(ii) Result. In general, under § 1.1503(d)-3(e), because the losses of FBX are subject to Country X's mirror legislation, there is a deemed foreign use of FBX's year 1 dual consolidated loss. However, in the absence of the Country X mirror legislation, no item of deduction or loss composing FBX's year 1 dual consolidated loss would be available in the year incurred for a foreign use (as defined in § 1.1503(d)-3), without regard to whether such availability is limited by election or otherwise. This is the case because there is no Country X entity through which the dual consolidated loss could be put to a foreign use (absent a sale, merger, or similar transaction involving FBX). As a result, the stand-alone exception in § 1.1503(d)-3(e)(2) may apply, provided P complies with the requirements of § 1.1503(d)-3(e)(2)(ii). Accordingly, P may make a domestic use election with respect to the year 1 dual consolidated loss of FBX pursuant to § 1.1503(d)-6(d). If, however, any item of the dual consolidated loss would otherwise be available for a foreign use during the certification period (for example, as a result of P acquiring a foreign corporation that is organized under the laws of Country X such that losses of FBX could be put to a foreign use through consolidation or similar means), then such loss would be recaptured pursuant to § 1.1503(d)-6(e)(1)(ix).

(iii) Alternative facts. The facts are the same as in paragraph (c)(18)(i) of this section, except that the Country X mirror legislation operates in a manner similar to the rules under section 1503(d). That is, it allows the taxpayer to elect to use the loss to either offset income of an affiliate in Country X, or income of an affiliate (or other income of the owner of the Country X branch or permanent establishment) in the other country, but not both. Because the Country X mirror legislation permits the taxpayer to choose to put the dual consolidated loss to a foreign use, it does not deny the opportunity to put the loss to a foreign use. Therefore, there is no deemed foreign use of the dual consolidated loss pursuant to § 1.1503(d)-4(e) and a domestic use election can be made for such loss.

(19) Example 19. Application of mirror legislation rule to combined separate unit—(i) Facts. P owns FBX, FSX, and DE1X. In year 1, there is a $50x dual consolidated loss attributable to FBX and $10x of income attributable to P's interest in DE1X. FSX has income of $100x. Pursuant to § 1.1503(d)-1(b)(4)(ii), FBX and P's interest in DE1X are combined and treated as a single separate unit (Country X separate unit) which has a year 1 dual consolidated loss of $40x. Country X enacted mirror legislation to prevent Country X branches or permanent establishments of nonresident corporations from offsetting losses both against income of Country X affiliates and against other income of its owner (or foreign affiliates thereof) under the tax laws of another country. The Country X mirror legislation prevents a Country X branch or permanent establishment of a nonresident corporation from offsetting its losses against the income of Country X affiliates if such losses may be deductible against income (other than income of the Country X branch or permanent establishment) under the laws of another country. However, the United States and Country X have entered into an agreement described in § 1.1503(d)-6(b) pursuant to the U.S.-Country X income tax convention (mirror agreement). The mirror agreement applies to Country X foreign branch separate units of domestic corporations, but not to Country X hybrid entity separate units. The mirror agreement provides that neither the Country X mirror legislation nor the mirror legislation rule under § 1.1503(d)-3(e) will apply to losses attributable to Country X foreign branch separate units, provided certain conditions and reporting requirements are satisfied (including a domestic use election, if the loss is to be used to offset income of a domestic affiliate). Thus, losses attributable to Country X foreign branch separate units can, subject to the requirements of the mirror agreement, be used to offset income of a domestic affiliate or a Country X affiliate (but not both).

(ii) Result. The Country X mirror legislation only applies to Country X foreign branch separate units and does not apply to hybrid entity separate units. In addition, if P complies with the terms and conditions of the mirror agreement, the Country X mirror legislation would not apply to FBX. As a result, the income tax laws of Country X would not deny the opportunity of a loss of either individual separate unit that composes P's combined Country X separate unit from being put to a foreign use. Therefore, notwithstanding § 1.1503(d)-3(e), a domestic use election can be made with respect to the dual consolidated loss attributable to P's Country X separate unit, provided the terms and conditions of the mirror agreement are satisfied. See § 1.1503(d)-6(b)(2).

(iii) Alternative facts. The facts are the same as in paragraph (c)(19)(i) of this section, except that the Country X mirror legislation also applies to losses attributable to DE1X, but the mirror agreement does not apply to such losses. The mirror legislation rule would apply with respect to P's interest in DE1X and, as a result, there is a deemed foreign use of the dual consolidated loss attributable to the Country X separate unit and a domestic use election cannot be made for such loss. This is the case even though, pursuant to § 1.1503(d)-5(c)(4)(ii)(A), P's interest in DE1X (which is subject to the Country X mirror legislation) does not, as an individual separate unit, have a dual consolidated loss in year 1. Further, the stand-alone exception to the mirror legislation rule in § 1.1503(d)-3(e)(2) does not apply because, absent the mirror legislation, the Country X combined separate unit's dual consolidated loss would be available in the year incurred for a foreign use (as defined in § 1.1503(d)-3) because it could be used to offset income of FSX under the Country X consolidation regime. This is the case even if Country X requires an election to consolidate and no such election is made. The result would be the same even if Country X did not recognize DE1X as having a loss.

(20) Example 20. Dual consolidated loss limitation after section 381 transaction. disposition of assets and subsequent liquidation of dual resident corporation—(i) Facts. P owns DRCX, a member of the P consolidated group. In year 1, DRCX incurs a dual consolidated loss and P does not make a domestic use election with respect to such loss. Under § 1.1503(d)-4(b), DRCX's year 1 dual consolidated loss is subject to the limitations under § 1.1503(d)-4(c) and, therefore, may not be used to offset the income of P or S (or any other domestic affiliate) on the group's U.S. income tax return. At the beginning of year 2, DRCX sells all of its assets for cash and distributes the cash to P pursuant to a liquidation that qualifies under section 332.

(ii) Result. In general, under section 381, P would succeed to, and be permitted to use, DRCX's net operating loss carryover. However, § 1.1503(d)-4(d)(1)(i) prohibits the dual consolidated loss of DRCX from carrying over to P. Therefore, DRCX's year 1 net operating loss carryover is eliminated.

(21) Example 21. Dual consolidated loss limitation applied to a separate unit transferred in a section 381 transaction—(i) Facts. S owns DE1X which, in turn, owns FBX. S's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, a dual consolidated loss is attributable to the Country X separate unit, and P does not make a domestic use election with respect to such loss. Under § 1.1503(d)-4(b), the year 1 dual consolidated loss attributable to the Country X separate unit may not be used to offset the income of P or S (other than income attributable to the Country X separate unit, subject to the application of § 1.1503(d)-4(c)) on the group's consolidated U.S. income tax return (nor may it be used to offset the income of any other domestic affiliates). At the beginning of year 2, S transfers its entire interest in DE1X, and thus its entire indirect interest in FBX, to FSX in a transaction described in section 381.

(ii) Result. Section 1.1503(d)-4(d)(1)(ii) provides that the dual consolidated loss attributable to a separate unit that is subject to the domestic use limitation under § 1.1503(d)-4(b) is eliminated if the separate unit ceases to be a separate unit of its affiliated domestic owner and all other members of the affiliated domestic owner's separate group. As a result of the transfer of the Country X separate unit to FSX, the Country X separate unit ceases to be a separate unit of S, and is not a separate unit of any other member of the P consolidated group. In addition, the exceptions in § 1.1503(d)-4(d)(2)(iii) do not apply because FSX is not a domestic corporation. Thus, the year 1 dual consolidated loss attributable to the Country X separate unit is eliminated.

(iii) Alternative facts. Assume the same facts as in paragraph (c)(21)(i) of this section, except S transfers its assets to DC, a domestic corporation that is not a member of the P consolidated group, in a transaction described in section 381(a). Immediately after the transaction, the Country X separate unit is a separate unit of DC. Under § 1.1503(d)-4(d)(1)(ii), the year 1 dual consolidated loss of the Country X separate unit would be eliminated because it ceases to be a separate unit of S, and is not a separate unit of any other member of the P consolidated group. However, because the transferee is a domestic corporation and the Country X separate unit is a separate unit in the hands of DC immediately after the transaction, the exception under § 1.1503(d)-4(d)(2)(iii)(A) applies. As a result, the year 1 dual consolidated loss of the Country X separate unit is not eliminated and any income generated by DC that is attributable to the Country X separate unit following the transfer may be offset by the carryover dual consolidated losses attributable to the Country X separate unit, subject to the limitations of § 1.1503(d)-4(b) and (c) applied as if DC generated the dual consolidated loss and such loss was attributable to the Country X separate unit.

(iv) Alternative facts. Assume the same facts as in paragraph (c)(21)(iii) of this section, except that P owns DE2X and the interest in DE2X is combined with and therefore included in the Country X separate unit. In addition, a portion of the dual consolidated loss of the Country X separate unit is attributable to P's interest in DE2X. Pursuant to § 1.1503(d)-4(d)(2)(iii)(A), the result would be the same as in paragraph (c)(21)(iii) of this section, with respect to the portion of the dual consolidated loss attributable to the combined separate unit that is succeeded to and taken into account by DC pursuant to section 381. The portion of the dual consolidated loss attributable to P's interest in DE2X, however, does not carry over to DC but is retained by P and continues to be subject to the limitations of § 1.1503(d)-4(b) and (c) with respect to P's interest in DE2X.

(v) Alternative facts. Assume the same facts as in paragraph (c)(21)(iv) of this section, except that DC is a member of the P consolidated group. Pursuant to § 1.1503(d)-4(d)(2)(iii)(B), the dual consolidated loss of the Country X separate unit is not eliminated and income attributable to the Country X separate unit may continue to be offset by the dual consolidated loss that is succeeded to and taken into account by DC pursuant to section 381, subject to the limitations of § 1.1503(d)-4(b) and (c). The result would be the same even if the interest in DE1X ceased to be a separate unit in the hands of DC (for example, because it dissolved under Country X law in connection with the transaction), provided P, or another member of the P consolidated group, continued to own a portion of the Country X separate unit.

(22) Example 22. Tainted income—(i) Facts. P owns 100 percent of DRCZ, a domestic corporation that is included as a member of the P consolidated group. DRCZ conducts a business in the United States. During year 1, DRCZ was managed and controlled in Country Z and therefore was subject to tax as a resident of Country Z and was a dual resident corporation. In year 1, DRCZ incurred a dual consolidated loss of $200x, and P did not make a domestic use election with respect to such loss. As a result, such loss is subject to the domestic use limitation rule of § 1.1503(d)-4(b). At the end of year 1, DRCZ moved its management and control to the United States and, as a result, ceased being a dual resident corporation. At the beginning of year 2, P transferred asset A, a non-depreciable asset, to DRCZ in exchange for common stock in a transaction that qualified for nonrecognition under section 351. At the time of the transfer, P's tax basis in asset A equaled $50x and the fair market value of asset A equaled $100x. The tax basis of asset A in the hands of DRCZ immediately after the transfer equaled $50x pursuant to section 362. Asset A did not constitute replacement property acquired in the ordinary course of business. DRCZ did not generate income or gain during years 2, 3, or 4. On June 30, year 5, DRCZ sold asset A to a third party for $100x, its fair market value at the time of the sale, and recognized $50x of income on such sale. In addition to the $50x income generated on the sale of asset A, DRCZ generated $100x of operating income in year 5. At the end of year 5, the fair market value of all the assets of DRCZ was $400x.

(ii) Result. DRCZ ceased being a dual resident corporation at the end of year 1. Therefore, its year 1 dual consolidated loss cannot be offset by tainted income. Asset A is a tainted asset because it was acquired in a nonrecognition transaction after DRCZ ceased being a dual resident corporation (and was not replacement property acquired in the ordinary course of business). As a result, the $50x of income recognized by DRCZ on the disposition of asset A is tainted income and cannot be offset by the year 1 dual consolidated loss of DRCZ. In addition, absent evidence establishing the actual amount of tainted income, $25x of the $100x year 5 operating income of DRCZ (($100x/$400x) × $100x) also is treated as tainted income and cannot be offset by the year 1 dual consolidated loss of DRCZ under § 1.1503(d)-4(e)(2)(ii). Therefore, $75x of the $150x year 5 income of DRCZ constitutes tainted income and may not be offset by the year 1 dual consolidated loss of DRCZ; however, the remaining $75x of year 5 income of DRCZ may be offset by such dual consolidated loss. The result would be the same if, instead of P transferring asset A to DRCZ, such asset was received from a separate unit or a transparent entity of DRCZ.

(23) Example 23. Treatment of disregarded item and books and records of a hybrid entity—(i) Facts. P owns DE1X which, in turn, owns FSX. In year 1, P borrows from a third party and on-lends the proceeds to DE1X. In year 1, P incurs interest expense attributable to the third-party loan. Also in year 1, DE1X incurs interest expense attributable to its loan from P, but such expense is generally disregarded for U.S. tax purposes because DE1X is disregarded as an entity separate from P. The third-party loan and related interest expense are reflected on the books and records of P (and not on the books and records of DE1X). The loan from P to DE1X and related interest expense are reflected on the books and records of DE1X. There are no other items of income, gain, deduction, or loss reflected on the books and records of DE1X in year 1.

(ii) Result. Because the interest expense on P's third-party loan is not reflected on the books and records of DE1X, no portion of such expense is attributable to P's interest in DE1X pursuant to § 1.1503(d)-5(c)(3) for purposes of calculating the year 1 dual consolidated loss, if any, attributable to such interest. In addition, even though P's interest in DE1X is treated as a separate domestic corporation for purposes of determining the amount of income or dual consolidated loss attributable to it pursuant to § 1.1503(d)-5(c)(1)(ii), such treatment does not cause the interest expense incurred on the loan from P to DE1X that is generally disregarded for U.S. tax purposes to be regarded for purposes of calculating the year 1 dual consolidated loss, if any, attributable to P's interest in DE1X. As a result, even though the disregarded interest expense is reflected on the books and records of DE1X, it is not taken into account for purposes of calculating income or a dual consolidated loss. But see § 1.1503(d)-1(d), which takes into account certain payments that are otherwise disregarded for purposes of section 1503(d) and the regulations thereunder. Therefore, there is no dual consolidated loss attributable to P's interest in DE1X in year 1.

(24) Example 24. Dividend income attributable to a separate unit—(i) Facts. P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). DE1X owns DE3Y. DE3Y owns the stock of FSX. P's Country X separate unit would, without regard to year 1 dividend income (or related section 78 gross-up) received from FSX, have a dual consolidated loss of $75x in year 1. In year 1, FSX distributes $50x to DE3Y that is taxable as a dividend. DE3Y distributes the same amount to DE1X. P computes foreign taxes deemed paid on the dividend under section 902 of $25x and includes that amount in gross income under section 78.

(ii) Result. The $50x dividend is reflected on the books and records of DE3Y and, therefore, is attributable to P's interest in DE3Y pursuant to § 1.1503(d)-5(c)(3)(i). In addition, the $25x section 78 gross-up is attributable to P's interest in DE3Y pursuant to § 1.1503(d)-5(c)(4)(iv). The distribution of $50x from DE3Y to DE1X is generally disregarded for U.S. tax purposes and, therefore, does not give rise to an item that is taken into account for purposes of calculating income or a dual consolidated loss. This is the case even though the item would be reflected on the books and records of DE1X. In addition, pursuant to § 1.1503(d)-5(c)(1)(iii), each separate unit must calculate its own income or dual consolidated loss, and each item of income, gain, deduction, and loss must be taken into account only once. As a result, the dual consolidated loss of $75x attributable to P's Country X separate unit in year 1 is not reduced by the amount of dividend income attributable to P's indirect interest in DE3Y.

(25) Example 25. Items reflected on books and records of a combined separate unit—(i) Facts. P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). The following items are reflected on the books and records of DE1X in year 1: Sales, depreciation expense, a political contribution, royalty expense paid to P, repairs and maintenance expense paid to a third party, and Country X income tax expense. The amount of sales under U.S. tax principles equals the amount of sales reported for accounting purposes. The depreciation expense is calculated on a straight-line basis over the useful life of the asset for accounting purposes, but is subject to accelerated depreciation for U.S. tax purposes. In addition, the repairs and maintenance expense, which is deducted when paid for accounting purposes, is properly capitalized and amortized over five years for U.S. tax purposes. Finally, P elects to claim as a credit under section 901 the Country X income tax expense that was paid in year 1.

(ii) Result. (A) For purposes of determining the income or dual consolidated loss attributable to P's Country X separate unit, items of income, gain, deduction, and loss must first be attributed to the individual separate units (that is, P's interest in DE1X and its indirect interest in FBX). For purposes of attributing items to P's interest in DE1X, P's items that are reflected on DE1X's books and records, as adjusted to conform to U.S. tax principles, are taken into account. See § 1.1503(d)-5(c)(3)(i). For purposes of attributing items (other than interest expense) to FBX, the principles of section 864(c)(2), (c)(4), and (c)(5) (as set forth in § 1.864-4(c) and §§ 1.864-5 through 1.864-7) must be applied and, for interest expense, the principles of § 1.882-5, as modified under § 1.1503(d)-5(c)(2)(ii), must be applied; however, for these purposes, pursuant to § 1.1503(d)-5(c)(4)(i)(A), FBX only takes into account items attributable to P's interest in DE1X and the assets, liabilities, and activities of such interest. In addition, to the extent such items are taken into account by FBX, they are not taken into account in determining the items attributable to P's interest in DE1X. § 1.1503(d)-5(c)(4)(i)(B). Because P's interest in DE1X has no assets or liabilities, and conducts no activities, other than through its ownership of FBX, all of the items that are reflected on the books and records of DE1X, as adjusted to conform to U.S. tax principles, are attributable to FBX; no items are attributable to P's interest in DE1X.

(B) The items reflected on the books and records of DE1X must be adjusted to conform to U.S. tax principles. No adjustment is required to sales because the amount of sales under U.S. tax principles equals the amount of sales for accounting purposes. The amount of straight-line depreciation expense reflected on DE1X's books and records must be adjusted to reflect the amount of depreciation on the asset that is allowable for U.S. tax purposes. The political contribution is not taken into account because it is not deductible for U.S. tax purposes. Similarly, because the royalty expense is paid to P, and therefore is generally disregarded for U.S. tax purposes, it is not taken into account. But see § 1.1503(d)-1(d), which takes into account certain payments that are otherwise disregarded for purposes of section 1503(d) and the regulations thereunder. The repair and maintenance expense that is deducted in year 1 for accounting purposes also must be adjusted to conform to U.S. tax principles. Thus, the repair and maintenance expense will be taken into account in computing the income or dual consolidated loss attributable to P's Country X separate unit over five years (even though no item related to such expense would be reflected on the books and records of DE1X for years 2 through 5). Finally, because P elected to claim as a credit the Country X foreign taxes paid during year 1, no deduction is allowed for such amount pursuant to section 275(a)(4) and, therefore, the Country X tax expense is not taken into account.

(C) Pursuant to § 1.1503(d)-5(c)(4)(ii)(B), the combined Country X separate unit of P calculates its income or dual consolidated loss by taking into account all the items of income, gain, deduction, and loss that were separately attributable to P's interest in DE1X and FBX. However, in this case, there are no items attributable to P's interest in DE1X. Therefore, the items attributable to the Country X separate unit are the items attributable to FBX.

(26) Example 26. Items attributable to a combined separate unit—(i) Facts. P owns DE1X. DE1X owns a 50 percent interest in PRSZ, a Country Z entity that is classified as a partnership both for Country Z tax purposes and for U.S. tax purposes. FSX, which is unrelated to P, owns the remaining 50 percent interest in PRSZ. PRSZ carries on operations in Country X that, if carried on by a U.S. person, would constitute a foreign branch as defined in § 1.367(a)-6T(g)(1). Therefore, P's share of the Country X operations carried on by PRSZ constitutes a foreign branch separate unit. PRSZ also owns assets that do not constitute a part of its Country X branch, including all of the interests in TET, a disregarded entity. TET is an entity incorporated under the laws of Country T, a country that does not have an income tax. Under the laws of Country X, an interest holder of TET does not take into account on a current basis the interest holder's share of items of income, gain, deduction, and loss of TET.

(ii) Result. (A) Pursuant to § 1.1503(d)-1(b)(4)(ii), P's interest in DE1X, and P's indirect ownership of a portion of the Country X operations carried on by PRSZ, are combined and treated as a single separate unit (Country X separate unit). Pursuant to § 1.1503(d)-5(c)(4)(ii)(A), for purposes of determining P's items of income, gain, deduction, and loss attributable to the Country X separate unit, the items of P are first attributed to each separate unit that composes the Country X separate unit.

(B) Pursuant to § 1.1503(d)-5(c)(2)(i), the principles of section 864(c)(2), (c)(4), and (c)(5) (as set forth in § 1.864-4(c) and §§ 1.864-5 through 1.864-7), apply for purposes of determining P's items of income, gain, deduction (other than interest expense), and loss that are attributable to P's indirect interest in the Country X operations carried on by PRSZ. For purposes of determining P's interest expense that is attributable to P's indirect interest in the Country X operations carried on by PRSZ, the principles of § 1.882-5, as modified under § 1.1503(d)-5(c)(2)(ii), shall apply. For purposes of applying these rules, P is treated as a foreign corporation, the Country X operations carried on by PRSZ are treated as a trade or business within the United States, and the assets of P (including its share of the PRSZ assets, other than those of the Country X operations) are treated as assets that are not U.S. assets. In addition, because P carries on its share of the Country X operations through DE1X, a hybrid entity, § 1.1503(d)-5(c)(4)(i)(A) provides that only the items attributable to P's interest in DE1X, and only the assets, liabilities, and activities of P's interest in DE1X, are taken into account for purposes of this determination.

(C) TET is a transparent entity as defined in § 1.1503(d)-1(b)(16) because it is not taxable as an association for Federal tax purposes, is not subject to income tax in a foreign country as a corporation (or otherwise at the entity level) either on its worldwide income or on a residence basis, and is not treated as a pass-through entity under the laws of Country X (the applicable foreign country). TET is not a pass-through entity under the laws of Country X because a Country X holder of an interest in TET does not take into account on a current basis the interest holder's share of items of income, gain, deduction, and loss of TET. For purposes of determining P's items of income, gain, deduction, and loss that are attributable to P's interest in TET, only those items of P that are reflected on the books and records of TET, as adjusted to conform to U.S. tax principles, are taken into account. § 1.1503(d)-5(c)(3)(i). Because the interest in TET is not a separate unit, a loss attributable to such interest is not a dual consolidated loss and is not subject to section 1503(d) and these regulations. Items must nevertheless be attributed to the interests in TET. For example, such attribution is required for purposes of calculating the income or dual consolidated loss attributable to the Country X separate unit, and for purposes of applying the domestic use limitation under § 1.1503(d)-4(b) to a dual consolidated loss attributable to the Country X separate unit.

(D) For purposes of determining P's items of income, gain, deduction, and loss that are attributable to P's interest in DE1X, only those items of P that are reflected on the books and records of DE1X, as adjusted to conform to U.S. tax principles, are taken into account. § 1.1503(d)-5(c)(3)(i). For this purpose, DE1X's distributive share of the items of income, gain, deduction, and loss that are reflected on the books and records of PRSZ, as adjusted to conform to U.S. tax principles, are treated as being reflected on the books and records of DE1X, except to the extent such items are taken into account by the Country X operations of PRSZ. See § 1.1503(d)-5(c)(3)(ii) and (4)(i)(B). Because TET is a transparent entity, the items reflected on its books and records are not treated as being reflected on the books and records of DE1X.

(E) Pursuant to § 1.1503(d)-5(c)(4)(ii)(B), the combined Country X separate unit of P calculates its income or dual consolidated loss by taking into account all the items of income, gain, deduction, and loss that were separately attributable to P's interest in DE1X and the Country X operations of PRSZ owned indirectly by P.

(27) Example 27. Sale of separate unit by another separate unit—(i) Facts. P owns DE3Y which, in turn, owns DE1X. DE3Y also owns other assets that do not constitute a foreign branch separate unit. DE1X owns FBX. Pursuant to § 1.1503(d)-1(b)(4)(ii), P's indirect interests in DE1X and FBX are combined and treated as one Country X separate unit (Country X separate unit). DE3Y sells its interest in DE1X at the end of year 1 to an unrelated foreign person for cash. The sale results in an ordinary loss of $30x. Items of income, gain, deduction, and loss derived from the assets that gave rise to the $30x loss would be attributable to the Country X separate unit under § 1.1503(d)-5(c) through (e). Without regard to the sale of DE1X, no items of income, gain, deduction, and loss are attributable to P's Country X separate unit in year 1.

(ii) Result. Pursuant to § 1.1503(d)-5(c)(4)(iii)(A), the $30x ordinary loss recognized on the sale is attributable to the Country X separate unit, and not P's interest in DE3Y. This is the case because the Country X separate unit is treated as owning the assets that gave rise to the loss under § 1.1503(d)-5(f). Thus, the loss attributable to the sale creates a year 1 dual consolidated loss attributable to the Country X separate unit. In addition, pursuant to § 1.1503(d)-6(d)(2), P cannot make a domestic use election with respect to the dual consolidated loss because the sale of the interest in DE1X is a triggering event described in § 1.1503(d)-6(e)(1)(iv) and (v). Further, although the year 1 dual consolidated loss would otherwise be subject to the domestic use limitation rule of § 1.1503(d)-4(b), it is eliminated pursuant to § 1.1503(d)-4(d)(1)(ii). Finally, if there were a dual consolidated loss attributable to P's interest in DE3Y, the sale of the interest in DE1X would not be taken into account for purposes of determining whether there is an asset triggering event with respect to such dual consolidated loss under § 1.1503(d)-6(e)(1)(iv).

(28) Example 28. Gain on sale of tiered separate units—(i) Facts. P owns 75 percent of HPSX, a Country X entity subject to Country X tax on its worldwide income. FSX owns the remaining 25 percent of HPSX. HPSX is classified as a partnership for Federal tax purposes. HPSX carries on operations in Country Y that, if carried on by a U.S. person, would constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1). HPSX also owns assets that do not constitute a part of its Country Y operations and would not themselves constitute a foreign branch within the meaning of § 1.367(a)-6T(g)(1) if owned by a U.S. person. Neither HPSX nor the Country Y operations has liabilities. P's indirect interest in the Country Y operations carried on by HPSX, and P's interest in HPSX, are each separate units. P sells its interest in HPSX and recognizes a gain of $150x on such sale. Immediately prior to P's sale of its interest in HPSX, P's portion of the assets of the Country Y operations (that is, assets the income, gain, deduction and loss from which would be attributable to P's Country Y foreign branch separate unit) had a built-in gain of $200x, and P's portion of HPSX's other assets (that is, assets the income, gain, deduction and loss from which would be attributable to P's interest in HPSX) had a built-in gain of $100x.

(ii) Result. Pursuant to § 1.1503(d)-5(c)(4)(iii)(B), $100x of the total $150x of gain recognized ($200x/$300x × $150x) is attributable to P's indirect interest in its share of the Country Y operations carried on by HPSX. Similarly, $50x of such gain ($100x/$300x × $150x) is attributable to P's interest in HPSX.

(29) Example 29. Effect on domestic affiliate—(i) Facts. (A) P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In years 1 and 2, the items of income, gain, deduction, and loss that are attributable to P's Country X separate unit pursuant to § 1.1503(d)-5 are as follows:

Table 1 to paragraph (c)(29)(i)(A)

Item | Year 1 | Year 2

Sales income | $100x | $160x

Salary expense | ($75x) | ($75x)

Research and experimental expense | ($50x) | ($50x)

Interest expense | ($25x) | ($25x)

Income/(dual consolidated loss) | ($50x) | $10x

(B) P does not make a domestic use election with respect to the year 1 dual consolidated loss attributable to its Country X separate unit. Pursuant to § 1.1503(d)-4(b) and (c)(2), the year 1 dual consolidated loss of $50x is treated as a loss incurred by a separate domestic corporation and is subject to the limitations under § 1.1503(d)-4(c)(3). The P consolidated group has $100x of consolidated taxable income in year 2.

(ii) Result. (A) P must compute its taxable income for year 1 without taking into account the $50x dual consolidated loss, pursuant to § 1.1503(d)-4(c)(2). Such amount consists of a pro rata portion of the expenses that were taken into account in calculating the year 1 dual consolidated loss. Thus, the items of the dual consolidated loss that are not taken into account by P in computing its taxable income are as follows: $25x of salary expense ($75x/$150x × $50x); $16.67x of research and experimental expense ($50x/$150x × $50x); and $8.33x of interest expense ($25x/$150x × $50x). The remaining amounts of each of these items, together with the $100x of sales income, are taken into account by P in computing its taxable income for year 1 as follows: $50x of salary expense ($75x − $25x); $33.33x of research and experimental expense ($50x − $16.67x); and $16.67x of interest expense ($25x − $8.33x).

(B) Subject to the limitations provided under § 1.1503(d)-4(c), the year 1 $50x dual consolidated loss is carried forward and is available to offset the $10x of income attributable to the Country X separate unit in year 2. Pursuant to § 1.1503(d)-4(c)(4), a pro rata portion of each item of deduction or loss included in such dual consolidated loss is considered to be used to offset the $10x of income, as follows: $5x of salary expense ($25x / $50x × $10x); $3.33x of research and experimental expense ($16.67x/$50x × $10x); and $1.67x of interest expense ($8.33x / $50x × $10x). The remaining amount of each item shall continue to be subject to the limitations under § 1.1503(d)-4(c).

(30) Example 30. Exception to domestic use limitation—no possibility of foreign use because items are not deducted or capitalized under foreign law—(i) Facts. P owns DE1X which, in turn, owns FSX. In year 1, the sole item of income, gain, deduction, and loss attributable to P's interest in DE1X, as provided under § 1.1503(d)-5, is $100x of interest expense paid on a loan to an unrelated lender. For Country X tax purposes, the $100x interest expense attributable to P's interest in DE1X in year 1 is treated as a repayment of principal and therefore cannot be deducted (at any time) or capitalized.

(ii) Result. The $100x of interest expense attributable to P's interest in DE1X constitutes a dual consolidated loss. However, because the sole item constituting the dual consolidated loss cannot be deducted or capitalized (at any time) for Country X tax purposes, P can demonstrate that there can be no foreign use of the dual consolidated loss at any time. As a result, pursuant to § 1.1503(d)-6(c)(1), if P prepares a statement described in § 1.1503(d)-6(c)(2) and attaches it to its timely filed tax return, the year 1 dual consolidated loss attributable to P's interest in DE1X will not be subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(31) Example 31. No exception to domestic use limitation—inability to demonstrate no possibility of foreign use—(i) Facts. P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, the sole items of income, gain, deduction, and loss attributable to P's Country X separate unit, as provided under § 1.1503(d)-5, are $75x of sales income and $100x of depreciation expense. For Country X tax purposes, DE1X also generates $75x of sales income in year 1, but the $100x of depreciation expense is not deductible until year 2.

(ii) Result. The year 1 $25x net loss attributable to P's interest in the Country X separate unit constitutes a dual consolidated loss. In addition, even though DE1X has positive income in year 1 for Country X tax purposes, P cannot demonstrate that there is no possibility of foreign use with respect to the Country X separate unit's dual consolidated loss as provided under § 1.1503(d)-6(c)(1)(i). P cannot make such a demonstration because the depreciation expense, an item composing the year 1 dual consolidated loss, is deductible (in a later year) for Country X tax purposes and, therefore, may be available to offset or reduce income for Country X purposes that would constitute a foreign use. For example, if DE1X elected to be classified as a corporation pursuant to § 301.7701-3(c) of this chapter effective as of the end of year 1, and the deferred depreciation expense were available for Country X tax purposes to offset year 2 income of DE1X, an entity treated as a foreign corporation in year 2 for U.S. tax purposes, there would be a foreign use.

(iii) Alternative facts. (A) The facts are the same as in paragraph (c)(31)(i) of this section, except as follows. In year 1, the sole items of income, gain, deduction, and loss attributable to P's Country X separate unit, as provided in § 1.1503(d)-5, are $75x of sales income, $100x of interest expense, and $25x of depreciation expense. For Country X tax purposes, DE1X generates $75x of sales income in year 1; the $100x interest expense is treated as a repayment of principal and therefore cannot be deducted or capitalized (at any time); and the $25x of depreciation expense is not deductible in year 1, but is deductible in year 2.

(B) In year 1, the $50x net loss attributable to P's Country X separate unit constitutes a dual consolidated loss. Even though the $100x interest expense, a nondeductible and noncapital item for Country X tax purposes, exceeds the $50x year 1 dual consolidated loss attributable to P's Country X separate unit, P cannot demonstrate that there is no possibility of foreign use of the dual consolidated loss as provided under § 1.1503(d)-6(c)(1)(i). P cannot make such a demonstration because the $25x depreciation expense, an item of deduction or loss composing the year 1 dual consolidated loss, is deductible under Country X law (in year 2) and, therefore, may be available to offset or reduce income for Country X tax purposes that would constitute a foreign use.

(32) Example 32. Triggering event rebuttal—expiration of losses in foreign country—(i) Facts. P owns DRCX, a member of the P consolidated group. In year 1, DRCX incurs a dual consolidated loss of $100x. P makes a domestic use election with respect to DRCX's year 1 dual consolidated loss and such loss therefore is included in the computation of the P group's consolidated taxable income. DRCX has no income or loss in year 2 through year 5. In year 5, P sells the stock of DRCX to FSX. At the time of the sale of the stock of DRCX, all of the losses and deductions that were included in the computation of the year 1 dual consolidated loss of DRCX had expired for Country X tax purposes because the laws of Country X only provide for a three-year carryover period for such items.

(ii) Result. The sale of DRCX to FSX generally would be a triggering event under § 1.1503(d)-6(e)(1)(ii), which would require DRCX to recapture the year 1 dual consolidated loss (and pay an applicable interest charge) on the P consolidated group's tax return for the year that includes the date on which DRCX ceases to be a member of the P consolidated group. However, upon adequate documentation that the losses and deductions have expired for Country X tax purposes, P can rebut the presumption that a triggering event has occurred pursuant to § 1.1503(d)-6(e)(2)(i). If the triggering event presumption is rebutted, the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss of DRCX is terminated and has no further effect pursuant to § 1.1503(d)-6(j)(1)(i). If the presumptive triggering event is not rebutted, the domestic use agreement would terminate and have no further effect pursuant to § 1.1503(d)-6(j)(1)(iii) because the dual consolidated loss would be recaptured.

(33) Example 33. Triggering events and rebuttals—tax basis carryover transaction—(i) Facts. (A) P owns DE1X. DE1X's sole asset is A, which it acquired at the beginning of year 1 for $100x. DE1X does not have any liabilities. For U.S. tax purposes, DE1X's tax basis in A at the beginning of year 1 is $100x and DE1X's sole item of income, gain, deduction, and loss for year 1 is a $20x depreciation deduction attributable to A. As a result, the $20x depreciation deduction constitutes a dual consolidated loss attributable to P's interest in DE1X. P makes a domestic use election with respect to the year 1 dual consolidated loss.

(B) For Country X tax purposes, DE1X has a $100x tax basis in A at the beginning of year 1, but A is not a depreciable asset. As a result, DE1X does not have any items of income, gain, deduction, and loss in year 1 for Country X tax purposes.

(C) During year 2, P sells its interest in DE1X to FSX for $80x. P's disposition of its interest in DE1X constitutes a presumptive triggering event under § 1.1503(d)-6(e)(1)(iv) and (v) requiring the recapture of the year 1 $20x dual consolidated loss (plus the applicable interest charge). For Country X tax purposes, DE1X retains its tax basis of $100x in A following the sale.

(ii) Result. The year 1 dual consolidated loss is a result of the $20x depreciation deduction attributable to A. Although no item of deduction or loss was recognized by DE1X at the time of the sale for Country X tax purposes, the deduction composing the dual consolidated loss was retained by DE1X after the sale in the form of tax basis in A. As a result, a portion of the dual consolidated loss may be available to offset income for Country X tax purposes in a manner that would constitute a foreign use. For example, if DE1X were to dispose of A, the amount of gain recognized by DE1X would be reduced (or an amount of loss recognized by DE1X would be increased) and, therefore, an item composing the dual consolidated loss would be available, under U.S. tax principles, to reduce income of a foreign corporation (and an owner of an interest in a hybrid entity that is not a separate unit). Thus, P cannot demonstrate pursuant to § 1.1503(d)-6(e)(2)(i) that there can be no foreign use of the year 1 dual consolidated loss following the triggering event, and must recapture the year 1 dual consolidated loss. Pursuant to § 1.1503(d)-6(j)(1)(iii), the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss is terminated and has no further effect.

(iii) Alternative facts. The facts are the same as paragraph (c)(33)(i) of this section, except that instead of P selling its interest in DE1X to FSX, DE1X sells asset A to FSX for $80x and, for Country X tax purposes, FSX's tax basis in A immediately after the sale is $80x. P's disposition of Asset A constitutes a presumptive triggering event under § 1.1503(d)-6(e)(1)(iv) requiring the recapture of the year 1 $20x dual consolidated loss (plus the applicable interest charge). For Country X tax purposes, FSX's tax basis in A was not determined, in whole or in part, by reference to the basis of A in the hands of DE1X. As a result, the deduction composing the dual consolidated loss will not give rise to an item of deduction or loss in the form of tax basis for Country X tax purposes (for example, when FSX disposes of A). Therefore, P may be able to demonstrate (for example, by obtaining the opinion of a Country X tax advisor) pursuant to § 1.1503(d)-6(e)(2)(i) that there can be no foreign use of the year 1 dual consolidated loss and, thus, would not be required to recapture the year 1 dual consolidated loss.

(34) Example 34. Triggering event resulting in a single consolidated group where acquirer files a new domestic use agreement—(i) Facts. P owns DRCX, a member of the P consolidated group. In year 1, DRCX incurs a dual consolidated loss and P makes a domestic use election with respect to such loss. No member of the P consolidated group incurs a dual consolidated loss in year 2. At the end of year 2, T, the parent of the T consolidated group, acquires all the stock of P, and all the members of the P group, including DRCX, become members of a consolidated group of which T is the common parent.

(ii) Result. (A) Under § 1.1503(d)-6(f)(2)(ii)(B), the acquisition by T of the P consolidated group is not an event described in § 1.1503(d)-6(e)(1)(ii) requiring the recapture of the year 1 dual consolidated loss of DRCX (and the payment of an interest charge), provided that the T consolidated group files a new domestic use agreement described in § 1.1503(d)-6(f)(2)(iii)(A). If a new domestic use agreement is filed, then pursuant to § 1.1503(d)-6(j)(1)(ii), the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss of DRCX is terminated and has no further effect.

(B) Assume that T files a new domestic use agreement and a triggering event occurs at the end of year 3. As a result, the T consolidated group must recapture the dual consolidated loss that DRCX incurred in year 1 (and pay an interest charge), as provided in § 1.1503(d)-6(h). Each member of the T consolidated group, including DRCX and any former members of the P consolidated group, is severally liable for the additional tax (and the interest charge) due upon the recapture of the dual consolidated loss of DRCX. In addition, pursuant to § 1.1503(d)-6(j)(1)(iii), the new domestic use agreement filed by the T group with respect to the year 1 dual consolidated loss of DRCX is terminated and has no further effect.

(35) Example 35. Triggering event exceptions for certain deemed transfers—(i) Facts. P owns DE1X. In year 1, there is a $100x dual consolidated loss attributable to P's interest in DE1X. P files a domestic use agreement under § 1.1503(d)-6(d) with respect to such loss. During year 2, P sells 33 percent of its interest in DE1X to T, an unrelated domestic corporation.

(ii) Result. Pursuant to Rev. Rul. 99-5, the transaction is treated as if P sold 33 percent of its interest in each of DE1X's assets to T and then immediately thereafter P and T transferred their interests in the assets of DE1X to a partnership in exchange for an ownership interest therein. Upon the transfer of 33 percent of P's interest to T, a domestic corporation, no foreign use occurs and, therefore, there is no foreign use triggering event. However, P's deemed transfer of 67 percent of its interest in the assets of DE1X to a partnership is nominally a triggering event under § 1.1503(d)-6(e)(1)(iv). Because the initial transfer of 33 percent of DE1X's interest was to a domestic corporation and there is only a triggering event because of the deemed transfer under Rev. Rul. 99-5, the deemed asset transfer is not treated as resulting in a triggering event pursuant to § 1.1503(d)-6(f)(4).

(iii) Alternative facts. The facts are the same as in paragraph (c)(35)(i) of this section, except that P sells 60 percent (rather than 33 percent) of its interest in DE1X to T. The sale is a triggering event under § 1.1503(d)-6(e)(1)(iv) and (v) without regard to the occurrence of a deemed transaction. Therefore, § 1.1503(d)-6(f)(4) does not apply.

(36) Example 36. Triggering event exception involving multiple parties—(i) Facts. P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, there is a $100x dual consolidated loss attributable to P's Country X separate unit and P makes a domestic use election with respect to such loss. No member of the P consolidated group incurs a dual consolidated loss in year 2. At the end of year 2, T, the parent of the T consolidated group, acquires all of P's interest in DE1X for cash.

(ii) Result. (A) Under § 1.1503(d)-6(f)(2)(i)(B), the acquisition by T of the interest in DE1X is not an event described in § 1.1503(d)-6(e)(1)(iv) or (v) requiring the recapture of the year 1 dual consolidated loss attributable to the Country X separate unit (and the payment of an interest charge), provided: (1) the T consolidated group files a new domestic use agreement described in § 1.1503(d)-6(f)(2)(iii)(A) with respect to the year 1 dual consolidated loss of the Country X separate unit; and (2) the P consolidated group files a statement described in § 1.1503(d)-6(f)(2)(iii)(B) with respect to the year 1 dual consolidated loss. If these requirements are satisfied, then pursuant to § 1.1503(d)-6(j)(1)(ii) the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss is terminated and has no further effect (if these requirements are not satisfied such that the P consolidated group recaptures the dual consolidated loss, the domestic use agreement would terminate pursuant to § 1.1503(d)-6(j)(1)(iii)).

(B) Assume a triggering event occurs at the end of year 3 that requires recapture by the T consolidated group of the year 1 dual consolidated loss, as well as the payment of an interest charge, as provided in § 1.1503(d)-6(h). T continues to own the Country X separate unit after the triggering event. In that case, each member of the T consolidated group is severally liable for the additional tax (and the interest charge) due upon the recapture of the year 1 dual consolidated loss. The T consolidated group must prepare a statement that computes the recapture tax amount as provided under § 1.1503(d)-6(h)(3)(iii). Pursuant to § 1.1503(d)-6(h)(3)(iv)(A), the recapture tax amount is assessed as an income tax liability of the T consolidated group and is considered as having been properly assessed as an income tax liability of the P consolidated group. If the T consolidated group does not pay in full the income tax liability attributable to the recapture tax amount, the unpaid balance of such recapture tax amount may be collected from the P consolidated group in accordance with the provisions of § 1.1503(d)-6(h)(3)(iv)(B). Pursuant to § 1.1503(d)-6(j)(1)(iii), the new domestic use agreement filed by the T consolidated group is terminated and has no further effect. Finally, pursuant to § 1.1503(d)-6(h)(6)(iii), T is treated as if it incurred the dual consolidated loss that is recaptured for purposes of applying § 1.1503(d)-6(h)(6)(i). Thus, T has a reconstituted net operating loss equal to the amount of the year 1 dual consolidated loss that was recaptured, and such loss is attributable to the Country X separate unit (and subject to the rules and limitations under § 1.1503(d)-6(h)(6)(i)). Because T is treated as if it incurred the year 1 dual consolidated loss, P shall not be treated as having a net operating loss under § 1.1503(d)-6(h)(6)(i).

(37) Example 37. No foreign use following multiple-party event exception to triggering event—(i) Facts. P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, there is a $100x dual consolidated loss attributable to P's Country X separate unit and P makes a domestic use election with respect to such loss. T, a domestic corporation unrelated to P, owns 95 percent of PRS, a partnership. FSX owns the remaining 5 percent of PRS. At the beginning of year 3, PRS purchases 100 percent of the interest in DE1X from P for cash. For Country X tax purposes, the $100x loss incurred by DE1X in year 1 carries forward and is available to offset income of DE1X in subsequent years.

(ii) Result. P's sale of its interest in DE1X is a triggering event under § 1.1503(d)-6(e)(1)(iv) and (v). However, if P and T comply with the requirements under § 1.1503(d)-6(f)(2)(iii), the sale would qualify for the multiple-party event exception under § 1.1503(d)-6(f)(2)(i). In addition, because the $100x loss of DE1X carries forward to subsequent years for Country X purposes and is available to offset income of DE1X, there would be a foreign use of the dual consolidated loss immediately after the sale pursuant to § 1.1503(d)-3(a)(1). This is the case because the dual consolidated loss would be available to offset or reduce income that is considered, under U.S. tax principles, to be an item of FSX, a foreign corporation (it would also be a foreign use because FSX is an indirect owner of an interest in a hybrid entity that is not a separate unit). However, there is no foreign use in this case as a result of FSX's 5 percent interest in DE1X pursuant to § 1.1503(d)-3(c)(8).

(38) Example 38. Character and source of recapture income—(i) Facts. (A) P owns FBX. In year 1, the items of income, gain, deduction, and loss that are attributable to FBX for purposes of determining whether it has a dual consolidated loss are as follows:

Table 2 to paragraph (c)(38)(i)(A)

Sales income | $100x

Salary expense | ($75x)

Interest expense | ($50x)

Dual consolidated loss | ($25x)

(B) P makes a domestic use election with respect to the year 1 dual consolidated loss attributable to FBX and, thus, the $25x dual consolidated loss is used to offset the P group's consolidated taxable income.

(C) Pursuant to § 1.861-8, the $75x of salary expense incurred by FBX is allocated and apportioned entirely to foreign source general limitation income. Pursuant to § 1.861-9T, $25x of the $50x interest expense attributable to FBX is allocated and apportioned to domestic source income, $15x of such interest expense is allocated and apportioned to foreign source general limitation income, and the remaining $10x of such interest expense is allocated and apportioned to foreign source passive income.

(D) During year 2, $5x of income is attributable to FBX under the rules of § 1.1503(d)-5, and the P consolidated group has $100x of consolidated taxable income. At the end of year 2, FBX undergoes a triggering event described in § 1.1503(d)-6(e)(1), and P continues to own FBX following the triggering event. Pursuant to § 1.1503(d)-6(h)(2)(i), P is able to demonstrate to the satisfaction of the Commissioner that the $25x dual consolidated loss attributable to FBX in year 1 would have offset the $5x of income attributable to FBX in year 2, if no domestic use election were made with respect to the year 1 loss such that it was subject to the limitations of § 1.1503(d)-4(b) and (c).

(ii) Result. P must recapture and report as ordinary income $20x ($25x − $5x) of FBX's year 1 dual consolidated loss, plus applicable interest. The $20x recapture income is attributable to FBX pursuant to § 1.1503(d)-5(c)(4)(vi). Pursuant to § 1.1503(d)-6(h)(5), the recapture income is treated as ordinary income whose source and character (including section 904 separate limitation character) is determined by reference to the manner in which the recaptured items of expense or loss taken into account in calculating the dual consolidated loss were allocated and apportioned. Further, pursuant to § 1.1503(d)-6(h)(5), the pro rata computation described in § 1.1503(d)-4(c)(4) shall apply. Thus, the character and source of the recapture income is determined in the same proportion as each item of deduction or loss that contributed to the dual consolidated loss being recaptured. Accordingly, P's $20x of recapture income is characterized and sourced as follows: $4x of domestic source income (($25x/$125x) × $20x); $14.4x of foreign source general limitation income (($75x + $15x)/$125x) × $20x); and $1.6x of foreign source passive income (($10x/$125x) × $20x). Pursuant to § 1.1503(d)-6(h)(6)(i), commencing in year 3, the $20x recapture amount is reconstituted and treated as a net operating loss incurred by FBX in a separate return limitation year, subject to the limitation under § 1.1503(d)-4(b) (and therefore subject to the restrictions of § 1.1503(d)-4(c)). Pursuant to § 1.1503(d)-6(j)(1)(iii), the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss of FBX is terminated and has no further effect.

(39) Example 39. Interest charge without recapture—(i) Facts. P owns DE1X which, in turn, owns FBX. P's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, a dual consolidated loss of $100x is attributable to P's Country X separate unit. P makes a domestic use election with respect to such loss and uses the loss to offset the P group's consolidated taxable income. In year 2, there is $100x of income attributable to P's Country X separate unit and the P consolidated group has $200x of consolidated taxable income. At the end of year 2, the Country X separate unit undergoes a triggering event within the meaning of § 1.1503(d)-6(e)(1). P demonstrates, to the satisfaction of the Commissioner, that if no domestic use election were made with respect to the year 1 dual consolidated loss such that it was subject to the limitations of § 1.1503(d)-4(b) and (c), the year 1 $100x dual consolidated loss would have been offset by the $100x of year 2 income.

(ii) Result. There is no recapture of the year 1 dual consolidated loss attributable to P's Country X separate unit because it is reduced to zero under § 1.1503(d)-6(h)(2)(i). However, P is liable for one year of interest charge under § 1.1503(d)-6(h)(1)(ii), even though P's recapture amount is zero. This is the case because the P consolidated group had the benefit of the dual consolidated loss in year 1, and the income that offset the recapture income was not recognized until year 2. Pursuant to § 1.1503(d)-6(j)(1)(iii), the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss is terminated and has no further effect.

(40) Example 40. Reduced recapture and interest charge, and reconstituted dual consolidated loss—(i) Facts. S owns DE1X which, in turn, owns FBX. S's interest in DE1X and its indirect interest in FBX are combined and treated as a single separate unit (Country X separate unit) pursuant to § 1.1503(d)-1(b)(4)(ii). In year 1, there is a $100x dual consolidated loss attributable to S's Country X separate unit, and P earns $100x. P makes a domestic use election with respect to the Country X separate unit's year 1 dual consolidated loss. Therefore, the consolidated group is permitted to offset P's $100x of income with the Country X separate unit's $100x dual consolidated loss. In year 2, $30x of income is attributable to the Country X separate unit under the rules of § 1.1503(d)-5 and such income is offset by a $30x net operating loss incurred by P in such year. In year 3, $25x of income is attributable to the Country X separate unit under the rules of § 1.1503(d)-5, and P earns $15x of income. In addition, at the end of year 3 there is a foreign use of the year 1 dual consolidated loss that constitutes a triggering event. S continues to own the Country X separate unit after the triggering event.

(ii) Result. (A) Under the presumptive rule of § 1.1503(d)-6(h)(1)(i), S must recapture $100x (plus applicable interest). However, under § 1.1503(d)-6(h)(2)(i), S may be able to demonstrate that a lesser amount is subject to recapture. The lesser amount is the amount of the $100x dual consolidated loss that would have remained subject to § 1.1503(d)-4(c) at the time of the foreign use triggering event if a domestic use election had not been made for such loss.

(B) Although the combined separate unit earned $30x of income in year 2, there was no consolidated taxable income in such year. As a result, as of the end of year 2 the $100x dual consolidated loss would continue to be subject to § 1.1503(d)-4(c) if a domestic use election had not been made for such loss. However, the $30x earned in year 2 can be carried forward to subsequent taxable years and may reduce the recapture income to the extent of consolidated taxable income generated in subsequent years. In year 3, $25x of income was attributable to the Country X separate unit and P earns $15x of income. Thus, the P consolidated group has $40x of consolidated taxable income in year 3. As a result, the $100x of recapture income can be reduced by $40x. This is the case because if a domestic use election had not been made for the $100x year 1 dual consolidated loss such that it was subject to the limitations of § 1.1503(d)-4(b) and (c), only $60x of the loss would have remained subject to such limitations at the time of the foreign use triggering event. Accordingly, if S can adequately document the lesser amount, the amount of recapture income is $60x ($100x − $40x). The $60x recapture income is attributable to the Country X separate unit pursuant to § 1.1503(d)-5(c)(4)(vi).

(C) Pursuant to § 1.1503(d)-6(h)(6)(i), commencing in year 4, the $60x recapture amount is reconstituted and treated as a net operating loss incurred by the Country X separate unit of S in a separate return limitation year, subject to the limitation under § 1.1503(d)-4(b) (and therefore subject to the restrictions of § 1.1503(d)-4(c)). The loss is only available for carryover to taxable years after year 3 (and is not available for carryback). The carryover period of the loss, for purposes of section 172(b), will start from year 1, when the dual consolidated loss that was subject to recapture was incurred. In addition, such reconstituted net operating loss is not eligible for the exceptions contained in § 1.1503(d)-6(b) through (d). Pursuant to § 1.1503(d)-6(j)(1)(iii), the domestic use agreement filed by the P consolidated group with respect to the year 1 dual consolidated loss of the Country X separate unit is terminated and has no further effect.

(iii) Alternative facts. The facts are the same as in paragraph (c)(40)(i) of this section, except that the triggering event that occurs at the end of year 3 is a sale by S of its entire interest in DE1X to B, an unrelated domestic corporation. The sale does not qualify as a transaction described in section 381. The results are the same as in paragraph (c)(40)(ii) of this section, except that pursuant to § 1.1503(d)-6(h)(6)(ii) the $60x net operating loss is not reconstituted (with respect to either S or B). The loss is not reconstituted with respect to S because the Country X separate unit ceases to be a separate unit of S (or any other member of the consolidated group that includes S) and therefore would have been eliminated pursuant to § 1.1503(d)-4(d)(1)(ii) if no domestic use election had been made with respect to such loss. The loss is not reconstituted with respect to B because B was not the domestic owner of the combined separate unit when the dual consolidated loss that is recaptured was incurred, and B did not acquire the Country X separate unit in a section 381 transaction.

(41) Example 41. Domestic consenting corporation—treated as dual resident corporation—(i) Facts. FSZ1, a Country Z entity that is subject to Country Z tax on its worldwide income or on a residence basis and is classified as a foreign corporation for U.S. tax purposes, owns all the interests in DCC, a domestic eligible entity that has filed an election to be classified as an association. Under Country Z tax law, DCC is fiscally transparent. For taxable year 1, DCC's only item of income, gain, deduction, or loss is a $100x deduction and such deduction comprises a $100x net operating loss of DCC. For Country Z tax purposes, FSZ1's only item of income, gain, deduction, or loss, other than the $100x loss attributable to DCC, is $60x of operating income.

(ii) Result. DCC is a domestic consenting corporation because by electing to be classified as an association, it consents to be treated as a dual resident corporation for purposes of section 1503(d). See § 301.7701-3(c)(3) of this chapter. For taxable year 1, DCC is treated as a dual resident corporation under § 1.1503(d)-1(b)(2)(iii) because FSZ1 (a specified foreign tax resident that bears a relationship to DCC that is described in section 267(b) or 707(b)) derives or incurs items of income, gain, deduction, or loss of DCC. See § 1.1503(d)-1(c). FSZ1 derives or incurs items of income, gain, deduction, or loss of DCC because, under Country Z tax law, DCC is fiscally transparent. Thus, DCC has a $100x dual consolidated loss for taxable year 1. See § 1.1503(d)-1(b)(5). Because the loss is available to, and in fact does, offset income of FSZ1 under Country Z tax law, there is a foreign use of the dual consolidated loss in year 1. Accordingly, the dual consolidated loss is subject to the domestic use limitation rule of § 1.1503(d)-4(b). The result would be the same if FSZ1 were to indirectly own its DCC stock through an intermediate entity that is fiscally transparent under Country Z tax law, or if an individual were to wholly own FSZ1 and FSZ1 were a disregarded entity. In addition, the result would be the same if FSZ1 had no items of income, gain, deduction, or loss, other than the $100x loss attributable to DCC.

(iii) Alternative facts—DCC not treated as a dual resident corporation. The facts are the same as in paragraph (c)(41)(i) of this section, except that DCC is not fiscally transparent under Country Z tax law and thus under Country Z tax law FSZ1 does not derive or incur items of income, gain, deduction, or loss of DCC. Accordingly, DCC is not treated as a dual resident corporation under § 1.1503(d)-1(b)(2)(iii) for year 1 and, consequently, its $100x net operating loss in that year is not a dual consolidated loss.

(iv) Alternative facts—mirror legislation. The facts are the same as in paragraph (c)(41)(i) of this section, except that, under provisions of Country Z tax law that constitute mirror legislation under § 1.1503(d)-3(e)(1) and that are substantially similar to the recommendations in Chapter 6 of OECD/G-20, Neutralising the Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report (October 2015), Country Z tax law prohibits the $100x loss attributable to DCC from offsetting FSZ1's income that is not also subject to U.S. tax. As is the case in paragraph (c)(41)(ii) of this section, DCC is treated as a dual resident corporation under § 1.1503(d)-1(b)(2)(iii) for year 1 and its $100x net operating loss is a dual consolidated loss. Pursuant to § 1.1503(d)-3(e)(3), however, the dual consolidated loss is not deemed to be put to a foreign use by virtue of the Country Z mirror legislation. Therefore, DCC is eligible to make a domestic use election for the dual consolidated loss.

(42) Example 42. Disregarded payment loss rules—triggering event resulting in DPL inclusion amount and suspended deduction—(i) Facts. P owns DE1X, and DE1X owns FSX. In year 1, DE1X pays $100x to P pursuant to a note. For U.S. tax purposes, the payment is disregarded as a transaction between DE1X and P, but if the payment were regarded it would be interest within the meaning of § 1.267A-5(a)(12). Under Country X tax law, the $100x is interest for which DE1X is allowed a deduction in year 1. In year 1, pursuant to a Country X group relief regime, DE1X's $100x deduction is made available to offset income of FSX. At the end of year 1, DE1X extinguishes the note by repaying the outstanding principal. In year 2, P enters into a licensing arrangement with DE1X pursuant to which P makes a $60x payment to DE1X in each of years 2 and 3. For U.S. tax purposes, the payment is disregarded as a transaction between DE1X and P, but if the payment were regarded it would be a royalty within the meaning of § 1.267A-5(a)(16). Under Country X tax law, the $60x is a royalty and included in the income of DE1X in years 2 and 3.

(ii) Result.—(A) Year 1. Because P owns all of the interests in DE1X, a disregarded entity, P is a DPE owner. See § 1.1503(d)-1(d)(1). In addition, DE1X, a disregarded payment entity with respect to P, incurs a $100x disregarded payment loss with respect to its Country X taxable year for year 1. See § 1.1503(d)-1(d)(5)(i)(A) and (d)(5)(ii)(B). DE1X's $100x deduction being made available to offset income of FSX pursuant to the Country X group relief regime constitutes a foreign use of, and thus a triggering event with respect to, the disregarded payment loss during the DPL certification period. See § 1.1503(d)-1(d)(3)(i) and (d)(5)(iii). As a result, in year 1, P must include in gross income $100x, the DPL inclusion amount with respect to the disregarded payment loss. See § 1.1503(d)-1(d)(1) and (d)(2)(i). The $100x DPL inclusion amount is treated for U.S. tax purposes as ordinary interest income, the source and character of which is determined as if DE1X were a foreign corporation, and the amount were interest income paid by the foreign corporation to P. See § 1.1503(d)-1(d)(2)(iv)(A). The result would be the same if DE1X recognized income in year 1 that was regarded for both U.S. and Country X tax purposes, or if P made payments (other than interest, structured payments, or royalties) to DE1X that were disregarded for U.S. tax purposes but regarded for Country X tax purposes. See § 1.1503(d)-1(d)(3)(i) (describing the application of the principles of the deemed ordering rule in § 1.1503(d)-3(c)(3)).

(B) Years 2 and 3. In year 2, P establishes a suspended deduction of $100x related to the year 1 DPL inclusion amount. See § 1.1503(d)-1(d)(1) and (d)(2)(ii). In each of years 2 and 3, DE1X derives $60x of disregarded payment income with respect to its Country X taxable year. See § 1.1503(d)-1(d)(5)(ii)(A). For year 2, P is allowed a $60x deduction with respect to the suspended deduction, and $40x remains suspended. See § 1.1503(d)-1(d)(2)(ii). For year 3, P is allowed a $40x deduction with respect to the suspended deduction. See id. Thus, in years 2 and 3 P is allowed a $60x deduction and $40x deduction, respectively, with respect to the suspended deduction relating to the year 1 DPL inclusion amount. The deductions are treated as interest deductions the source and character of which are determined in the same manner as the income for the DPL inclusion amount to which they relate. See § 1.1503(d)-1(d)(2)(iv)(B). At the end of year 3, the DPL cumulative register is $20x (that is, the $120x of disregarded payment income for years 2 and 3, less the $100 of DPL cumulative register that is used under § 1.1503(d)-1(d)(2)(ii) in years 2 and 3). See § 1.1503(d)-1(d)(2)(iii).

(43) Example 43. Income from U.S. business operations to avoid the purposes of the dual consolidated loss rules—(i) Facts. P owns DE1X. DE1X owns FSX. DE1X and FSX file a consolidated tax return for Country X tax purposes such that deductions and losses of DE1X are available to offset income of FSX. P conducts business operations in the United States that are expected to generate items of income or gain (U.S. business operations). With a view to avoid the purposes of the rules under §§ 1.1503(d)-1 through 1.1503(d)-8 by eliminating what would otherwise be a dual consolidated loss and obtaining a double deduction outcome, P transfers the U.S. business operations to DE1X. But for P's items of income or gain from the U.S. business operations (held indirectly through DE1X), there would be a dual consolidated loss attributable to P's interest in DE1X and a foreign use of that dual consolidated loss (as a result of the Country X consolidation regime). For purposes of determining taxable income under the income tax laws of Country X, items of income, gain, deduction, and loss attributable to a permanent establishment (or similar taxable presence) in another country, which would include the U.S. business operations, are not taken into account.

(ii) Result. Because P transferred the U.S. business operations to DE1X with a view to avoid the purposes of the rules under §§ 1.1503(d)-1 through 1.1503(d)-8, and the transfer would otherwise result in a double deduction outcome (that is, in effect putting DE1X's items of deduction or loss that would compose a dual consolidated loss to both a domestic use and a foreign use), the anti-avoidance rule in § 1.1503(d)-1(f)(1) applies. As a result, the income or gain that P takes into account from the U.S. business operations (held indirectly through DE1X) is not taken into account for purposes of determining the amount of income or dual consolidated loss attributable to P's interest in DE1X under § 1.1503(d)-5(c). The result would be the same if, instead of the income tax laws of Country X not taking into account the items of income, gain, deduction, and loss attributable to a permanent establishment (or similar taxable presence) in another country for purposes of determining taxable income, the income tax laws of Country X took such items into account for this purpose but provided a foreign tax credit with respect to taxes paid on the taxable income determined by taking such items into account.

(44) Example 44. Disallowed interest deductions—(i) Facts. P owns S. S owns DE1X, a disregarded entity and, thus, is a DPE owner. See § 1.1503(d)-1(d)(1). DE1X owns FSX. DE1X and FSX file a consolidated tax return for Country X tax purposes such that deductions and losses of DE1X are available to offset income of FSX. With a view to avoid the purposes of the rules under §§ 1.1503(d)-1 through 1.1503(d)-8, and obtain a double deduction or similar outcome, P transfers cash to DE1X in exchange for an interest-bearing note. Under the terms of the note, payments of interest are made in cash or, at the option of DE1X, in stock of S. In year 1, DE1X accrues $100x of interest expense under the note. The taxpayer takes the position that for U.S. tax purposes, the interest expense deductions are disallowed under section 163(l) because DE1X has the option to pay the interest with S stock. Further, because S's interest expense deductions on the note held by P are disallowed, the taxpayer takes the position that P's interest income on the loan is treated as tax-exempt income under the intercompany transaction rules in § 1.1502-13. In year 1, DE1X is allowed a $100x interest expense deduction for Country X tax purposes; the $100x deduction is available to offset FSX's income for Country X tax purposes.

(ii) Result. DE1X issued the note to P in exchange for cash with a view to avoid the purposes of §§ 1.1503(d)-1 through 1.1503(d)-8. Moreover, under the taxpayer's position, the issuance would otherwise result in a double deduction or similar outcome (that is, a foreign use of DE1X's $100x interest expense deduction where P does not recognize a corresponding income inclusion for U.S. tax purposes). Accordingly, the anti-avoidance rule in § 1.1503(d)-1(f)(1) applies. As a result, adjustments are made such that the $100x interest expense deduction is treated as a disregarded payment loss of DE1X, a disregarded payment entity. This is the case even though the $100x interest payment is not disregarded for U.S. tax purposes as a transaction between a disregarded entity and its tax owner or between disregarded entities with the same tax owner under § 1.1503(d)-1(d)(5)(ii)(C)(2). Because the $100x disregarded payment loss is made available under the Country X consolidation regime to offset income of FSX, a foreign corporation, a foreign use triggering event (within the meaning of § 1.1503(d)-1(d)(3)(i)) occurs. As a result, S includes in income a $100x DPL inclusion amount in year 1 and establishes a suspended deduction of $100x in year 2. See § 1.1503(d)-1(d)(1), (d)(2)(i), and (d)(2)(ii).

(45) Example 45. Restructuring to avoid the application of the DPL rules—(i) Facts. P owns DE1X and S. DE1X owns FSX. DE1X and FSX file a consolidated tax return for Country X tax purposes such that deductions and losses of DE1X are available to offset income of FSX. P holds an interest-bearing note issued by DE1X. For U.S. tax purposes, interest accrued and paid on the note is disregarded. For Country X tax purposes, DE1X is allowed a $100x interest expense deduction each year for interest accrued under the note. At the end of year 1, and with a view to avoid the application of the disregarded payment loss rules under § 1.1503(d)-1(d) in year 2, P transfers the note to S. In year 2, DE1X is allowed a $100x interest expense deduction for Country X tax purposes. For U.S. tax purposes, the $100x interest expense deduction in year 2 gives rise to a dual consolidated loss attributable to P's interest in DE1X, a hybrid entity separate unit, and that loss is subject to the domestic use limitation rule of § 1.1503(d)-4(b).

(ii) Result. Although P transferred the note to S with a view to avoid the application of the disregarded payment loss rules under § 1.1503(d)-1(d), the anti-avoidance rule in § 1.1503(d)-1(f)(1) does not apply with respect to the transfer. This is because the resulting year 2 $100x dual consolidated loss is subject to the domestic use limitation rule of § 1.1503(d)-4(b) (or the terms of a domestic use agreement, if a domestic use election were to be made) and thus cannot be put to both a domestic use and a foreign use (that is, it does not result in a double deduction or similar outcome). The same result would obtain if, instead of P transferring the note to S at the end of year 1, DE1X extinguished the note at the end of year 1 such that there are no disregarded payments in year 2 and, thus, no double non-taxation outcome.

(iii) Alternative facts. The facts are the same as in paragraph (c)(45)(i) of this section, except that P does not transfer the note to S in year 1. Instead, with a view to prevent a foreign use of a disregarded payment loss attributable to DE1X, at the end of year 1 FSX distributes all its property to DE1X in a complete liquidation described in section 332. The anti-avoidance rule in § 1.1503(d)-1(f)(1) does not apply because the disregarded payment loss is not put to a foreign use (that is, there is no double deduction or similar outcome).

(46) Example 46. Disregarded payment loss rules—scope—(i) Facts. P owns DE1X. DE1X owns FBZ. FBZ is a foreign branch, within the meaning of § 1.1503(d)-1(d)(5)(iv), located in Country Z. DE1X makes a $10x payment to P, which, under the laws of Country Z, gives rise to a $10x deduction allowable to FBZ. If such payment were regarded for U.S. tax purposes, it would be interest within the meaning of § 1.267A-5(a)(12). In addition, under the laws of Country Z, FBZ is allowed a $60x interest deduction for an accrual or other transaction between FBZ and DE1X, and if such item were regarded for U.S. tax purposes, it would be interest within the meaning of § 1.267A-5(a)(12).

(ii) Result. P is a DPE owner because it owns DE1X, a disregarded entity. See § 1.1503(d)-1(d)(1). As such, P determines disregarded payment income or disregarded payment loss of DE1X, a disregarded payment entity described in § 1.1503(d)-1(d)(5)(i)(A), and of FBZ, a disregarded payment entity described in § 1.1503(d)-1(d)(5)(i)(B). See § 1.1503(d)-1(d)(1). The payment from DE1X to P is disregarded for U.S. tax purposes as a transaction between a disregarded entity (DE1X) and its tax owner (P) and therefore satisfies the condition in § 1.1503(d)-1(d)(5)(ii)(C)(2). The payment also satisfies the conditions described in § 1.1503(d)-1(d)(5)(ii)(C)(1) and (3) because FBZ is allowed a deduction under Country Z law for a payment that, if regarded for U.S. tax purposes, would be interest within the meaning of § 1.267A-5(a)(12). As such, the $10x deduction attributable to the payment from DE1X to P is taken into account in determining whether FBZ has disregarded payment income or a disregarded payment loss under § 1.1503(d)-1(d)(5)(ii)(A) and (B), respectively. The $60x item of deduction allowed to FBZ, however, does not satisfy the condition described in § 1.1503(d)-1(d)(5)(ii)(C)(2), because the accrual or other transaction giving rise to the deduction is not between a disregarded entity and its tax owner (here, P), or between disregarded entities with the same tax owner. Accordingly, the $60x item of deduction is not taken into account in determining whether FBZ has disregarded payment income or a disregarded payment loss. The result would be the same with respect to the $60x deduction allowed to FBZ under the laws of Country Z if, instead of P owning FBZ indirectly through DE1X, P owned FBZ directly and the accrual or other transaction giving rise to the deduction is between FBZ and P.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007; 72 FR 20424, Apr. 25, 2007, as amended by T.D. 9896, 85 FR 19855, Apr. 8, 2020; 85 FR 48651, Aug. 12, 2020; T.D. 10026, 90 FR 3018, Jan. 14, 2025]

§ 1.1503(d)-8 Applicability dates.

(a) General rule. Except as provided in paragraph (b) of this section, this paragraph (a) provides the dates of applicability of §§ 1.1503(d)-1 through 1.1503(d)-7. Sections 1.1503(d)-1 through 1.1503(d)-7 apply to dual consolidated losses incurred in taxable years beginning on or after April 18, 2007. However, a taxpayer may apply §§ 1.1503(d)-1 through 1.1503(d)-7, in their entirety, to dual consolidated losses incurred in taxable years beginning on or after January 1, 2007, by filing its return and attaching to such return the domestic use agreements, certifications, or other information in accordance with these regulations. For purposes of this section, the term application date means either April 18, 2007, or, if the taxpayer applies these regulations pursuant to the preceding sentence, January 1, 2007. Section 1.1503-2, as contained in 26 CFR part 1, revised as of April 1, 2024, applies for dual consolidated losses incurred in taxable years beginning on or after October 1, 1992, and before the application date.

(b) Special rules—

(1)-(2) [Reserved]

(3) Relief for untimely filings. Paragraphs (b)(3)(i) through (iii) of this section set forth the effective dates for rules that provide relief for the failure to make timely filings of an election, agreement, statement, rebuttal, computation, closing agreement, or other information, pursuant to section 1503(d) and these regulations.

(i) General rule. Except as provided in paragraphs (b)(3)(ii) and (iii) of this section, the reasonable cause relief standard of § 1.1503(d)-1(d) applies for all untimely filings with respect to dual consolidated losses, including with respect to dual consolidated losses incurred in taxable years beginning before the application date.

(ii)-(iii) [Reserved]

(4) [Reserved]

(5) Basis adjustment rules. Taxpayers may apply the basis adjustment rules of § 1.1503(d)-5(g) for all open years in which such basis is relevant, even if the basis adjustment is attributable to a dual consolidated loss incurred (or recaptured) in a closed taxable year. Taxpayers applying the provisions of § 1.1503(d)-5(g), however, must do so consistently for all open years.

(6) Rules regarding domestic consenting corporations. Section 1.1503(d)-1(b)(2)(iii) and (c), as well § 1.1503(d)-3(e)(1) and (3), apply to determinations under §§ 1.1503(d)-1 through 1.1503(d)-7 relating to taxable years ending on or after December 20, 2018. For taxable years ending before December 20, 2018, see § 1.1503(d)-3(e)(1) as contained in 26 CFR part 1 revised as of April 1, 2018.

(7) Compulsory transfer triggering event exception. Section 1.1503(d)-6(f)(5)(i) through (iii) applies to transfers that occur on or after December 20, 2018. For transfers occurring before December 20, 2018, see § 1.1503(d)-6(f)(5)(i) through (iii) as contained in 26 CFR part 1 revised as of April 1, 2018. However, taxpayers may consistently apply § 1.1503(d)-6(f)(5)(i) through (iii) to transfers occurring before December 20, 2018.

(8) Rule providing that SRLY limitation applies without regard to § 1.1502-21(c)(1)(i)(E). Section 1.1503(d)-4(c)(3)(v) applies to any period to which § 1.1502-21(c)(1)(i)(E) applies.

(9)-(10) [Reserved]

(11) Disregarded payment loss rules. Section 1.1503(d)-1(d) applies to taxable years beginning on or after January 1, 2026. See also § 301.7701-2(e)(10) of this chapter (applicability dates for the entity classification provisions relevant to the disregarded payment loss rules).

(12)-(14) [Reserved]

(15) Anti-avoidance rule. Section 1.1503(d)-1(f) applies to dual consolidated losses incurred in taxable years ending on or after August 6, 2024, and to disregarded payment losses in taxable years beginning on or after January 1, 2026.

(16) [Reserved].

(17) Deemed ordering rule. Section 1.1503(d)-3(c)(3) applies to dual consolidated losses incurred in taxable years beginning on or after January 1, 2026, and to disregarded payment losses in taxable years beginning on or after January 1, 2026. For the application of the deemed ordering rule to dual consolidated losses incurred in taxable years beginning before January 1, 2026, but on or after April 18, 2007, see § 1.1503(d)-3(c)(3) as contained in 26 CFR part 1 revised as of April 1, 2024.

[T.D. 9315, 72 FR 12914, Mar. 19, 2007; 72 FR 20424, Apr. 25, 2007, as amended by T.D. 9896, 85 FR 19856, Apr. 8, 2020; T.D. 9927, 85 FR 67988, Oct. 27, 2020; T.D. 10018, 89 FR 106878, Dec. 30, 2024; T.D. 10026, 90 FR 3020, Jan. 14, 2025]

§ 1.1504-0 Outline of provisions.

In order to facilitate the use of §§ 1.1504-1 through 1.1504-4, this section lists the captions contained in §§ 1.1504-1 through 1.1504-4.

§ 1.1504-1 Definitions. §§ 1.1504-2—1.1504-3 [Reserved] § 1.1504-4 Treatment of warrants, options, convertible obligations, and other similar interests.

(a) Introduction.

(1) General rule.

(2) Exceptions.

(b) Options not treated as stock or as exercised.

(1) General rule.

(2) Options treated as exercised.

(i) In general.

(ii) Aggregation of options.

(iii) Effect of treating option as exercised.

(A) In general.

(B) Cash settlement options, phantom stock, stock appreciation rights, or similar interests.

(iv) Valuation.

(3) Example.

(1) Issuing corporation.

(2) Related or sequential option.

(3) Related persons.

(4) Measurement date.

(i) General rule.

(ii) Issuances, transfers, or adjustments not treated as measurement dates.

(iii) Transactions increasing likelihood of exercise.

(iv) Measurement date for options issued pursuant to a plan.

(v) Measurement date for related or sequential options.

(vi) Example.

(5) In-the-money.

(d) Options.

(1) Instruments treated as options.

(2) Instruments generally not treated as options.

(i) Options on section 1504(a)(4) stock.

(ii) Certain publicly traded options.

(A) General rule.

(B) Exception.

(iii) Stock purchase agreements.

(iv) Escrow, pledge, or other security agreements.

(v) Compensatory options.

(A) General rule.

(B) Exceptions.

(vi) Options granted in connection with a loan.

(vii) Options created pursuant to a title 11 or similar case.

(viii) Convertible preferred stock.

(ix) Other enumerated instruments.

(e) Elimination of federal income tax liability.

(f) Substantial amount of federal income tax liability.

(g) Reasonable certainty of exercise.

(1) Generally.

(i) Purchase price.

(ii) In-the-money option.

(iii) Not in-the-money option.

(iv) Exercise price.

(v) Time of exercise.

(vi) Related or sequential options.

(vii) Stockholder rights.

(viii) Restrictive covenants.

(ix) Intention to alter value.

(x) Contingencies.

(2) Cash settlement options, phantom stock, stock appreciation rights, or similar interests.

(3) Safe harbors.

(i) Options to acquire stock.

(ii) Options to sell stock.

(iii) Options exercisable at fair market value.

(iv) Exceptions.

(v) Failure to satisfy safe harbor.

(h) Examples.

(i) Effective date.

[T.D. 8462, 57 FR 61800, Dec. 29, 1992]

§ 1.1504-1 Definitions.

The privilege of filing consolidated returns is extended to all includible corporations constituting affiliated groups as defined in section 1504. See the regulations under § 1.1502 for a description of an affiliated group and the corporations which may be considered as includible corporations.

[T.D. 6500, 25 FR 12106, Nov. 26, 1960]

§ 1.1504-2 [Reserved]

§ 1.1504-3 Treatment of stock in a QOF C corporation for purposes of consolidation.

(a) Scope and definitions—(1) Scope. This section provides rules regarding the treatment of stock in a QOF C corporation for purposes of determining whether such corporation can join in the filing of a consolidated return. Paragraph (b) of this section generally prevents a subsidiary QOF C corporation from joining in the filing of a consolidated return, but it provides an election to consolidate a subsidiary QOF C corporation (subject to certain conditions). Paragraph (c) of this section provides instructions for making the election provided by paragraph (b) of this section. Paragraph (d) of this section provides an example. Paragraph (e) of this section provides the applicability dates.

(2) Definitions. The definitions provided in §§ 1.1400Z2(a)-1(b) and 1.1502-14Z(a)(2)(ii) apply for purposes of this section.

(b) QOF stock not stock for purposes of consolidation—(1) In general. Except as otherwise provided in paragraph (b)(2) of this section, stock in a QOF C corporation (whether qualifying QOF stock or otherwise) is not treated as stock under section 1504 for purposes of determining whether any corporation may join in the filing of a consolidated return under section 1501. Therefore, a QOF C corporation can be the common parent of a consolidated group, and a QOF C corporation generally can be a member of an affiliated group for purposes of section 1504, but a QOF C corporation cannot join in the filing of a consolidated return as a subsidiary member (except as provided in paragraph (b)(2) of this section).

(2) Election to consolidate a subsidiary QOF C corporation—(i) In general. Notwithstanding paragraph (b)(1) of this section, a consolidated group may elect to consolidate a subsidiary QOF C corporation that was formed, or section 1504 control of which was acquired, by the consolidated group after May 1, 2019, and that otherwise meets the affiliation requirements under section 1504. If a pre-existing corporation was a member of the consolidated group prior to becoming a QOF C corporation, a consolidated group may elect to continue to consolidate such pre-existing corporation if it self-certified to be a QOF after May 1, 2019. The consolidated group must make the election under this paragraph (b)(2) with regard to the first taxable year during which the subsidiary QOF C corporation otherwise meets the section 1504 affiliation requirements (without regard to paragraph (b)(1) of this section). See § 1.1502-14Z(f)(3) for an election available with regard to a subsidiary QOF C corporation that met the section 1504 affiliation requirements as of May 1, 2019. The election under this paragraph (b)(2) is effective on the later of May 1, 2019, or the first date on which the QOF C corporation otherwise meets the requirements of section 1504. If a consolidated group makes the election under this paragraph (b)(2), then the conditions in paragraph (b)(2)(ii) of this section apply to the consolidated group and to the QOF member. See paragraph (c) of this section for the form and manner of making this election.

(ii) Conditions to consolidate a subsidiary QOF C corporation—(A) Ownership status of QOF investor member. On and at all times after the date of the investment, the common parent must directly or indirectly own all shares of all classes of stock (including non-qualified preferred stock) issued by any QOF investor member.

(B) Direct investment. Except as provided in § 1.1502-14Z(c), each QOF investor member must maintain direct ownership of its qualifying investment (see, for example, § 1.1400Z2(b)-1(c), which generally treats transfers of a qualifying investment as an inclusion event). See § 1.1502-14Z(c)(4) for rules regarding the treatment of intercompany transfers as qualifying investments in a QOF member. See also § 1.1502-14Z(c)(2) and (c)(3)(ii) for rules regarding actual and deemed intercompany transfers of qualifying investments.

(3) Failure of continued qualification. Consolidation of a subsidiary QOF C corporation is contingent upon continued satisfaction of all of the conditions of paragraph (b)(2)(ii) of this section. The requirements of paragraph (b)(2) of this section continue to apply (with appropriate modifications to reflect single-entity treatment) following any intercompany transfer of the QOF member stock that is subject to § 1.1502-14Z(c)(3)(ii). For example, following an intercompany transfer of the QOF member stock that is subject to § 1.1502-14Z(c)(3)(ii), the buying member must maintain a direct investment in the QOF member. On the failure to satisfy any condition of paragraph (b)(2), the QOF member will deconsolidate, and § 1.1502-14Z(g) will apply with respect to such deconsolidation.

(c) Election under paragraph (b)(2) of this section to consolidate a subsidiary QOF C corporation—(1) In general. The election under paragraph (b)(2) of this section is irrevocable and is made in the form provided in paragraph (c)(2) of this section.

(2) Form of election. The election under paragraph (b)(2) of this section must be made in the form of a statement titled “THIS IS AN ELECTION UNDER § 1.1504-3(b)(2) TO CONSOLIDATE [insert name and employer identification number (E.I.N.) of subsidiary QOF C corporation] as of [insert date].” The statement must be included with the consolidated group's timely filed return (original, superseding, or amended return, as applicable, including extensions) for the year the election under § 1.1504-3(b)(2) is made.

(d) Example. The following example illustrates the treatment of QOF stock as not stock for purposes of affiliation as described in paragraph (b)(1) of this section.

(1) QOF stock as not stock for purposes of affiliation to join in the filing of a consolidated return—(i) Facts. P wholly owns S, which wholly owns corporation Q1. P, S, and Q1 are members of the P group. In 2021, S sells an asset to an unrelated party and realizes $500x of eligible gain. S contributes $500x to Q1 and properly elects to defer the eligible gain under section 1400Z-2(a) and § 1.1400Z2(a)-1. At such time, Q1 qualifies and elects to be treated as a QOF, but the P group does not elect to consolidate Q1 under paragraph (b)(2) of this section.

(ii) Analysis. Under paragraph (b)(1) of this section, stock of a QOF C corporation (qualifying or otherwise) is not treated as stock for purposes of determining whether the QOF C corporation may join in the filing of a consolidated return. Thus, because no election has been made under paragraph (b)(2) of this section, once Q1 becomes a QOF, Q1 ceases to be affiliated with the P group members for purposes of section 1501, and it deconsolidates from the P group. See the consolidated return regulations generally for the consequences of deconsolidation.

(2) [Reserved]

(e) Applicability dates—(1) In general. This section applies for taxable years beginning after March 13, 2020.

(2) Prior periods. With respect to the portion of a consolidated group's first taxable year ending after December 21, 2017, and for taxable years beginning after December 21, 2017, and on or before March 13, 2020, a consolidated group may choose either—

(i) To apply the section 1400Z-2 regulations, if applied in a consistent manner for all such taxable years; or

(ii) To rely on the rules in proposed § 1.1400Z2(g)-1 contained in the notice of proposed rulemaking (REG-120186-18) published on May 1, 2019, but only if applied in a consistent manner for all such taxable years.

[T.D. 9889, 85 FR 2000, Jan. 13, 2020; 85 FR 19086, Apr. 6, 2020; T.D. 10018, 89 FR 106878, Dec. 30, 2024]

§ 1.1504-4 Treatment of warrants, options, convertible obligations, and other similar interests.

(a) Introduction—(1) General rule. This section provides regulations under section 1504(a)(5) (A) and (B) regarding the circumstances in which warrants, options, obligations convertible into stock, and other similar interests are treated as exercised for purposes of determining whether a corporation is a member of an affiliated group. The fact that an instrument may be treated as an option under these regulations does not prevent such instrument from being treated as stock under general principles of law. Except as provided in paragraph (a)(2) of this section, this section applies to all provisions under the Internal Revenue Code and the regulations to which affiliation within the meaning of section 1504(a) (with or without the exceptions in section 1504(b)) is relevant, including those provisions that refer to section 1504(a)(2) (with or without the exceptions in section 1504(b)) without referring to affiliation, provided that the 80 percent voting power and 80 percent value requirements of section 1504(a)(2) are not modified therein.

(2) Exceptions. This section does not apply to sections 864(e) or 904(i) or to the regulations thereunder. This section also does not apply to any other provision specified by the Internal Revenue Service in regulations, a revenue ruling, or revenue procedure. See § 601.601(d)(2)(ii)(b) of this chapter.

(b) Options not treated as stock or as exercised—(1) General rule. Except as provided in paragraph (b)(2) of this section, an option is not considered either as stock or as exercised. Thus, options are disregarded in determining whether a corporation is a member of an affiliated group unless they are described in paragraph (b)(2) of this section.

(2) Options treated as exercised—(i) In general. Solely for purposes of determining whether a corporation is a member of an affiliated group, an option is treated as exercised if, on a measurement date with respect to such option—

(A) It could reasonably be anticipated that, if not for this section, the issuance or transfer of the option in lieu of the issuance, redemption, or transfer of the underlying stock would result in the elimination of a substantial amount of federal income tax liability (as described in paragraphs (e) and (f) of this section); and

(B) It is reasonably certain that the option will be exercised (as described in paragraph (g) of this section).

(ii) Aggregation of options. All options with the same measurement date are aggregated in determining whether the issuance or transfer of an option in lieu of the issuance, redemption, or transfer of the underlying stock would result in the elimination of a substantial amount of federal income tax liability.

(iii) Effect of treating option as exercised—(A) In general. An option that is treated as exercised is treated as exercised for purposes of determining the percentage of the value of stock owned by the holder and other parties, but is not treated as exercised for purposes of determining the percentage of the voting power of stock owned by the holder and other parties.

(B) Cash settlement options, phantom stock, stock appreciation rights, or similar interests. If a cash settlement option, phantom stock, stock appreciation right, or similar interest is treated as exercised, the option is treated as having been converted into stock of the issuing corporation. If the amount to be received upon the exercise of such an option is determined by reference to a multiple of the increase in the value of a share of the issuing corporation's stock on the exercise date over the value of a share of the stock on the date the option is issued, the option is treated as converted into a corresponding number of shares of such stock. Appropriate adjustments must be made in any situation in which the amount to be received upon exercise of the option is determined in another manner.

(iv) Valuation. For purposes of section 1504(a)(2)(B) and this section, all shares of stock within a single class are considered to have the same value. Thus, control premiums and minority and blockage discounts within a single class are not taken into account.

(3) Example. The provisions of paragraph (b)(2) of this section may be illustrated by the following example:

Example. (i) Corporation P owns all 100 shares of the common stock of Corporation S, the only class of S stock outstanding. Each share of S stock has a fair market value of $10 and has one vote. On June 30, 1992, P issues to Corporation X an option to acquire 80 shares of the S stock from P.

(ii) If, under the provisions of this section, the option is treated as exercised, then, solely for purposes of determining affiliation, P is treated as owning only 20 percent of the value of the outstanding S stock and X is treated as owing the remaining 80 percent of the value of the S stock. P is still treated as owning all of the voting power of S. Accordingly, because P is treated as owning less than 80 percent of the value of the outstanding S stock, P and S are no longer affiliated. However, because X is not treated as owning any of the voting power of S, X and S are also not affiliated.

(1) Issuing corporation. “Issuing corporation” means the corporation whose stock is subject to an option.

(2) Related or sequential option. “Related or sequential option” means an option that is one of a series of options issued to the same or related persons. For purposes of this section, any options issued to the same person or related persons within a two-year period are presumed to be part of a series of options. This presumption may be rebutted if the facts and circumstances clearly establish that the options are not part of a series of options. Any options issued to the same person or related persons more than two years apart are presumed not to be part of a series of options. This presumption may be rebutted if the facts and circumstances clearly establish that the options are part of a series of options.

(3) Related persons. Persons are related if they are related within the meaning of section 267(b) (without the application of sections 267(c) and 1563(e)(1)) or 707(b)(1), substituting “10 percent” for “50 percent” wherever it appears.

(4) Measurement date—(i) General rule. “Measurement date” means a date on which an option is issued or transferred or on which the terms of an existing option or the underlying stock are adjusted (including an adjustment pursuant to the terms of the option or the underlying stock).

(ii) Issuances, transfers, or adjustments not treated as measurement dates. A measurement date does not include a date on which—

(A) An option is issued or transferred by gift, at death, or between spouses or former spouses under section 1041;

(B) An option is issued or transferred—

(1) Between members of an affiliated group (determined with the exceptions in section 1504(b) and without the application of this section); or

(2) Between persons none of which is a member of the affiliated group (determined without the exceptions in section 1504(b) and without the application of this section), if any, of which the issuing corporation is a member, unless—

(i) Any such person is related to (or acting in concert with) the issuing corporation or any member of its affiliated group; and

(ii) The issuance or transfer is pursuant to a plan a principal purpose of which is to avoid the application of section 1504 and this section;

(C) An adjustment occurs in the terms or pursuant to the terms of an option or the underlying stock that does not materially increase the likelihood that the option will be exercised; or

(D) A change occurs in the exercise price of an option or in the number of shares that may be issued or transferred pursuant to the option as determined by a bona fide, reasonable, adjustment formula that has the effect of preventing dilution of the interests of the holders of the options.

(iii) Transactions increasing likelihood of exercise. If a change or alteration referred to in this paragraph (c)(4)(iii) is made for a principal purpose of increasing the likelihood that an option will be exercised, a measurement date also includes any date on which—

(A) The capital structure of the issuing corporation is changed; or

(B) The fair market value of the stock of the issuing corporation is altered through a transfer of assets to or from the issuing corporation (other than regular, ordinary dividends) or by any other means.

(iv) Measurement date for options issued pursuant to a plan. In the case of options issued pursuant to a plan, a measurement date for any of the options constitutes a measurement date for all options issued pursuant to the plan that are outstanding on the measurement date.

(v) Measurement date for related or sequential options. In the case of related or sequential options, a measurement date for any of the options constitutes a measurement date for all related or sequential options that are outstanding on the measurement date.

(vi) Example. The provisions of paragraph (c)(4)(v) of this section may be illustrated by the following example.

Example. (i) Corporation P owns all 80 shares of the common stock of Corporation S, the only class of S stock outstanding. On January 1, 1992, S issues a warrant, exercisable within 3 years, to U, an unrelated corporation, to acquire 10 newly issued shares of S common stock. On July 1, 1992, S issues a second warrant to U to acquire 10 additional newly issued shares of S common stock. On January 1, 1993, S issues a third warrant to T, a wholly owned subsidiary of U, to acquire 10 newly issued shares of S common stock. Assume that the facts and circumstances do not clearly establish that the options are not part of a series of options.

(ii) January 1, 1992, July 1, 1992, and January 1, 1993, constitute measurement dates for the first warrant, the second warrant, and the third warrant, respectively, because the warrants were issued on those dates.

(iii) Because the first and second warrants were issued within two years of each other, and both warrants were issued to U, the warrants constitute related or sequential options. Accordingly, July 1, 1992, constitutes a measurement date for the first warrant as well as for the second warrant.

(iv) Because the first, second, and third warrants were all issued within two years of each other, and were all issued to the same or related persons, the warrants constitute related or sequential options. Accordingly, January 1, 1993, constitutes a measurement date for the first and second warrants, as well as for the third warrant.

(5) In-the-money. “In-the-money” means the exercise price of the option is less than (or in the case of an option to sell stock, greater than) the fair market value of the underlying stock.

(d) Options—(1) Instruments treated as options. For purposes of this section, except to the extent otherwise provided in this paragraph (d), the following are treated as options:

(i) A call option, warrant, convertible obligation, put option, redemption agreement (including a right to cause the redemption of stock), or any other instrument that provides for the right to issue, redeem, or transfer stock (including an option on an option); and

(ii) A cash settlement option, phantom stock, stock appreciation right, or any other similar interest (except for stock).

(2) Instruments generally not treated as options. For purposes of this section, the following will not be treated as options:

(i) Options on section 1504(a)(4) stock. Options on stock described in section 1504(a)(4);

(ii) Certain publicly traded options—(A) General rule. Options which on the measurement date are traded on (or subject to the rules of) a qualified board or exchange as defined in section 1256(g)(7), or on any other exchange, board of trade, or market specified by the Internal Revenue Service in regulations, a revenue ruling, or revenue procedure. See § 601.601(d)(2)(ii)(b) of this chapter;

(B) Exception. Paragraph (d)(2)(ii)(A) of this section does not apply to options issued, transferred, or listed with a principal purpose of avoiding the application of section 1504 and this section. For example, a principal purpose of avoiding the application of section 1504 and this section may exist if warrants, convertible or exchangeable debt instruments, or other similar instruments have an exercise price (or, in the case of convertible or exchangeable instruments, a conversion or exchange premium) that is materially less than, or a term that is materially longer than, those that are customary for publicly traded instruments of their type. A principal purpose may also exist if a large percentage of an issuance of an instrument is placed with one investor (or group of investors) and a very small percentage of the issuance is traded on a qualified board or exchange;

(iii) Stock purchase agreements. Stock purchase agreements or similar arrangements whose terms are commercially reasonable and in which the parties' obligations to complete the transaction are subject only to reasonable closing conditions;

(iv) Escrow, pledge, or other security agreements. Agreements for holding stock in escrow or under a pledge or other security agreement that are part of a typical commercial transaction and that are subject to customary commercial conditions;

(v) Compensatory options—(A) General rule. Stock appreciation rights, warrants, stock options, phantom stock, or other similar instruments provided to employees, directors, or independent contractors in connection with the performance of services for the corporation or a related corporation (and that is not excessive by reference to the services performed) and which—

(1) Are nontransferable within the meaning of § 1.83-3(d); and

(2) Do not have a readily ascertainable fair market value as defined in § 1.83-7(b) on the measurement date;

(B) Exceptions. (1) Paragraph (d)(2)(v)(A) of this section does not apply to options issued or transferred with a principal purpose of avoiding the application of section 1504 and this section; and

(2) Paragraph (d)(2)(v)(A) of this section ceases to apply to options that become transferable;

(vi) Options granted in connection with a loan. Options granted in connection with a loan if the lender is actively and regularly engaged in the business of lending and the options are issued in connection with a loan to the issuing corporation that is commercially reasonable. This paragraph (d)(2)(vi) continues to apply if the option is transferred with the loan (or if a portion of the option is transferred with a corresponding portion of the loan). However, if the option is transferred without a corresponding portion of the loan, this paragraph (d)(2)(vi) ceases to apply;

(vii) Options created pursuant to a title 11 or similar case. Options created by the solicitation or receipt of acceptances to a plan of reorganization in a title 11 or similar case (within the meaning of section 368(a)(3)(A)), the option created by the confirmation of the plan, and any option created under the plan prior to the time the plan becomes effective;

(viii) Convertible preferred stock. Convertible preferred stock, provided the terms of the conversion feature do not permit or require the tender of any consideration other than the stock being converted; and

(ix) Other enumerated instruments. Any other instruments specified by the Internal Revenue Service in regulations, a revenue ruling, or revenue procedure. See § 601.601(d)(2)(ii)(b) of this chapter.

(e) Elimination of federal income tax liability. For purposes of this section, the elimination of federal income tax liability includes the elimination or deferral of federal income tax liability. In determining whether there is an elimination of federal income tax liability, the tax consequences to all involved parties are considered. Examples of elimination of federal income tax liability include the use of a loss or deduction that would not otherwise be utilized, the acceleration of a loss or deduction to a year earlier than the year in which the loss or deduction would otherwise be utilized, the deferral of gain or income to a year later than the year in which the gain or income would otherwise be reported, and the acceleration of gain or income to a year earlier than the year in which the gain or income would otherwise be reported, if such gain or income is offset by a net operating loss or net capital loss that would otherwise expire unused. The elimination of federal income tax liability does not include the deferral of gain with respect to the stock subject to the option that would be recognized if such stock were sold on a measurement date.

(f) Substantial amount of federal income tax liability. The determination of what constitutes a substantial amount of federal income tax liability is based on all the facts and circumstances, including the absolute amount of the elimination, the amount of the elimination relative to overall tax liability, and the timing of items of income and deductions, taking into account present value concepts.

(g) Reasonable certainty of exercise—(1) Generally. The determination of whether, as of a measurement date, an option is reasonably certain to be exercised is based on all the facts and circumstances, including:

(i) Purchase price. The purchase price of the option in absolute terms and in relation to the fair market value of the stock or the exercise price of the option;

(ii) In-the-money option. Whether and to what extent the option is in-the-money on the measurement date;

(iii) Not in-the-money option. If the option is not in-the-money on the measurement date, the amount or percentage by which the exercise price of the option is greater than (or in the case of an option to sell stock, is less than) the fair market value of the underlying stock;

(iv) Exercise price. Whether the exercise price of the option is fixed or fluctuates depending on the earnings, value, or other indication of economic performance of the issuing corporation;

(v) Time of exercise. The time at which, or the period of time during which, the option can be exercised;

(vi) Related or sequential options. Whether the option is one in a series of related or sequential options;

(vii) Stockholder rights. The existence of an arrangement (either within the option agreement or in a related agreement) that, directly or indirectly, affords managerial or economic rights in the issuing corporation that ordinarily would be afforded to owners of the issuing corporation's stock (e.g., voting rights, dividend rights, or rights to proceeds on liquidation) to the person who would acquire the stock upon exercise of the option or a person related to such person. For this purpose, managerial or economic rights in the issuing corporation possessed because of actual stock ownership in the issuing corporation are not taken into account;

(viii) Restrictive covenants. The existence of restrictive covenants or similar arrangements (either within the option agreement or in a related agreement) that, directly or indirectly, prevent or limit the ability of the issuing corporation to undertake certain activities while the option is outstanding (e.g., covenants limiting the payment of dividends or borrowing of funds);

(ix) Intention to alter value. Whether it was intended that through a change in the capital structure of the issuing corporation or a transfer of assets to or from the issuing corporation (other than regular, ordinary dividends) or by any other means, the fair market value of the stock of the issuing corporation would be altered for a principal purpose of increasing the likelihood that the option would be exercised; and

(x) Contingencies. Any contingency (other than the mere passage of time) to which the exercise of the option is subject (e.g., a public offering of the issuing corporation's stock or reaching a certain level of earnings).

(2) Cash settlement options, phantom stock, stock appreciation rights, or similar interests. A cash settlement option, phantom stock, stock appreciation right, or similar interest is treated as reasonably certain to be exercised if it is reasonably certain that the option will have value at some time during the period in which the option may be exercised.

(3) Safe harbors—(i) Options to acquire stock. Except as provided in paragraph (g)(3)(iv) of this section, an option to acquire stock is not considered reasonably certain, as of a measurement date, to be exercised if—

(A) The option may be exercised no more than 24 months after the measurement date and the exercise price is equal to or greater than 90 percent of the fair market value of the underlying stock on the measurement date; or

(B) The terms of the option provide that the exercise price of the option is equal to or greater than the fair market value of the underlying stock on the exercise date.

(ii) Options to sell stock. Except as provided in paragraph (g)(3)(iv) of this section, an option to sell stock is not considered reasonably certain, as of a measurement date, to be exercised if—

(A) The option may be exercised no more than 24 months after the measurement date and the exercise price is equal to or less than 110 percent of the fair market value of the underlying stock on the measurement date; or

(B) The terms of the option provide that the exercise price of the option is equal to or less than the fair market value of the underlying stock on the exercise date.

(iii) Options exercisable at fair market value. For purposes of paragraphs (g)(3)(i)(B) and (g)(3)(ii)(B) of this section, an option whose exercise price is determined by a formula is considered to have an exercise price equal to the fair market value of the underlying stock on the exercise date if the formula is agreed upon by the parties when the option is issued in a bona fide attempt to arrive at fair market value on the exercise date and is to be applied based upon the facts in existence on the exercise date.

(iv) Exceptions. The safe harbors of this paragraph (g)(3) do not apply if—

(A) An arrangement exists that provides the holder or a related party with stockholder rights described in paragraph (g)(1)(vii) of this section (except for rights arising upon a default under the option or a related agreement);

(B) It is intended that through a change in the capital structure of the issuing corporation or a transfer of assets to or from the issuing corporation (other than regular, ordinary dividends) or by any other means, the fair market value of the stock of the issuing corporation will be altered for a principal purpose of increasing the likelihood that the option will be exercised; or

(C) The option is one in a series of related or sequential options, unless all such options satisfy paragraph (g)(3) (i) or (ii) of this section.

(v) Failure to satisfy safe harbor. Failure of an option to satisfy one of the safe harbors of this paragraph (g)(3) does not affect the determination of whether an option is treated as reasonably certain to be exercised.

(h) Examples. The provisions of this section may be illustrated by the following examples. These examples assume that the measurement dates set forth in the examples are the only measurement dates that have taken place or will take place.

Example 1. (i) P is the common parent of a consolidated group, consisting of P, S, and T. P owns all 100 shares of S's only class of stock, which is voting common stock. P also owns all the stock of T. On June 30, 1992, when the fair market value of the S stock is $40 per share, P sells to U, an unrelated corporation, an option to acquire 40 shares of the S stock that P owns at an exercise price of $30 per share, exercisable at any time within 3 years after the granting of the option. P and T have had substantial losses for 5 consecutive years while S has had substantial income during the same period. Because P, S, and T have been filing consolidated returns, P and T have been able to use all of their losses to offset S's income. It is anticipated that P, S, and T will continue their earnings histories for several more years. On July 31, 1992, S declares and pays a dividend of $1 per share to P.

(ii) If P, S, and T continue to file consolidated returns after June 30, 1992, it could reasonably be anticipated that P, S, and T would eliminate a substantial amount of federal income tax liability by using P's and T's future losses to offset S's income in consolidated returns. Furthermore, based on the difference between the exercise price of the option and the fair market value of the S stock, it is reasonably certain, on June 30, 1992, a measurement date, that the option will be exercised. Therefore, the option held by U is treated as exercised. As a result, for purposes of determining whether P and S are affiliated, P is treated as owning only 60 percent of the value of outstanding shares of S stock and U is treated as owning the remaining 40 percent. P is still treated as owning 100 percent of the voting power. Because members of the P group are no longer treated as owning stock possessing 80 percent of the total value of the S stock as of June 30, 1992, S is no longer a member of the P group. Additionally, P is not entitled to a 100 percent dividends received deduction under section 243(a)(3) because P and S are also treated as not affiliated for purposes of section 243. P is only entitled to an 80 percent dividends received deduction under section 243(c).

Example 2. (i) The facts are the same as in Example 1 except that rather than P issuing an option to acquire 40 shares of S stock to U on June 30, 1992, P, pursuant to a plan, issues an option to U1 on July 1, 1992, to acquire 20 shares of S stock, and issues an option to U2 on July 2, 1992, to acquire 20 shares of S stock.

(ii) Because the options issued to U1 and U2 were issued pursuant to a plan, July 2, 1992, constitutes a measurement data for both options. Therefore, both options are aggregated in determining whether the issuance of the options, rather than the sale of the S stock, would result in the elimination of a substantial amount of federal income tax liability. Accordingly, as in Example 1, because the continued affiliation of P, S, and T could reasonably be anticipated to result in the elimination of a substantial amount of federal income tax liability and the options are reasonably certain to be exercised, the options are treated as exercised for purposes of determining whether P and S are affiliated, and P and S are no longer affiliated as of July 2, 1992.

Example 3. (i) The facts are the same as in Example 1 except that the option gives U the right to acquire all 100 shares of the S stock, and U is the common parent of a consolidated group. The U group has had substantial losses for 5 consecutive years and it is anticipated that the U group will continue its earnings history for several more years.

(ii) If P sold the S stock, in lieu of the option, to U, S would become a member of the U group. Because the U group files consolidated returns, if P sold the S stock to U, U would be able to use its future losses to offset future income of S. When viewing the transaction from the effect on all parties, the sale of the option, in lieu of the underlying S stock, does not result in the elimination of federal income tax liability because S's income would be offset by the losses of members of either the P or U group. Accordingly, the option is disregarded and S remains a member of the P group.

Example 4. (i) P is the common parent of a consolidated group, consisting of P and S. P owns 90 of the 100 outstanding shares of S's only class of stock, which is voting common stock, and U, an unrelated corporation, owns the remaining 10 shares. On August 31, 1992, when the fair market value of the S stock is $100 per share, P sells a call option to U that entitles U to purchase 20 shares of S stock from P, at any time before August 31, 1993, at an exercise price of $115 per share. The call option does not provide U with any voting rights, dividend rights, or any other managerial or economic rights ordinarily afforded to owners of the S stock. There is no intention on August 31, 1992, to alter the value of S to increase the likelihood of the exercise of the call option.

(ii) Because the exercise price of the call option is equal to or greater than 90 percent of the fair market value of the S stock on August 31, 1992, a measurement date, the option may be exercised no more than 24 months after the measurement date, and none of the items described in paragraph (g)(3)(iv) of this section that preclude application of the safe harbor are present, the safe harbor of paragraph (g)(3)(i) of this section applies and the call option is treated as if it is not reasonably certain to be exercised. Therefore, regardless of whether the continued affiliation of P and S would result in the elimination of a substantial amount of federal income tax liability, the call option is disregarded in determining whether S remains a member of the P group.

Example 5. (i) The facts are the same as in Example 4 except that the call option gives U the right to vote similar to that of a shareholder.

(ii) Under paragraph (g)(3)(iv) of this section, the safe harbor of paragraph (g)(3)(i) of this section does not apply because the call option entitles U to voting rights equivalent to that of a shareholder. Accordingly, all of the facts and circumstances surrounding the sale of the call option must be taken into consideration in determining whether it is reasonably certain that the call option will be exercised.

Example 6. (i) In 1992, two unrelated corporations, X and Y, decide to engage jointly in a new business venture. To accomplish this purpose, X organizes a new corporation, S, on September 30, 1992. X acquires 100 shares of the voting common stock of S, which are the only shares of S stock outstanding. Y acquires a debenture of S which is convertible, on September 30, 1995, into 100 shares of S common stock. If the conversion right is not exercised, X will have the right, on September 30, 1995, to put 50 shares of its S stock to Y in exchange for 50 percent of the debenture held by Y. The likelihood of the success of the venture is uncertain. It is anticipated that S will generate substantial losses in its early years of operation. X expects to have substantial taxable income during the three years following the organization of S.

(ii) Under the terms of this arrangement, it is reasonably certain on September 30, 1992, a measurement date, that on September 30, 1995, either through Y's exercise of its conversion right or X's right to put S stock to Y, that Y will own 50 percent of the S stock. Additionally, it could reasonably be anticipated, on September 30, 1992, a measurement date, that the affiliation of X and S would result in the elimination of a substantial amount of federal income tax liability. Accordingly, for purposes of determining whether X and S are affiliated, X is treated as owning only 50 percent of the value of the S stock as of September 30, 1992, a measurement date, and S is not a member of the X affiliated group.

Example 7. (i) The facts are the same as in Example 6 except that rather than acquiring 100 percent of the S stock and the right to put S stock to Y, X acquires only 80 percent of the S stock, while S, rather than acquiring a convertible debenture, acquires 20 percent of the S stock, and an option to acquire an additional 30 percent of the S stock. The terms of the option are such that the option will only be exercised if the new business venture succeeds.

(ii) In contrast to Example 6, because of the true business risks involved in the start-up of S and whether the business venture will ultimately succeed, along with the fact that X does not have an option to put S stock to Y, it is not reasonably certain on September 30, 1992, a measurement date, that the option will be exercised and that X will only own 50 percent of the S stock on September 30, 1995. Accordingly, the option is disregarded in determining whether S is a member of the X group.

(i) Effective date. This section applies, generally, to options with a measurement date on or after February 28, 1992. This section does not apply to options issued prior to February 28, 1992, which have a measurement date on or after February 28, 1992, if the measurement date for the option occurs solely because of an adjustment in the terms of the option pursuant to the terms of the option as it existed on February 28, 1992. Paragraph (b)(2)(iv) of this section applies to stock outstanding on or after February 28, 1992. Paragraph (a)(2) of this section applies with respect to taxable years beginning on or after November 13, 2020. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of this section to a taxable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of this section, the section 163(j) regulations (as defined in § 1.163(j)-1(b)(37)), and, if applicable, §§ 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§ 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-1), to that taxable year.

[T.D. 8462, 57 FR 61801, Dec. 29, 1992; 58 FR 7041, Feb. 3, 1993, as amended by T.D. 9905, 85 FR 56845, Sept. 14, 2020]

17 Regulations Applicable to Taxable Years Beginning Before June 28, 2002

§ 1.1502-77A Common parent agent for subsidiaries applicable for consolidated return years beginning before June 28, 2002.

(a) Scope of agency of common parent corporation. The common parent, for all purposes (other than the making of the consent required by paragraph (a)(1) of § 1.1502-75, the making of an election under section 936(e), the making of an election to be treated as a DISC under § 1.992-2, and a change of the annual accounting period pursuant to paragraph (b)(3)(ii) of § 1.991-1) shall be the sole agent for each subsidiary in the group, duly authorized to act in its own name in all matters relating to the tax liability for the consolidated return year. Except as provided in the preceding sentence, no subsidiary shall have authority to act for or to represent itself in any such matter. For example, any election available to a subsidiary corporation in the computation of its separate taxable income must be made by the common parent, as must any change in an election previously made by the subsidiary corporation; all correspondence will be carried on directly with the common parent; the common parent shall file for all extensions of time including extensions of time for payment of tax under section 6164; notices of deficiencies will be mailed only to the common parent, and the mailing to the common parent shall be considered as a mailing to each subsidiary in the group; notice and demand for payment of taxes will be given only to the common parent and such notice and demand will be considered as a notice and demand to each subsidiary; the common parent will file petitions and conduct proceedings before the Tax Court of the United States, and any such petition shall be considered as also having been filed by each such subsidiary. The common parent will file claims for refund or credit, and any refund will be made directly to and in the name of the common parent and will discharge any liability of the Government in respect thereof to any such subsidiary; and the common parent in its name will give waivers, give bonds, and execute closing agreements, offers in compromise, and all other documents, and any waiver or bond so given, or agreement, offer in compromise, or any other document so executed, shall be considered as having also been given or executed by each such subsidiary. Notwithstanding the provisions of this paragraph, any notice of deficiency, in respect of the tax for a consolidated return year, will name each corporation which was a member of the group during any part of such period (but a failure to include the name of any such member will not affect the validity of the notice of deficiency as to the other members); any notice and demand for payment will name each corporation which was a member of the group during any part of such period (but a failure to include the name of any such member will not affect the validity of the notice and demand as to the other members); and any levy, any notice of a lien, or any other proceeding to collect the amount of any assessment, after the assessment has been made, will name the corporation from which such collection is to be made. The provisions of this paragraph shall apply whether or not a consolidated return is made for any subsequent year, and whether or not one or more subsidiaries have become or have ceased to be members of the group at any time. Notwithstanding the provisions of this paragraph, the Commissioner may, upon notifying the common parent, deal directly with any member of the group in respect of its liability, in which event such member shall have full authority to act for itself.

(b) Notification of deficiency to corporation which has ceased to be a member of the group. If a subsidiary has ceased to be a member of the group and if such subsidiary files written notice of such cessation with the Commissioner, then the Commissioner upon request of such subsidiary will furnish it with a copy of any notice of deficiency in respect of the tax for a consolidated return year for which it was a member and a copy of any notice and demand for payment of such deficiency. The filing of such written notification and request by a corporation shall not have the effect of limiting the scope of the agency of the common parent provided for in paragraph (a) of this section and a failure by the Commissioner to comply with such written request shall not have the effect of limiting the tax liability of such corporation provided for in § 1.1502-6.

(c) Effect of waiver given by common parent. Unless the Commissioner agrees to the contrary, an agreement entered into by the common parent extending the time within which an assessment may be made or levy or proceeding in court begun in respect of the tax for a consolidated return year shall be applicable:

(1) To each corporation which was a member of the group during any part of such taxable year, and

(2) To each corporation the income of which was included in the consolidated return for such taxable year, notwithstanding that the tax liability of any such corporation is subsequently computed on the basis of a separate return under the provisions of § 1.1502-75.

(d) Effect of dissolution of common parent corporation. If the common parent corporation contemplates dissolution, or is about to be dissolved, or if for any other reason its existence is about to terminate, it must forthwith notify the Commissioner of such fact and designate, subject to the approval of the Commissioner, another member to act as agent in its place to the same extent and subject to the same conditions and limitations as are applicable to the common parent. If the notice thus required is not given by the common parent, or the designation is not approved by the Commissioner, the remaining members may, subject to the approval of the Commissioner, designate another member to act as such agent, and notice of such designation must be given to the Commissioner. Until a notice in writing designating a new agent has been approved by the Commissioner, any notice of deficiency or other communication mailed to the common parent will be considered as having been properly mailed to the agent of the group; or, if the Commissioner has reason to believe that the existence of the common parent has terminated, the Commissioner may deal directly with any member in respect of its liability.

(e) General rules—(1) Scope. This section applies if the corporation that is the common parent of the group ceases to be the common parent, whether or not the group remains in existence under § 1.1502-75(d).

(2) Notice of deficiency. A notice of deficiency mailed to any one or more corporations referred to in paragraph (e)(4) of this section is deemed for purposes of § 1.1502-77A to be mailed to the agent of the group. If the group has designated an agent that has been approved by the Commissioner under § 1.1502-77A(d), a notice of deficiency shall be mailed to that designated agent in addition to any other corporation referred to in paragraph (e)(4) of this section. However, failure by the Commissioner to mail a notice of deficiency to that designated agent shall not invalidate the notice of deficiency mailed to any other corporation referred to in paragraph (e)(4) of this section.

(3) Waiver of statute of limitations. A waiver of the statute of limitations with respect to the group given by any one or more corporations referred to in paragraph (e)(4) of this section is deemed to be given by the agent of the group.

(4) Alternative agents. The corporations referred to in paragraph (e) (2) and (3) of this section are—

(i) The common parent of the group for all or any part of the year to which the notice or waiver applies,

(ii) A successor to the former common parent in a transaction to which section 381(a) applies,

(iii) The agent designated by the group under § 1.1502-77A(d), or

(iv) If the group remains in existence under § 1.1502-75(d) (2) or (3), the common parent of the group at the time the notice is mailed or the waiver given.

(f) Cross-reference. For further rules applicable to groups that include insolvent financial institutions, see § 301.6402-7 of this chapter.

(g) Effective/applicability dates. This section applies to taxable years beginning before June 28, 2002, except paragraph (e) of this section applies to statutory notices and waivers of the statute of limitations for taxable years for which the due date (without extensions) of the consolidated return is after September 7, 1988, and which begin before June 28, 2002.

[T.D. 6894, 31 FR 11794, Sept. 8, 1966, as amended by T.D. 7323, 39 FR 34409, Sept. 25, 1974; T.D. 7673, 45 FR 8588, Feb. 8, 1980; T.D. 8226, 53 FR 34733, Sept. 8, 1988; T.D. 8446, 57 FR 53034, Nov. 6, 1992. Redesignated and amended by T.D. 9002, 67 FR 43540, 43544, June 28, 2002; T.D. 9715, 80 FR 17318, Apr. 1, 2015; T. D. 10018, 89 FR 106876, Dec. 30, 2024]

18 Regulations Applicable to Taxable Years Beginning on or After June 28, 2002, and Before April 1, 2015

§ 1.1502-77B Agent for the group applicable for consolidated return years beginning on or after June 28, 2002, and before April 1, 2015.

(a) Scope of agency—(1) In general—(i) Common parent. Except as provided in paragraphs (a)(3) and (6) of this section, the common parent (or a substitute agent described in paragraph (a)(1)(ii) of this section) for a consolidated return year is the sole agent (agent for the group) that is authorized to act in its own name with respect to all matters relating to the tax liability for that consolidated return year, for—

(A) Each member in the group; and

(B) Any successor (see paragraph (a)(1)(iii) of this section) of a member.

(ii) Substitute agents. For purposes of this section, any corporation designated as a substitute agent pursuant to paragraph (d) of this section to replace the common parent or a previously designated substitute agent acts as agent for the group to the same extent and subject to the same limitations as are applicable to the common parent, and any reference in this section to the common parent includes any such substitute agent.

(iii) Successor. For purposes of this section only, the term successor means an individual or entity (including a disregarded entity) that is primarily liable, pursuant to applicable law (including, for example, by operation of a state or Federal merger statute), for the tax liability of a member of the group. Such determination is made without regard to § 1.1502-1(f)(4) or 1.1502-6(a). (For inclusion of a successor in references to a subsidiary or member, see paragraph (c)(2) of this section.)

(iv) Disregarded entity. If a subsidiary of a group becomes, or its successor is or becomes, a disregarded entity for Federal tax purposes, the common parent continues to serve as the agent with respect to that subsidiary's tax liability under § 1.1502-6 for consolidated return years during which it was included in the group, even though the entity generally is not treated as a person separate from its owner for Federal tax purposes.

(v) Transferee liability. For purposes of assessing, paying and collecting transferee liability, any exercise of or reliance on the common parent's agency authority pursuant to this section is binding on a transferee (or subsequent transferees) of a member, regardless of whether the member's existence terminates prior to such exercise or reliance.

(vi) Purported common parent. If any corporation files a consolidated return purporting to be the common parent of a consolidated group but is subsequently determined not to have been the common parent of the claimed group, that corporation is treated, to the extent necessary to avoid prejudice to the Commissioner, as if it were the common parent.

(2) Examples of matters subject to agency. With respect to any consolidated return year for which it is the common parent—

(i) The common parent makes any election (or similar choice of a permissible option) that is available to a subsidiary in the computation of its separate taxable income, and any change in an election (or similar choice of a permissible option) previously made by or for a subsidiary, including, for example, a request to change a subsidiary's method or period of accounting;

(ii) All correspondence concerning the income tax liability for the consolidated return year is carried on directly with the common parent;

(iii) The common parent files for all extensions of time, including extensions of time for payment of tax under section 6164, and any extension so filed is considered as having been filed by each member;

(iv) The common parent gives waivers, gives bonds, and executes closing agreements, offers in compromise, and all other documents, and any waiver or bond so given, or agreement, offer in compromise, or any other document so executed, is considered as having also been given or executed by each member;

(v) The common parent files claims for refund, and any refund is made directly to and in the name of the common parent and discharges any liability of the Government to any member with respect to such refund;

(vi) The common parent takes any action on behalf of a member of the group with respect to a foreign corporation, for example, elections by, and changes to the method of accounting of, a controlled foreign corporation in accordance with § 1.964-1(c)(3);

(vii) Notices of claim disallowance are mailed only to the common parent, and the mailing to the common parent is considered as a mailing to each member;

(viii) Notices of deficiencies are mailed only to the common parent (except as provided in paragraph (b) of this section), and the mailing to the common parent is considered as a mailing to each member;

(ix) Notices of final partnership administrative adjustment under section 6223 with respect to any partnership in which a member of the group is a partner may be mailed to the common parent, and, if so, the mailing to the common parent is considered as a mailing to each member that is a partner entitled to receive such notice (for other rules regarding partnership proceedings, see paragraphs (a)(3)(v) and (a)(6)(iii) of this section);

(x) The common parent files petitions and conducts proceedings before the United States Tax Court, and any such petition is considered as also having been filed by each member;

(xi) Any assessment of tax may be made in the name of the common parent, and an assessment naming the common parent is considered as an assessment with respect to each member; and

(xii) Notice and demand for payment of taxes is given only to the common parent, and such notice and demand is considered as a notice and demand to each member.

(3) Matters reserved to subsidiaries. Except as provided in this paragraph (a)(3) and paragraph (a)(6) of this section, no subsidiary has authority to act for or to represent itself in any matter related to the tax liability for the consolidated return year. The following matters, however, are reserved exclusively to each subsidiary—

(i) The making of the consent required by § 1.1502-75(a)(1);

(ii) Any action with respect to the subsidiary's liability for a federal tax other than the income tax imposed by chapter 1 of the Internal Revenue Code (including, for example, employment taxes under chapters 21 through 25 of the Internal Revenue Code, and miscellaneous excise taxes under chapters 31 through 47 of the Internal Revenue Code);

(iii) The making of an election under section 936(e);

(iv) The making of an election to be treated as a DISC under § 1.992-2; and

(v) Any actions by a subsidiary acting as tax matters partner under sections 6221 through 6234 and the accompanying regulations (but see paragraph (a)(2)(ix) of this section regarding the mailing of a final partnership administrative adjustment to the common parent).

(4) Term of agency—(i) In general. Except as provided in paragraph (a)(4)(iii) of this section, the common parent for the consolidated return year remains the agent for the group with respect to that year until the common parent's existence terminates, regardless of whether one or more subsidiaries in that year cease to be members of the group, whether the group files a consolidated return for any subsequent year, whether the common parent ceases to be the common parent or a member of the group in any subsequent year, or whether the group continues pursuant to § 1.1502-75(d) with a new common parent in any subsequent year.

(ii) Replacement of substitute agent designated by Commissioner. If the Commissioner replaces a previously designated substitute agent pursuant to paragraph (d)(3)(ii) of this section, the replaced substitute agent ceases to be the agent after the Commissioner designates another substitute agent.

(iii) New common parent after a group structure change. If the group continues in existence with a new common parent pursuant to § 1.1502-75(d) during a consolidated return year, the common parent at the beginning of the year is the agent for the group through the date of the § 1.1502-75(d) transaction, and the new common parent becomes the agent for the group beginning the day after the transaction, at which time it becomes the agent for the group with respect to the entire consolidated return year (including the period through the date of the transaction) and the former common parent is no longer the agent for that year.

(5) Identifying members in notice of a lien. Notwithstanding any other provisions of this paragraph (a), any notice of a lien, any levy or any other proceeding to collect the amount of any assessment, after the assessment has been made, must name the entity from which such collection is to be made.

(6) Direct dealing with a member—(i) Several liability. The Commissioner may, upon issuing to the common parent written notice that expressly invokes the authority of this provision, deal directly with any member of the group with respect to its liability under § 1.1502-6 for the consolidated tax of the group, in which event such member has sole authority to act for itself with respect to that liability. However, if the Commissioner believes or has reason to believe that the existence of the common parent has terminated, the Commissioner may deal directly with any member with respect to that member's liability under § 1.1502-6 without giving the notice required by this provision.

(ii) Information requests. The Commissioner may, upon informing the common parent, request information relevant to the consolidated tax liability from any member of the group. However, if the Commissioner believes or has reason to believe that the existence of the common parent has terminated, the Commissioner may request such information from any member of the group without informing the common parent.

(iii) Members as partners in partnerships. The Commissioner generally will deal directly with any member in its capacity as a partner of a partnership that is subject to the provisions of sections 6221 through 6234 and the accompanying regulations (but see paragraph (a)(2)(ix) of this section regarding the mailing of a final partnership administrative adjustment to the common parent). However, if requested to do so in accordance with the provisions of § 301.6223(c)-1(b) of this chapter, the Commissioner may deal with the common parent as agent for such member on any matter related to the partnership, except in regards to a settlement under section 6224(c) and except to the extent the member acts as tax matters partner of the partnership.

(b) Copy of notice of deficiency to entity that has ceased to be a member of the group. An entity that ceases to be a member of the group during or after a consolidated return year may file a written notice of that fact with the Commissioner and request a copy of any notice of deficiency with respect to the tax for a consolidated return year during which the entity was a member, or a copy of any notice and demand for payment of such deficiency, or both. Such filing does not limit the scope of the agency of the common parent provided for in paragraph (a) of this section. Any failure by the Commissioner to comply with such request does not limit an entity's tax liability under § 1.1502-6. For purposes of this paragraph (b), references to an entity include a successor of such entity.

(c) References to member or subsidiary. For purposes of this section, all references to a member or subsidiary for a consolidated return year include—

(1) Each corporation that was a member of the group during any part of such year (except that any reference to a subsidiary does not include the common parent);

(2) Except as indicated otherwise, a successor (as defined in paragraph (a)(1)(iii) of this section) of any corporation described in paragraph (c)(1) of this section; and

(3) Each corporation whose income was included in the consolidated return for such year, notwithstanding that the tax liability of such corporation should have been computed on the basis of a separate return, or as a member of another consolidated group, under the provisions of § 1.1502-75.

(d) Termination of common parent—(1) Designation of substitute agent by common parent. (i) If the common parent's existence terminates, it may designate a substitute agent for the group and notify the Commissioner, as provided in this paragraph (d)(1).

(A) Subject to the Commissioner's approval under paragraph (d)(1)(ii) of this section, before the common parent's existence terminates, the common parent may designate, for each consolidated return year for which it is the common parent and for which the period of limitations either for assessment, for collection after assessment, or for claiming a credit or refund has not expired, one of the following to act as substitute agent in its place—

(1) Any corporation that was a member of the group during any part of the consolidated return year and, except as provided in paragraph (e)(3)(ii) of this section, has not subsequently been disregarded as an entity separate from its owner or reclassified as a partnership for Federal tax purposes; or

(2) Any successor (as defined in paragraph (a)(1)(iii) of this section) of such a corporation or of the common parent that is a domestic corporation (and, except as provided in paragraph (e)(3)(ii) of this section, is not disregarded as an entity separate from its owner or classified as a partnership for Federal tax purposes), including a corporation that will become a successor at the time that the common parent's existence terminates.

(B) The common parent must notify the Commissioner in writing (under procedures prescribed by the Commissioner) of the designation and provide the following—

(1) An agreement executed by the designated corporation agreeing to serve as the group's substitute agent; and

(2) If the designated corporation was not itself a member of the group during the consolidated return year (because the designated corporation is a successor of a member of the group for the consolidated return year), a statement by the designated corporation acknowledging that it is or will be primarily liable for the consolidated tax as a successor of a member.

(ii) A designation under paragraph (d)(1)(i)(A) of this section does not apply unless and until it is approved by the Commissioner. The Commissioner's approval of such a designation is not effective before the existence of the common parent terminates.

(2) Default substitute agent. If the common parent fails to designate a substitute agent for the group before its existence terminates and if the common parent has a single successor that is a domestic corporation, such successor becomes the substitute agent for the group upon termination of the common parent's existence. However, see paragraph (d)(4) of this section regarding the consequences of the successor's failure to notify the Commissioner of its status as default substitute agent in accordance with procedures established by the Commissioner.

(3) Designation by the Commissioner. (i) In the event the common parent's existence terminates and no designation is made and approved under paragraph (d)(1) of this section and the Commissioner believes or has reason to believe that there is no successor of the common parent that satisfies the requirements of paragraph (d)(2) of this section (or the Commissioner believes or has reason to believe there is such a successor but has no last known address on file for such successor), the Commissioner may, at any time, with or without a request from any member of the group, designate a corporation described in paragraph (d)(1)(i)(A) of this section to act as the substitute agent. The Commissioner will notify the designated substitute agent in writing of its designation, and the designation is effective upon receipt by the designated substitute agent of such notice. The designated substitute agent must give notice of the designation to each corporation that was a member of the group during any part of the consolidated return year, but a failure by the designated substitute agent to notify any such member of the group does not invalidate the designation.

(ii) At the request of any member, the Commissioner may, but is not required to, replace a substitute agent previously designated under paragraph (d)(3)(i) of this section with another corporation described in paragraph (d)(1)(i)(A) of this section.

(4) Absence of designation or notification of default substitute agent. Until a designation of a substitute agent for the group under paragraph (d)(1) of this section has become effective, the Commissioner has received notification in accordance with procedures established by the Commissioner that a successor qualifying under paragraph (d)(2) of this section has become the substitute agent by default, or the Commissioner has designated a substitute agent under paragraph (d)(3) of this section—

(i) Any notice of deficiency or other communication mailed to the common parent, even if no longer in existence, is considered as having been properly mailed to the agent for the group; and

(ii) The Commissioner is not required to act on any communication (including, for example, a claim for refund) submitted on behalf of the group by any person other than the common parent (including a successor of the common parent qualifying as a default substitute agent under paragraph (d)(2) of this section).

(e) Termination of a corporation's existence—(1) In general. For purposes of paragraphs (a)(1)(v), (a)(4)(i), (d), and (j) of this section, the existence of a corporation is deemed to terminate if—

(i) Its existence terminates under applicable law; or

(ii) Except as provided in paragraph (e)(3) of this section, it becomes, for Federal tax purposes, either—

(A) An entity that is disregarded as an entity separate from its owner; or

(B) An entity that is reclassified as a partnership.

(2) Purported agency. If the existence of the agent for the group terminates under circumstances described in paragraph (e)(1)(ii) of this section, until the Commissioner has approved the designation of a substitute agent for the group pursuant to paragraph (d)(1) of this section or the Commissioner designates a substitute agent and notifies the designated substitute agent pursuant to paragraph (d)(3) of this section, any post-termination action by that purported agent on behalf of the group has the same effect, to the extent necessary to avoid prejudice to the Commissioner, as if the agent's corporate existence had not terminated.

(3) Exceptions where no eligible corporation exists. (i) For purposes of the common parent's term as agent under paragraph (a)(4)(i) of this section and the term as agent of the substitute agent designated under paragraph (d) of this section, if a corporation either becomes disregarded as an entity separate from its owner or is reclassified as a partnership for Federal tax purposes, its existence is not deemed to terminate if the effect of such termination would be that no corporation remains eligible to serve as the substitute agent for the group's consolidated return year.

(ii) Similarly, for purposes of paragraph (d) of this section, an entity that is either disregarded as an entity separate from its owner or reclassified as a partnership for Federal tax purposes is not precluded from designation as a substitute agent merely because of such classification if the effect of the inability to make such designation would be that no corporation remains eligible to serve as the substitute agent for the group's consolidated return year.

(iii) Any entity described in paragraphs (e)(3)(i) or (ii) of this section that remains or becomes the agent for the group is treated as a corporation for purposes of this section.

(4) Exception for section 338 transactions. Notwithstanding section 338(a)(2), a target corporation for which an election is made under section 338 is not deemed to terminate for purposes of this section.

(f) Examples. The following examples illustrate the principles of this section. Unless otherwise indicated, each example addresses the question of which corporation is the proper party to execute a consent to waive the statute of limitations for Years 1 and 2 or the more general question of which corporation may be designated as a substitute agent for the group for Years 1 and 2. In each example, as of January 1 of Year 1, the P group consists of P and its two subsidiaries, S and S-1. P, as the common parent of the P group, files consolidated returns for the P group in Years 1 and 2. On January 1 of Year 1, domestic corporations S-2, U, V, W, W-1, X, Y, Z and Z-1 are not related to P or the members of the P group. All corporations are calendar year taxpayers. For none of the tax years at issue does the Commissioner exercise the authority under paragraph (a)(6) of this section to deal with any member separately. Any surviving corporation in a merger is a successor as described in paragraph (a)(1)(iii) of this section. Any notification to the Commissioner of the designation of the P group's substitute agent also contains a statement signed on behalf of the designated agent that it agrees to act as the group's substitute agent and, in the case of a successor, that it is primarily liable as a successor of a member. The examples are as follows:

Example 1. Disposition of all group members.On December 31 of Year 1, P sells all the stock of S-1 to X. On December 31 of Year 2, P distributes all the stock of S to P's shareholders. P files a separate return for Year 3. Although P is no longer a common parent after Year 2, P remains the agent for the P group for Years 1 and 2. For as long as P remains in existence, only P may execute a waiver of the period of limitations on assessment on behalf of the group for Years 1 and 2.

Example 2. Acquisition of common parent by another group.The facts are the same as in Example 1, except on January 1 of Year 3, all of the outstanding stock of P is acquired by Y. P thereafter joins in the Y group consolidated return as a member of Y group. Although P is a member of Y group in Year 3, P remains the agent for the P group for Years 1 and 2. For as long as P remains in existence, only P may execute a waiver of the period of limitations on assessment on behalf of the P group for Years 1 and 2.

Example 3. Merger of common parent—designation of remaining member as substitute agent.On December 31 of Year 1, P sells all the stock of S-1 to X. On July 1 of Year 2, P acquires all the stock of S-2. On November 30 of Year 2, P distributes all the stock of S to P's shareholders. On January 1 of Year 3, P merges into Y corporation. Just before the merger, P notifies the Commissioner in writing of the planned merger and of its designation of S as the substitute agent for the P group for Years 1 and 2. S is the only member that P can designate as the substitute agent for both Years 1 and 2 because it is the only subsidiary that was a member of the P group during part of both years. Although S-2 is the only remaining subsidiary of the P group when P merges into Y, S-2 was a member of the P group only in Year 2. For that reason, S-2 cannot be the substitute agent for the P group for Year 1. Alternatively, P could designate a different substitute agent for each year, selecting S or S-1 as the substitute agent for Year 1, and S or S-2 as the substitute agent for Year 2. P could also designate its successor Y as the substitute agent for both Years 1 and 2.

Example 4. Forward triangular merger of common parent.On January 1 of Year 3, P merges with and into Z-1, a subsidiary of Z, in a forward triangular merger described in section 368(a)(1)(A) and (a)(2)(D). The transaction constitutes a reverse acquisition under § 1.1502-75(d)(3)(i) because P's shareholders receive more than 50% of Z's stock in exchange for all of P's stock. Just before the merger, P notifies the Commissioner in writing of the planned merger and its designation of Z-1, the corporation that will survive the planned merger, as the substitute agent of the P group for Years 1 and 2. Because Z-1 will be P's successor (within the meaning of paragraph (a)(1) of this section) after the planned merger, P may designate Z-1 as the substitute agent for the P group for Years 1 and 2, pursuant to paragraph (d)(1) of this section. Alternatively, P could have designated S or S-1 as the substitute agent for the P group for Years 1 and 2. Although Z is the new common parent of the P group, which continues pursuant to § 1.1502-75(d)(3)(i), P may not designate Z as the substitute agent for Years 1 and 2 because Z was not a member of the group during any part of Years 1 or 2 and is not a successor of P or any other member of P group.

Example 5. Reverse triangular merger of common parent.On March 1 of Year 3, W-1, a subsidiary of W, merges into P, in a reverse triangular merger described in section 368(a)(1)(A) and (a)(2)(E). P survives the merger with W-1. The transaction constitutes a reverse acquisition under § 1.1502-75(d)(3)(i) because P's shareholders receive more than 50% of W's stock in exchange for all of P's stock. Under paragraph (a) of this section, P remains the agent for the P group for Years 1 and 2, even though the P group continues with W as its new common parent pursuant to § 1.1502-75(d)(3)(i). Because the transaction constitutes a reverse acquisition, the P group is treated as remaining in existence with W as its common parent. Before March 2 of Year 3, P is the agent for the P group for Year 3. Beginning on March 2 of Year 3, W becomes the agent for the P group with respect to all of Year 3 (including the period through March 1) and subsequent consolidated return years. For as long as P remains in existence, P remains the agent of the P group under paragraph (a) of this section for Years 1 and 2, and therefore only P may execute a waiver of the period of limitations on assessment on behalf of the P group for Years 1 and 2.

Example 6. Reverse triangular merger of common parent-subsequent spinoff of common parent.The facts are the same as in Example 5, except that on April 1 of Year 4, in a transaction unrelated to the Year 3 reverse acquisition, P distributes the stock of its subsidiaries S and S-1 to W, and W then distributes the stock of P to the W shareholders. Beginning on March 2 of Year 3, W becomes the agent for the P group with respect to Year 3 (including the period through March 1) and subsequent consolidated return years. Although P is no longer a member of the P group after the Year 4 spinoff, P remains the agent for the P group under paragraph (a) of this section for Years 1 and 2. Thus, for as long as P remains in existence, only P may execute a waiver of the period of limitations on assessment on behalf of the P group for Years 1 and 2.

Example 7. Qualified stock purchase and section 338 election.On March 31 of Year 2, V purchases the stock of P in a qualified stock purchase (within the meaning of section 338(d)(3)), and V makes a timely election pursuant to section 338(g) with respect to P. Although section 338(a)(2) provides that P is treated as a new corporation as of the beginning of the day after the acquisition date for purposes of subtitle A, paragraph (e)(4) of this section provides that P's existence is not deemed to terminate for purposes of this section notwithstanding the general rule of section 338(a)(2). Therefore, the election under section 338(g) does not result in a termination of P under paragraph (e) of this section, and new P remains the agent of the P group for Year 1 and the period ending March 31 of Year 2 (short Year 2). For as long as new P remains in existence, only new P may execute a waiver of the period of limitations on assessment on behalf of the P group for Year 1 and short Year 2.

Example 8. Fraudulent conveyance of assets.On March 15 of Year 2, P files a consolidated return that includes the income of S and S-1 for Year 1. On December 1 of Year 2, S-1 transfers assets having a fair market value of $100x to U in exchange for $10x. This transfer of assets for less than fair market value constitutes a fraudulent conveyance under applicable state law. On March 1 of Year 5, P executes a waiver extending to December 31 of Year 6 the period of limitations on assessment with respect to the group's Year 1 consolidated return. On February 1 of Year 6, the Commissioner issues a notice of deficiency to P asserting a deficiency of $30x for the P group's Year 1 consolidated tax liability. P does not file a petition for redetermination in the Tax Court, and the Commissioner makes a timely assessment against the P group. P, S and S-1 are all insolvent and are unable to pay the deficiency. On February 1 of Year 8, the Commissioner sends a notice of transferee liability to U, which does not file a petition in the Tax Court. On August 1 of Year 8, the Commissioner assesses the amount of the P group's deficiency against U. Under section 6901(c), the Commissioner may assess U's transferee liability within one year after the expiration of the period of limitations against the transferor S-1. By operation of section 6213(a) and 6503(a), the issuance of the notice of deficiency to P and the expiration of the 90-day period for filing a petition in the Tax Court have the effect of further extending by 150 days the P group's limitations period on assessment from the previously extended date of December 31 of Year 6 to May 30 of Year 7. Pursuant to paragraph (a)(1)(v) of this section, the waiver executed by P on March 1 of Year 5 to extend the period of limitations on assessment to December 31 of Year 6 and the further extension of the P group's limitations period to May 30 of Year 7 (by operation of sections 6213(a) and 6503(a)) have the derivative effect of extending the period of limitations on assessment of U's transferee liability to May 30 of Year 8. By operation of section 6901(f), the issuance of the notice of transferee liability to U and the expiration of the 90-day period for filing a petition in the Tax Court have the effect of further extending the limitations period on assessment of U's liability as a transferee by 150 days, from May 30 of Year 8 to October 27 of Year 8. Accordingly, the Commissioner may send a notice of transferee liability to U at any time on or before May 30 of Year 8 and assess the unpaid liability against U at any time on or before October 27 of Year 8. The result would be the same even if S-1 ceased to exist before March 1 of Year 5, the date P executed the waiver.

(g) Cross-reference. For further rules applicable to groups that include insolvent financial institutions, see § 301.6402-7 of this chapter.

(h) Effective/applicability date—(1) Application—(i) In general. This section applies to consolidated return years beginning on or after June 28, 2002, and before April 1, 2015. For instructions regarding communications relating to the determination of a substitute agent and other matters under this section, see Rev. Proc. 2002-43, 2002-2 CB 99 (see § 601.601(d)(2)(ii)(b) of this chapter). For rules governing the resignation of certain agents for the group subject to this section, see § 1.1502-77(c)(7) and (j)(2).

(ii) Election to apply for prior taxable years. Notwithstanding paragraphs (h)(1)(i) and (h)(2) of this section, the common parent may elect to apply paragraph (d)(1) of this section in lieu of § 1.1502-77A(d) in designating a substitute agent for taxable years beginning before June 28, 2002. The common parent makes such an election by expressly referring to the election under this paragraph (h)(1)(ii) in notifying the Commissioner of the designation of the substitute agent. Once made, such election applies to any subsequent designation of a substitute agent for the consolidated return year(s) subject to the election.

(2) Prior law. For taxable years beginning before June 28, 2002, see § 1.1502-77A.

(3) Designation of a domestic substitute agent—(i) In general. The provisions of paragraphs (e)(1) and (j) of this section apply to taxable years for which the consolidated Federal income tax return is due (without extensions) after July 23, 2007.

(ii) Prior law. For taxable years for which the consolidated Federal income tax return is due (without extensions) on or before July 23, 2007, see § 1.1502-77(e)(1) as contained in the 26 CFR part 1 edition revised as of April 1, 2007. For taxable years for which the consolidated Federal income tax return is due (without extensions) after March 14, 2006, and on or before July 23, 2007, see § 1.1502-77T as contained in the 26 CFR part 1 edition revised as of April 1, 2007.

(i) [Reserved]

(j) Designation by Commissioner if common parent is treated as a domestic corporation under section 7874 or section 953(d)—(1) In general. If the common parent is an entity created or organized under the law of a foreign country and is treated as a domestic corporation by reason of section 7874 (or regulations under that section) or a section 953(d) election (a foreign common parent), the Commissioner may at any time, with or without a request from any member of the group, designate another member of the group to act as the agent for the group (a domestic substitute agent) for any taxable year for which the consolidated Federal income tax return is due (without extensions) after July 23, 2007, and the foreign common parent would otherwise be the agent for the group. For each such year, the domestic substitute agent will be the sole agent for the group even though the foreign common parent remains in existence. The foreign common parent ceases to be the agent for the group when the Commissioner's designation of a domestic substitute agent becomes effective. The Commissioner may designate a domestic substitute agent for the term of a single taxable year, multiple years, or on a continuing basis.

(2) Domestic substitute agent. The domestic substitute agent, by designation or by succession, shall be a domestic corporation described in paragraph (d)(1)(i)(A) of this section (determined without regard to section 7874, a section 953(d) election or section 1504(d)).

(3) Designation by the Commissioner. The Commissioner will notify the domestic substitute agent in writing by mail or faxed transmission of the designation. The domestic substitute agent's designation is effective on the earliest of the 14th day following the date of a mailing, the 4th day following a faxed transmission, or the date the Commissioner receives written confirmation of the designation by a duly authorized officer of the domestic substitute agent (within the meaning of section 6062). The domestic substitute agent must give notice of its designation to the foreign common parent and each corporation that was a member of the group during any part of any consolidated return year for which the domestic substitute agent will be the agent. A failure of the domestic substitute agent to notify the foreign common parent or any member of the group does not invalidate the designation. The Commissioner will send a copy of the notification to the foreign common parent, and if applicable, to any domestic substitute agent the designation replaces; a failure to send a copy of the notification does not invalidate the designation.

(4) Term of agency—(i) Taxable years for which domestic substitute agent is the agent. If the Commissioner designates a domestic substitute agent for one or more taxable years, unless the designation is expressly limited to such term, such domestic substitute agent will continue as the group's sole agent for subsequent taxable years until the domestic substitute agent ceases to be a member of the continuing group, is replaced by a new domestic common parent (as provided in paragraph (j)(4)(iv)(A) of this section), is replaced by the Commissioner, or is replaced by a default substitute agent (as provided in paragraph (j)(5)(ii) of this section). If during the course of a consolidated return year the domestic substitute agent ceases to be a member of the continuing group or is replaced, it shall no longer act as agent for such taxable year or subsequent taxable years in any matter.

(ii) Continuing agency for prior taxable years. Unless replaced by a default substitute agent (as provided in paragraph (j)(5)(ii) of this section) or by the Commissioner, the domestic substitute agent at the end of a taxable year of the group will remain the agent for such year until its existence terminates, even if the group subsequently ceases to exist or the domestic substitute agent subsequently ceases to be a member of the group.

(iii) Replacement of a § 1.1502-77(d)(1) agent. If, pursuant to paragraph (d)(1) of this section, the common parent of the group designates a foreign common parent as the agent for the group for any taxable year, the Commissioner may, at any time, designate a domestic substitute agent to replace the foreign common parent, even if the Commissioner approved the terminating common parent's designation.

(iv) Group continues with a new common parent—(A) Year the new common parent becomes the common parent. If the group has a domestic substitute agent and the group continues in existence with a new common parent during a consolidated return year, and such new common parent is a domestic corporation (determined without regard to section 7874 or a section 953(d) election), the domestic substitute agent at the beginning of the year is the agent for the group through the date of the transaction in which the new common parent becomes the common parent, and the new common parent becomes the agent for the group beginning the day after the transaction, at which time it becomes the agent for the group with respect to the entire consolidated return year (including the period through the date of the transaction) and the former domestic substitute agent will no longer be the agent for the group for that year.

(B) Years preceding the year the new common parent becomes the common parent. If after the Commissioner's designation of a domestic substitute agent the group remains in existence with a new common parent, and such new common parent is a domestic corporation (determined without regard to section 7874 or a section 953(d) election), the Commissioner may designate the new common parent as the sole agent for the group for any of the group's prior taxable years (for which the consolidated Federal income tax return is due (without extensions) after July 23, 2007) in which the new common parent was a member of the group. For this purpose, the new common parent is treated as having been a member of the group for any taxable year it is primarily liable for the group's income tax liability.

(v) Replacement of domestic substitute agent by the Commissioner. The Commissioner may at any time, with or without a request from any member of the group, designate a replacement for a domestic substitute agent (or a successor to such agent).

(5) Deemed § 1.1502-77(d) designation—(i) In general. If the Commissioner designates a domestic substitute agent under this paragraph (j), it will be treated as a designation of a substitute agent under paragraph (d) of this section.

(ii) Default substitute agent. If the domestic substitute agent's existence terminates and it has a single successor that is a domestic corporation (without regard to section 269B) that is eligible to be a domestic substitute agent, such successor becomes the domestic substitute agent and is treated as a default substitute agent under paragraph (d)(2) of this section. See paragraph (d)(4) of this section regarding the consequences of the successor's failure to notify the Commissioner of its status as a default substitute agent. The default substitute agent shall use procedures in section 9 of Rev. Proc. 2002-43 (2002-2 CB 99) or a corresponding provision of a successor revenue procedure for notification. (See § 601.601(d)(2)(ii)(b) of this chapter.)

(6) Request that IRS designate a domestic substitute agent—(i) Original designation. If the common parent of the group is a foreign common parent, and the IRS has not designated a domestic substitute agent, one or more members of the group may request the IRS to make a designation for taxable years for which the consolidated Federal income tax return is due (without extensions) after July 23, 2007. Such request is deemed to be a request under paragraph (d)(3)(i) of this section. Members of the group shall use the procedures in section 10 of Rev. Proc. 2002-43 (2002-2 CB 99) or a corresponding provision of a successor revenue procedure for this purpose. (See § 601.601(d)(2)(ii)(b) of this chapter.)

(ii) Request that IRS replace a previously designated substitute agent. If the IRS designates a domestic substitute agent pursuant to this paragraph (j), one or more members of the group may request that the IRS replace the designated domestic substitute agent with another member (or successor to another member). Such a request is deemed to be a request pursuant to paragraph (d)(3)(ii) of this section. Members of the group shall use the procedures in section 11 of Rev. Proc. 2002-43 (2002-2 CB 99) or a corresponding provision of a successor revenue procedure for this purpose. (See § 601.601(d)(2)(ii)(b) of this chapter.)

[T.D. 9002, 67 FR 43540, June 28, 2002, as amended by T.D. 9255, 71 FR 13002, Mar. 14, 2006; T.D. 9343, 72 FR 40067, July 23, 2007. Redesignated and amended by T.D. 9715, 80 FR 17318, Apr. 1, 2015; T.D. 10018, 89 FR 106876, Dec. 30, 2024]

CHAPTER I INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED)

SUBCHAPTER A INCOME TAX (CONTINUED)

PART 1 INCOME TAXES (CONTINUED)

Authority: 26 U.S.C. 7805, unless otherwise noted. Link to an amendment published at 91 FR 57235, Sept. 8, 2026. Section 1.1561-2 also issued under 26 U.S.C. 1561. Section 1.5000A-3 also issued under 26 U.S.C. 5000A(e)(4). Section 1.5000C-1 is also issued under 26 U.S.C. 5000C Section 1.5000C-2 is also issued under 26 U.S.C. 5000C Section 1.5000C-3 is also issued under 26 U.S.C. 5000C Section 1.5000C-4 is also issued under 26 U.S.C. 5000C Section 1.5000C-5 is also issued under 26 U.S.C. 5000C Section 1.5000C-6 is also issued under 26 U.S.C. 5000C Section 1.6011-4T also issued under 26 U.S.C. 6001 and 6011(a). Section 1.6011-4T also issued under 26 U.S.C. 6011. Section 1.6011-6 also issued under 26 U.S.C. 6011(a). Section 1.6011-7 also issued under 26 U.S.C. 6011(e). Section 1.6011-9 also issued under 26 U.S.C. 6001 and 6011. Section 1.6011-10 also issued under 26 U.S.C. 6001 and 6011. Section 1.6011-11 also issued under 26 U.S.C. 6001 and 6011. Section 1.6011-15 also issued under 26 U.S.C. 6001 and 26 U.S.C. 6011. Section 1.6011-18 also issued under 26 U.S.C. 6001 and 26 U.S.C. 6011. Section 1.6012-2 is also issued under the authority of 26 U.S.C. 6011 and 6012. Section 1.6013-6 also issued under 26 U.S.C. 7701(b)(11). Section 1.6015-1 also issued under 26 U.S.C. 6015(h). Section 1.6015-2 also issued under 26 U.S.C. 6015(h). Section 1.6015-3 also issued under 26 U.S.C. 6015(h). Section 1.6015-4 also issued under 26 U.S.C. 6015(h). Section 1.6015-5 also issued under 26 U.S.C. 6015(h). Section 1.6015-6 also issued under 26 U.S.C. 6015(h). Section 1.6015-7 also issued under 26 U.S.C. 6015(h). Section 1.6015-8 also issued under 26 U.S.C. 6015(h). Section 1.6015-9 also issued under 26 U.S.C. 6015(h). Section 1.6031(a)-1 also issued under section 404 of the Tax Equity and Fiscal Responsibility Act of 1982 (Public Law 97-248; 96 Stat. 324, 669) (TEFRA). Section 1.6033-4 also issued under 26 U.S.C. 6033. Section 1.6033-6 also issued under 26 U.S.C. 6033(i)(1). Section 1.6035-1 also issued under 26 U.S.C. 6035. Section 1.6035-2 also issued under 26 U.S.C. 6035(b). Section 1.6035-2T also issued under 26 U.S.C. 6035. Section 1.6037-2 also issued under 26 U.S.C. 6037. Section 1.6038-2 also issued under 26 U.S.C. 6038. Section 1.6038-2T also issued under 26 U.S.C. 6038(d). Section 1.6038-3 also issued under 26 U.S.C. 6038. Section 1.6038-4 also issued under 26 U.S.C. 6001, 6011, 6012, 6031, and 6038. Section 1.6038-5 also issued under 26 U.S.C. 6038. Section 1.6038A-1 also issued under 26 U.S.C. 6001. Section 1.6038A-2 also issued under 26 U.S.C. 6038A and 6038C. Section 1.6038A-3 also issued under 26 U.S.C. 6038A and 7701(l). Section 1.6038A-4 also issued under 26 U.S.C. 6038A. Section 1.6038A-5 also issued under 26 U.S.C. 6038A. Section 1.6038A-6 also issued under 26 U.S.C. 6038A. Section 1.6038A-7 also issued under 26 U.S.C. 6038A. Section 1.6038B-1 also issued under 26 U.S.C. 6038B. Section 1.6038B-1T also issued under 26 U.S.C 6038B. Section 1.6038B-2 also issued under 26 U.S.C. 6038B. Section 1.6038B-2T also issued under 26 U.S.C. 6038B. Section 1.6038D-0 also issued under 26 U.S.C. 6038D. Section 1.6038D-1 also issued under 26 U.S.C. 6038D. Section 1.6038D-2 also issued under 26 U.S.C. 6038D. Section 1.6038D-3 also issued under 26 U.S.C. 6038D. Section 1.6038D-4 also issued under 26 U.S.C. 6038D. Section 1.6038D-5 also issued under 26 U.S.C. 6038D. Section 1.6038D-6 also issued under 26 U.S.C. 6038D. Section 1.6038D-7 also issued under 26 U.S.C. 6038D. Section 1.6038D-8 also issued under 26 U.S.C. 6038D. Section 1.6039I-1 also issued under 26 U.S.C. 6039I. Section 1.6041-1 also issued under 26 U.S.C. 6041(a). Section 1.6041-2 also issued under 26 U.S.C. 6041(d). Section 1.6041-3 also issued under 26 U.S.C. 62 and 6041(a). Section 1.6042-3 also issued under 26 U.S.C. 6045. Section 1.6043-4 also issued under 26 U.S.C. 6043(c). Section 1.6045-1 also issued under 26 U.S.C. 6045. Section 1.6045-1 also issued under 26 U.S.C. 6045(a). Section 1.6045-1T also issued under 26 U.S.C. 6045(g). Section 1.6045-2 also issued under 26 U.S.C. 6045. Section 1.6045-3 also issued under 26 U.S.C. 6045. Section 1.6045-4 also issued under 26 U.S.C. 6045. Section 1.6045A-1 also issued under 26 U.S.C. 6045A(a), (b), (c). Section 1.6045B-1 also issued under 26 U.S.C. 6045B(a), (c), (e). Section 1.6046-1 also issued 26 U.S.C. 6046(b). Section 1.6046A-1 also issued under 26 U.S.C. 6046A. Section 1.6047-2 is also issued under 26 U.S.C. 6047(d). Section 1.6049-4 also issued under 26 U.S.C. 6049 (a), (b), and (d). Section 1.6049-5 also issued under 26 U.S.C. 6049 (a), (b), and (d). Section 1.6049-5T also issued under 26 U.S.C. 6049. Section 1.6049-6 also issued under 6049(a), (b), and (d). Section 1.6049-7 also issued under 26 U.S.C. 860G(e), 1275(c) and 26 U.S.C. 6049(d)(7)(D). Section 1.6049-9 also issued under 26 U.S.C. 6049(a). Section 1.6049-10 also issued under 26 U.S.C. 6049(a). Section 1.6050E-1 also issued under 26 U.S.C. 6050E. Section 1.6050H-1 also issued under 26 U.S.C. 6050H. Section 1.6050H-2 also issued under 26 U.S.C. 6050H. Section 1.6050H-3 also issued under 26 U.S.C. 6050H(h). Section 1.6050I-1 also issued under 26 U.S.C. 6050I. Section 1.6050I-2 also issued under 26 U.S.C. 6050I. Section 1.6050K-1 also issued under 26 U.S.C. 6050K(a). Section 1.6050M-1 also issued under 26 U.S.C. 6050M. Section 1.6050P-1 also issued under 26 U.S.C. 6050P. Section 1.6050P-2 also issued under 26 U.S.C. 6050P. Section 1.6050S-1 also issued under 26 U.S.C. 6050S(g). Section 1.6050S-2 also issued under 26 U.S.C. 6050S(g). Section 1.6050S-3 also issued under 26 U.S.C. 6050S(g). Section 1.6050S-4 also issued under 26 U.S.C. 6050S(g). Section 1.6050X-1 also issued under 26 U.S.C. 6050X(a), (b). Section 1.6050Y-2 also issued under 26 U.S.C. 6050Y(a). Section 1.6050Y-3 also issued under 26 U.S.C. 6050Y(b). Section 1.6050Y-4 also issued under 26 U.S.C. 6050Y(c). Sections 1.6055-1 and 1.6055-2 also issued under 26 U.S.C. 6055. Section 1.6060-1 also issued under 26 U.S.C. 6060(a). Section 1.6061-2T also issued under 26 U.S.C. 6061. Section 1.6065-2T also issued under 26 U.S.C. 6065. Section 1.6081-1 also issued under 26 U.S.C. 6081. Section 1.6081-2 also issued under 26 U.S.C. 6081. Section 1.6081-2T also issued under 26 U.S.C. 6081. Section 1.6081-3 also issued under 26 U.S.C. 6081. Section 1.6081-4 also issued under 26 U.S.C. 6081. Section 1.6081-5 also issued under 26 U.S.C. 6081. Section 1.6081-6 also issued under 26 U.S.C. 6081. Section 1.6081-6T also issued under 26 U.S.C. 6081. Section 1.6081-7 also issued under 26 U.S.C. 6081. Section 1.6081-8 also issued under 26 U.S.C. 6081(a). Section 1.6081-9 also issued under 26 U.S.C. 6081(a). Section 1.6081-10 also issued under 26 U.S.C. 6081. Section 1.6081-11 also issued under 26 U.S.C. 6081. Section 1.6109-2 also issued under 26 U.S.C. 6109(a). Sections 1.6302-1, 1.6302-2, 1.6302-3 and 1.6302-4 also issued under 26 U.S.C. 6302(h). Section 1.6411-4 also issued under 26 U.S.C. 6402(i) and 6411(c). Section 1.6417-0 also issued under 26 U.S.C. 6417(h). Section 1.6417-1 also issued under 26 U.S.C. 6417(h). Section 1.6417-2 also issued under 26 U.S.C. 6417(h). Section 1.6417-3 also issued under 26 U.S.C. 6417(h). Section 1.6417-4 also issued under 26 U.S.C. 6417(h). Section 1.6417-5 also issued under 26 U.S.C. 6417(h). Section 1.6417-6 also issued under 26 U.S.C. 6417(h). Section 1.6418-1 also issued under 26 U.S.C. 6418(g) and (h). Section 1.6418-2 also issued under 26 U.S.C. 6418(g) and (h). Section 1.6418-3 also issued under 26 U.S.C. 6418(g) and (h). Section 1.6418-4 also issued under 26 U.S.C. 6418(g) and (h). Section 1.6418-5 also issued under 26 U.S.C. 48(a)(10)(C) and 6418(g) and (h). Section 1.6418-4T also issued under 26 U.S.C. 6418(g)(1) and (h). Section 1.6654-2 also issued under 26 U.S.C. 6654(n). Section 1.6655-5 also issued under 26 U.S.C. 6655(i)(2). Section 1.6662-6 also issued under 26 U.S.C. 6662. Section 1.6695-1 also issued under 26 U.S.C. 6060(b) and 6695(b). Section 1.6695-1 also issued under 26 U.S.C. 6695(b). Section 1.6695-2 also issued under 26 U.S.C. 6695(g). Section 1.6695-2T also issued under 26 U.S.C. 6695(g). Section 1.6851-2 also issued under 26 U.S.C 6851(d). Section 1.7520-1 also issued under 26 U.S.C. 7520(c)(2). Section 1.7520-1T also issued under 26 U.S.C. 7520(c)(2). Section 1.7520-2 also issued under 26 U.S.C. 7520(c)(2). Section 1.7520-3 also issued under 26 U.S.C. 7520(c)(2). Section 1.7520-4 also issued under 26 U.S.C. 7520(c)(2). Section 1.7701(l)-1 also issued under 26 U.S.C. 7701(l). Section 1.7701(l)-3 also issued under 26 U.S.C. 7701(l). Section 1.7701(l)-4 also issued under 26 U.S.C. 7701(l) and 954(c)(6)(A). Section 1.7702-2 also issued under 26 U.S.C. 7702(k). Section 1.7872-5(b)(17) also issued under 26 U.S.C. 7872. Section 1.7872-5T also issued under 26 U.S.C. 7872. Section 1.7872-15 also issued under 26 U.S.C. 1275 and 7872. Section 1.7874-1 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-1T also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-2 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-3 is also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-4 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-4T also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-5 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-5T also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-6 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-7 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-8 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-9 also issued under 26 U.S.C. 7874(c)(6) and (g). Section 1.7874-10 also issued under 26 U.S.C. 7874(c)(4) and (g). Section 1.7874-11 also issued under 26 U.S.C. 7874(g). Section 1.7874-12 also issued under 26 U.S.C. 7874(g).

Source: Sections 1.1401-1 through 1.1403-1 contained in T.D. 6691, 28 FR 12796, Dec. 3, 1963, unless otherwise noted. RELATED RULES

§ 1.1551-1 Disallowance of surtax exemption and accumulated earnings credit.

(a) In general. If:

(1) Any corporation transfers, on or after January 1, 1951, and before June 13, 1963, all or part of its property (other than money) to a transferee corporation,

(2) Any corporation transfers, directly or indirectly, after June 12, 1963, all or part of its property (other than money) to a transferee corporation, or

(3) Five or fewer individuals are in control of a corporation and one or more of them transfer, directly or indirectly, after June 12, 1963, property (other than money) to a transferee corporation, and the transferee was created for the purpose of acquiring such property or was not actively engaged in business at the time of such acquisition, and if after such transfer the transferor or transferors are in control of the transferee during any part of the taxable year of the transferee, then for such taxable year of the transferee the Secretary or his delegate may disallow the surtax exemption defined in section 11(d) or the accumulated earnings credit of $150,000 ($100,000 in the case of taxable years beginning before January 1, 1975) provided in paragraph (2) or (3) of section 535(c), unless the transferee establishes by the clear preponderance of the evidence that the securing of such exemption or credit was not a major purpose of the transfer.

(b) Purpose of section 1551. The purpose of section 1551 is to prevent avoidance or evasion of the surtax imposed by section 11(c) or of the accumulated earnings tax imposed by section 531. It is not intended, however, that section 1551 be interpreted as delimiting or abrogating any principle of law established by judicial decision, or any existing provisions of the Code, such as sections 269 and 482, which have the effect of preventing the avoidance or evasion of income taxes. Such principles of law and such provisions of the Code, including section 1551, are not mutually exclusive, and in appropriate cases they may operate together or they may operate separately.

(c) Application of section 269(b) to cases covered by section 1551. The provisions of section 269(b) and the authority of the district director thereunder, to the extent not inconsistent with the provisions of section 1551, are applicable to cases covered by section 1551. Pursuant to the authority provided in section 269(b) the district director may allow to the transferee any part of a surtax exemption or accumulated earnings credit for a taxable year for which such exemption or credit would otherwise be disallowed under section 1551(a); or he may apportion such exemption or credit among the corporations involved. For example, corporation A transfers on January 1, 1955, all of its property to corporations B and C in exchange for all of the stock of such corporations. Immediately thereafter, corporation A is dissolved and its stockholders become the sole stockholders of corporations B and C. Assuming that corporations B and C are unable to establish by the clear preponderance of the evidence that the securing of the surtax exemption defined in section 11(d) or the accumulated earnings credit provided in section 535, or both, was not a major purpose of the transfer, the district director is authorized under sections 1551(c) and 269(b) to allow one such exemption and credit and to apportion such exemption and credit between corporations B and C.

(d) Actively engaged in business. For purposes of this section, a corporation maintaining an office for the purpose of preserving its corporate existence is not considered to be “actively engaged in business” even though such corporation may be deemed to be “doing business” for other purposes. Similarly, for purposes of this section, a corporation engaged in winding up its affairs, prior to an acquisition to which section 1551 is applicable, is not considered to be “actively engaged in business.”

(e) Meaning and application of the term “control”—(1) In general. For purposes of this section, the term “control” means:

(i) With respect to a transferee corporation described in paragraph (a) (1) or (2) of this section, the ownership by the transferor corporation, its shareholders, or both, of stock possessing either (a) at least 80 percent of the total combined voting power of all classes of stock entitled to vote, or (b) at least 80 percent of the total value of shares of all classes of stock.

(ii) With respect to each corporation described in paragraph (a)(3) of this section, the ownership by five or fewer individuals of stock possessing (a) at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of the stock of each corporation, and (b) more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such individual only to the extent such stock ownership is identical with respect to each such corporation.

(2) Special rules. In determining for purposes of this section whether stock possessing at least 80 percent (or more than 50 percent in the case of subparagraph (1)(ii)(b) of this paragraph) of the total combined voting power of all classes of stock entitled to vote is owned, all classes of such stock shall be considered together; it is not necessary that at least 80 percent (or more than 50 percent) of each class of voting stock be owned. Likewise, in determining for purposes of this section whether stock possessing at least 80 percent (or more than 50 percent) of the total value of shares of all classes of stock is owned, all classes of stock of the corporation shall be considered together; it is not necessary that at least 80 percent (or more than 50 percent) of the value of shares of each class be owned. The fair market value of a share shall be considered as the value to be used for purposes of this computation. With respect to transfers described in paragraph (a) (2) or (3) of this section, the ownership of stock shall be determined in accordance with the provisions of section 1563(e) and the regulations thereunder. With respect to transfers described in paragraph (a)(1) of this section, the ownership of stock shall be determined in accordance with the provisions of section 544 and the regulations thereunder, except that constructive ownership under section 544(a)(2) shall be determined only with respect to the individual's spouse and minor children. In determining control, no stock shall be excluded because such stock was acquired before January 1, 1951 (the effective date of section 1551(a)(1)), or June 13, 1963 (the effective date of section 1551(a) (2) and (3)).

(3) Example. This paragraph may be illustrated by the following example:

Example. On January 1, 1964, individual A, who owns 50 percent of the voting stock of corporation X, and individual B, who owns 30 percent of such voting stock, transfer property (other than money) to corporation Y (newly created for the purpose of acquiring such property) in exchange for all of Y's voting stock. After the transfer, A and B own the voting stock of corporations X and Y in the following proportions:

Individual | Corp. X | Corp. Y | Identical ownership

A | 50 | 30 | 30

B | 30 | 50 | 30

Total | 80 | 80 | 60

The transfer of property by A and B to corporation Y is a transfer described in paragraph (a)(3) of this section since (i) A and B own at least 80 percent of the voting stock of corporations X and Y, and (ii) taking into account each such individual's stock ownership only to the extent such ownership is identical with respect to each such corporation, A and B own more than 50 percent of the voting stock of corporations X and Y.

(f) Taxable year of allowance or disallowance—(1) In general. The district director's authority with respect to cases covered by section 1551 is not limited to the taxable year of the transferee corporation in which the transfer of property occurs. Such authority extends to the taxable year in which the transfer occurs or any subsequent taxable year of the transferee corporation if, during any part of such year, the transferor or transferors are in control of the transferee.

(2) Examples. This paragraph may be illustrated by the following examples:

Example 1.On January 1, 1955, corporation D transfers property (other than money) to corporation E, a corporation not actively engaged in business at the time of the acquisition of such property, in exchange for 60 percent of the voting stock of E. During a later taxable year of E, corporation D acquires an additional 20 percent of such voting stock. As a result of such additional acquisition, D owns 80 percent of the voting stock of E. Accordingly, section 1551(a)(1) is applicable for the taxable year in which the later acquisition of stock occurred and for each taxable year thereafter in which the requisite control continues.

Example 2.On June 20, 1963, individual A, who owns all of the stock of corporation X, transfers property (other than money) to corporation Y, a corporation not actively engaged in business at the time of the acquisition of such property, in exchange for 60 percent of the voting stock of Y. During a later taxable year of Y, A acquires an additional 20 percent of such voting stock. After such acquisition A owns at least 80 percent of the voting stock of corporations X and Y. Accordingly, section 1551(a)(3) is applicable for the taxable year in which the later acquisition of stock occurred and for each taxable year thereafter in which the requisite control continues.

Example 3.Individuals A and B each owns 50 percent of the stock of corporation X. On January 15, 1964, A transfers property (other than money) to corporation Y (newly created by A for the purpose of acquiring such property) in exchange for all the stock of Y. In a subsequent taxable year of Y, individual B buys 50 percent of the stock which A owns in Y (or he transfers money to Y in exchange for its stock, as a result of which he owns 50 percent of Y's stock). Immediately thereafter the stock ownership of A and B in corporation Y is identical to their stock ownership in corporation X. Accordingly, section 1551(a)(3) is applicable for the taxable year in which B acquires stock in corporation Y (see paragraph (g)(3) of this section) and for each taxable year thereafter in which the requisite control continues. Moreover, if B's acquisition of stock in Y is pursuant to a preexisting agreement with A, A's transfer to Y and B's acquisition of Y's stock are considered a single transaction and section 1551(a)(3) also would be applicable for the taxable year in which A's transfer to Y took place and for each taxable year thereafter in which the requisite control continues.

(g) Nature of transfer—(1) Corporate transfers before June 13, 1963. A transfer made before June 13, 1963, by any corporation of all or part of its assets, whether or not such transfer qualifies as a reorganization under section 368, is within the scope of section 1551(a)(1), except that section 1551(a)(1) does not apply to a transfer of money only. For example, the transfer of cash for the purpose of expanding the business of the transferor corporation through the formation of a new corporation is not a transfer within the scope of section 1551(a)(1), irrespective of whether the new corporation uses the cash to purchase from the transferor corporation stock in trade or similar property.

(2) Corporate transfers after June 12, 1963. A direct or indirect transfer made after June 12, 1963, by any corporation of all or part of its assets to a transferee corporation, whether or not such transfer qualifies as a reorganization under section 368, is within the scope of section 1551(a)(2) except that section 1551(a)(2) does not apply to a transfer of money only. For example, if a transferor corporation transfers property to its shareholders or to a subsidiary, the transfer of that property by the shareholders or the subsidiary to a transferee corporation as part of the same transaction is a transfer of property by the transferor corporation to which section 1551(a)(2) applies. A transfer of property pursuant to a purchase by a transferee corporation from a transferor corporation controlling the transferee is within the scope of section 1551(a)(2), whether or not the purchase follows a transfer of cash from the controlling corporation.

(3) Other transfers after June 12, 1963. A direct or indirect transfer made after June 12, 1963, by five or fewer individuals to a transferee corporation, whether or not such transfer qualifies under one or more other provisions of the Code (for example, section 351), is within the scope of section 1551(a)(3) except that section 1551(a)(3) does not apply to a transfer of money only. Thus, if one of five or fewer individuals who are in control of a corporation transfers property (other than money) to a controlled transferee corporation, the transfer is within the scope of section 1551(a)(3) notwithstanding that the other individuals transfer nothing or transfer only money.

(4) Examples. This paragraph may be illustrated by the following examples:

Example 1.Individuals A and B each owns 50 percent of the voting stock of corporation X. On January 15, 1964, A and B each acquires property (other than money) from X and, as part of the same transaction, each transfers such property to his wholly owned corporation (newly created for the purpose of acquiring such property). A and B retain substantial continuing interests in corporation X. The transfers to the two newly created corporations are within the scope of section 1551(a)(2).

Example 2.Corporation W organizes corporation X, a wholly owned subsidiary, for the purpose of acquiring the properties of corporation Y. Pursuant to a reorganization qualifying under section 368(a)(1)(C), substantially all of the properties of corporation Y are transferred on June 15, 1963, to corporation X solely in exchange for voting stock of corporation W. There is a transfer of property from W to X within the meaning of section 1551(a)(2).

Example 3.Individuals A and B, each owning 50 percent of the voting stock of corporation X, organize corporation Y to which each transfers money only in exchange for 50 percent of the stock of Y. Subsequently, Y uses such money to acquire other property from A and B after June 12, 1963. Such acquisition is within the scope of section 1551(a)(3).

Example 4.Individual A owns 55 percent of the stock of corporation X. Another 25 percent of corporation X's stock is owned in the aggregate by individuals B, C, D, and E. On June 15, 1963, individual A transfers property to corporation Y (newly created for the purpose of acquiring such property) in exchange for 60 percent of the stock of Y, and B, C, and D acquire all of the remaining stock of Y. The transfer is within the scope of section 1551(a)(3).

(h) Purpose of transfer. In determining, for purposes of this section, whether the securing of the surtax exemption or accumulated earnings credit constituted “a major purpose” of the transfer, all circumstances relevant to the transfer shall be considered. “A major purpose” will not be inferred from the mere purchase of inventory by a subsidiary from a centralized warehouse maintained by its parent corporation or by another subsidiary of the parent corporation. For disallowance of the surtax exemption and accumulated earnings credit under section 1551, it is not necessary that the obtaining of either such credit or exemption, or both, have been the sole or principal purpose of the transfer of the property. It is sufficient if it appears, in the light of all the facts and circumstances, that the obtaining of such exemption or credit, or both, was one of the major considerations that prompted the transfer. Thus, the securing of the surtax exemption or the accumulated earnings credit may constitute “a major purpose” of the transfer, notwithstanding that such transfer was effected for a valid business purpose and qualified as a reorganization within the meaning of section 368. The taxpayer's burden of establishing by the clear preponderance of the evidence that the securing of either such exemption or credit or both was not “a major purpose” of the transfer may be met, for example, by showing that the obtaining of such exemption, or credit, or both, was not a major factor in relationship to the other consideration or considerations which prompted the transfer.

[T.D. 6911, 32 FR 3214, Feb. 24, 1967, as amended by T.D. 7376, 40 FR 42745, Sept. 16, 1975]

§ 1.1552-1 Earnings and profits.

(a) General rule. For the purpose of determining the earnings and profits of each member of an affiliated group which is required to be included in a consolidated return for such group filed for a taxable year beginning after December 31, 1953, and ending after August 16, 1954, the tax liability of the group shall be allocated among the members of the group in accordance with one of the following methods, pursuant to an election under paragraph (c) of this section:

(1)(i) The tax liability of the group shall be apportioned among the members of the group in accordance with the ratio which that portion of the consolidated taxable income attributable to each member of the group having taxable income bears to the consolidated taxable income.

(ii) For consolidated return years beginning after December 31, 1965, a member's portion of the tax liability of the group under the method of allocation provided by subdivision (i) of this subparagraph is an amount equal to the tax liability of the group multiplied by a fraction, the numerator of which is the taxable income of such member, and the denominator of which is the sum of the taxable incomes of all the members. For purposes of this subdivision the taxable income of a member shall be the separate taxable income determined under § 1.1502-12, adjusted for the following items taken into account in the computation of consolidated taxable income:

(A) The portion of the consolidated net operating loss deduction, the consolidated charitable contributions deduction, the consolidated dividends received deduction, the consolidated section 247 deduction, the consolidated section 582(c) net loss, and the consolidated section 922 deduction, attributable to such member;

(B) Such member's capital gain net income (determined without regard to any net capital loss carryover attributable to such member);

(C) Such member's net capital loss and section 1231 net loss, reduced by the portion of the consolidated net capital loss attributable to such member; and

(D) The portion of any consolidated net capital loss carryover attributable to such member which is absorbed in the taxable year.

If the computation of the taxable income of a member under this subdivision results in an excess of deductions over gross income, then for purposes of this subdivision such member's taxable income shall be zero.

(2)(i) The tax liability of the group shall be allocated to the several members of the group on the basis of the percentage of the total tax which the tax of such member if computed on a separate return would bear to the total amount of the taxes for all members of the group so computed.

(ii) For consolidated return years beginning after December 31, 1965, a member's portion of the tax liability of the group under the method of allocation provided by subdivision (i) of this subparagraph is an amount equal to the tax liability of the group multiplied by a fraction, the numerator of which is the separate return tax liability of such member, and the denominator of which is the sum of the separate return tax liabilities of all the members. For purposes of this subdivision the separate return tax liability of a member is its tax liability computed as if it has filed a separate return for the year except that:

(A) Gains and losses on intercompany transactions shall be taken into account as provided in § 1.1502-13 as if a consolidated return had been filed for the year;

(B) [Reserved]

(C) Transactions with respect to stock, bonds, or other obligations of members shall be reflected as provided in § 1.1502-13 (f) and (g) as if a consolidated return had been filed for the year;

(D) Excess losses shall be included in income as provided in § 1.1502-19 as if a consolidated return had been filed for the year;

(E) In the computation of the deduction under section 167, property shall not lose its character as new property as a result of a transfer from one member to another member during the year;

(F) A dividend distributed by one member to another member during the year shall not be taken into account in computing the deductions under section 243(a)(1), 244(a), 245, or 247 (relating to deductions with respect to dividends received and dividends paid);

(G) Basis shall be determined under §§ 1.1502-31 and 1.1502-32, and earnings and profits shall be determined under § 1.1502-33, as if a consolidated return had been filed for the year;

(H) Subparagraph (2) of § 1.1502-3(f) shall apply as if a consolidated return had been filed for the year; and

(I) For purposes of subtitle A of the Code, if two or more taxable income brackets are set forth in section 11(b) of the Code, the amount in each taxable income bracket is divided by the number of members (or such portion of each bracket which is apportioned to the member pursuant to a schedule attached to the consolidated return for the consolidated return year). However, if for the taxable year some or all of the members are component members of a controlled group of corporations (within the meaning of section 1563) and if there are other such component members which do not join in filing the consolidated return for such year, the amount to be divided among the members filing the consolidated return is (in lieu of the taxable income brackets) the sum of the amounts apportioned to the component members which join in filing the consolidated return.

(3)(i) The tax liability of the group (excluding the tax increases arising from the consolidation) shall be allocated on the basis of the contribution of each member of the group to the consolidated taxable income of the group. Any tax increases arising from the consolidation shall be distributed to the several members in direct proportion to the reduction in tax liability resulting to such members from the filing of the consolidated return as measured by the difference between their tax liabilities determined on a separate return basis and their tax liabilities (determined without regard to the 2-percent increase provided by section 1503(a) and paragraph (a) of § 1.1502-30A (as contained in the 26 CFR edition revised as of April 1, 1996) for taxable years beginning before January 1, 1964) based on their contributions to the consolidated taxable income.

(a) Allocating the tax liability of the group in accordance with subparagraph (1)(ii) of this paragraph, but

(b) The amount of tax liability allocated to any member shall not exceed the separate return tax liability of such member, determined in accordance with subparagraph (2)(ii) of this paragraph, and

(c) The sum of the amounts which would be allocated to the members but for (b) of this subdivision (ii) shall be apportioned among the other members in direct proportion to, but limited to, the reduction in tax liability resulting to such other members. Such reduction for any member shall be the excess, if any, of (1) its separate this paragraph.

(4) The tax liability of the group shall be allocated in accordance with any other method selected by the group with the approval of the Commissioner. No method of allocation may be approved under this subparagraph which may result in the allocation of a positive tax liability for a taxable year, among the members who are allocated a positive tax liability for such year, in a total amount which is more or less than the tax liability of the group for such year. (However, see paragraph (d) of § 1.1502-33.)

(b) Application of rules—(1) Tax liability of the group. For purposes of section 1552 and this section, the tax liability of the group for a taxable year shall consist of the Federal income tax liability of the group for such year determined in accordance with § 1.1502-2 or § 1.1502-30A (as contained in the 26 CFR edition revised as of April 1, 1996), which-ever is applicable. Thus, in the case of a carryback of a loss or credit to such year, although the earnings and profits of the members of the group may not be adjusted until the subsequent taxable year from which the loss or credit was carried back, the effect of the carryback, for purposes of this section, shall be determined by allocating the amount of the adjustment as a part of the tax liability of the group for the taxable year to which the loss or credit is carried. For example, if a consolidated net operating loss is carried back from 1969 to 1967, the allocation of the tax liability of the group for 1967 shall be recomputed in accordance with the method of allocation used for 1967, and the changes resulting from such recomputation shall, for accrual method taxpayers, be reflected in the earnings and profits of the appropriate members in 1969.

(2) Effect of allocation. The amount of tax liability allocated to a corporation as its share of the tax liability of the group, pursuant to this section, shall (i) result in a decrease in the earnings and profits of such corporation in such amount, and (ii) be treated as a liability of such corporation for such amount. If the full amount of such liability is not paid by such corporation, pursuant to an agreement among the members of the group or otherwise, the amount which is not paid will generally be treated as a distribution with respect to stock, a contribution to capital, or a combination thereof, as the case may be.

(c) Method of election. (1) The election under paragraph (a) (1), (2), or (3) of this section shall be made not later than the time prescribed by law for filing the first consolidated return of the group for a taxable year beginning after December 31, 1953, and ending after August 16, 1954 (including extensions thereof). If the group elects to allocate its tax liability in accordance with the method prescribed in paragraph (a) (1), (2), or (3) of this section, a statement shall be attached to the return stating which method is elected. Such statement shall be made by the common parent corporation and shall be binding upon all members of the group. In the event that the group desires to allocate its tax liability in accordance with any other method pursuant to paragraph (a)(4) of this section, approval of such method by the Commissioner must be obtained within the time prescribed above. If such approval is not obtained in such time, the group shall allocate in accordance with the method prescribed in paragraph (a)(1) of this section. The request shall state fully the method which the group wishes to apply in apportioning the tax liability. Except as provided in subparagraph (2) of this paragraph, an election once made shall be irrevocable and shall be binding upon the group with respect to the year for which made and for all future years for which a consolidated return is filed or required to be filed unless the Commissioner authorizes a change to another method prior to the time prescribed by law for filing the return for the year in which such change is to be effective.

(2) Each group may make a new election to use any one of the methods prescribed in paragraph (a) (1), (2), or (3) of this section for its first consolidated return year beginning after December 31, 1965, or in conjunction with an election under paragraph (d) of § 1.1502-33, or may request the Commissioner's approval of a method under paragraph (a)(4) of this section for its first consolidated return year beginning after December 31, 1965, irrespective of its previous method of allocation under this section. If such new election is not made in conjunction with an election under paragraph (d) of § 1.1502-33, it shall be effective for the first consolidated return year beginning after December 31, 1965, and all succeeding years. (See § 1.1502-33 for the method of making such new election in conjunction with an election under paragraph (d) of § 1.1502-33.) Any other such new election (or request for the Commissioner's approval of a method under paragraph (a)(4) of this section) shall be made within the time prescribed by law for filing the consolidated return for the first taxable year beginning after December 31, 1965 (including extensions thereof), or within 60 days after July 3, 1968, whichever is later. Such new election shall be made by attaching a statement to the consolidated return for the first taxable year beginning after December 31, 1965, or if such election is made within the time prescribed above but after such return is filed, by filing a statement with the internal revenue officer with whom such return was filed.

(d) Failure to elect. If a group fails to make an election in its first consolidated return, or any other election, in accordance with paragraph (c) of this section, the method prescribed under paragraph (a)(1) of this section shall be applicable and shall be binding upon the group in the same manner as if an election had been made to so allocate.

(e) Definitions. Except as otherwise provided in this section, the terms used in this section shall have the same meaning as provided in the regulations under section 1502.

(f) Example. The provisions of this section may be illustrated by the following example:

Example.Corporation P is the common parent owning all of the stock of corporations S1 and S2, members of an affiliated group. A consolidated return is filed for the taxable year ending December 31, 1966, by P, S1, and S2. For 1966 such corporations had the following taxable incomes or losses computed in accordance with paragraph (a)(1)(ii) of this section: P 0 S1 $2,000 S2 (1,000) The group has not made an election under paragraph (c) of this section or paragraph (d) of § 1.1502-33. Accordingly, the method of allocation provided by paragraph (a)(1) of this section is in effect for the group. Assuming that the consolidated taxable income is equal to the sum of the members taxable income and losses, or $1,000, the tax liability of the group for the year (assuming a 22-percent rate) is $220, all of which is allocated to S1. S1 accordingly reduces its earnings and profits in the amount of $220, irrespective of who actually pays the tax liability. If S1 pays the $220 tax liability there will be no further effect upon the income, earnings and profits, or the basis of stock of any member. If, however, P pays the $220 tax liability (and such payment is not in fact a loan from P to S1), then P shall be treated as having made a contribution to the capital of S1 in the amount of $220. On the other hand, if S2 pays the $220 tax liability (and such payment is not in fact a loan from S2), then S2 shall be treated as having made a distribution with respect to its stock to P in the amount of $220, and P shall be treated as having made a contribution to the capital of S1 in the amount of $220.

(g) Applicability date. This section applies to taxable years beginning on or after January 1, 2025. See 26 CFR 1.1552-1, as revised April 1, 2024, for rules applicable prior to January 1, 2025.

[T.D. 6962, 33 FR 9655, July 3, 1968, as amended by T.D. 7825, 42 FR 64694, Dec. 28, 1977; T.D. 7728, 45 FR 72650, Nov. 3, 1980; T.D. 8560, 59 FR 41675, Aug. 15, 1994; T.D. 8597, 60 FR 36680, July 18, 1995; T.D. 8677, 61 FR 33325, June 27, 1996; T.D. 10018, 89 FR 106878, Dec. 30, 2024]

1 Certain Controlled Corporations

§ 1.1561-0 Table of contents.

This section lists the table of contents for §§ 1.1561-1 through 1.1561-3.

§ 1.1561-1 General rules regarding certain tax benefits available to the component members of a controlled group of corporations.

(a) In general.

(1) Limitation.

(2) Definitions.

(b) Special rules.

(1) S Corporation.

(2) 52-53-week taxable year.

(d) Effective/applicability date.

§ 1.1561-2 Special rules for allocating reductions of certain Section 1561(a) tax-benefit items.

(a) Additional tax.

(1) Calculation.

(2) Apportionment.

(3) Examples.

(b) Reduction to the amount exempted from the alternative minimum tax.

(1) Calculation.

(2) Apportionment.

(3) Examples.

(d) [Reserved]

(e) Short taxable year not including a December 31st date.

(1) General rule.

(2) Additional rules.

(3) Calculation of the additional tax.

(4) Calculation of the alternative minimum tax.

(5) Examples.

(f) Effective/applicability date.

§ 1.1561-3 Allocation of the section 1561(a) tax items.

(a) Filing of form.

(1) In general.

(2) Exception for component members that are members of a consolidated group.

(b) No apportionment plan in effect.

(1) Adoption of plan.

(2) Limitation on adopting a plan.

(3) Termination of plan.

(d) Effective/applicability date.

[T.D. 9476, 74 FR 68532, Dec. 28, 2009]

§ 1.1561-1 General rules regarding certain tax benefits available to the component members of a controlled group of corporations.

(a) In general—(1)—Limitation. Part II (section 1561 and following) of subchapter B of chapter 6 of the Internal Revenue Code (Code) (part II) provides rules to limit the amounts of certain specified tax benefit items of component members of a controlled group of corporations for their tax years which include a particular December 31st date, or, in the case of a short taxable year member (see section 1561(b) and § 1.1561-2(e)), the date substituted for that December 31st date. The amount of the tax items enumerated in section 1561(a) available to any of the component members of a controlled group shall be determined for purposes of subtitle A of the Code as if the component members were a single corporation. Certain other tax items also set forth in section 1561(a) (for example, the additional tax imposed by section 11(b)(1) and the section 55(d)(3) phase out of the alternative minimum tax exemption amount) will be determined by combining the positive taxable income or positive alternative minimum taxable income of the component members of such a group and then allocating the amount of such items among those members.

(2) Definitions. For certain definitions (including the definition of a controlled group of corporations and a component member) and special rules for purposes of this part II see section 1563.

(b) Special rules—(1) S Corporation. For purposes of this part II, the term corporation includes a small business corporation (as defined in section 1361). However, for the treatment of such a corporation as an excluded member of a controlled group of corporations see § 1.1563-1(b)(2)(ii)(C).

(2) 52-53-week taxable year. In the case of corporations electing a 52-53-week taxable year under section 441(f)(1), the provisions of this part II shall be applied in accordance with the special rule of section 441(f)(2)(A). See § 1.441-2.

(c) Tax avoidance. The provisions of this part II do not delimit or abrogate any principle of law established by judicial decision, or any existing provisions of the Code, such as sections 269, 482, and 1551, which serve to prevent any avoidance or evasion of income taxes.

(d) Effective/applicability date. This section applies to any tax year beginning on or after December 21, 2009. However, taxpayers may apply this section to any Federal income tax return filed on or after December 21, 2009. For tax years beginning before December 21, 2009, see § 1.1561-1T as contained in 26 CFR part 1 in effect on April 1, 2009.

[T.D. 9476, 74 FR 68532, Dec. 28, 2009]

§ 1.1561-2 Special rules for allocating reductions of certain section 1561(a) tax-benefit items.

(a) Additional tax—(1) Calculation—(i) In general. For the purpose of determining the amount, if any, of the additional tax imposed by section 11(b)(1) (the additional tax), the taxable incomes of all of the component members of a controlled group of corporations shall be combined to determine whether either of the income thresholds for imposing the additional tax have been attained.

(ii) Special rules. For purposes of paragraph (a)(1)(i) of this section—

(A) Component member means a corporation that is apportioned some part of any applicable tax bracket amount; and

(B) Taxable income means the positive taxable income of a component member for its entire tax year (even if it was not a member of the group for each day of that tax year) that includes the same December 31st testing date, which is also applicable to the other component members of that same controlled group.

(2) Apportionment—(i) General rule. Any additional tax determined under paragraph (a)(1) of this section shall be apportioned among such members in the same manner as the corresponding tax bracket of section 11(b)(1) is apportioned. For rules to apportion the section 11(b)(1) tax brackets among the component members of a controlled group, see § 1.1561-3(b) or (c).

(ii) Apportionment methods. Unless the component members of a controlled group elect to use the first-in-first-out (FIFO) method described in paragraph (a)(2)(ii)(B) of this section, such members are required to apportion the amount of the additional tax using the proportionate method described in paragraph (a)(2)(ii)(A) of this section. These component members may elect the FIFO method by specifically adopting such method in their apportionment plan.

(A) Proportionate method. Under the proportionate method, the additional tax is allocated to each component member in the same proportion as the portion of the tax-benefit amount that inured to a member from utilizing lower tax brackets bears to the amount of the group's total tax-benefit amount inuring to it from utilizing those lower tax brackets. The tax-benefit amount that inures to a corporation from using a particular tax bracket is the tax savings that such corporation realizes from having a portion of its taxable income taxed at the lower rate attributed to that tax bracket instead of the high tax rates to which it would otherwise be subject. The steps for applying the proportionate method of allocation are as follows:

(1) Step 1. The regular tax (not including the additional tax) owed by a component member under a particular tax bracket is divided by the total tax owed by all component members under that tax bracket;

(2) Step 2. The percentage calculated under Step 1 is multiplied by the total tax-benefit amount inuring to all the members of the group from their use of this tax bracket. This computed amount equals the portion of the group's tax-benefit amount that inured to such member from using its portion of this tax bracket;

(3) Step 3. The amount determined under Step 2 is divided by the total tax-benefit amount, inuring to all the component members of the group from using all the tax brackets to which any component member's income was subject;

(4) Step 4. The percentage calculated under Step 3 is multiplied by the amount of the group's additional tax. The amount determined under this Step 4 equals the amount of the additional tax apportioned to such member for that tax bracket; and

(5) Step 5. If a component member is liable for regular tax (not including the additional tax) under more than one tax bracket, that member must calculate the amount of the additional tax apportioned to it with respect to each tax bracket. Accordingly, steps 1 through 4 must be applied for each tax bracket applicable to that member. The sum of all the apportioned amounts of additional tax from each tax bracket for which the member is subject is the total amount of the additional tax apportioned to that member.

(B) FIFO method. Under the FIFO method, the first dollars of the additional tax are to be allocated proportionately to the members starting with the lowest tax bracket (that is, the first tax bracket), up to the amount of the tax benefit inuring to those members from using that tax bracket. Any remaining amount of additional tax is then allocated proportionately among the component members who use the next higher tax bracket, and so on, until the entire amount of the additional tax has been fully apportioned among the members. For example, the first $9,500 of the additional tax liability of a controlled group is apportioned entirely to the member(s) that availed themselves of the benefit of the 15 percent tax bracket.

(3) Examples. The provisions of this paragraph (a) may be illustrated by the following examples:

Example 1. (i) Facts. A controlled group of corporations consists of three members: X, Y and Z. X owns all the stock of Y and Z. Each corporation files its separate return on a calendar year basis. For calendar year 2007, the component members of the controlled group have an apportionment plan in effect. The members apportioned 80% of the 15 percent tax-bracket amount ($40,000) to X and the remaining 10% ($10,000) to Y. The members apportioned 100% of the 25 percent tax-bracket amount ($25,000) to Y. However, these members have not adopted the FIFO method for apportioning the additional taxes. Therefore, they must follow the proportionate method. For 2007, X had taxable income (TI) of $40,000, Y had TI of $60,000 and Z had TI of $100,000. Thus the total TI of the group is $200,000.

(ii) Calculating the tax from the tax brackets and the tax benefit derived from such tax. (A) Regular tax of group subject to a 15 percent tax rate. (1) Calculating the group's tax which resulted from applying a 15 percent tax rate. The amount of tax under the 15 percent tax bracket is $7,500 (15% × $50,000).

(2) The tax-benefit amount inuring to the group from using the 15 percent tax bracket. A tax benefit inures to those members of the group who avail themselves of the 15 percent tax bracket. That tax benefit results from having the first $50,000 of its income taxed at the 15 percent tax rate, instead of at the 34 percent tax rate. Thus, the tax-benefit amount inuring to this group from using the 15 percent tax bracket is $9,500 ($17,000 (34% × $50,000) minus $7,500 (15% × $50,000)).

(B) Regular tax of group subject to a 25 percent tax rate. (1) Calculating the group's tax which resulted from applying a 25 percent tax rate. The amount of tax under the 25 percent tax bracket is $6,250 (25% × $25,000 ($75,000−$50,000)).

(2) The tax-benefit amount inuring to the group from using the 25 percent tax bracket. A tax benefit inures to those members of the group who avail themselves of the 25 percent tax bracket. That tax benefit results from having $25,000 of its income taxed at the 25 percent tax rate, instead of at the 34 percent tax rate. Thus, the tax-benefit amount inuring to this group from using the 25 percent tax bracket is $2,250 ($8,500 (34% × $25,000) minus $6,250 (25% × $25,000)).

(C) Regular tax of group subject to a 34 percent tax rate. (1) Calculating the group's tax which resulted from applying a 34 percent tax rate. The amount of tax under the 34 percent tax bracket is $42,500 (34% × $125,000 ($200,000 (total TI)−$75,000) (amount taxed at lower rates)).

(2) The tax-benefit amount inuring to the group from using the 34 percent tax bracket. The group's total TI of $200,000 is less than the $15,000,000 income threshold for imposing any 3 percent additional tax on the group. Therefore, there is no tax benefit inuring to the members of this group for using the 34 percent tax bracket.

(D) The computation of the additional tax. Since the combined TI of the group exceeds $100,000, a 5 percent additional tax is imposed on the group. That 5 percent additional tax is the lesser amount of 5 percent of the group's taxable income exceeding $100,000 or $11,750. Five percent of that excess amount of taxable income is $5,000 (5% × $100,000 ($200,000−$100,000)). Since $5,000 is less than $11,750, the group's 5 percent additional tax is $5,000.

(iii) Apportioning the amount of additional tax to each applicable tax bracket. (A) The apportioned tax under each bracket. The amount of tax owed by each member under each tax bracket pursuant to the apportionment plan is as follows:

Name of component member | Amount of tax owed under the 15% tax bracket | Amount of tax owed under the 25% tax bracket | Amount of tax owed under the 34% tax bracket

X | $6,000 | 0 | 0

Y | 1,500 | $6,250 | $8,500

Z | 0 | 0 | 34,000

(B) Apportioning the 5 percent additional tax among the component members of the controlled group. Since the group did not elect to adopt the FIFO method of apportionment, it is required to apportion the $5,000 of its 5 percent additional tax pursuant to the proportionate method in the following manner:

(1) Amount of the additional tax apportioned to X. Pursuant to the plan, X was liable for $6,000 of the group's $7,500 regular tax (80%) owed under the 15 percent tax bracket (and X is not liable for any regular tax under any higher tax bracket). See Step 1 of paragraph (a)(2)(ii)(A) of this section. X's portion of the group's tax benefit which it derived from using the 15 percent tax rate is $7,600 (0.8 × $9,500). See Step 2. The tax benefit inuring to the entire group from using the 15 percent and 25 percent tax brackets is $11,750 ($9,500 (from the 15 percent tax bracket) + $2,250 (from the 25 percent tax bracket)). So, X's percentage portion of the group's total tax benefit is $7,600/$11,750 (64.68%). See Step 3. Thus, X's allocated portion of the 5 percent additional tax from using the 15 percent tax bracket is $3,234 (0.6468 × $5,000). See Step 4.

(2) Amount of the additional tax apportioned to Y. (i) Regular tax apportioned to Y from using the 15 percent tax bracket. Pursuant to the plan, Y was liable for the remaining $1,500 of the group's $7,500 regular tax (20%) owed under the 15 percent tax bracket. See Step 1. Y's portion of the group's tax benefit which it derived from using the 15 percent tax rate is $1,900 ($9,500−$7,600, or 0.2 × $9,500). See Step 2. So, Y's percentage portion of the group's total tax benefit is $1,900/$11,750 (16.17%). See Step 3. Thus, Y's allocated portion of the 5 percent additional tax from using the 15 percent tax bracket is $809 (0.1617 × $5,000). See Step 4.

(ii) Regular tax apportioned to Y from using the 25 percent tax bracket. Pursuant to the plan, Y was liable for 100% of the group's regular tax owed under the 25 percent tax bracket, an amount of $6,250. See Step 1. Y is, therefore, entitled to 100% of the group's tax benefit which it derived from using this tax bracket, an amount of $2,250. See Step 2. So, Y's percentage portion of the group's total tax benefit is $2,250/$11,750 (19.15%). See Step 3. Thus, Y's allocated portion of the 5 percent additional tax from using the 25 percent tax bracket is $957 (0.1915 × $5,000). See Step 4. Y's total allocated portion of the additional tax is $1,766 ($809 + $957). See Step 5.

Example 2. (i) Facts. The facts are the same as in Example 1, except that on August 31, 2007, X of the X-Y-Z controlled group sold all of the stock of Z to M of the M-N controlled group, a pair of corporations unrelated to the X-Y group. Pursuant to the terms of the sales agreement, the members of the M-N group properly notified the members of the X-Y group on a timely basis that Z's taxable income for its 2007 tax year, as based on the group's December 31st testing date, was $100,000.

(ii) Controlled group analysis. On December 31st, 2007, X and Y are members of the selling controlled group and M, N and Z are members of the buying controlled group. However, pursuant to section 1563(b)(3), Z is treated as an additional member of the X-Y group on December31st 2007, since it was a member for at least one-half the number of days (243 out of 364) during the period beginning on January 1 and ending on December 30, 2007. Conversely, pursuant to section 1563(b)(2)(A), Z is treated as an excluded member of the M-N controlled group. Therefore, on December 31st, 2007, X, Y, and Z qualify as component members of the selling group, and only M and N qualify as component members of the buying group.

(iii) Additional tax analysis. With regard to X and Y's 2007 tax years, X and Y together owed $5,000 of additional tax, as calculated in Example 1. X's allocated portion of the additional tax is $3,234, as calculated in the manner set forth in Example 1. Y's allocated portion of the additional tax is $1,766, also as calculated in the manner set forth in Example 1.

Example 3. (i) Facts. The facts are the same as in Example 2, except that in 2012, pursuant to an IRS audit, Z's 2007 taxable income was re-determined. It was adjusted by an income increase of $10,000. Pursuant to the terms of the sales agreement, the members of the M-N group timely notified the members of the X-Y group of Z's income adjustment.

(ii) Additional tax analysis. For 2007 the X-Y-Z group owed a revised additional tax in the amount of $5,500, allocated as follows: $3,557.40 to X and $1,942.60 to Y. X and Y each filed an amended 2007 tax return to report their portions of the $500 increase to the group's additional tax. Pursuant to their apportionment plan for allocating their regular tax, and as a result of defaulting to the proportionate method for allocating the group's additional tax, X reported $323.40 as its share of the group's increase to its additional tax and Y reported $176.60 as its share of the group's increase to its additional tax.

Example 4.The facts are the same as in Example 1, except that the members elected in their apportionment plan to adopt the FIFO method for apportioning the additional tax. Under the FIFO method, the 5 percent additional tax amount of $5,000 will be apportioned entirely to those members who would benefit from using the 15 percent tax bracket, by reason that $5,000 of the group's additional tax is less than $9,500, which is the full tax-benefit amount inuring to a controlled group from having a 15 percent tax rate applied to the full income bracket subject to that rate. Since X derived 80 percent of the group's tax benefit by its use of the 15 percent tax bracket, its share of the group's 5 percent additional tax is $4,000 (80% × $5,000), and Y's share of the group's 5 percent additional tax is, therefore, $1,000, which is the remaining amount of the group's 5 percent additional tax, attributable to the 15 percent tax bracket.

(b) Reduction to the amount exempted from the alternative minimum tax—(1) Calculation. The alternative minimum taxable incomes of the component members of a controlled group of corporations shall be taken into account in calculating the reduction set forth in section 55(d)(3) to the amount exempted from the alternative minimum tax (the exemption amount). For purposes of the preceding sentence, alternative minimum taxable income means the positive alternative minimum taxable income of a component member for its entire tax year (even if it was not a member of the group for each day of that tax year) that includes the same December 31st testing date, which is also applicable to the other component members of that same controlled group.

(2) Apportionment. Any reduction to the exemption amount shall be apportioned to the component members of a controlled group in the same manner that the amount of the exemption (provided in section 55(d)(2)) to the alternative minimum tax was allocated under section 1561(a). For rules to apportion the section 55(d)(2) exemption amount among the component members of a controlled group, see § 1.1561-3(b) or (c).

(3) Examples. The provisions of this paragraph (b) may be illustrated by the following example:

Example. (i) Facts. A controlled group of corporations consists of three members: X, Y and Z. X owns all of the stock of Y and Z. Each corporation files its separate return on a calendar year basis. For calendar year 2007, the component members of this controlled group have an apportionment plan in effect. The group has chosen to apportion the entire section 55(d)(2) exemption amount of $40,000 to Z. For 2007, X had alternative minimum taxable income (AMTI) of $40,000, Y had AMTI of $60,000 and Z had AMTI of $100,000. Thus the total AMTI of the group is $200,000.

(ii) Calculating the reduction to the exemption amount. Section 55(d)(3)(A) provides that the section 55(d)(2) exemption amount shall be reduced (but not below zero) by an amount equal to 25 percent of the amount by which the AMTI of a corporation exceeds $150,000. For the purpose of computing the group's AMTI, the AMTI of each of the component members, for their tax years that have the same December 31st testing date, shall be taken into account. In accordance with these provisions, the $40,000 exemption amount is reduced by $12,500 (25% × $50,000 ($200,000−$150,000)). Pursuant to the group's allocation plan, the entire $12,500 reduction to the exemption amount is allocated to Z. Thus, after such allocation, Z's $40,000 exemption amount is reduced to $27,500 ($40,000−$12,500).

(c) Accumulated earnings credit. The component members of a controlled group of corporations are permitted to allocate the amount of the accumulated earnings credit unequally if they have an apportionment plan in effect.

(d) [Reserved]

(e) Short taxable years not including a December 31st date—(1) General rule. If a corporation has a short taxable year not including a December 31st date and, after applying the rules of section 1561(b) and paragraph (e)(2)(i) of this section, it qualifies as a component member of the group with respect to its short taxable year (short-year member), then, for purposes of subtitle A of the Internal Revenue Code, the amount of any tax-benefit item described in section 1561(b) allocated to that component member's short taxable year shall be the amount specified in section 1561(a) for that item, divided by the number of corporations which are component members of that group on the last day of that component member's short taxable year. The component members of such group may not apportion, by an apportionment plan, an amount of such tax-benefit item to any short-year member that differs from equal apportionment of that item.

(2) Additional rules. For purposes of paragraph (e)(1) of this section—

(i) Section 1563(b) shall be applied as if the last day of the taxable year of a short-year member were substituted for December 31st; and

(ii) The term short taxable year does not refer to any portion of a tax year of a corporation for which its income is required to be included in a consolidated return pursuant to § 1.1502-76(b).

(3) Calculation of the additional tax. A short-year member (as defined in paragraph (e)(1) of this section) for its short taxable year calculates its additional tax liability imposed by section 11(b)(1) only on its own income, and therefore the subsequent calculation of the additional tax liability with regard to the remaining members of the group will not include the income of this short-year member.

(4) Calculation of the alternative minimum tax. If a component member has a tax year of less than 12 months, whether or not such tax year includes a December 31st date, see section 443(d) for the annualization method required for calculating the alternative minimum tax.

(5) Examples. The provisions of this paragraph (e) may be illustrated by the following examples:

Example 1. Formation of a new member of a controlled group—(i) Facts. On January 2, 2007, corporation X transfers cash to newly formed corporation Y (which begins business on that date) and receives all of the stock of Y in return. X also owns all of the stock of corporation Z on each day of 2006 and 2007. X, Y and Z have an apportionment plan in effect, apportioning the 15 percent taxbracket amount as follows: 40% ($20,000) to each of X and Y and 20% ($10,000) to Z. X, Y and Z each file a separate return with respect to the group's December 31st, 2007 testing date. X is on a calendar tax year and Z is on a fiscal tax year ending on March 31. Y adopts a fiscal year ending on June 30 and timely files a tax return for its short taxable year beginning on January 2, 2007, and ending on June 30, 2007. (ii) Y's short taxable year. On June 30, 2007, Y is a component member of a parentsubsidiary controlled group of corporations composed of X, Y and Z. Pursuant to paragraph (e)(1) of this section, the group may not apportion any amount of the 15 percent tax bracket to Y's short taxable year ending on June 30, 2007. Rather, Y is entitled to exactly 1/3 of such bracket amount, or $16,667.

(iii) The members' subsequent tax years. On December 31st, 2007, X, Y and Z are component members of a parent-subsidiary controlled group of corporations. For their tax years that include December 31st, 2007 (X's calendar year ending December 31st, 2007, Z's fiscal year ending March 31, 2008 and Y's fiscal year ending June 30, 2008), X, Y and Z apportion among themselves the full amount of all of the applicable tax brackets pursuant to their apportionment plan. For example, 40% of the 15 percent tax-bracket amount, or $20,000, was apportioned to each of X and Y, and the remaining 10%, or $10,000, was apportioned to Z.

Example 2. Allocating a tax bracket to the short taxable year of a liquidated member of a controlled group—(i) Facts. On January 1, 2007, corporation P owns all of the stock of corporations S1, S2 and S3 (the P group). Each of these four component members of the P group, with respect to the group's December 31st, 2007 testing date, files its separate return on a calendar year basis. These members have an apportionment plan in effect (the P group plan) under which S1 and S2 are each entitled to 40% of the 15 percent tax-bracket amount ($20,000), and P and S3 are each entitled to 10% of the 15 percent tax-bracket amount ($5,000). On May 31, 2007, S1 liquidates and therefore files a return for the short taxable year beginning on January 1, 2007, and ending on May 31, 2007. On July 31, 2007, S2 liquidates and therefore files a return for the short taxable year beginning on January 1, 2007 and ending on July 31, 2007. P and S3 each file a return for their 2007 calendar tax years. (ii) Apportionment of the 15 percent tax bracket to S1 for its short taxable year. On May 31, 2007, S1 is a component member of the P group composed of P, S1, S2 and S3. Pursuant to paragraph (e)(1) of this section, the group may not apportion any amount of the 15 percent tax bracket to S1's short taxable year ending on June 30, 2007. Rather, S1 is entitled to exactly 1/4 of such bracket amount, or $12,500.

(iii) Apportionment of the 15 percent tax bracket to S2 for its short taxable year. On July 31, 2007, S2 is a component member of the P group composed of P, S2 and S3. Pursuant to paragraph (e)(1) of this section, the group may not apportion any amount of the 15 percent tax bracket to S2's short taxable year ending on June 30, 2007. Rather, S2 is entitled to exactly 1/4 of such bracket amount, or $16,667.

(iv) Apportionment of the 15 percent tax bracket to P and S3 for each of their calendar tax years. On December 31st, 2007, P and S3 are component members of the P group. Accordingly, for P and S3's 2007 calendar tax year, they are each apportioned $25,000 of the 15 percent tax bracket, pursuant to the applicable P group plan.

Example 3. Liquidation of member after its transfer to another controlled group—(i) Facts. The facts are the same as in Example 2, except that P, on April 30, 2007, sold all of the stock of S2 to the M-N controlled group. At the time of the sale, M and N are both unrelated to any members of the P group. As in Example 2, S2 liquidates on July 31, 2007, and therefore files a tax return for its short taxable year beginning on January 1, 2007, and ending on July 31, 2007. Pursuant to the sales agreement, the N-M group timely notified P that S2 had liquidated. (ii) Controlled group analysis. On April 30, 2007, the date of the sale of S2, the P group reasonably expected that S2 would be treated as an excluded member with respect to its December 31st, 2007 testing date. On that April 30th date, S2 had been a member of the P group for less than one-half the number of days of what it expected would be a full 2007 calendar tax year preceding December 31st, 2007 (120 days (January 1-April 30) out of 364 days (January 1-December 30)). Yet, as a result of S2's subsequent liquidation by the M-N group prior to December 31st, 2007, S2 became a component member of the P group with respect to the P group's December 31st, 2007 testing date. With respect to that December 31st testing date, S2 thus was a member of the P group for more than one-half of the number of days of its tax year ending on July 31, 2007, which days proceeded December 31st, 2007 (120 days (January 1-April 30 of 2007) out of 211 days (January 1-July 30 of 2007)). The allocation of the 15 percent tax-bracket amount to the P group members is determined in the same manner as in Example 2 and, therefore, the bracket amounts allocated to P, S1, S2 and S3 are the same as determined in Example 2. The allocation of the bracket amounts would be the same if, at the time P sold all of the S2 stock, the parties had made a section 338(h)(10) election.

Example 4. Short tax year including a December 31st date. Corporation X owns all of the stock of corporations Y and Z. X, Y and Z each file separate returns. X and Y are on a calendar tax year and Z is on a fiscal tax year beginning October 1 and ending September 30. On January 2, 2007, Z liquidates. Because Z's final tax year (beginning on October 1, 2006 and ending on January 2, 2007) includes a December 31st date, that is, December 31, 2006, it is therefore not subject to the short taxable year rule provided by section 1561(b) and paragraph (e) of this section. Accordingly, Z is a component member of the X-Y-Z group, for the group's December 31st, 2006 testing date. Thus, the rules of this paragraph (e) do not limit the amount of any of the tax-benefit items of section 1561(a) available to Z or to this controlled group.

(f) Effective/applicability date. This section applies to any tax year beginning on or after December 21, 2009. However, taxpayers may apply this section to any Federal income tax return filed on or after December 21, 2009. For tax years beginning before December 21, 2009, see § 1.1561-2T as contained in 26 CFR part 1 in effect on April 1, 2009.

[T.D. 9476, 74 FR 68533, Dec. 28, 2009]

§ 1.1561-3 Allocation of the section 1561(a) tax items.

(a) Filing of form—(1) In general. For each tax year that a corporation is a component member of the same controlled group of corporations on a December 31st (its testing date), or, in the case of a short-year member (see section 1561(b) and § 1.1561-2(e)), the date substituted for that December 31st date (its testing date), such corporation and all the other component members of such group each must file the required form (that is, Schedule O or any successor form) with the Federal income tax return for that component member's tax year that includes a particular testing date. Each such corporation must file that form with its return whether or not—

(i) An apportionment plan is in effect; or

(ii) Any change is made to the group's apportionment of its section 1561(a) tax benefit items from the previous year.

(2) Exception for component members that are members of a consolidated group. If any of the component members of a controlled group of corporations are also members of a consolidated group, the parent of such consolidated group shall file only one form on behalf of all such members. Such form shall contain the information required for each such member.

(b) No apportionment plan in effect. If the component members of a controlled group of corporations do not have an apportionment plan in effect, the amounts of the section 1561(a) items must be divided equally among all such members. For purposes of the preceding sentence, if any of the component members of a controlled group of corporations are also members of a consolidated group, such members will each be treated as a separate component member of the controlled group.

(c) Apportionment plan in effect—(1) Adoption of plan. The component members of a controlled group of corporations consent to the adoption (or amendment) of an apportionment plan by checking the box to that effect on such form. For purposes of this paragraph (c)—

(i) An apportionment plan that is adopted (including a plan that has been amended) continues in effect until it is terminated;

(ii) A consolidated group is treated collectively as one component member of such group. This treatment occurs even where a member of that consolidated group has joined or left the group, if after such corporation joins or leaves the consolidated group, that group remains in existence, pursuant to § 1.1502-75(d); and

(iii) The members must allocate the amounts of the section 1561(a) items between/among themselves as described in the plan.

(2) Limitation on adopting a plan—(i) Sufficient statute of limitations period for making an assessment of tax. The members may only adopt or amend such a plan if there is at least one year remaining in the statutory period (including any extensions thereof) for the assessment of a deficiency against every member the tax liability of which would be increased by the adoption of such a plan.

(ii) Insufficient statute of limitations period for making an assessment of tax. If any member cannot satisfy the requirement of paragraph (c)(2)(i) of this section, the members may not adopt or amend such a plan unless the member not satisfying such requirement has entered into an agreement with the Internal Revenue Service to extend the statute of limitations for the limited purpose of assessing any deficiency against such member attributable to the adoption of such a plan.

(3) Termination of plan. An apportionment plan that is in effect for the component members of a controlled group with respect to a preceding December 31st is terminated with respect to the current December 31st if—

(i) Each member of such group consents to the termination of such a plan for the current December 31st by checking the box to that effect on its form;

(ii) The controlled group ceases to remain in existence (within the meaning of section 1563(a)) during the calendar year ending on the current December 31st;

(iii) Any corporation which was a component member of such group on the preceding December 31st is not a component member of such group on the current December 31st; or

(iv) Any corporation which was not a component member of such group on the preceding December 31st is a component member of such group on the current December 31st.

(d) Effective/applicability date. This section applies to any tax year beginning on or after December 21, 2009. However, taxpayers may apply this section to any Federal income tax return filed on or after December 21, 2009. For tax years beginning before December 21, 2009, see § 1.1561-3T as contained in 26 CFR part 1 in effect on April 1, 2009.

[T.D. 9476, 74 FR 68536, Dec. 28, 2009]

§ 1.1563-1 Definition of controlled group of corporations and component members and related concepts.

(a) Controlled group of corporations—(1) In general—(i) Types of controlled groups. For purposes of sections 1561 through 1563, the term controlled group of corporations means any group of corporations which is—

(A) A parent-subsidiary controlled group (as defined in paragraph (a)(2) of this section);

(B) A brother-sister controlled group (as defined in paragraph (a)(3)(i) of this section);

(D) A life insurance controlled group (as defined in paragraph (a)(5) of this section).

(ii) Special rules. In determining whether a corporation is included in a controlled group of corporations, section 1563(b) and paragraph (b) of this section shall not be taken into account. For rules defining a component member of a controlled group of corporations, including rules defining an excluded member and an additional member, see section 1563(b) and paragraph (b) of this section.

(iii) Cross reference. For the exclusion of certain stock for purposes of applying the definitions contained in this paragraph, see section 1563(c) and § 1.1563-2.

(2) Parent-subsidiary controlled group—(i) Definition. The term parent-subsidiary controlled group means one or more chains of corporations connected through stock ownership with a common parent corporation if—

(A) Stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each of the corporations, except the common parent corporation, is owned (directly and with the application of § 1.1563-3(b)(1), (2), and (3)) by one or more of the other corporations; and

(B) The common parent corporation owns (directly and with the application of § 1.1563-3(b)(1), (2), and (3)) stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of at least one of the other corporations, excluding, in computing such voting power or value, stock owned directly by such other corporations.

(ii) Examples. The definition of a parent-subsidiary controlled group of corporations may be illustrated by the following examples:

Example 1.P Corporation owns stock possessing 80 percent of the total combined voting power of all classes of stock entitled to vote of S Corporation. P is the common parent of a parent-subsidiary controlled group consisting of member corporations P and S.

Example 2.Assume the same facts as in Example 1. Assume further that S owns stock possessing 80 percent of the total value of shares of all classes of stock of X Corporation. P is the common parent of a parent-subsidiary controlled group consisting of member corporations P, S, and X. The result would be the same if P, rather than S, owned the X stock.

Example 3.P Corporation owns 80 percent of the only class of stock of S Corporation and S, in turn, owns 40 percent of the only class of stock of X Corporation. P also owns 80 percent of the only class of stock of Y Corporation and Y, in turn, owns 40 percent of the only class of stock of X. P is the common parent of a parent-subsidiary controlled group consisting of member corporations P, S, X, and Y.

Example 4.P Corporation owns 75 percent of the only class of stock of Y and Z Corporations; Y owns all the remaining stock of Z; and Z owns all the remaining stock of Y. Since intercompany stockholdings are excluded (that is, are not treated as outstanding) for purposes of determining whether P owns stock possessing at least 80 percent of the voting power or value of at least one of the other corporations, P is treated as the owner of stock possessing 100 percent of the voting power and value of Y and of Z for purposes of paragraph (a)(2)(i)(B) of this section. Also, stock possessing 100 percent of the voting power and value of Y and Z is owned by the other corporations in the group within the meaning of paragraph (a)(2)(i)(A) of this section. (P and Y together own stock possessing 100 percent of the voting power and value of Z, and P and Z together own stock possessing 100 percent of the voting power and value of Y.) Therefore, P is the common parent of a parent-subsidiary controlled group of corporations consisting of member corporations P, Y, and Z.

(3) Brother-sister controlled group—(i) Definition. The term brother-sister controlled group means two or more corporations if the same five or fewer persons who are individuals, estates, or trusts own (directly and with the application of the rules contained in § 1.1563-3(b)) stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation.

(ii) Additional stock ownership requirement for purposes of certain other provisions of law. For purposes of any provision of law (other than sections 1561 through 1563) that incorporates the section 1563(a) definition of a controlled group, the term brother-sister controlled group means two or more corporations if the same five or fewer persons who are individuals, estates, or trusts own (directly and with the application of the rules contained in § 1.1563-3(b)) stock possessing—

(A) At least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each corporation (the 80 percent requirement);

(B) More than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation (the more-than-50 percent identical ownership requirement); and

(C) The five or fewer persons whose stock ownership is considered for purposes of the 80 percent requirement must be the same persons whose stock ownership is considered for purposes of the more-than-50 percent identical ownership requirement.

(iii) Examples. The principles of paragraph (a)(3)(ii) of this section may be illustrated by the following examples:

Example 1. (i) The outstanding stock of corporations P, W, X, Y, and Z, which have only one class of stock outstanding, is owned by the following unrelated individuals:

Individuals | P (%) | W (%) | X (%) | Y (%) | Z (%) | Identical ownership

A | 55 | 51 | 55 | 55 | 55 | 51.

B | 45 | 49 | (45% in P and W).

C | 45

D | 45

E | 45

Total | 100 | 100 | 100 | 100 | 100

(ii) Corporations P and W are members of a brother-sister controlled group of corporations. Although the more-than-50 percent identical ownership requirement is met for all 5 corporations, corporations X, Y, and Z are not members because at least 80 percent of the stock of each of those corporations is not owned by the same 5 or fewer persons whose stock ownership is considered for purposes of the more-than-50 percent identical ownership requirement.

Example 2. (i) The outstanding stock of corporations X and Y, which have only one class of stock outstanding, is owned by the following unrelated individuals:

Individuals | Corporations

X (%) | Y (%)

A | 12 | 12

B | 12 | 12

C | 12 | 12

D | 12 | 12

E | 13 | 13

F | 13 | 13

G | 13 | 13

H | 13 | 13

Total | 100 | 100

(ii) Any group of five of the shareholders will own more than 50 percent of the stock in each corporation, in identical holdings. However, X and Y are not members of a brother-sister controlled group because at least 80 percent of the stock of each corporation is not owned by the same five or fewer persons.

Example 3. (i) Corporation X and Y each have two classes of stock outstanding, voting common and non-voting common. (None of this stock is excluded from the definition of stock under section 1563(c).) Unrelated individuals A and B own the following percentages of the class of stock entitled to vote (voting) and of the total value of shares of all classes of stock (value) in each of corporations X and Y:

Individuals | Corporations

X | Y

A | 100% voting; 60% value | 75% voting; 60% value.

B | 0% voting; 10% value | 25% voting; 10% value.

(ii) No other shareholder of X owns (or is considered to own) any stock in Y. X and Y are a brother-sister controlled group of corporations. The group meets the more-than-50 percent identical ownership requirement because A and B own more than 50 percent of the total value of shares of all classes of stock of X and Y in identical holdings. (The group also meets the more-than-50 percent identical ownership requirement because of A's voting stock ownership.) The group meets the 80 percent requirement because A and B own at least 80 percent of the total combined voting power of all classes of stock entitled to vote.

Example 4.Assume the same facts as in Example 3 except that the value of the stock owned by A and B is not more than 50 percent of the total value of shares of all classes of stock of each corporation in identical holdings. X and Y are not a brother-sister controlled group of corporations. The group meets the more-than-50 percent identical ownership requirement because A owns more than 50 percent of the total combined voting power of the voting stock of each corporation. For purposes of the 80 percent requirement, B's voting stock in Y cannot be combined with A's voting stock in Y since B, who does not own any voting stock in X, is not a person whose ownership is considered for purposes of the more-than-50 percent identical ownership requirement. Because no other shareholder owns stock in both X and Y, these other shareholders' stock ownership is not counted towards meeting either the more-than-50 percent identical ownership requirement or the 80 percent ownership requirement.

(iv) Special rule if prior law applies. Paragraph (a)(3)(ii) of this section, as amended by TD 8179, applies to taxable years ending on or after December 31, 1970. See, however, the transitional rule in paragraph (d) of this section.

(4) Combined group—(i) Definition. The term combined group means any group of three or more corporations if—

(A) Each such corporation is a member of either a parent-subsidiary controlled group of corporations or a brother-sister controlled group of corporations; and

(B) At least one of such corporations is the common parent of a parent-subsidiary controlled group and also is a member of a brother-sister controlled group.

(ii) Examples. The definition of a combined group of corporations may be illustrated by the following examples:

Example 1. A, an individual, owns stock possessing 80 percent of the total combined voting power of all classes of the stock of corporations X and Y. Y, in turn, owns stock possessing 80 percent of the total combined voting power of all classes of the stock of corporation Z. X, Y, and Z are members of the same combined group since—

(i) X, Y, and Z are each members of either a parent-subsidiary or brother-sister controlled group of corporations; and

(ii) Y is the common parent of a parent-subsidiary controlled group of corporations consisting of Y and Z, and also is a member of a brother-sister controlled group of corporations consisting of X and Y.

Example 2.Assume the same facts as in Example 1, and further assume that corporation X owns 80 percent of the total value of shares of all classes of stock of corporation S. X, Y, Z, and S are members of the same combined group.

(5) Life insurance controlled group—(i) Definition. The term life insurance controlled group means two or more life insurance companies each of which is a member of a controlled group of corporations described in paragraph (a)(2), (a)(3)(i), or (a)(4) of this section and to which § 1.1502-47(f)(6) does not apply. Such insurance companies shall be treated as a controlled group of corporations separate from any other corporations which are members of a controlled group described in such paragraph (a)(2), (a)(3)(i), or (a)(4) of this section. For purposes of this section, the common parent of the controlled group described in paragraph (a)(2) of this section shall be referred to as the common parent of the life insurance controlled group.

(ii) Examples. The following examples illustrate the definition of a life insurance controlled group. In these examples, L indicates a life company, another letter indicates a nonlife company and each corporation uses the calendar year as its taxable year:

Example 1.Since January 1, 1999, corporation P has owned all the stock of corporations L 1 and Y, and L 1 has owned all the stock of corporation X. On January 1, 2005, Y acquired all of the stock of corporation L 2. Since L 1 and L 2 are members of a parent-subsidiary controlled group of corporations, such companies are treated as members of a life insurance controlled group separate from the parent-subsidiary controlled group consisting of P, X and Y. For purposes of this section, P is referred to as the common parent of the life insurance controlled group even though P is not a member of such group.

Example 2.The facts are the same as in Example 1, except that, beginning with the 2005 tax year, the P affiliated group elected to file a consolidated return and P made a section 1504(c)(2) election. Pursuant to paragraph (a)(5)(i) of this section, L 1 and L 2 are not members of a separate life insurance controlled group. Instead, P, X, Y, L 1 and L 2 constitute one controlled group. See § 1.1502-47(f)(6).

(6) Voting power of stock. For purposes of this section, and §§ 1.1563-2 and 1.1563-3, in determining whether the stock owned by a person (or persons) possesses a certain percentage of the total combined voting power of all classes of stock entitled to vote of a corporation, consideration will be given to all the facts and circumstances of each case. A share of stock will generally be considered as possessing the voting power accorded to such share by the corporate charter, by-laws, or share certificate. On the other hand, if there is any agreement, whether express or implied, that a shareholder will not vote the shareholder's stock in a corporation, the formal voting rights possessed by the shareholder's stock may be disregarded in determining the percentage of the total combined voting power possessed by the stock owned by other shareholders in the corporation, if the result is that the corporation becomes a component member of a controlled group of corporations. Moreover, if a shareholder agrees to vote the shareholder's stock in a corporation in the manner specified by another shareholder in the corporation, the voting rights possessed by the stock owned by the first shareholder may be considered to be possessed by the stock owned by such other shareholder if the result is that the corporation becomes a component member of a controlled group of corporations.

(b) Component members—(1) In general—(i) Definition. For purposes of sections 1561 through 1563, a corporation is with respect to its taxable year a component member of a controlled group of corporations for the group's testing date if such corporation—

(A) Is a member of such controlled group on such testing date and is not treated as an excluded member under paragraph (b)(2) of this section; or

(B) Is not a member of such controlled group on such testing date but is treated as an additional member under paragraph (b)(3) of this section.

(ii) Member of a controlled group of corporations. For purposes of sections 1561 through 1563, a member of a controlled group is a corporation connected with other member(s) of a controlled group under the stock ownership rules and the stock qualification rules set forth in section 1563. Under these rules, for a corporation to qualify as a component member of the group with respect to a group's December 31st testing date (or the short-year testing date for a short-year member), that corporation does not have to be a member of that group on that group's testing date. In addition, a corporation that is a member of a controlled group on the group's testing date does not necessarily qualify as a component member of that group with respect to that testing date.

(iii) Additional concepts used in applying the controlled group rules.

(A) The term testing date means the date used for determining the status of controlled group members as either component members or excluded members. That testing date is then also used to determine which taxable years of those component members are to be subjected to the controlled group rules. Generally, a member's testing date is the December 31st date included within that member's taxable year, whether such member is on a calendar or fiscal taxable year. However, if a component member of a controlled group has a short taxable year that does not include a December 31st date, then the last day of that short taxable year becomes that member's testing date.

(B) The term testing period means the time period used for determining the status of controlled group members as either component members or excluded members. The testing period begins on the first day of a member's taxable year and ends on the day before its testing date. (Generally, the testing date is December 31st, but for a component member having a short taxable year not ending on December 31st, the testing date for the short taxable year of that member (and only that member) becomes the last day of that member's short taxable year.) Thus, for a member on a fiscal taxable year, the portion of its taxable year beginning on December 31st and ending on the last day of its taxable year is not taken into account for determining its status as a component member or an excluded member.

(2) Excluded members—(i) Temporal test. A corporation, which is a member of a controlled group of corporations on the group's testing date, a date included within that member's taxable year, but who was a member of such group for less than one-half of the number of days of its testing period, shall be treated as an excluded member of such group for that group's testing date.

(ii) Qualification test. A corporation which is a member of a controlled group of corporations on a testing date shall be treated as an excluded member of such group on such date if, for its taxable year including such date, such corporation is—

(A) Exempt from taxation under section 501(a) (except a corporation which is subject to tax on its unrelated business taxable income under section 511) or 521 for such taxable year;

(B) A foreign corporation not subject to taxation under section 882(a) for the taxable year;

(C) An S corporation (as defined in section 1361) for purposes of any tax benefit item described in section 1561(a) to which it is not subject;

(D) A franchised corporation (as defined in section 1563(f)(4) and § 1.1563-4); or

(E) An insurance company subject to taxation under section 801, unless such insurance company (without regard to this paragraph (b)(2)(ii)(E)) is a component member of a life insurance controlled group described in paragraph (a)(5)(i) of this section or unless § 1.1502-47(f)(6) applies (which treats a life insurance company, for which a section 1504(c)(2) election is effective, as a member (whether eligible or ineligible) of a life-nonlife affiliated group).

(3) Additional members. A corporation shall be treated as an additional member of a controlled group of corporations, that is, an additional component member, on the group's testing date if it—

(i) Is not a member of such group on such date;

(ii) Is not described, with respect to such taxable year, in paragraph (b)(2)(ii)(A), (b)(2)(ii)(B), (b)(2)(ii)(C), (b)(2)(ii)(D), or (b)(2)(ii)(E) of this section; and

(iii) Was a member of such group for one-half (or more) of the number of days in its testing period.

(4) Examples. The provisions of this paragraph (b) may be illustrated by the following examples:

(i) Example 1. B, an individual, owns all of the stock of corporations W and X on each day of 1964. W and X each use the calendar year as their taxable year. On January 1, 1964, B also owns all the stock of corporation Y (a fiscal year corporation with a taxable year beginning on July 1, 1964, and ending on June 30, 1965), which stock B sells on October 15, 1964. On December 1, 1964, B purchases all the stock of corporation Z (a fiscal year corporation with a taxable year beginning on September 1, 1964, and ending on August 31, 1965). On December 31, 1964, W, X, and Z are members of the same controlled group. However, the component members of the group on such December 31st are W, X, and Y. Under paragraph (b)(2)(i) of this section, Z is treated as an excluded member of the group on December 31, 1964, since Z was a member of the group for less than one-half of the number of days (29 out of 121 days) during the period beginning on September 1, 1964 (the first day of its taxable year) and ending on December 30, 1964. Under paragraph (b)(3) of this section, Y is treated as an additional member of the group on December 31, 1964, since Y was a member of the group for at least one-half of the number of days (107 out of 183 days) during the period beginning on July 1, 1964 (the first day of its taxable year) and ending on December 30, 1964.

(ii) Example 2. On January 1, 1964, corporation P owns all the stock of corporation S, which in turn owns all the stock of corporation S-1. On November 1, 1964, P purchases all of the stock of corporation X from the public and sells all of the stock of S to the public. Corporation X owns all the stock of corporation Y during 1964. P, S, S-1, X, and Y file their returns on the basis of the calendar year. On December 31, 1964, P, X, and Y are members of a parent-subsidiary controlled group of corporations; also, corporations S and S-1 are members of a different parent-subsidiary controlled group on such date. However, since X and Y have been members of the parent-subsidiary controlled group of which P is the common parent for less than one-half the number of days during the period January 1 through December 30, 1964, they are not component members of such group on such date. On the other hand, X and Y have been members of a parent-subsidiary controlled group of which X is the common parent for at least one-half the number of days during the period January 1 through December 30, 1964, and therefore they are component members of such group on December 31, 1964. Also since S and S-1 were members of the parent-subsidiary controlled group of which P is the common parent for at least one-half the number of days in the taxable years of each such corporation during the period January 1 through December 30, 1964, P, S, and S-1 are component members of such group on December 31, 1964.

(iii) Example 3. Throughout 1964, corporation M owns all the stock of corporation F which, in turn, owns all the stock of corporations L1, L2, X, and Y. M is a domestic mutual insurance company subject to taxation under section 821, F is a foreign corporation not engaged in a trade or business within the United States, L1 and L2 are domestic life insurance companies subject to taxation under section 802, and X and Y are domestic corporations subject to tax under section 11 of the Code. Each corporation uses the calendar year as its taxable year. On December 31, 1964, M, F, L1, L2, X, and Y are members of a parent-subsidiary controlled group of corporations. However, under paragraph (b)(2)(ii) of this section, M, F, L1, and L2 are treated as excluded members of the group on December 31, 1964. Thus, on December 31, 1964, the component members of the parent-subsidiary controlled group of which M is the common parent include only X and Y.

Furthermore, since paragraph (b)(2)(ii)(E) of this section does not result in L1 and L2 being treated as excluded members of a life insurance controlled group, L1 and L2 are component members of a life insurance controlled group on December 31, 1964.

(iv) Example 4. Individual A owns all of the stock of corporations X, Y and Z. Each of these corporations is an S corporation. X, Y, and Z are each members of a brother-sister controlled group, even though each such corporation is treated as an excluded member of such group. See § 1.1563-1(b)(2)(ii)(C).

(5) Application of constructive ownership rules. For purposes of paragraphs (b)(2)(i) and (b)(3)(iii) of this section, it is necessary to determine whether a corporation was a member of a controlled group of corporations for one-half (or more) of the number of days in its taxable year which precede the December 31st falling within such taxable year. Therefore, the constructive ownership rules contained in § 1.1563-3(b) (to the extent applicable in making such determination) must be applied on a day-by-day basis. For example, if P Corporation owns all the stock of X Corporation on each day of 1964, and on December 30, 1964, acquires an option to purchase all the stock of Y Corporation (a calendar-year taxpayer which has been in existence on each day of 1964), the application of § 1.1563-3(b)(1) on a day-by-day basis results in Y being a member of the brother-sister controlled group on only one day of Y's 1964 year which precedes December 31, 1964. Accordingly, since Y is not a member of such group for one-half or more of the number of days in its 1964 year preceding December 31, 1964, Y is treated as an excluded member of such group on December 31, 1964.

(c) Overlapping groups—(1) In general. If on a December 31st a corporation is a component member of a controlled group of corporations by reason of ownership of stock possessing at least 80 percent of the total value of shares of all classes of stock of the corporation, and if on such December 31st such corporation is also a component member of another controlled group of corporations by reason of ownership of other stock (that is, stock not used to satisfy the at-least-80 percent total value test) possessing at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote, then such corporation shall be treated as a component member only of the controlled group of which it is a component member by reason of the ownership of at least 80 percent of the total value of its shares.

(2) Brother-sister controlled groups—(i) One corporation. If on a December 31st, a corporation would, without the application of this paragraph (c)(2), be a component member of more than one brother-sister controlled group on such date, the corporation will be treated as a component member of only one such group on such date. Such corporation may elect the group in which it is to be included by including on or with its income tax return for the taxable year that includes such date a statement entitled, “STATEMENT TO ELECT CONTROLLED GROUP PURSUANT TO § 1.1563-1(c)(2).” This statement must include—

(A) A description of each of the controlled groups in which the corporation could be included. The description must include the name and employer identification number of each component member of each such group and the stock ownership of the component members of each such group; and

(B) The following representation: [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF CORPORATION] ELECTS TO BE TREATED AS A COMPONENT MEMBER OF THE [INSERT DESIGNATION OF GROUP].

(ii) Multiple corporations. If more than one corporation would, without the application of this paragraph (c)(2), be a component member of more than one controlled group, those corporations electing to be component members of the same group must file a single statement. The statement must contain the information described in paragraph (c)(2)(i) of this section, plus the names and employer identification numbers of all other corporations designating the same group. The original statement must be included on or with the original Federal income tax return (including any amended return filed on or before the due date (including extensions) of such return) of the corporation that, among those corporations which would (without the application of this paragraph (c)(2)) belong to more than one group, has the taxable year including such December 31st which ends on the earliest date. That corporation must provide a copy of the statement to each other corporation included in the statement and represent in its statement that it has done so. Either the original or a copy of the statement must be retained by each corporation as part of its records. See § 1.6001-1(e) of this chapter.

(iii) Election. (A) An election filed under this paragraph (c)(2) is irrevocable and effective until a change in the stock ownership of the corporation results in termination of membership in the controlled group in which such corporation has been included.

(B) In the event no election is filed in accordance with the provisions of this paragraph (c)(2), then the Internal Revenue Service will determine the group in which such corporation is to be included. Such determination will be binding for all subsequent years unless the corporation files a valid election with respect to any such subsequent year or until a change in the stock ownership of the corporation results in termination of membership in the controlled group in which such corporation has been included.

(iv) Examples. The provisions of this paragraph (c)(2) may be illustrated by the following examples (in which it is assumed that all the individuals are unrelated):

Example 1. (i) On each day of 1970 all the outstanding stock of corporations X, Y, and Z is held in the following manner:

Individuals | Corporations

X (%) | Y (%) | Z (%)

A | 55 | 40 | 5

B | 40 | 20 | 40

C | 5 | 40 | 55

(ii) Since the more-than-50 percent identical ownership requirement of section 1563(a)(2) is met with respect to corporations X and Y and with respect to corporations Y and Z, but not with respect to corporations X, Y, and Z, corporation Y would, without the application of this paragraph (c)(2), be a component member on December 31, 1970, of overlapping groups consisting of X and Y and of Y and Z. If Y does not file an election in accordance with paragraph (c)(2)(i) of this section, the Internal Revenue Service will determine the group in which Y is to be included.

Example 2. (i) On each day of 1970, all the outstanding stock of corporations V, W, X, Y, and Z is held in the following manner:

Individuals | Corporations

V | W | X | Y | Z

D | 52 | 52 | 52 | 52 | 52

E | 40 | 2 | 2 | 2 | 2

F | 2 | 40 | 2 | 2 | 2

G | 2 | 2 | 40 | 2 | 2

H | 2 | 2 | 2 | 40 | 2

I | 2 | 2 | 2 | 2 | 40

(ii) On December 31, 1970, the more-than-50 percent identical ownership requirement of section 1563(a)(2) may be met with regard to any combination of the corporations but all five corporations cannot be included as component members of a single controlled group because the inclusion of all the corporations in a single group would be dependent upon taking into account the stock ownership of more than five persons. Therefore, if the corporations do not file a statement in accordance with paragraph (c)(2)(ii) of this section, the Internal Revenue Service will determine the group in which each corporation is to be included. The corporations or the Internal Revenue Service, as the case may be, may designate that three corporations be included in one group and two corporations in another, or that any four corporations be included in one group and that the remaining corporation not be included in any group.

(d) Transitional rules—(1) In general. Treasury decision 8179 amended paragraph (a)(3)(ii) of this section to revise the definition of a brother-sister controlled group of corporations. In general, those amendments are effective for taxable years ending on or after December 31, 1970.

(2) Limited nonretroactivity—(i) Old group. Under the authority of section 7805(b), the Internal Revenue Service will treat an old group as a brother-sister controlled group corporations for purposes of applying sections 401, 404(a), 408(k), 409A, 410, 411, 412, 414, 415, and 4971 of the Internal Revenue Code (Code) and sections 202, 203, 204, and 302 of the Employment Retirement Income Security Act of 1974 (ERISA) in a plan year or taxable year beginning before March 2, 1988, to the extent necessary to prevent an adverse effect on any old member (or any other corporation), or on any plan or other entity described in such sections (including plans, etc., of corporations not part of such old group), that would result solely from the retroactive effect of the amendment to this section by TD 8179. An adverse effect includes the disqualification of a plan or the disallowance of a deduction or credit for a contribution to a plan. The Internal Revenue Service, however, will not treat an old member as a member of an old group to the extent that such treatment will have an adverse effect on that old member.

(ii) Old member of old group. Section 7805(b) will not be applied pursuant to paragraph (d)(2)(i) of this section to treat an old member of an old group as a member of a brother-sister controlled group to prevent an adverse effect for a taxable year if, for that taxable year, that old member treats or has treated itself as not being a member of that old group for purposes of sections 401, 404(a), 408(k), 409A, 410, 411, 412, 414, 415, and 4971 of the Code and sections 202, 203, 204, and 302 and title IV of ERISA for such taxable year (such as by filing, with respect to such taxable year, a return, amended return, or claim for credit or refund in which the amount of any deduction, credit, limitation, or tax due is determined by treating itself as not being a member of the old group for purposes of those sections). However, the fact that one or more (but not all) of the old members do not qualify for section 7805(b) treatment because of the preceding sentence will not preclude that old member (or members) from being treated as a member of the old group under paragraph (d)(2)(i) of this section in order to prevent the disallowance of a deduction or credit of another old member (or other corporation) or to prevent the disqualification of, or other adverse effect on, another old member's plan (or other entity) described in the sections of the Code and ERISA enumerated in such paragraph.

(3) Election of general nonretroactivity. In the case of a taxable year ending on or after December 31, 1970, and before March 2, 1988, an old group will be treated as a brother-sister controlled group of corporations for all purposes of the Code for such taxable year if—

(i) Each old member files a statement consenting to such treatment for such taxable year with the District Director having audit jurisdiction over its return within six months after March 2, 1988; and

(ii) No old member—

(A) Files or has filed, with respect to such taxable year, a return, amended return, or claim for credit or refund in which the amount of any deduction, credit, limitation, or tax due is determined by treating any old member as not a member of the old group; or

(B) Treats the employees of all members of the old group as not being employed by a single employer for purposes of sections 401, 404(a), 408(k), 409A, 410, 411, 412, 414, 415, and 4971 of the Code and sections 202, 203, 204, and 302 of ERISA for such taxable year.

(4) Definitions. For purposes of this paragraph (d)—

(i) An old group is a brother-sister controlled group of corporations, determined by applying paragraph (a)(3)(ii) of this section as in effect before the amendments made by TD 8179, that is not a brother-sister controlled group of corporations, determined by applying paragraph (a)(3)(ii) of this section as amended by such Treasury decision; and

(ii) An old member is any corporation that is a member of an old group.

(5) Election to choose between membership in more than one controlled group—(i) In general. A corporation may make an election under paragraph (c)(2) of this section by filing an amended return on or before September 2, 1988 if—

(A) An old member has filed an election under paragraph (c)(2) of this section to be treated as a component member of an old group for a December 31st before March 2, 1988; and

(B) That corporation would (without regard to such paragraph (c)(2)) be a component member of more than one brother-sister controlled group (not including an old group) on December 31st.

(ii) Exception. This paragraph (d)(5) does not apply to a corporation that is treated as a member of an old group under paragraph (d)(3) of this section.

(6) Refunds. See section 6511(a) for period of limitation on filing claims for credit or refund.

(e) Applicability dates—(1) In general. Except as provided in paragraph (e)(2) of this section, this section applies to taxable years beginning on or after May 26, 2009. However, taxpayers may apply this section to taxable years beginning before May 26, 2009. For taxable years beginning before May 26, 2009, see § 1.1563-1T as contained in 26 CFR part 1 in effect on April 1, 2009.

(2) Exceptions. (i) Paragraph (a)(1)(ii) of this section applies to taxable years beginning on or after April 11, 2011.

(ii) Paragraphs (a)(2)(i)(A) and (B), (a)(6), and (b)(4) of this section apply to taxable years beginning on or after December 30, 2024.

[T.D. 9451, 74 FR 25148, May 27, 2009, as amended by T.D. 9522, 76 FR 19907, Apr. 11, 2011; T.D. 10018, 89 FR 106879, Dec. 30, 2024]

§ 1.1563-2 Excluded stock.

(a) Certain stock excluded. For purposes of sections 1561 through 1563 and the regulations thereunder, the term “stock” does not include:

(1) Nonvoting stock which is limited and preferred as to dividends, and

(2) Treasury stock.

(b) Stock treated as excluded stock—(1) Parent-subsidiary controlled group. If a corporation (hereinafter in this paragraph referred to as “parent corporation”) owns 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock in another corporation (hereinafter in this paragraph referred to as “subsidiary corporation”), the provisions of subparagraph (2) of this paragraph shall apply. For purposes of this subparagraph, stock owned by a corporation means stock owned directly plus stock owned with the application of the constructive ownership rules of paragraph (b) (1) and (4) of § 1.1563-3, relating to options and attribution from corporations. In determining whether the stock owned by a corporation possesses the requisite percentage of the total combined voting power of all classes of stock entitled to vote of another corporation, see paragraph (a)(6) of § 1.1563-1.

(2) Stock treated as not outstanding. If the provisions of this subparagraph apply, then for purposes of determining whether the parent corporation or the subsidiary corporation is a member of a parent-subsidiary controlled group of corporations within the meaning of paragraph (a)(2) of § 1.1563-1, the following stock of the subsidiary corporation shall, except as otherwise provided in paragraph (c) of this section, be treated as if it were not outstanding:

(i) Plan of deferred compensation. Stock in the subsidiary corporation held by a trust which is part of a plan of deferred compensation for the benefit of the employees of the parent corporation or the subsidiary corporation. The term “plan of deferred compensation” shall have the same meaning such term has in section 406(a)(3) and the regulations thereunder.

(ii) Principal stockholders and officers. Stock in the subsidiary corporation owned (directly and with the application of the rules contained in paragraph (b) of § 1.1563-3) by an individual who is a principal stockholder or officer of the parent corporation. A principal stockholder of the parent corporation is an individual who owns (directly and with the application of the rules contained in paragraph (b) of § 1.1563-3) 5 percent or more of the total combined voting power of all classes of stock entitled to vote or 5 percent or more of the total value of shares of all classes of stock of the parent corporation. An officer of the parent corporation includes the president, vice-presidents, general manager, treasurer, secretary, and comptroller of such corporation, and any other person who performs duties corresponding to those normally performed by persons occupying such positions.

(iii) Employees. Stock in the subsidiary corporation owned (directly and with the application of the rules contained in § 1.1563-3(b)) by an employee of the subsidiary corporation if such stock is subject to conditions which substantially restrict or limit the employee's right (or if the employee constructively owns such stock, the direct owner's right) to dispose of such stock and which run in favor of the parent or subsidiary corporation. In general, any condition which extends, directly or indirectly, to the parent corporation or the subsidiary corporation preferential rights with respect to the acquisition of the employee's (or direct owner's) stock will be considered to be a condition described in the preceding sentence. It is not necessary, in order for a condition to be considered to be in favor of the parent corporation or the subsidiary corporation, that the parent or subsidiary be extended a discriminatory concession with respect to the price of the stock. For example, a condition whereby the parent corporation is given a right of first refusal with respect to any stock of the subsidiary corporation offered by an employee for sale is a condition which substantially restricts or limits the employee's right to dispose of such stock and runs in favor of the parent corporation. Moreover, any legally enforceable condition which prohibits the employee from disposing of the employee's stock without the consent of the parent (or a subsidiary of the parent) will be considered to be a substantial limitation running in favor of the parent corporation.

(iv) Controlled exempt organization. Stock in the subsidiary corporation owned (directly and with the application of the rules contained in paragraph (b) of § 1.1563-3) by an organization (other than the parent corporation):

(a) To which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies, and

(b) Which is controlled directly or indirectly by the parent corporation or subsidiary corporation, by an individual, estate, or trust that is a principal stockholder of the parent corporation, by an officer of the parent corporation, or by any combination thereof.

The terms “principal stockholder of the parent corporation” and “officer of the parent corporation” shall have the same meanings in this subdivision as in subdivision (ii) of this subparagraph. The term “control” as used in this subdivision means control in fact and the determination of whether the control requirement of (b) of this subdivision is met will depend upon all the facts and circumstances of each case, without regard to whether such control is legally enforceable and irrespective of the method by which such control is exercised or exercisable.

(3) Brother-sister controlled group. If five or fewer persons (hereinafter referred to as common owners) who are individuals, estates, or trusts own (directly and with the application of the rules contained in paragraph (b) of § 1.1563-3) stock possessing 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock in a corporation, the provisions of subparagraph (4) of this paragraph shall apply. In determining whether the stock owned by such person or persons possesses the requisite percentage of the total combined voting power of all classes of stock entitled to vote of a corporation, see paragraph (a)(6) of § 1.1563-1.

(4) Stock treated as not outstanding. If the provisions of this subparagraph apply, then for purposes of determining whether a corporation is a member of a brother-sister controlled group of corporations within the meaning of paragraph (a)(3) of § 1.1563-1, the following stock of such corporation shall, except as otherwise provided in paragraph (c) of this section, be treated as if it were not outstanding:

(i) Exempt employees' trust. Stock in such corporation held by an employees' trust described in section 401(a) which is exempt from tax under section 501(a), if such trust is for the benefit of the employees of such corporation.

(ii) Employees. Stock in such corporation owned (directly and with the application of the rules contained in § 1.1563-3(b)) by an employee of such corporation if such stock is subject to conditions which run in favor of a common owner of such corporation (or in favor of such corporation) and which substantially restrict or limit the employee's right (or if the employee constructively owns such stock, the record owner's right) to dispose of such stock. The principles of paragraph (b)(2)(iii) of this section apply in determining whether a condition satisfies the requirements of the preceding sentence. Thus, in general, a condition which extends, directly or indirectly, to a common owner or such corporation preferential rights with respect to the acquisition of the employee's (or record owner's) stock will be considered to be a condition which satisfies such requirements. For purposes of this paragraph (b)(4)(ii), if a condition which restricts or limits an employee's right (or record owner's right) to dispose of the employee's (or record owner's) stock also applies to the stock in such corporation held by such common owner pursuant to a bona fide reciprocal stock purchase arrangement, such condition is not treated as one which restricts or limits the employee's (or record owner's) right to dispose of such stock. An example of a reciprocal stock purchase arrangement is an agreement whereby a common owner and the employee are given a right of first refusal with respect to stock of the employer corporation owned by the other party. If, however, the agreement also provides that the common owner has the right to purchase the stock of the employer corporation owned by the employee in the event that the corporation should discharge the employee for reasonable cause, the purchase arrangement would not be reciprocal within the meaning of this paragraph (b)(4)(ii).

(iii) Controlled exempt organization. Stock in such corporation owned (directly and with the application of the rules contained in paragraph (b) of § 1.1563-3) by an organization:

(a) To which section 501(c)(3) (relating to certain educational and charitable organizations which are exempt from tax) applies, and

(b) Which is controlled directly or indirectly by such corporation, by an individual, estate, or trust that is a principal stockholder of such corporation, by an officer of such corporation, or by any combination thereof.

The terms “principal stockholder” and “officer” shall have the same meanings in this subdivision as in subparagraph (2)(ii) of this paragraph. The term “control” as used in this subdivision means control in fact and the determination of whether the control requirement of (b) of this subdivision is met will depend upon all the facts and circumstances of each case, without regard to whether such control is legally enforceable and irrespective of the method by which such control is exercised or exercisable.

(5) Other controlled groups. The provisions of subparagraphs (1), (2), (3), and (4) of this paragraph shall apply in determining whether a corporation is a member of a combined group (within the meaning of paragraph (a)(4) of § 1.1563-1) or an insurance group (within the meaning of paragraph (a)(5) of § 1.1563-1). For example, under paragraph (a)(4) of § 1.1563-1, in order for a corporation to be a member of a combined group such corporation must be a member of a parent-subsidiary group or a brother-sister group. Accordingly, the excluded stock rules provided by this paragraph are applicable in determining whether the corporation is a member of such group.

(6) Meaning of employee. For purposes of this section §§ 1.1563-3 and 1.1563-4, the term “employee” has the same meaning such term is given in section 3306(i) of the Code (relating to definitions for purposes of the Federal Unemployment Tax Act). Accordingly, the term employee as used in such sections includes an officer of a corporation.

(7) Examples. The provisions of this paragraph may be illustrated by the following examples:

(i) Example 1. Corporation P owns 70 of the 100 shares of the only class of stock of corporation S. The remaining shares of S are owned as follows: 4 shares by Jones (the general manager of P), and 26 shares by Smith (who also owns 5 percent of the total combined voting power of the stock of P). P satisfies the 50 percent stock ownership requirement of subparagraph (1) of this paragraph with respect to S. Since Jones is an officer of P and Smith is a principal stockholder of P, under subparagraph (2)(ii) of this paragraph the S stock owned by Jones and Smith is treated as not outstanding for purposes of determining whether P and S are members of a parent-subsidiary controlled group of corporations within the meaning of paragraph (a)(2) of § 1.1563-1. Thus, P is considered to own stock possessing 100 percent (70 ÷ 70) of the total voting power and value of all the S stock. Accordingly, P and S are members of a parent-subsidiary controlled group of corporations.

(ii) Example 2. The facts are the same as in paragraph (b)(7)(i) of this section (Example 1), except that Jones owns 15 shares of the 100 shares of the only class of stock of corporation S-1, and corporation S owns 75 shares of such stock. P satisfies the 50 percent stock ownership requirement of paragraph (b)(1) of this section with respect to S-1 since P is considered as owning 52.5 percent (70 percent × 75 percent) of the S-1 stock with the application of § 1.1563-3(b)(4). Since Jones is an officer of P, under paragraph (b)(2)(ii) of this section, the S-1 stock owned by Jones is treated as not outstanding for purposes of determining whether S-1 is a member of the parent-subsidiary controlled group of corporations. Thus, S is considered to own stock possessing 88.2 percent (75 ÷ 85) of the voting power and value of the S-1 stock. Accordingly, P, S, and S-1 are members of a parent-subsidiary controlled group of corporations.

(iii) Example 3. Corporation X owns 60 percent of the only class of stock of corporation Y. D, the president of Y, owns the remaining 40 percent of the stock of Y. D has agreed that, if D offers D's stock in Y for sale, D will first offer the stock to X at a price equal to the fair market value of the stock on the first date the stock is offered for sale. Since D is an employee of Y within the meaning of section 3306(i) of the Code, and D's stock in Y is subject to a condition which substantially restricts or limits D's right to dispose of such stock and runs in favor of X, under paragraph (b)(2)(iii) of this section such stock is treated as if it were not outstanding for purposes of determining whether X and Y are members of a parent-subsidiary controlled group of corporations. Thus, X is considered to own stock possessing 100 percent of the voting power and value of the stock of Y. Accordingly, X and Y are members of a parent-subsidiary controlled group of corporations. The result would be the same if D's spouse, instead of D, owned directly the 40 percent stock interest in Y and such stock was subject to a right of first refusal running in favor of X.

(c) Exception—(1) General. If stock of a corporation is owned by a person directly or with the application of the rules contained in paragraph (b) of § 1.1563-3 and such ownership results in the corporation being a component member of a controlled group of corporations on a December 31, then the stock shall not be treated as excluded stock under the provisions of paragraph (b) of this section if the result of applying such provisions is that such corporation is not a component member of a controlled group of corporations on such December 31.

(2) Illustration. The provisions of this paragraph may be illustrated by the following example:

Example.On each day of 1965, corporation P owns directly 50 of the 100 shares of the only class of stock of corporation S. Jones, an officer of P, owns directly 30 shares of S stock and P has an option to acquire such 30 shares from Jones. The remaining shares of S are owned by unrelated persons. If, pursuant to the provisions of paragraph (b)(2)(ii) of this section, the 30 shares of S stock owned directly by Jones is treated as not outstanding, the result is that P would be treated as owning stock possessing only 71 percent (50 ÷ 70) of the total voting power and value of S stock, and S would not be a component member of a controlled group of corporations on December 31, 1965. However, since P is considered as owning the 30 shares of S stock with the application of paragraph (b)(1) of this section, and such ownership plus the S stock directly owned by P (50 shares) results in S being a component member of a controlled group of corporations on December 31, 1965, the provisions of this paragraph apply. Therefore, the provisions of paragraph (b)(2)(ii) of this section do not apply with respect to the 30 shares of S stock, and on December 31, 1965, S is a component member of a controlled group of corporations consisting of P and S.

(d) Applicability date. This section applies to taxable years beginning on or after December 30, 2024. For taxable years beginning before December 30, 2024, see § 1.1563-2 as contained in 26 CFR part 1 in effect on April 1, 2024.

[T.D. 6845, 30 FR 9753, Aug. 5, 1965, as amended by T.D. 7181, 37 FR 8070, Apr. 4, 1972; T.D. 10018, 89 FR 106879, Dec. 30, 2024]

§ 1.1563-3 Rules for determining stock ownership.

(a) In general. In determining stock ownership for purposes of §§ 1.1562-5, 1.1563-1, 1.1563-2, and this section, the constructive ownership rules of paragraph (b) of this section apply to the extent such rules are referred to in such sections. The application of such rules shall be subject to the operating rules and special rules contained in paragraphs (c) and (d) of this section.

(b) Constructive ownership—(1) Options. If a person has an option to acquire any outstanding stock of a corporation, such stock shall be considered as owned by such person. For purposes of this subparagraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock. For example, assume Smith owns an option to purchase 100 shares of the outstanding stock of M Corporation. Under this subparagraph, Smith is considered to own such 100 shares. The result would be the same if Smith owned an option to acquire the option (or one of a series of options) to purchase 100 shares of M stock.

(2) Attribution from partnerships. (i) Rule. Stock owned, directly or indirectly, by or for a partnership is considered as owned by any partner having an interest of 5 percent or more in either the capital or profits of the partnership in proportion to the partner's interest in capital or profits, whichever such proportion is the greater.

(ii) Example—(A) Facts. Green, Jones, and White are unrelated individuals and are partners in the GJW partnership. The partners' interests in the capital and profits of the partnership are as follows:

Table 1 to Paragraph (b)(2)(ii)(A)

Partner | Capital percent | Profit percent

Green | 36 | 25

Jones | 60 | 71

White | 4 | 4

(B) Analysis. The GJW partnership owns the entire outstanding stock (100 shares) of X Corporation. Under this paragraph (b)(2), Green is considered to own the X stock owned by the partnership in proportion to Green's interest in capital (36 percent) or profits (25 percent), whichever such proportion is the greater. Therefore, Green is considered to own 36 shares of the X stock. However, since Jones has a greater interest in the profits of the partnership, Jones is considered to own the X stock in proportion to Jones's interest in such profits. Therefore, Jones is considered to own 71 shares of the X stock. Since White does not have an interest of 5 percent or more in either the capital or profits of the partnership, White is not considered to own any shares of the X stock.

(3) Attribution from estates or trusts. (i) Stock owned, directly or indirectly, by or for an estate or trust is considered as owned by any beneficiary who has an actuarial interest of 5 percent or more in such stock, to the extent of such actuarial interest. For purposes of this paragraph (b)(3)(i), the actuarial interest of each beneficiary is determined by assuming the maximum exercise of discretion by the fiduciary in favor of such beneficiary and the maximum use of such stock to satisfy the beneficiary's rights as a beneficiary. A beneficiary of an estate or trust who cannot under any circumstances receive any interest in stock held by the estate or trust, including the proceeds from the disposition thereof, or the income therefrom, does not have an actuarial interest in such stock. Thus, where stock owned by a decedent's estate has been specifically bequeathed to certain beneficiaries and the remainder of the estate is bequeathed to other beneficiaries, the stock is attributable only to the beneficiaries to whom it is specifically bequeathed. Similarly, a remainderman of a trust who cannot under any circumstances receive any interest in the stock of a corporation which is a part of the corpus of the trust (including any accumulated income therefrom or the proceeds from a disposition thereof) does not have an actuarial interest in such stock. However, an income beneficiary of a trust does have an actuarial interest in stock if that beneficiary has any right to the income from such stock even though under the terms of the trust instrument such stock can never be distributed to that beneficiary. The factors and methods prescribed in § 20.2031-7 of this chapter (Estate Tax Regulations) for use in ascertaining the value of an interest in property for estate tax purposes must be used for purposes of this paragraph (b)(3)(i) in determining a beneficiary's actuarial interest in stock owned directly or indirectly by or for a trust.

(ii) For the purposes of this paragraph (b)(3), property of a decedent is considered as owned by the decedent's estate if such property is subject to administration by the executor or administrator for the purposes of paying claims against the estate and expenses of administration notwithstanding that, under local law, legal title to such property vests in the decedent's heirs, legatees or devisees immediately upon death. With respect to an estate, the term beneficiary includes any person entitled to receive property of the decedent pursuant to a will or pursuant to laws of descent and distribution. A person no longer is considered a beneficiary of an estate when all the property to which the person is entitled has been received by the person, when the person no longer has a claim against the estate arising out of having been a beneficiary, and when there is only a remote possibility that it will be necessary for the estate to seek the return of property or to seek payment from the person by contribution or otherwise to satisfy claims against the estate or expenses of administration. When pursuant to the preceding sentence, a person ceases to be a beneficiary, stock owned by the estate is not thereafter considered owned by the person.

(iii) Stock owned, directly or indirectly, by or for any portion of a trust of which a person is considered the owner under Subpart E, Part I, Subchapter J of the Code (relating to grantors and others treated as substantial owners) is considered as owned by such person.

(iv) This subparagraph does not apply to stock owned by any employees' trust described in section 401(a) which is exempt from tax under section 501(a).

(4) Attribution from corporations. (i) Stock owned, directly or indirectly, by or for a corporation shall be considered as owned by any person who owns (within the meaning of section 1563(d)) 5 percent or more in value or its stock in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.

(ii) Example. Brown, an individual, owns 60 shares of the 100 shares of the only class of outstanding stock of corporation P. Smith, an individual, owns 4 shares of the P stock, and corporation X owns 36 shares of the P stock. Corporation P owns, directly and indirectly, 50 shares of the stock of corporation S. Under this paragraph (b)(4), Brown is considered to own 30 shares of the S stock (60/100 × 50), and X is considered to own 18 shares of the S stock (36/100 × 50). Since Smith does not own 5 percent or more in value of the P stock, Smith is not considered as owning any of the S stock owned by P. If, in this example, Smith's spouse had owned directly 1 share of the P stock, Smith (and Smith's spouse) would each own 5 shares of the P stock, and therefore Smith (and Smith's spouse) would be considered as owning 2.5 shares of the S stock (5/100 × 50).

(5) Spouse. (i) Except as provided in paragraph (b)(5)(ii) of this section, an individual is considered to own the stock owned, directly or indirectly, by or for the individual's spouse, other than a spouse who is legally separated from the individual under a decree of divorce, whether interlocutory or final, or a decree of separate maintenance.

(ii) An individual is not considered to own stock in a corporation owned, directly or indirectly, by or for the individual's spouse on any day of a taxable year of such corporation, provided that each of the following conditions are satisfied with respect to such taxable year:

(A) Such individual does not, at any time during such taxable year, own directly any stock in such corporation.

(B) Such individual is not a member of the board of directors or an employee of such corporation and does not participate in the management of such corporation at any time during such taxable year.

(C) Not more than 50 percent of such corporation's gross income for such taxable year was derived from royalties, rents, dividends, interest, and annuities.

(D) Such stock in such corporation is not, at any time during such taxable year, subject to conditions which substantially restrict or limit the spouse's right to dispose of such stock and which run in favor of the individual or the individual's children who have not attained the age of 21 years. The principles of § 1.1563-2(b)(2)(iii) apply in determining whether a condition is a condition described in the preceding sentence.

(iii) For purposes of subdivision (ii)(c) of this subparagraph, the gross income of a corporation for a taxable year shall be determined under section 61 and the regulations thereunder. The terms “royalties”, “rents”, “dividends”, “interest”, and “annuities” shall have the same meanings such terms are given for purposes of section 1244(c). See paragraph (e)(1)(ii), (iii), (iv), (v), and (vi) of § 1.1244(c)-1.

(6) Children, grandchildren, parents, and grandparents. (i) An individual is considered to own the stock owned, directly or indirectly, by or for the individual's children who have not attained the age of 21 years, and, if the individual has not attained the age of 21 years, the stock owned, directly or indirectly, by or for the individual's parents.

(ii) If an individual owns (directly, and with the application of the rules of this paragraph but without regard to this paragraph (b)(6)(ii)) stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock in a corporation, then such individual is considered to own the stock in such corporation owned, directly or indirectly, by or for the individual's parents, grandparents, grandchildren, and children who have attained the age of 21 years. In determining whether the stock owned by an individual possesses the requisite percentage of the total combined voting power of all classes of stock entitled to vote of a corporation, see § 1.1563-1(a)(6).

(iii) For purposes of section 1563, and §§ 1.1563-1 through 1.1563-4, a legally adopted child of an individual shall be treated as a child of such individual by blood.

(iv) Example—(A) Facts. Individual B owns directly 40 shares of the 100 shares of the only class of stock of Z Corporation. B's child, M (20 years of age), owns directly 30 shares of such stock, and B's child, A (30 years of age), owns directly 20 shares of such stock. The remaining 10 shares of the Z stock are owned by an unrelated person.

(B) B's ownership. Individual B owns 40 shares of the Z stock directly and is considered to own the 30 shares of Z stock owned directly by M. Since, for purposes of the more-than-50-percent stock ownership test contained in paragraph (b)(6)(ii) of this section, B is treated as owning 70 shares or 70 percent of the total voting power and value of the Z stock, B is also considered as owning the 20 shares owned by B's adult child, A. Accordingly, B is considered as owning a total of 90 shares of the Z stock.

(C) M's ownership. Minor child, M, owns 30 shares of the Z stock directly, and is considered to own the 40 shares of Z stock owned directly by B. However, M is not considered to own the 20 shares of Z stock owned directly by M's sibling, A, and constructively by B, because stock constructively owned by B by reason of family attribution is not considered as owned by M for purposes of making another member of B's family the constructive owner of such stock. See paragraph (c)(2) of this section. Accordingly, M owns and is considered as owning a total of 70 shares of the Z stock.

(D) A's ownership. Adult child, A, owns 20 shares of the Z stock directly. Since, for purposes of the more-than-50-percent stock ownership test contained in paragraph (b)(6)(ii) of this section, A is treated as owning only the Z stock which A owns directly, A does not satisfy the condition precedent for the attribution of Z stock from B. Accordingly, A is treated as owning only the 20 shares of Z stock which A owns directly.

(c) Operating rules and special rules—(1) In general. Except as provided in subparagraph (2) of this paragraph, stock constructively owned by a person by reason of the application of subparagraph (1), (2), (3), (4), (5), or (6) of paragraph (b) of this section shall, for purposes of applying such subparagraphs, be treated as actually owned by such person.

(2) Members of family. Stock constructively owned by an individual by reason of the application of paragraph (b)(5) or (6) of this section is not treated as owned by the individual for purposes of again applying such paragraphs in order to make another the constructive owner of such stock.

(3) Precedence of option attribution. For purposes of this section, if stock may be considered as owned by a person under subparagraph (1) of paragraph (b) of this section (relating to option attribution) and under any other subparagraph of such paragraph, such stock shall be considered as owned by such person under subparagraph (1) of such paragraph.

(4) Examples. The provisions of this paragraph (c) may be illustrated by the following examples:

(i) Example 1. A, 30 years of age, has a 90 percent interest in the capital and profits of a partnership. The partnership owns all the outstanding stock of corporation X and X owns 60 shares of the 100 outstanding shares of corporation Y. Under paragraph (c)(1) of this section, the 60 shares of Y constructively owned by the partnership by reason of paragraph (b)(4) of this section is treated as actually owned by the partnership for purposes of applying paragraph (b)(2) of this section. Therefore, A is considered as owning 54 shares of the Y stock (90 percent of 60 shares).

(ii) Example 2. The facts are the same as in paragraph (c)(4)(i) of this section (Example 1), except that that B, who is 20 years of age and the sibling of A, directly owns 40 shares of Y stock. Although the stock of Y owned by B is considered as owned by C (the parent of A and B) under paragraph (b)(6)(i) of this section, under paragraph (c)(2) of this section such stock may not be treated as owned by C for purposes of applying paragraph (b)(6)(ii) of this section in order to make A the constructive owner of such stock.

(iii) Example 3. The facts are the same as in paragraph (c)(4)(ii) of this section (Example 2), except that that C has an option to acquire the 40 shares of Y stock owned by B. The rule contained in paragraph (c)(2) of this section does not prevent the reattribution of such 40 shares to A because, under paragraph (c)(3) of this section, C is considered as owning the 40 shares by reason of option attribution and not by reason of family attribution. Therefore, since A satisfies the more-than-50-percent stock ownership test contained in paragraph (b)(6)(ii) of this section with respect to Y, the 40 shares of Y stock constructively owned by C are reattributed to A, and A is considered as owning a total of 94 shares of Y stock.

(d) Special rule of section 1563 (f)(3)(B)—(1) In general. If the same stock of a corporation is owned (within the meaning of section 1563(d)) by two or more persons, then such stock shall be treated as owned by the person whose ownership of such stock results in the corporation being a component member of a controlled group on a December 31 which has at least one other component member on such date.

(2) Component member of more than one group. (i) If, by reason of subparagraph (1) of this paragraph, a corporation would (but for this subparagraph) become a component member of more than one controlled group on a December 31, such corporation shall be treated as a component member of only one such controlled group on such date. The determination as to which group such corporation is treated as a component member of shall be made in accordance with the rules contained in paragraphs (d)(2)(ii), (iii) and (iv) of this section.

(ii) In any case in which a corporation is a component member of a controlled group of corporations on a December 31 as a result of treating each share of its stock as owned only by the person who owns such share directly, then each such share shall be treated as owned by the person who owns such share directly.

(iii) If the application of subdivision (ii) of this subparagraph does not result in a corporation being treated as a component member of only one controlled group on a December 31, then the stock of such corporation described in subparagraph (1) of this paragraph shall be treated as owned by the one person described in such subparagraph who owns, directly and with the application of the rules contained in paragraph (b) (1), (2), (3), and (4) of this section, the stock possessing the greatest percentage of the total value of shares of all classes of stock of the corporation.

(iv) Statement. If the application of paragraph (d)(2)(ii) or (iii) of this section does not result in a corporation being treated as a component member of only one controlled group of corporations on a December 31, then such corporation will be treated as a component member of only one such group on such date. Such corporation may elect the group in which it is to be included by including on or with its income tax return a statement entitled, “STATEMENT TO ELECT CONTROLLED GROUP PURSUANT TO § 1.1563-3(d)(2)(iv).” The statement must include—

(B) The following representation: [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF CORPORATION] ELECTS TO BE TREATED AS A COMPONENT MEMBER OF THE [INSERT DESIGNATION OF GROUP].

(v) Election—(A) Election filed. An election filed under paragraph (d)(2)(iv) of this section is irrevocable and effective until paragraph (d)(2)(ii) or (iii) of this section applies or until a change in the stock ownership of the corporation results in termination of membership in the controlled group in which such corporation has been included.

(B) Election not filed. In the event no election is filed in accordance with the provisions of paragraph (d)(2)(iv) of this section, then the Internal Revenue Service will determine the group in which such corporation is to be included. Such determination will be binding for all subsequent years unless the corporation files a valid election with respect to any such subsequent year or until a change in the stock ownership of the corporation results in termination of membership in the controlled group in which such corporation has been included.

(3) Examples. The provisions of this paragraph (d) may be illustrated by the following examples, in which each corporation referred to uses the calendar year as its taxable year and the stated facts are assumed to exist on each day of 1970 (unless otherwise provided in the example):

(i) Example 1. Jones owns all the stock of corporation X and has an option to purchase from Smith all the outstanding stock of corporation Y. Smith owns all the outstanding stock of corporation Z. Since the Y stock is considered as owned by two or more persons, under paragraph (d)(2)(ii) of this section, the Y stock is treated as owned only by Smith since Smith has direct ownership of such stock. Therefore, on December 31, 1970, Y and Z are component members of the same brother-sister controlled group. If, however, Smith had owned Smith's stock in corporation Z for less than one-half of the number of days of Z's 1970 taxable year, then under paragraph (d)(1) of this section, the Y stock would be treated as owned only by Jones since Jones's ownership results in Y being a component member of a controlled group on December 31,1970.

(ii) Example 2. Individual A owns directly all the outstanding stock of corporation M. B (the spouse of A) owns directly all the outstanding stock of corporation N. Neither spouse is considered as owning the stock directly owned by the other because each of the conditions prescribed in paragraph (b)(5)(ii) of this section is satisfied with respect to each corporation's 1970 taxable year. A owns directly 60 percent of the only class of stock of corporation P and B owns the remaining 40 percent of the P stock. Under paragraph (d)(2)(iii) of this section, the stock of P is treated as owned only by A since A owns (directly and with the application of the rules contained in paragraphs (b)(1) through (4) of this section) the stock possessing the greatest percentage of the total value of shares of all classes of stock of P. Accordingly, on December 31, 1970, P is treated as a component member of a brother-sister group consisting of M and P.

(iii) Example 3. Unrelated individuals A and B each own 49 percent of all the outstanding stock of corporation R, which in turn owns 70 percent of the only class of outstanding stock of corporation S. The remaining 30 percent of the stock of corporation S is owned by unrelated individual C. C also owns the remaining 2 percent of the stock of corporation R. Under the attribution rule of paragraph (b)(4) of this section, A and B are each considered to own 34.3 percent of the stock of corporation S. Accordingly, since five or fewer persons own at least 80 percent of the stock of corporations R and S and also own more than 50 percent identically (A's and B's identical ownership each is 34.3 percent, C's identical ownership is 2 percent), on December 31, 1970, corporations R and S are treated as component members of the same brother-sister controlled group for purposes of § 1.1563-1(a)(3)(ii).

(e) Applicability dates. This section applies to taxable years beginning on or after December 30, 2024. For taxable years beginning before December 30, 2024, see § 1.1563-3 as contained in 26 CFR part 1 in effect on April 1, 2024.

[T.D. 6845, 30 FR 9755, Aug. 5, 1965, as amended by T.D. 7181, 37 FR 8070, Apr. 25, 1972; T.D. 7779, 46 FR 29474, June 2, 1981; T.D. 8179, 53 FR 6613, Mar. 2, 1988; T.D. 9264, 71 FR 30606, 30608, May 30, 2006; T.D. 9304, 71 FR 76913, Dec. 22, 2006; T.D. 9329, 72 FR 32806, 32807, June 14, 2007; T.D. 9451, 74 FR 25148, May 27, 2009; T.D. 10018, 89 FR 106880, Dec. 30, 2024]

§ 1.1563-4 Franchised corporations.

(a) In general. For purposes of paragraph (b)(2)(ii)(d) of § 1.1563-1, a member of a controlled group of corporations shall be considered to be a franchised corporation for a taxable year if each of the following conditions is satisfied for one-half (or more) of the number of days preceding the December 31 included within such taxable year (or, if such taxable year does not include a December 31, for one-half or more of the number of days in such taxable year preceding the last day of such year):

(1) Such member is franchised to sell the products of another member, or the common owner, of such controlled group.

(2) More than 50 percent (determined on the basis of cost) of all the goods held by such member primarily for sale to its customers are acquired from members or the common owner of the controlled group, or both.

(3) The stock of such member is to be sold to an employee (or employees) of such member pursuant to a bona fide plan designed to eliminate the stock ownership of the parent corporation (as defined in paragraph (b)(1) of § 1.1563-2) or of the common owner (as defined in paragraph (b)(3) of § 1.1563-2) in such member.

(4) Such employee owns (or such employees in the aggregate own) directly more than 20 percent of the total value of shares of all classes of stock of such member. For purposes of this subparagraph, the determination of whether an employee (or employees) owns the requisite percentage of the total value of the stock of the member shall be made without regard to paragraph (b) of § 1.1563-2, relating to certain stock treated as excluded stock. Furthermore, if the corporation has more than one class of stock outstanding, the relative voting rights as between each such class of stock shall be disregarded in making such determination.

(b) Plan for elimination of stock ownership. (1) A plan referred to in paragraph (a)(3) of this section must:

(i) Provide a reasonable selling price for the stock of the member, and

(ii) Require that a portion of the employee's compensation or dividends, or both, from such member be applied to the purchase of such stock (or to the purchase of notes, bonds, debentures, or similar evidences of indebtedness of such member held by the parent corporation or the common owner).

It is not necessary, in order to satisfy the requirements of subdivision (ii) of this subparagraph, that the plan require that a percentage of every dollar of the compensation and dividends be applied to the purchase of the stock (or the indebtedness). The requirements of such subdivision are satisfied if an otherwise qualified plan provides that under certain specified conditions (such as a requirement that the member earn a specified profit) no portion of the compensation and/or dividends need be applied to the purchase of the stock (or indebtedness), provided such conditions are reasonable.

(2) A plan for the elimination of the stock ownership of the parent corporation or of the common owner will satisfy the requirements of paragraph (a)(3) of this section and subparagraph (1) of this paragraph even though it does not require that the stock of the member be sold to an employee (or employees) if it provides for the redemption of the stock of the member held by the parent or common owner and under the plan the amount of such stock to be redeemed during any period is calculated by reference to the profits of such member during such period.

[T.D. 6845, 30 FR 9757, Aug. 5, 1965]

2 Individual Shared Responsibility Payment for Not Maintaining Minimum Essential Coverage

3 Information and Returns

Source: Sections 1.6001-1 through 1.6091-4 contained in T.D. 6500, 25 FR 12108, Nov. 26, 1960, unless otherwise noted.

§ 1.5000A-0 Table of contents.

This section lists the captions contained in §§ 1.5000A-1 through 1.5000A-5.

§ 1.5000A-1 Maintenance of minimum essential coverage and liability for the shared responsibility payment.

(a) In general.

(b) Coverage under minimum essential coverage.

(1) In general.

(2) Special rule for United States citizens or residents residing outside the United States or residents of territories.

(1) In general.

(2) Liability for dependents.

(i) In general.

(ii) Special rules for dependents adopted or placed in foster care during the taxable year.

(A) Taxpayers adopting an individual.

(B) Taxpayers placing an individual for adoption.

(3) Liability of individuals filing a joint return.

(d) Definitions.

(1) Affordable Care Act.

(2) Employee.

(3) Exchange.

(4) Family.

(5) Family coverage.

(6) Group health insurance coverage.

(7) Group health plan.

(8) Health insurance coverage.

(9) Health insurance issuer.

(10) Household income.

(i) In general.

(ii) Modified adjusted gross income.

(11) Individual market.

(12) Large and small group market.

(13) Month.

(14) Qualified health plan.

(15) Rating area.

(16) Self-only coverage.

(17) Shared responsibility family.

(18) State.

§ 1.5000A-2 Minimum essential coverage.

(a) In general.

(b) Government-sponsored program.

(1) In general.

(i) Medicare.

(ii) Medicaid.

(iii) Children's Health Insurance Program.

(iv) TRICARE.

(v) Veterans programs.

(vi) Peace Corp program.

(vii) Nonappropriated Fund Health Benefits Program.

(2) Certain health care coverage not minimum essential coverage under a government-sponsored program.

(1) In general.

(2) Government-sponsored program generally not an eligible employer-sponsored plan.

(d) Plan in the individual market.

(1) In general.

(2) Qualified health plan offered by an Exchange.

(e) Grandfathered health plan.

(f) Other coverage that qualifies as minimum essential coverage.

(g) Excepted benefits not minimum essential coverage.

§ 1.5000A-3 Exempt individuals.

(a) Members of recognized religious sects.

(1) In general.

(2) Exemption certification.

(b) Member of health care sharing ministries.

(1) In general.

(2) Health care sharing ministry.

(1) In general.

(2) Exempt noncitizens.

(d) Incarcerated individuals.

(1) In general.

(2) Incarcerated.

(e) Individuals with no affordable coverage.

(1) In general.

(2) Required contribution percentage.

(i) In general.

(ii) Indexing.

(iii) Plan year.

(3) Individuals eligible for coverage under eligible employer-sponsored plans.

(i) Eligibility.

(A) In general.

(B) Multiple eligibility.

(ii) Required contribution for individuals eligible for coverage under an eligible employer-sponsored plan.

(A) Employees.

(B) Individuals related to employees.

(D) Employer contributions to health reimbursement arrangements.

(E) Wellness program incentives.

(iii) Examples.

(4) Individuals ineligible for coverage under eligible employer-sponsored plans.

(i) Eligibility for coverage other than an eligible employer-sponsored plan.

(ii) Required contribution for individuals ineligible for coverage under eligible employer-sponsored plans.

(A) In general.

(B) Applicable plan.

(1) In general.

(2) Lowest cost bronze plan does not cover all individuals included in the taxpayer's nonexempt family.

(i) In general.

(ii) Optional simplified method for applicable plan identification.

(D) Credit allowable under section 36B.

(E) Required contribution for part-year period.

(iii) Examples.

(f) Household income below filing threshold.

(1) In general.

(2) Applicable filing threshold.

(i) In general.

(ii) Certain dependents.

(3) Manner of claiming the exemption.

(g) Members of Indian tribes.

(h) Individuals with hardship exemption certification.

(1) In general.

(2) Hardship exemption certification.

(3) Hardship exemption without hardship exemption certification.

(i) [Reserved]

(j) Individuals with certain short coverage gaps.

(1) In general.

(2) Short coverage gap.

(i) In general.

(ii) Coordination with other exemptions.

(iii) More than one short coverage gap during calendar year.

(3) Continuous period.

(i) In general.

(ii) Continuous period straddling more than one taxable year.

(4) Examples.

§ 1.5000A-4 Computation of shared responsibility payment.

(a) In general.

(b) Monthly penalty amount.

(1) In general.

(2) Flat dollar amount.

(i) In general.

(ii) Applicable dollar amount.

(iii) Special applicable dollar amount for individuals under age 18.

(iv) Indexing of applicable dollar amount.

(3) Excess income amount.

(i) In general.

(ii) Income percentage.

(d) Examples.

§ 1.5000A-5 Administration and procedure.

(a) In general.

(b) Special rules.

(1) Waiver of criminal penalties.

(2) Limitations on liens and levies.

(3) Authority to offset against overpayment.

[T.D. 9632, 78 FR 53655, Aug. 30, 2013, as amended at 78 FR 78255, Dec. 26, 2013; T.D. 9705, 79 FR 70468, Nov. 26, 2014]

§ 1.5000A-1 Maintenance of minimum essential coverage and liability for the shared responsibility payment.

(a) In general. For each month during the taxable year, a nonexempt individual must have minimum essential coverage or pay the shared responsibility payment. For a month, a nonexempt individual is an individual in existence for the entire month who is not an exempt individual described in § 1.5000A-3.

(b) Coverage under minimum essential coverage—(1) In general. An individual has minimum essential coverage for a month in which the individual is enrolled in and entitled to receive benefits under a program or plan identified as minimum essential coverage in § 1.5000A-2 for at least one day in the month.

(2) Special rule for United States citizens or residents residing outside the United States or residents of territories. An individual is treated as having minimum essential coverage for a month—

(i) If the month occurs during any period described in section 911(d)(1)(A) or section 911(d)(1)(B) that is applicable to the individual; or

(ii) If, for the month, the individual is a bona fide resident of a possession of the United States (as determined under section 937(a)).

(c) Liability for shared responsibility payment—(1) In general. A taxpayer is liable for the shared responsibility payment for a month for which—

(i) The taxpayer is a nonexempt individual without minimum essential coverage; or

(ii) A nonexempt individual for whom the taxpayer is liable under paragraph (c)(2) or (c)(3) of this section does not have minimum essential coverage.

(2) Liability for dependents—(i) In general. For a month when a nonexempt individual does not have minimum essential coverage, if the nonexempt individual is a dependent (as defined in section 152) of another individual for the other individual's taxable year including that month, the other individual is liable for the shared responsibility payment attributable to the dependent's lack of coverage. An individual is a dependent of a taxpayer for a taxable year if the individual satisfies the definition of dependent under section 152, regardless of whether the taxpayer claims the individual as a dependent on a Federal income tax return for the taxable year. If an individual may be claimed as a dependent by more than one taxpayer in the same calendar year, the taxpayer who properly claims the individual as a dependent for the taxable year is liable for the shared responsibility payment attributable to the individual. If more than one taxpayer may claim an individual as a dependent in the same calendar year but no one claims the individual as a dependent, the taxpayer with priority under the rules of section 152 to claim the individual as a dependent is liable for the shared responsibility payment for the individual.

(ii) Special rules for dependents adopted or placed in foster care during the taxable year—(A) Taxpayers adopting an individual. If a taxpayer adopts a nonexempt dependent (or accepts a nonexempt dependent who is an eligible foster child as defined in section 152(f)(1)(C)) during the taxable year and is otherwise liable for the nonexempt dependent under paragraph (c)(2)(i) of this section, the taxpayer is liable under paragraph (c)(2)(i) of this section for the nonexempt dependent only for the full months in the taxable year that follow the month in which the adoption or acceptance occurs.

(B) Taxpayers placing an individual for adoption. If a taxpayer who is otherwise liable for a nonexempt dependent under paragraph (c)(2)(i) of this section places (or, by operation of law, must place) the nonexempt dependent for adoption or foster care during the taxable year, the taxpayer is liable under paragraph (c)(2)(i) of this section for the nonexempt dependent only for the full months in the taxable year that precede the month in which the adoption or foster care placement occurs.

(C) Examples. The following examples illustrate the provisions of this paragraph (c)(2)(ii). In each example the taxpayer's taxable year is a calendar year.

Example 1. Taxpayers adopting a child. (i) E and F, married individuals filing a joint return, initiate proceedings for the legal adoption of a 2-year old child, G, in January 2016. On May 15, 2016, G becomes the adopted child (within the meaning of section 152(f)(1)(B)) of E and F, and resides with them for the remainder of 2016. Prior to the adoption, G resides with H, an unmarried individual, with H providing all of G's support. For 2016 G meets all requirements under section 152 to be E and F's dependent, and not H's dependent.

(ii) Under paragraph (c)(2) of this section, E and F are not liable for a shared responsibility payment attributable to G for January through May of 2016, but are liable for a shared responsibility payment attributable to G, if any, for June through December of 2016. H is not liable for a shared responsibility payment attributable to G for any month in 2016, because G is not H's dependent for 2016 under section 152.

Example 2. Taxpayers placing a child for adoption. (i) The facts are the same as Example 1, except the legal adoption occurs on August 15, 2016, and, for 2016, G meets all requirements under section 152 to be H's dependent, and not E and F's dependent.

(ii) Under paragraph (c)(2) of this section, H is liable for a shared responsibility payment attributable to G, if any, for January through July of 2016, but is not liable for a shared responsibility payment attributable to G for August through December of 2016. E and F are not liable for a shared responsibility payment attributable to G for any month in 2016, because G is not E and F's dependent for 2016 under section 152.

(3) Liability of individuals filing a joint return. Married individuals (within the meaning of section 7703) who file a joint return for a taxable year are jointly liable for any shared responsibility payment for a month included in the taxable year.

(d) Definitions. The definitions in this paragraph (d) apply to this section and §§ 1.5000A-2 through 1.5000A-5.

(1) Affordable Care Act. Affordable Care Act refers to the Patient Protection and Affordable Care Act, Public Law 111-148 (124 Stat. 119 (2010)), and the Health Care and Education Reconciliation Act of 2010, Public Law 111-152 (124 Stat. 1029 (2010)), as amended.

(2) Employee. Employee includes former employees.

(3) Exchange. Exchange has the same meaning as in 45 CFR 155.20.

(4) Family. A taxpayer's family means the individuals for whom the taxpayer properly claims a deduction for a personal exemption under section 151 for the taxable year.

(5) Family coverage. Family coverage means health insurance that covers more than one individual.

(6) Group health insurance coverage. Group health insurance coverage has the same meaning as in section 2791(b)(4) of the Public Health Service Act (42 U.S.C. 300gg-91(b)(4)).

(7) Group health plan. Group health plan has the same meaning as in section 2791(a)(1) of the Public Health Service Act (42 U.S.C. 300gg-91(a)(1)).

(8) Health insurance coverage. Health insurance coverage has the same meaning as in section 2791(b)(1) of the Public Health Service Act (42 U.S.C. 300gg-91(b)(1)).

(9) Health insurance issuer. Health insurance issuer has the same meaning as in section 2791(b)(2) of the Public Health Service Act (42 U.S.C. 300gg-91(b)(2)).

(10) Household income—(i) In general. Household income means the sum of—

(A) A taxpayer's modified adjusted gross income; and

(B) The aggregate modified adjusted gross income of all other individuals who—

(1) Are included in the taxpayer's family under paragraph (d)(4) of this section; and

(2) Are required to file a Federal income tax return for the taxable year.

(ii) Modified adjusted gross income. Modified adjusted gross income means adjusted gross income (within the meaning of section 62) increased by—

(A) Amounts excluded from gross income under section 911; and

(B) Tax-exempt interest the taxpayer receives or accrues during the taxable year.

(11) Individual market. Individual market has the same meaning as in section 1304(a)(2) of the Affordable Care Act (42 U.S.C. 18024(a)(2)).

(12) Large and small group market. Large group market and small group market have the same meanings as in section 1304(a)(3) of the Affordable Care Act (42 U.S.C. 18024(a)(3)).

(13) Month. Month means calendar month.

(14) Qualified health plan. Qualified health plan has the same meaning as in section 1301(a) of the Affordable Care Act (42 U.S.C. 18021(a)).

(15) Rating area. Rating area has the same meaning as in § 1.36B-1(n).

(16) Self-only coverage. Self-only coverage means health insurance that covers one individual.

(17) Shared responsibility family. Shared responsibility family means, for a month, all nonexempt individuals for whom the taxpayer (and the taxpayer's spouse, if the taxpayer is married and files a joint return with the spouse) is liable for the shared responsibility payment under paragraph (c) of this section.

(18) State. State means each of the 50 states and the District of Columbia.

[T.D. 9632, 78 FR 53655, Aug. 30, 2013, as amended at 78 FR 78255, Dec. 26, 2013]

§ 1.5000A-2 Minimum essential coverage.

(a) In general. Minimum essential coverage means coverage under a government-sponsored program (described in paragraph (b) of this section), an eligible employer-sponsored plan (described in paragraph (c) of this section), a plan in the individual market (described in paragraph (d) of this section), a grandfathered health plan (described in paragraph (e) of this section), or other health benefits coverage (described in paragraph (f) of this section). Minimum essential coverage does not include coverage described in paragraph (g) of this section. All terms defined in this section apply for purposes of this section and § 1.5000A-1 and §§ 1.5000A-3 through 1.5000A-5.

(b) Government-sponsored program—(1) In general. Except as provided in paragraph (2), government-sponsored program means any of the following:

(i) Medicare. The Medicare program under part A of Title XVIII of the Social Security Act (42 U.S.C. 1395c and following sections);

(ii) Medicaid. The Medicaid program under Title XIX of the Social Security Act (42 U.S.C. 1396 and following sections);

(iii) Children's Health Insurance Program. The Children's Health Insurance Program (CHIP) under Title XXI of the Social Security Act (42 U.S.C. 1397aa and following sections);

(iv) TRICARE. Medical coverage under chapter 55 of Title 10, U.S.C., including coverage under the TRICARE program;

(v) Veterans programs. The following health care programs under chapter 17 or 18 of Title 38, U.S.C.:

(A) The medical benefits package authorized for eligible veterans under 38 U.S.C. 1710 and 38 U.S.C. 1705;

(B) The Civilian Health and Medical Program of the Department of Veterans Affairs (CHAMPVA) authorized under 38 U.S.C. 1781; and

(C) The comprehensive health care program authorized under 38 U.S.C. 1803 and 38 U.S.C. 1821 for certain children of Vietnam Veterans and Veterans of covered service in Korea who are suffering from spina bifida.

(vi) Peace Corp program. A health plan under section 2504(e) of Title 22, U.S.C. (relating to Peace Corps volunteers); and

(vii) Nonappropriated Fund Health Benefits Program. The Nonappropriated Fund Health Benefits Program of the Department of Defense, established under section 349 of the National Defense Authorization Act for Fiscal Year 1995 (Pub. L. 103-337; 10 U.S.C. 1587 note).

(2) Certain health care coverage not minimum essential coverage under a government-sponsored program. Government-sponsored program does not mean any of the following:

(i) Optional coverage of family planning services under section 1902(a)(10)(A)(ii)(XXI) of the Social Security Act (42 U.S.C. 1396a(a)(10)(A)(ii)(XXI));

(ii) Optional coverage of tuberculosis-related services under section 1902(a)(10)(A)(ii)(XII) of the Social Security Act (42 U.S.C. 1396a(a)(10)(A)(ii)(XII));

(iii) Coverage of pregnancy-related services under section 1902(a)(10)(A)(i)(IV) and (a)(10)(A)(ii)(IX) of the Social Security Act (42 U.S.C. 1396a(a)(10)(A)(i)(IV), (a)(10)(A)(ii)(IX));

(iv) Coverage limited to treatment of emergency medical conditions in accordance with 8 U.S.C. 1611(b)(1)(A), as authorized by section 1903(v) of the Social Security Act (42 U.S.C. 1396b(v));

(v) Coverage for medically needy individuals under section 1902(a)(10)(C) of the Social Security Act (42 U.S.C. 1396a(a)(10)(C)) and 42 CFR 435.300 and following sections;

(vi) Coverage authorized under section 1115(a) of the Social Security Act (42 U.S.C. 1315(a));

(vii) Coverage under 10 U.S.C. 1079(a), 1086(c)(1), or 1086(d)(1) that is solely limited to space available care in a facility of the uniformed services for individuals excluded from TRICARE coverage for care from private sector providers;

(viii) Coverage under 10 U.S.C. 1074a and 1074b for an injury, illness, or disease incurred or aggravated in the line of duty for individuals who are not on active duty; and

(ix) Medicaid coverage limited to COVID-19 testing and diagnostic services provided under section 6004(a)(3) of the Families First Coronavirus Response Act, Pub. L. 116-127, 134 Stat. 178 (March 18, 2020).

(c) Eligible employer-sponsored plan—(1) In general. Eligible employer-sponsored plan means, with respect to any employee:

(i) Group health insurance coverage offered by, or on behalf of, an employer to the employee that is—

(A) A governmental plan (within the meaning of section 2791(d)(8) of the Public Health Service Act (42 U.S.C. 300gg-91(d)(8)));

(B) Any other plan or coverage offered in the small or large group market within a State; or

(ii) A self-insured group health plan under which coverage is offered by, or on behalf of, an employer to the employee.

(2) Government-sponsored program generally not an eligible employer-sponsored plan. Except for the program identified in paragraph (b)(1)(vii) of this section, a government-sponsored program described in paragraph (b) of this section is not an eligible employer-sponsored plan.

(d) Plan in the individual market—(1) In general. Plan in the individual market means health insurance coverage offered to individuals in the individual market within a state, other than short-term limited duration insurance within the meaning of section 2791(b)(5) of the Public Health Service Act (42 U.S.C. 300gg-91(b)(5)).

(2) Qualified health plan offered by an Exchange. A qualified health plan offered by an Exchange is a plan in the individual market. If a territory of the United States elects to establish an Exchange under section 1323(a)(1) and (b) of the Affordable Care Act (42 U.S.C. 18043(a)(1), (b)), a qualified health plan offered by that Exchange is a plan in the individual market.

(e) Grandfathered health plan. Grandfathered health plan means any group health plan or group health insurance coverage to which section 1251 of the Affordable Care Act (42 U.S.C. 18011) applies.

(f) Other coverage that qualifies as minimum essential coverage. Minimum essential coverage includes any plan or arrangement recognized by the Secretary of Health and Human Services, in coordination with the Secretary of the Treasury, as minimum essential coverage.

(g) Excepted benefits not minimum essential coverage. Minimum essential coverage does not include any coverage that consists solely of excepted benefits described in section 2791(c)(1), (c)(2), (c)(3), or (c)(4) of the Public Health Service Act (42 U.S.C. 300gg-91(c)).

[T.D. 9632, 78 FR 53655, Aug. 30, 2013, as amended at 78 FR 78255, Dec. 26, 2013; T.D. 9705, 79 FR 70469, Nov. 26, 2014; T.D. 9970, 87 FR 76575, Dec. 15, 2022]

§ 1.5000A-3 Exempt individuals.

(a) Members of recognized religious sects—(1) In general. An individual is an exempt individual for a month that includes a day on which the individual has in effect a religious conscience exemption certification described in paragraph (a)(2) of this section.

(2) Exemption certification. A religious conscience exemption certification is issued by an Exchange in accordance with the requirements of section 1311(d)(4)(H) of the Affordable Care Act (42 U.S.C. 18031(d)(4)(H)), 45 CFR 155.605(c), and 45 CFR 155.615(b) and certifies that an individual is—

(i) A member of a recognized religious sect or division of the sect that is described in section 1402(g)(1); and

(ii) An adherent of established tenets or teachings of the sect or division as described in that section.

(b) Member of health care sharing ministries—(1) In general. An individual is an exempt individual for a month that includes a day on which the individual is a member of a health care sharing ministry.

(2) Health care sharing ministry. For purposes of this section, health care sharing ministry means an organization—

(i) That is described in section 501(c)(3) and is exempt from tax under section 501(a);

(ii) Members of which share a common set of ethical or religious beliefs and share medical expenses among themselves in accordance with those beliefs and without regard to the state in which a member resides or is employed;

(iii) Members of which retain membership even after they develop a medical condition;

(iv) That (or a predecessor of which) has been in existence at all times since December 31, 1999;

(v) Members of which have shared medical expenses continuously and without interruption since at least December 31, 1999; and

(vi) That conducts an annual audit performed by an independent certified public accounting firm in accordance with generally accepted accounting principles and makes the annual audit report available to the public upon request.

(c) Exempt noncitizens—(1) In general. An individual is an exempt individual for a month that the individual is an exempt noncitizen.

(2) Exempt noncitizens. For purposes of this section, an individual is an exempt noncitizen for a month if the individual—

(i) Is not a U.S. citizen or U.S. national for any day during the month; and

(ii) Is either—

(A) A nonresident alien (within the meaning of section 7701(b)(1)(B)) for the taxable year that includes the month; or

(B) An individual who is not lawfully present (within the meaning of 45 CFR 155.20) on any day in the month.

(d) Incarcerated individuals—(1) In general. An individual is an exempt individual for a month that includes a day on which the individual is incarcerated.

(2) Incarcerated. For purposes of this section, the term incarcerated means confined, after the disposition of charges, in a jail, prison, or similar penal institution or correctional facility.

(e) Individuals with no affordable coverage—(1) In general. An individual is an exempt individual for a month in which the individual lacks affordable coverage. For purposes of this paragraph (e), an individual lacks affordable coverage in a month if the individual's required contribution (determined on an annual basis) for minimum essential coverage for the month exceeds the required contribution percentage (as defined in paragraph (e)(2) of this section) of the individual's household income. For purposes of this paragraph (e), an individual's household income is increased by any amount of the required contribution made through a salary reduction arrangement that is excluded from gross income.

(2) Required contribution percentage—(i) In general. Except as provided in paragraph (e)(2)(ii) of this section, the required contribution percentage is 8 percent.

(ii) Indexing. For plan years beginning in any calendar year after 2014, the required contribution percentage is the percentage determined by the Department of Health and Human Services that reflects the excess of the rate of premium growth between the preceding calendar year and 2013 over the rate of income growth for the period.

(iii) Plan year. For purposes of this paragraph (e), plan year means the eligible employer-sponsored plan's regular 12-month coverage period, or for a new employee or an individual who enrolls during a special enrollment period, the remainder of a 12-month coverage period.

(3) Individuals eligible for coverage under eligible employer-sponsored plans—(i) Eligibility—(A) In general. Except as provided in paragraph (e)(3)(i)(B) of this section, an employee or related individual (as defined in paragraph (e)(3)(ii)(B) of this section) is treated as eligible for coverage under an eligible employer-sponsored plan for a month during a plan year if the employee or related individual could have enrolled in the plan for any day in that month during an open or special enrollment period, regardless of whether the employee or related individual is eligible for any other type of minimum essential coverage.

(B) Multiple eligibility. For purposes of this paragraph (e)(3), an employee eligible for coverage under an eligible employer-sponsored plan offered by the employee's employer is not treated as eligible as a related individual for coverage under an eligible employer-sponsored plan (for example, an eligible employer-sponsored plan offered by the employer of the employee's spouse) for any month included in the plan year of the eligible employer-sponsored plan offered by the employee's employer.

(C) Special rule for post-employment coverage. A former employee or an individual related to a former employee, who may enroll in continuation coverage required under Federal law or a state law that provides comparable continuation coverage, or in retiree coverage under an eligible employer-sponsored plan, is eligible for coverage under an eligible employer-sponsored plan only if the individual enrolls in the coverage.

(ii) Required contribution for individuals eligible for coverage under an eligible employer-sponsored plan—(A) Employees. In the case of an employee who is eligible to purchase coverage under an eligible employer-sponsored plan sponsored by the employee's employer, the required contribution is the portion of the annual premium that the employee would pay (whether through salary reduction or otherwise) for the lowest cost self-only coverage.

(B) Individuals related to employees. In the case of an individual who is eligible for coverage under an eligible employer-sponsored plan because of a relationship to an employee and for whom a personal exemption deduction under section 151 is claimed on the employee's Federal income tax return (related individual), the required contribution is the portion of the annual premium that the employee would pay (whether through salary reduction or otherwise) for the lowest cost family coverage that would cover the employee and all related individuals who are included in the employee's family and are not otherwise exempt under § 1.5000A-3.

(C) Required contribution for part-year period. For each individual described in paragraph (e)(3)(ii)(A) or (e)(3)(ii)(B) of this section, affordability under this paragraph (e)(3) is determined separately for each employment period that is less than a full calendar year or for the portions of an employer's plan year that fall in different taxable years of the individual. Coverage under an eligible employer-sponsored plan is affordable for a part-year period if the annualized required contribution for self-only coverage (in the case of the employee) or family coverage (in the case of a related individual) under the plan for the part-year period does not exceed the required contribution percentage of the individual's household income for the taxable year. The annualized required contribution is the required contribution determined under paragraph (e)(3)(ii)(A) or (e)(3)(ii)(B) of this section for the part-year period times a fraction, the numerator of which is 12 and the denominator of which is the number of months in the part-year period during the individual's taxable year. Only full calendar months are included in the computation under this paragraph (e)(3)(ii)(C).

(D) Employer contributions to health reimbursement arrangements. Amounts newly made available for the current plan year under a health reimbursement arrangement that an employee may use to pay premiums, or may use to pay cost-sharing or benefits not covered by the primary plan in addition to premiums, are counted toward the employee's required contribution if the health reimbursement arrangement would be integrated, as that term is used in Notice 2013-54 (2013-40 IRB 287) or in any successor published guidance (see § 601.601(d) of this chapter), with an eligible employer-sponsored plan for an employee enrolled in the plan. The eligible employer-sponsored plan and the health reimbursement arrangement must be offered by the same employer. Employer contributions to a health reimbursement arrangement count toward an employee's required contribution only to the extent the amount of the annual contribution is required under the terms of the plan or otherwise determinable within a reasonable time before the employee must decide whether to enroll in the eligible employer-sponsored plan.

(E) Employer contributions to cafeteria plans. Amounts made available for the current plan year under a cafeteria plan, within the meaning of section 125, are taken into account in determining an employee's or a related individual's required contribution if:

(1) The employee may not opt to receive the amount as a taxable benefit;

(2) The employee may use the amount to pay for minimum essential coverage; and

(3) The employee may use the amount exclusively to pay for medical care, within the meaning of section 213.

(F) Wellness program incentives. Nondiscriminatory wellness program incentives, within the meaning of § 54.9802-1(f) of this chapter, offered by an eligible employer-sponsored plan that affect premiums are treated as earned in determining an employee's required contribution for purposes of affordability of an eligible employer-sponsored plan to the extent the incentives relate exclusively to tobacco use. Wellness program incentives that do not relate to tobacco use or that include a component unrelated to tobacco use are treated as not earned for this purpose. For purposes of this section, the term wellness program incentive has the same meaning as the term reward in § 54.9802-1(f)(1)(i) of this chapter.

(G) Opt-out arrangements. [Reserved]

(iii) Examples. The following examples illustrate the application of this paragraph (e)(3). Unless stated otherwise, in each example, each individual's taxable year is a calendar year, the individual is ineligible for any other exemptions described in this section for a month, the rate of premium growth has not exceeded the rate of income growth since 2013, and the individual's employer offers a single plan that uses a calendar plan year and is an eligible employer-sponsored plan as described in § 1.5000A-2(c).

Example 1. Unmarried employee with no dependents.Taxpayer A is an unmarried individual with no dependents. In November 2015, A is eligible to enroll in self-only coverage under a plan offered by A's employer for calendar year 2016. If A enrolls in the coverage, A is required to pay $5,000 of the total annual premium. In 2016, A's household income is $60,000. Under paragraph (e)(3)(ii)(A) of this section, A's required contribution is $5,000, the portion of the annual premium A pays for self-only coverage. Under paragraph (e)(1) of this section, A lacks affordable coverage for 2016 because A's required contribution ($5,000) is greater than 8% of A's household income ($4,800).

Example 2. Married employee with dependents.Taxpayers B and C are married and file a joint return for 2016. B and C have two children, D and E. In November 2015, B is eligible to enroll in self-only coverage under a plan offered by B's employer for calendar year 2016 at a cost of $5,000 to B. C, D, and E are eligible to enroll in family coverage under the same plan for 2016 at a cost of $20,000 to B. B, C, D, and E's household income for 2016 is $90,000. Under paragraph (e)(3)(ii)(A) of this section, B's required contribution is B's share of the cost for self-only coverage, $5,000. Under paragraph (e)(1) of this section, B has affordable coverage for 2016 because B's required contribution ($5,000) does not exceed 8% of B's household income ($7,200). Under paragraph (e)(3)(ii)(B) of this section, the required contribution for C, D, and E is B's share of the cost for family coverage, $20,000. Under paragraph (e)(1) of this section, C, D, and E lack affordable coverage for 2016 because their required contribution ($20,000) exceeds 8% of their household income ($7,200).

Example 3. Plan year is a fiscal year. (i) Taxpayer F is an unmarried individual with no dependents. In June 2015, F is eligible to enroll in self-only coverage under a plan offered by F's employer for the period July 2015 through June 2016 at a cost to F of $4,750. In June 2016, F is eligible to enroll in self-only coverage under a plan offered by F's employer for the period July 2016 through June 2017 at a cost to F of $5,000. In 2016, F's household income is $60,000.

(ii) Under paragraph (e)(3)(ii)(C) of this section, F's annualized required contribution for the period January 2016 through June 2016 is $4,750 ($2,375 paid for premiums in 2016 × 12/6). Under paragraph (e)(1) of this section, F has affordable coverage for January 2016 through June 2016 because F's annualized required contribution ($4,750) does not exceed 8% of F's household income ($4,800).

(iii) Under paragraph (e)(3)(ii)(C) of this section, F's annualized required contribution for the period July 2016 to December 2016 is $5,000 ($2,500 paid for premiums in 2016 × 12/6). Under paragraph (e)(1) of this section, F lacks affordable coverage for July 2016 through December 2016 because F's annualized required contribution ($5,000) exceeds 8% of F's household income ($4,800).

Example 4. Eligibility for coverage under an eligible employer-sponsored plan and under government sponsored coverage.Taxpayer G is unmarried and has one child, H. In November 2015, H is eligible to enroll in family coverage under a plan offered by G's employer for 2016. H is also eligible to enroll in the CHIP program for 2016. Under paragraph (e)(3)(i) of this section, H is treated as eligible for coverage under an eligible employer-sponsored plan for each month in 2016, notwithstanding that H is eligible to enroll in government sponsored coverage for the same period.

(4) Individuals ineligible for coverage under eligible employer-sponsored plans—(i) Eligibility for coverage other than an eligible employer-sponsored plan. An individual is treated as ineligible for coverage under an eligible employer-sponsored plan for a month that is not described in paragraph (e)(3)(i) of this section.

(ii) Required contribution for individuals ineligible for coverage under eligible employer-sponsored plans—(A) In general. In the case of an individual who is ineligible for coverage under an eligible employer-sponsored plan, the required contribution is the premium for the applicable plan, reduced by the maximum amount of any credit allowable under section 36B for the taxable year, determined as if the individual was covered for the entire taxable year by a qualified health plan offered through the Exchange serving the rating area where the individual resides.

(B) Applicable plan—(1) In general. Except as provided in paragraph (e)(4)(ii)(B)(2) of this section, applicable plan means the single lowest cost bronze plan available in the individual market through the Exchange serving the rating area in which the individual resides (without regard to whether the individual purchased a qualified health plan through the Exchange) that would cover all individuals in the individual's nonexempt family. For purposes of this paragraph (e)(4), an individual's nonexempt family means the family (as defined in § 1.5000A-1(d)(4)) that includes the individual, excluding any family members who are otherwise exempt under section 1.5000A-3 or are treated as eligible for coverage under an eligible employer-sponsored plan under paragraph (e)(3)(i) of this section. The premium for the applicable plan takes into account rating factors (for example, an individual's age or tobacco use) that an Exchange would use to determine the cost of coverage.

(2) Lowest cost bronze plan does not cover all individuals included in the taxpayer's nonexempt family—(i) In general. If the Exchange serving the rating area where the individual resides does not offer a single bronze plan covering all individuals included in the individual's nonexempt family, the premium for the applicable plan is the sum of the premiums for the lowest cost bronze plans that are offered through the Exchanges serving the rating areas where one or more of the individuals reside that would cover in the aggregate all the individuals in the individual's nonexempt family. For instance, coverage offered through the Exchange in a rating area might not cover a family member living in different rating area or a single policy might not cover all the members in a taxpayer's household.

(ii) Optional simplified method for applicable plan identification. [Reserved]

(D) Credit allowable under section 36B. For purposes of paragraph (e)(4)(ii)(A) of this section, maximum amount of any credit allowable under section 36B means the maximum amount of the credit that would be allowable to the individual, or to the taxpayer who can properly claim the individual as a dependent, under section 36B if all members of the individual's nonexempt family enrolled in a qualified health plan through the Exchange serving the rating area where the individual resides.

(E) Required contribution for part-year period. For each individual, affordability under paragraph (e)(4) of this section is determined separately for each period described in paragraph (e)(4)(ii)(E) of this section that is less than a 12-month period. Coverage under a plan is affordable for a part-year period if the annualized required contribution for coverage under the plan for the part-year period does not exceed the required contribution percentage of the individual's household income for the taxable year. The annualized required contribution is the required contribution determined under paragraph (e)(4)(ii)(A) of this section for the part-year period times a fraction, the numerator of which is 12 and the denominator of which is the number of months in the part-year period during the individual's taxable year. Only full calendar months are included in the computation under this paragraph (e)(4)(ii)(D).

(iii) Examples. The following examples illustrate the provisions of this paragraph (e)(4). Unless stated otherwise, in each example the taxpayer's taxable year is a calendar year, the rate of premium growth has not exceeded the rate of income growth since 2013, and the taxpayer is ineligible for any of the exemptions described in paragraphs (a) through (d) and (f) through (j) of this section for a month.

Example 1. Unmarried individual with no dependents. (i) Taxpayer G is an unmarried individual with no dependents. G is ineligible to enroll in any minimum essential coverage other than coverage in the individual market for all months in 2016. The annual premium for the lowest cost bronze self-only plan in G's rating area (G's applicable plan) is $5,000. The adjusted annual premium for the second lowest cost silver self-only plan in G's rating area (G's applicable benchmark plan within the meaning of § 1.36B-3(f)) is $5,500. In 2016 G's household income is $40,000, which is 358% of the Federal poverty line for G's family size for the taxable year.

(ii) Under paragraph (e)(4)(ii)(C) of this section, the credit allowable under section 36B is determined pursuant to section 36B. With household income at 358% of the Federal poverty line, G's applicable percentage is 9.5. Because each month in 2016 is a coverage month (within the meaning of § 1.36B-3(c)), G's maximum credit allowable under section 36B is the excess of G's premium for the applicable benchmark plan over the product of G's household income and G's applicable percentage ($1,700). Therefore, under paragraph (e)(4)(ii)(A) of this section, G's required contribution is $3,300. Under paragraph (e)(1) of this section, G lacks affordable coverage for 2016 because G's required contribution ($3,300) exceeds 8% of G's household income ($3,200).

Example 2. Family. (i) In 2016 Taxpayers M and N are married and file a joint return. M and N have two children, P and Q. M, N, P, and Q are ineligible to enroll in minimum essential coverage other than coverage in the individual market for a month in 2016. The annual premium for M, N, P, and Q's applicable plan is $20,000. The adjusted annual premium for M, N, P, and Q's applicable benchmark plan (within the meaning of § 1.36B-3(f)) is $25,000. M and N's household income is $80,000, which is 347% of the Federal poverty line for a family size of 4 for the taxable year.

(ii) Under paragraph (e)(4)(ii)(C) of this section, the credit allowable under section 36B is determined pursuant to section 36B. With household income at 347% of the Federal poverty line, the applicable percentage is 9.5. Because each month in 2016 is a coverage month (within the meaning of § 1.36B-3(c)), the maximum credit allowable under section 36B is the excess of the premium for the applicable benchmark plan over the product of the household income and the applicable percentage ($17,400). Therefore, under paragraph (e)(4)(ii)(A) of this section, the required contribution for M, N, P, and Q is $2,600. Under paragraph (e)(1) of this section, M, N, P, and Q have affordable coverage for 2016 because their required contribution ($2,600) does not exceed 8% of their household income ($6,400).

Example 3. Family with some members eligible for government-sponsored coverage. (i) In 2016 Taxpayers U and V are married and file a joint return. U and V have two children, W and X. U and V are ineligible to enroll in minimum essential coverage other than coverage in the individual market for all months in 2016; however, W and X are eligible for coverage under CHIP for 2016. The annual premium for U, V, W, and X's applicable plan is $20,000. The adjusted annual premium for the second lowest cost silver plan that would cover U and V (the applicable benchmark plan within the meaning of § 1.36B-3(f)) is $12,500. U and V's household income is $50,000, which is 217% of the Federal poverty line for a family size of 4 for the taxable year. W and X do not enroll in CHIP coverage.

(ii) Under paragraph (e)(4)(ii)(C) of this section, the credit allowable under section 36B is determined pursuant to section 36B. With household income at 217% of the Federal poverty line, the applicable percentage is 6.89. Each month in 2016 is a coverage month (within the meaning of § 1.36B-3(c)) for U and V, but no months in 2016 are coverage months for W and X because they are eligible for CHIP coverage. The maximum credit allowable under section 36B is the excess of the premium for the applicable benchmark plan over the product of the household income and the applicable percentage ($9,055). Therefore, under paragraph (e)(4)(ii)(A) of this section, the required contribution is $10,945. Under paragraph (e)(1) of this section, U, V, W, and X lack affordable coverage for 2016 because their required contribution ($10,945) exceeds 8% of their household income ($4,000).

Example 4. Family with some members enrolled in government-sponsored minimum essential coverage.The facts are the same as Example 3, except W and X enroll in CHIP coverage on January 1, 2016. Under paragraph (e)(4)(ii)(B), U, V, W, and X are members of U and V's nonexempt family for 2016. Therefore, the annual premium for the applicable plan is the same as in Example 3 ($20,000). The maximum credit allowable under section 36B is also the same as in Example 3 ($9,055). Under paragraph (e)(4)(ii)(A) of this section, the required contribution is $10,945. Under paragraph (e)(1) of this section, U and V lack affordable coverage for 2016 because their required contribution ($10,945) exceeds 8% of their household income ($4,000).

(f) Household income below filing threshold—(1) In general. An individual is an exempt individual for any taxable year for which the individual's household income is less than the applicable filing threshold.

(2) Applicable filing threshold—(i) In general. For purposes of this section, applicable filing threshold means the amount of gross income that would trigger an individual's requirement to file a Federal income tax return under section 6012(a)(1).

(ii) Certain dependents. The applicable filing threshold for an individual who is properly claimed as a dependent by another taxpayer is equal to the other taxpayer's applicable filing threshold.

(3) Manner of claiming the exemption. A taxpayer is not required to file a Federal income tax return solely to claim the exemption described in this paragraph (f). If a taxpayer has a household income below the applicable filing threshold and nevertheless files a Federal income tax return, the taxpayer may claim the exemption described in this paragraph (f) on the return.

(g) Members of Indian tribes. An individual is an exempt individual for a month that includes a day on which the individual is a member of an Indian tribe. For purposes of this section, Indian tribe means a group or community described in section 45A(c)(6).

(h) Individuals with hardship exemption certification—(1) In general. Except as provided in paragraph (h)(3) of this section, an individual is an exempt individual for a month that includes a day on which the individual has in effect a hardship exemption certification described in paragraph (h)(2) of this section.

(2) Hardship exemption certification. A hardship exemption certification is issued by an Exchange under section 1311(d)(4)(H) of the Affordable Care Act (42 U.S.C. 18031(d)(4)(H)), 45 CFR 155.605(g)(1), (g)(2), (g)(4) and (g)(6), 45 CFR 155.610(i), and 45 CFR 155.615(f), and certifies that an individual has suffered a hardship (as that term is defined in 45 CFR 155.605(g)) affecting the capability to obtain minimum essential coverage.

(3) Hardship exemption without hardship exemption certification. An individual may claim an exemption without obtaining a hardship exemption certification described in paragraph (h)(2) of this section for any month that includes a day on which the individual meets the requirements of any hardship for which:

(i) The Secretary of HHS issues guidance of general applicability describing the hardship and indicating that an exemption for such hardship can be claimed on a Federal income tax return pursuant to guidance published by the Secretary; and

(ii) The Secretary issues published guidance of general applicability, see § 601.601(d)(2) of this chapter, allowing an individual to claim the hardship exemption on a return without obtaining a hardship exemption from an Exchange.

(i) [Reserved]

(j) Individuals with certain short coverage gaps—(1) In general. An individual is an exempt individual for a month the last day of which is included in a short coverage gap.

(2) Short coverage gap—(i) In general. Short coverage gap means a continuous period of less than three months in which the individual is not covered under minimum essential coverage. If the individual does not have minimum essential coverage for a continuous period of three or more months, none of the months included in the continuous period are treated as included in a short coverage gap.

(ii) Coordination with other exemptions. For purposes of this paragraph (j), an individual is treated as having minimum essential coverage for a month in which an individual is exempt under any of paragraphs (a) through (h) of this section.

(iii) More than one short coverage gap during calendar year. If a calendar year includes more than one short coverage gap, the exemption provided by this paragraph (j) only applies to the earliest short coverage gap.

(3) Continuous period—(i) In general. Except as provided in paragraph (j)(3)(ii) of this section, the number of months included in a continuous period is determined without regard to the calendar years in which months included in that period occur. For purposes of paragraph (j) of this section, a continuous period begins no earlier than January 1, 2014.

(ii) Continuous period straddling more than one taxable year. If an individual does not have minimum essential coverage for a continuous period that begins in one taxable year and ends in the next, for purposes of applying this paragraph (j) to the first taxable year, the months in the second taxable year included in the continuous period are disregarded. For purposes of applying this paragraph (j) to the second taxable year, the months in the first taxable year included in the continuous period are taken into account.

(4) Examples. The following examples illustrate the provisions of this paragraph (j). Unless stated otherwise, in each example the taxpayer's taxable year is a calendar year and the taxpayer is ineligible for any of the exemptions described in paragraphs (a) through (h) of this section for a month.

Example 1. Short coverage gap.Taxpayer D has minimum essential coverage in 2016 from January 1 through March 2. After March 2, D does not have minimum essential coverage until D enrolls in an eligible employer-sponsored plan effective June 15. Under § 1.5000A-1(b), for purposes of section 5000A, D has minimum essential coverage for January, February, March, and June through December. D's continuous period without coverage is 2 months, April and May. April and May constitute a short coverage gap under paragraph (j)(2)(i) of this section.

Example 2. Continuous period of 3 months or more.The facts are the same as in Example 1, except D's coverage is not effective until July 1. D's continuous period without coverage is 3 months, April, May, and June. Under paragraph (j)(2)(i) of this section, April, May, and June are not included in a short coverage gap.

Example 3. Short coverage gap following exempt period.Taxpayer E is incarcerated from January 1 through June 2. E enrolls in an eligible employer-sponsored plan effective September 15. Under paragraph (d) of this section, E is exempt for the period January through June. Under paragraph (j)(2)(ii) of this section, E is treated as having minimum essential coverage for this period, and E's continuous period without minimum essential coverage is 2 months, July and August. July and August constitute a short coverage gap under paragraph (j)(2)(i) of this section.

Example 4. Continuous period covering more than one taxable year.Taxpayer F, an unmarried individual with no dependents, has minimum essential coverage for the period January 1 through October 15, 2016. F is without coverage until February 15, 2017. F files his Federal income tax return for 2016 on March 10, 2017. Under paragraph (j)(3)(ii) of this section, November and December of 2016 are treated as a short coverage gap. However, November and December of 2016 are included in the continuous period that includes January 2017. The continuous period for 2017 is not less than 3 months and, therefore, January is not a part of a short coverage gap.

Example 5. Enrollment following loss of coverage.The facts are the same as in Example 4 except F loses coverage on June 15, 2017. F enrolls in minimum essential coverage effective September 15, 2017. The continuous period without minimum essential coverage in July and August of 2017 is two months and, therefore, is a short coverage gap. Because January 2017 was not part of a short coverage gap, the earliest short coverage gap occurring in 2017 is the gap that includes July and August.

Example 6. Multiple coverage gaps. (i) The facts are the same as in Example 5 except F has minimum essential coverage for November 2016. Under paragraph (j)(3)(ii) of this section, December 2016 is treated as a short coverage gap.

(ii) December 2016 is included in the continuous period that includes January 2017. This continuous period is two months and, therefore, January 2017 is the earliest month in 2017 that is included in a short coverage gap. Under paragraph (j)(2)(iii) of this section, the exemption under this paragraph (j) applies only to January 2017. Thus, the continuous period without minimum essential coverage in July and August of 2017 is not a short coverage gap.

[T.D. 9632, 78 FR 53655, Aug. 30, 2013, as amended at 78 FR 78255, Dec. 26, 2013; T.D. 9705, 79 FR 70469, Nov. 26, 2014; T.D. 9804, 81 FR 91768, Dec. 19, 2016]

§ 1.5000A-4 Computation of shared responsibility payment.

(a) In general. For each taxable year, the shared responsibility payment imposed on a taxpayer in accordance with § 1.5000A-1(c) is the lesser of—

(1) The sum of the monthly penalty amounts; or

(2) The sum of the monthly national average bronze plan premiums for the shared responsibility family.

(b) Monthly penalty amount—(1) In general. Monthly penalty amount means, for a month that a nonexempt individual is not covered under minimum essential coverage, 1/12 multiplied by the greater of—

(i) The flat dollar amount; or

(ii) The excess income amount.

(2) Flat dollar amount—(i) In general. Flat dollar amount means the lesser of—

(A) The sum of the applicable dollar amounts for all individuals included in the taxpayer's shared responsibility family; or

(B) 300 percent of the applicable dollar amount (determined without regard to paragraph (b)(2)(iii) of this section) for the calendar year with or within which the taxable year ends.

(ii) Applicable dollar amount. Except as provided in paragraphs (b)(2)(iii) and (b)(2)(iv) of this section, the applicable dollar amount is—

(A) $95 in 2014;

(B) $325 in 2015; or

(iii) Special applicable dollar amount for individuals under age 18. If an individual has not attained the age of 18 before the first day of a month, the applicable dollar amount for the individual is equal to one-half of the applicable dollar amount (as expressed in paragraph (b)(2)(ii) of this section) for the calendar year in which the month occurs. For purposes of this paragraph (b)(2)(iii), an individual attains the age of 18 on the anniversary of the date when the individual was born. For example, an individual born on March 1, 1999, attains the age of 18 on March 1, 2017.

(iv) Indexing of applicable dollar amount. In any calendar year after 2016, the applicable dollar amount is $695 as increased by the product of $695 and the cost-of-living adjustment determined under section 1(f)(3) for the calendar year. For purposes of this paragraph (b)(2)(iv), the cost-of-living adjustment is determined by substituting “calendar year 2015” for “calendar year 1992” in section 1(f)(3)(B). If any increase under this paragraph (b)(2)(iv) is not a multiple of $50, the increase is rounded down to the next lowest multiple of $50.

(3) Excess income amount—(i) In general. Excess income amount means the product of—

(A) The excess of the taxpayer's household income over the taxpayer's applicable filing threshold (as defined in § 1.5000A-3(f)(2)); and

(B) The income percentage.

(ii) Income percentage. For purposes of this section, income percentage means—

(A) 1.0 percent for taxable years beginning in 2013;

(B) 1.0 percent for taxable years beginning in 2014;

(D) 2.5 percent for taxable years beginning after 2015.

(c) Monthly national average bronze plan premium. Monthly national average bronze plan premium means, for a month for which a shared responsibility payment is imposed, 1/12 of the annual national average premium for qualified health plans that have a bronze level of coverage, would provide coverage for the taxpayer's shared responsibility family members who do not have minimum essential coverage for the month, and are offered through Exchanges for plan years beginning in the calendar year with or within which the taxable year ends.

(d) Examples. The following examples illustrate the provisions of this section. In each example the taxpayer's taxable year is a calendar year and all members of the taxpayer's shared responsibility family are ineligible for any of the exemptions described in § 1.5000A-3 for a month.

Example 1. Unmarried taxpayer without minimum essential coverage. (i) In 2016, Taxpayer G is an unmarried individual with no dependents. G does not have minimum essential coverage for any month in 2016. G's household income is $120,000. G's applicable filing threshold is $12,000. The annual national average bronze plan premium for G is $5,000.

(ii) For each month in 2016, under paragraph (b)(2)(ii) of this section, G's applicable dollar amount is $695. Under paragraph (b)(2)(i) of this section, G's flat dollar amount is $695 (the lesser of $695 and $2,085 ($695 × 3)). Under paragraph (b)(3) of this section, G's excess income amount is $2,700 (($120,000 − $12,000) × 0.025). Therefore, under paragraph (b)(1) of this section, the monthly penalty amount is $225 (the greater of $58 ($695/12) or $225 ($2,700/12)).

(iii) The sum of the monthly penalty amounts is $2,700 ($225 × 12). The sum of the monthly national average bronze plan premiums is $5,000 ($5,000/12 × 12). Therefore, under paragraph (a) of this section, the shared responsibility payment imposed on G for 2016 is $2,700 (the lesser of $2,700 or $5,000).

Example 2. Part-year coverage.The facts are the same as in Example 1, except G has minimum essential coverage for January through June. The sum of the monthly penalty amounts is $1,350 ($225 × 6). The sum of the monthly national average bronze plan premiums is $2,500 ($5,000/12 × 6). Therefore, under paragraph (a) of this section, the shared responsibility payment imposed on G for 2016 is $1,350 (the lesser of $1,350 or $2,500).

Example 3. Family without minimum essential coverage. (i) In 2016, Taxpayers H and J are married and file a joint return. H and J have three children: K, age 21, L, age 15, and M, age 10. No member of the family has minimum essential coverage for any month in 2016. H and J's household income is $250,000. H and J's applicable filing threshold is $24,000. The annual national average bronze plan premium for a family of 5 (3 adults, 2 children) is $15,000.

(ii) For each month in 2016, under paragraphs (b)(2)(ii) and (b)(2)(iii) of this section, the applicable dollar amount is $2,780 (($695 × 3 adults) + (($695/2) × 2 children)). Under paragraph (b)(2)(i) of this section, the flat dollar amount is $2,085 (the lesser of $2,780 and $2,085 ($695 × 3)). Under paragraph (b)(3) of this section, the excess income amount is $5,650 (($250,000−$24,000) × 0.025). Therefore, under paragraph (b)(1) of this section, the monthly penalty amount is $470.83 (the greater of $173.75 ($2,085/12) or $470.83 ($5,650/12)).

(iii) The sum of the monthly penalty amounts is $5,650 ($470.83 × 12). The sum of the monthly national average bronze plan premiums is $15,000 ($15,000/12 × 12). Therefore, under paragraph (a) of this section, the shared responsibility payment imposed on H and J for 2016 is $5,650 (the lesser of $5,650 or $15,000).

Example 4. Change in shared responsibility family during the year. (i) The facts are the same as in Example 3, except J has minimum essential coverage for January through June. The annual national average bronze plan premium for a family of 4 (2 adults, 2 children) is $10,000.

(ii) For the period January through June 2016, under paragraphs (b)(2)(ii) and (b)(2)(iii) of this section the applicable dollar amount is $2,085 (($695 × 2 adults) + (($695/2) × 2 children)). Under paragraph (b)(2)(i) of this section, the flat dollar amount is $2,085 (the lesser of $2,085 or $2,085 ($695 × 3)).

(iii) For the period July through December 2016, the applicable dollar amount is $2,780 (($695 × 3 adults) + (($695/2) × 2 children)). Under paragraph (b)(2) of this section, the flat dollar amount is $2,085 (the lesser of $2,780 or $2,085 ($695 × 3)). Under paragraph (b)(3) of this section, the excess income amount is $5,650 (($250,000−$24,000) × 0.025). Therefore, under paragraph (b)(1) of this section, for January through June the monthly penalty amount is $470.83 (the greater of $173.75 ($2,085/12) or $470.83 ($5,650/12)). The monthly penalty amount for July through December is $470.83 (the greater of $173.75 ($2,085/12) or $470.83 ($5,650/12)).

(iv) The sum of the monthly penalty amounts is $5,650 ($470.83 × 12). The sum of the monthly national average bronze plan premiums is $12,500 ((($10,000/12) × 6) + (($15,000/12) × 6))). Therefore, under paragraph (a) of this section, the shared responsibility payment imposed on H and J for 2016 is $5,650 (the lesser of $5,650 or $12,500).

Example 5. Eighteenth birthday during the year. (i) In 2016 Taxpayers S and T are married and file a joint return. S and T have one child, U, who turns 18 years old on June 28. S, T, and U do not enroll in, and as a result are not eligible to receive benefits under, affordable employer-sponsored coverage offered by T's employer for 2016. S and T's household income is $60,000. S and T's applicable filing threshold is $24,000. The annual national average bronze plan premium for a family of 3 (2 adults, 1 child) is $11,000.

(ii) For the period January through June 2016, under paragraphs (b)(2)(ii) and (b)(2)(iii) of this section, the applicable dollar amount is $1,737.50 (($695 × 2 adults) + ($695/2) × 1 child)). Under paragraph (b)(2) of this section, the flat dollar amount is $1,737.50 (the lesser of $1,737.50 or $2,085 ($695 × 3)).

(iii) For the period July through December 2016, the applicable dollar amount is $2,085 ($695 × 3). Under paragraph (b)(2)(i) of this section, the flat dollar amount is $2,085 (the lesser of $2,085 or $2,085 ($695 × 3)). Under paragraph (b)(3) of this section, the excess income amount is $900 (($60,000−$24,000) × 0.025). Therefore, under paragraph (b)(1) of this section, for January through June the monthly penalty amount is $144.79 (the greater of $144.79 ($1,737.50/12) or $75 ($900/12)). The monthly penalty amount for July through December is $173.75 (the greater of $173.75 ($2,085/12) or $75 ($900/12)).

(iv) The sum of the monthly penalty amounts is $1,911.24 (($144.79 × 6) + ($173.75 × 6)). The sum of the monthly national average bronze plan premiums is $11,000 ($11,000/12 × 12). Therefore, under paragraph (a) of this section, the shared responsibility payment imposed on S and T for 2016 is $1,911.24 (the lesser of $1,911.24 or $11,000).

[T.D. 9632, 78 FR 53655, Aug. 30, 2013, as amended at 78 FR 78255, Dec. 26, 2013; T.D. 9705, 79 FR 70469, Nov. 26, 2014]

§ 1.5000A-5 Administration and procedure.

(a) In general. A taxpayer's liability for the shared responsibility payment for a month must be reported on the taxpayer's Federal income tax return for the taxable year that includes the month. The period of limitations for assessing the shared responsibility payment is the same as that prescribed by section 6501 for the taxable year to which the Federal income tax return on which the shared responsibility payment is to be reported relates. The shared responsibility payment is payable upon notice and demand by the Secretary, and except as provided in paragraph (b) of this section, is assessed and collected in the same manner as an assessable penalty under subchapter B of chapter 68 of the Internal Revenue Code. The shared responsibility payment is not subject to deficiency procedures of subchapter B of chapter 63 of the Internal Revenue Code. Interest on this payment accrues in accordance with the rules in section 6601.

(b) Special rules. Notwithstanding any other provision of law—

(1) Waiver of criminal penalties. In the case of a failure by a taxpayer to timely pay the shared responsibility payment, the taxpayer is not subject to criminal prosecution or penalty for the failure.

(2) Limitations on liens and levies. If a taxpayer fails to pay the shared responsibility payment imposed by this section and §§ 1.5000A-1 through 1.5000A-4, the Secretary will not file notice of lien on any property of the taxpayer, or levy on any property of the taxpayer for the failure.

(3) Authority to offset against overpayment. Nothing in this section prohibits the Secretary from offsetting any liability for the shared responsibility payment against any overpayment due the taxpayer, in accordance with section 6402(a) and its corresponding regulations.

(c) Applicability date. Except as otherwise provided in this paragraph (c), this section and §§ 1.5000A-1 through 1.5000A-4 apply for months beginning after December 31, 2013. Section 1.5000A-2(b)(2)(ix) applies for months beginning after September 28, 2020.

[T.D. 9632, 78 FR 53655, Aug. 30, 2013, as amended by T.D. 9970, 87 FR 76575, Dec. 15, 2022]

Tax on Certain Foreign Procurement

§ 1.5000C-0 Outline of regulation provisions for section 5000C.

This section lists the captions contained in §§ 1.5000C-1 through 1.5000C-7.

§ 1.5000C-1 Tax on specified Federal procurement payments.

(a) Overview.

(b) Imposition of tax.

(d) Exemptions.

(1) Simplified acquisitions.

(2) Emergency acquisitions.

(3) Certain personal service contracts.

(4) Certain foreign humanitarian assistance contracts.

(5) Certain international agreements.

(6) Goods manufactured or produced or services provided in the United States.

(7) Goods manufactured or produced or services provided in a country that is a party to an international procurement agreement.

(e) Country in which goods are manufactured or produced or services provided.

(1) Goods manufactured or produced.

(2) Provision of services.

(3) Allocation of total contract price to determine the nonexempt amount.

(4) Reduction or elimination of withholding by an acquiring agency.

§ 1.5000C-2 Withholding on specified Federal procurement payments.

(a) In general.

(b) Steps in determining the obligation to withhold under section 5000C.

(1) Determine whether the payment is pursuant to a contract for goods or services.

(2) Determine whether the payment is made pursuant to a contract with a U.S. person.

(3) Determine whether the payment is for purchases under the simplified acquisition procedures.

(4) Determine whether the payment is for emergency acquisitions.

(5) Determine whether the payment is for personal services under the simplified acquisition threshold.

(6) Determine whether the payment is pursuant to a foreign humanitarian assistance contract.

(7) Determine whether the foreign contracting party is entitled to relief pursuant to an international agreement.

(8) Determine whether the contract is for goods manufactured or produced or services provided in the United States or in a foreign country that is a party to an international procurement agreement.

(9) Compute amounts to withhold.

(10) Deposit and report amounts withheld.

(1) In general.

(2) Determination based on Taxpayer Identification Number (TIN).

(3) Determination based on the Form W-9.

(4) Contracting party treated as a foreign contracting party.

(d) Withholding when a foreign contracting party submits a Section 5000C Certificate.

(1) In general.

(2) Exemption for a foreign contracting party entitled to the benefit of relief pursuant to certain international agreements.

(3) Exemption when goods are manufactured or produced or services provided in the United States, or in a foreign country that is a party to an international procurement agreement.

(4) Information required for Section 5000C Certificate.

(5) Validity period of Section 5000C Certificate.

(6) Change in circumstances.

(7) Form W-14.

(8) Time for submitting Section 5000C Certificate.

(e) Offset for underwithholding or overwithholding.

(1) In general.

(2) Underwithholding.

(3) Overwithholding.

§ 1.5000C-3 Payment and returns of tax withheld by the acquiring agency.

(a) In general.

(b) Deposit rules.

(1) Acquiring agency with a chapter 3 deposit requirement treats amounts withheld as under chapter 3.

(2) Acquiring agency with no chapter 3 filing obligation deposits withheld amounts monthly.

(1) In general.

(2) Classified or confidential contracts.

(d) Special arrangement for certain contracts.

§ 1.5000C-4 Requirement for the foreign contracting party to file a return and pay tax, and procedures for the contracting party to seek a refund.

(a) In general.

(b) Tax obligation of foreign contracting party independent of withholding.

(d) Time and manner of paying tax.

(e) Refund requests when amount withheld exceeds tax liability.

§ 1.5000C-5 Anti-abuse rule. § 1.5000C-6 Examples. § 1.5000C-7 Effective/applicability date.

[T.D. 9782, 81 FR 55137, Aug. 18, 2016]

§ 1.5000C-1 Tax on specified Federal procurement payments.

(a) Overview. This section provides definitions and general rules relating to the imposition of, and exemption from, the tax on specified Federal procurement payments under section 5000C. Section 1.5000C-2 provides rules concerning withholding under section 5000C(d)(1), including the steps that must be taken to determine the obligation to withhold and whether an exemption from withholding applies. Section 1.5000C-3 provides the time and manner for depositing the amounts withheld under section 5000C and the related reporting requirements. Section 1.5000C-4 contains the rules that apply to a foreign contracting party that must pay and report the tax under section 5000C when the tax obligation under section 5000C is not fully satisfied by withholding, as well as procedures by which a contracting party may seek a refund when the amount withheld exceeds its tax liability under section 5000C. Section 1.5000C-5 contains an anti-abuse rule. Section 1.5000C-6 contains examples illustrating the principles of §§ 1.5000C-1 through 1.5000C-4. Finally, § 1.5000C-7 contains the effective/applicability date for §§ 1.5000C-1 through 1.5000C-7.

(b) Imposition of tax. Except as otherwise provided, section 5000C imposes on any foreign contracting party a tax equal to 2 percent of the amount of a specified Federal procurement payment. In general, the tax imposed under section 5000C applies to specified Federal procurement payments received pursuant to contracts entered into on and after January 2, 2011. Specified Federal procurement payments received by a nominee or agent on behalf of a contracting party are considered to be received by that contracting party. The tax imposed under section 5000C is to be applied in a manner consistent with U.S. obligations under international agreements. Payments for the purchase or lease of land or an interest in land are not subject to the tax imposed under section 5000C.

(c) Definitions. Solely for purposes of section 5000C and §§ 1.5000C-1 through 1.5000C-7, the following definitions apply:

(1) The term acquiring agency means the U.S. government department, agency, independent establishment, or corporation described in paragraph (c)(7) of this section that is a party to the contract. To the extent that a U.S. government department or agency, other than the acquiring agency, is making the payments pursuant to the contract, that department or agency is also considered to be the acquiring agency.

(2) The term contract has the same meaning as provided in 48 CFR 2.101, and thus does not include a grant agreement or a cooperative agreement within the meaning of 31 U.S.C. 6304 and 6305, respectively. A contract may include an agreement that is not executed under the Federal Acquisition Regulations (FAR), 48 CFR Chapter 1.

(3) The term contract ratio refers to the nonexempt amount over the total contract price.

(4) The term contracting party means any person that is a party to a contract with the U.S. government that is entered into on or after January 2, 2011. See § 1.5000C-1(b) for situations involving a nominee or agent.

(5) The term foreign contracting party means a contracting party that is a foreign person.

(6) The term foreign person means any person other than a United States person (as defined in section 7701(a)(30)).

(7) The term Government of the United States or U.S. government means the executive departments specified in 5 U.S.C. 101, the military departments specified in 5 U.S.C. 102, the independent establishments specified in 5 U.S.C. 104(1), and wholly owned government corporations specified in 31 U.S.C. 9101(3). Unless otherwise specified in 5 U.S.C. 101, 102, or 104(1), or 31 U.S.C. 9101(3), the term Government of the United States or U.S. government does not include any quasi-governmental entities or instrumentalities of the U.S. government.

(8) The term international procurement agreement means the World Trade Organization Government Procurement Agreement within the meaning of 48 CFR 25.400(a)(1) and any free trade agreement to which the United States is a party that includes government procurement obligations that provide appropriate competitive government procurement opportunities to U.S. goods, services, and suppliers. A party to an international procurement agreement is a signatory to the agreement and does not include a country that is merely an observer with respect to the agreement.

(9) The term nonexempt amount means the portion of the contract price allocated to nonexempt goods and nonexempt services.

(10) The term nonexempt goods means goods manufactured or produced in a foreign country that is not a party to an international procurement agreement with the United States.

(11) The term nonexempt services means services provided in a foreign country that is not a party to an international procurement agreement with the United States.

(12) The term outlying areas has the same meaning as set forth in 48 CFR 2.101(b), which includes Puerto Rico, the Northern Mariana Islands, American Samoa, Guam, the Virgin Islands, Baker Island, Howland Island, Jarvis Island, Johnston Atoll, Kingman Reef, Midway Islands, Navassa Island, Palmyra Atoll, and Wake Atoll.

(13) The term qualified income tax treaty means a U.S. income tax treaty in force that contains a nondiscrimination provision that applies to the tax imposed under section 5000C and prohibits taxation that is more burdensome on a foreign national than a U.S. national (or in the case of certain income tax treaties, taxation that is more burdensome on a foreign citizen than a U.S. citizen), regardless of its residence.

(14) The term Section 5000C Certificate means a written statement that includes the information described in § 1.5000C-2(d) that the foreign contracting party submits to an acquiring agency for the purposes of demonstrating that the foreign contracting party is eligible for certain exemptions from withholding (in whole or in part) under section 5000C with respect to a contract. The term may also include any form that the Internal Revenue Service may prescribe as a substitute for the Section 5000C Certificate, such as Form W-14, “Certificate of Foreign Contracting Party Receiving Federal Procurement Payments.”

(15) The term specified Federal procurement payment means any payment made pursuant to a contract with a foreign contracting party that is for goods manufactured or produced or services provided in a foreign country that is not a party to an international procurement agreement with the United States. For purposes of the prior sentence, a foreign country does not include an outlying area.

(16) The term Taxpayer Identification Number or TIN means the identifying number assigned to a person under section 6109, as defined in section 7701(a)(41).

(17) The term total contract price means the total cost to the U.S. Government of the goods and services procured under a contract and paid to the contracting party.

(d) Exemptions. The tax imposed under paragraph (b) of this section does not apply to the payments made in the following situations. For the exemptions in paragraphs (d)(5), (6) and (7) of this section, see § 1.5000C-2(d) for the procedures to eliminate withholding by an acquiring agency.

(1) Simplified acquisitions. Payments for purchases under the simplified acquisition procedures that do not exceed the simplified acquisition threshold as described in 48 CFR 2.101.

(2) Emergency acquisitions. Payments made pursuant to a contract if the contract is—

(i) Awarded under the “unusual and compelling urgency” authority of 48 CFR 6.302-2, or

(ii) Entered into under the emergency acquisition flexibilities as defined in 48 CFR part 18.

(3) Certain personal service contracts. Payments for services provided by, and under contracts with, a single individual in which the payments do not (and will not) exceed on an annual calendar year basis the simplified acquisition threshold as described in 48 CFR 2.101 for all years of the contract. Payments that satisfy this exemption remain exempt if the contract is later renegotiated so that future payments under the contract do not meet this exemption.

(4) Certain foreign humanitarian assistance contracts. Payments made by the U.S. government pursuant to a contract with a foreign contracting party to obtain goods or services described in or authorized under 7 U.S.C. 1691, et seq., 22 U.S.C. 2151, et seq., 22 U.S.C. 2601 et seq., 22 U.S.C. 5801 et seq., 22 U.S.C. 5401 et seq., 10 U.S.C. 402, 10 U.S.C. 404, 10 U.S.C. 407, 10 U.S.C. 2557, and 10 U.S.C. 2561, if the acquiring agency determines that the payment is for the purpose of providing foreign humanitarian assistance.

(5) Certain international agreements. Payments made by the U.S. government pursuant to a contract with a foreign contracting party when the payments are entitled to relief from the tax imposed under section 5000C pursuant to an international agreement with the United States, including relief pursuant to a nondiscrimination provision of a qualified income tax treaty, because the foreign contracting party is entitled to the benefit of that provision.

(6) Goods manufactured or produced or services provided in the United States. A payment made pursuant to a contract to the extent that the payment is for goods manufactured or produced or services provided in the United States.

(7) Goods manufactured or produced or services provided in a country that is a party to an international procurement agreement. A payment made pursuant to a contract to the extent the payment is for goods manufactured or produced or services provided in a country that is a party to an international procurement agreement, as defined in paragraph (c)(8) of this section.

(e) Country in which goods are manufactured or produced or services provided—

(1) Goods manufactured or produced. Solely for purposes of section 5000C, goods are manufactured or produced in the country (or countries)—

(i) Where property has been substantially transformed into the goods that are procured pursuant to a contract; or

(ii) Where there has been assembly or conversion of component parts (involving activities that are substantial in nature and generally considered to constitute the manufacture or production of property) into the final product that constitutes the goods procured pursuant to a contract.

(2) Provision of services. Solely for purposes of section 5000C, services are considered to be provided in the country where the individuals performing the services are physically located when they perform their duties pursuant to the contract.

(3) Allocation of total contract price to determine the nonexempt amount. If, pursuant to a contract, goods are manufactured or produced, or services are provided, in multiple countries and only a portion of the goods manufactured or produced, or the services provided, pursuant to the contract are nonexempt goods or nonexempt services, a foreign contracting party may use a reasonable allocation method to determine the nonexempt amount. A reasonable allocation method would include taking into account the proportionate costs (including the cost of labor and raw materials) incurred to manufacture or produce the goods in each country, or taking into account the proportionate costs incurred to provide the services in each country.

(4) Reduction or elimination of withholding by an acquiring agency. For procedures to reduce or eliminate withholding by an acquiring agency based on where goods are manufactured or produced or where services are provided, including as a result of an allocation under this paragraph (e), see § 1.5000C-2(d).

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

§ 1.5000C-2 Withholding on specified Federal procurement payments.

(a) In general. Except as otherwise provided in this section, every acquiring agency making a specified Federal procurement payment on which tax is imposed under section 5000C and §§ 1.5000C-1 through 1.5000C-7 must deduct and withhold an amount equal to 2 percent of the payment. For rules relating to the liability of a foreign contracting party with respect to specified Federal procurement payments not fully withheld upon at source, see § 1.5000C-4. An acquiring agency may rely upon any information furnished by a contracting party under this section unless the acquiring agency has reason to know that the information is incorrect or unreliable. An acquiring agency has reason to know that the information is incorrect or unreliable if it has knowledge of relevant facts or statements contained in the submitted information such that a reasonably prudent person in the position of the acquiring agency would know that the information provided is incorrect or unreliable.

(b) Steps in determining the obligation to withhold under section 5000C. An acquiring agency generally determines its obligation to withhold under section 5000C according to the steps described in this paragraph (b). See, however, paragraph (e) of this section for situations in which withholding may be increased in the case of underwithholding, or may be decreased in the case of overwithholding.

(1) Determine whether the payment is pursuant to a contract for goods or services. The acquiring agency determines whether it is making a payment pursuant to a contract for goods or services. To the extent that the acquiring agency is making a payment for any other purpose, it does not have an obligation to withhold under section 5000C on the payment.

(2) Determine whether the payment is made pursuant to a contract with a U.S. person. The acquiring agency determines whether the payment is made pursuant to a contract with a person considered to be a United States person (U.S. person) in accordance with paragraph (c) of this section. If the other contracting party is a U.S. person, the acquiring agency does not have an obligation to withhold under section 5000C on the payment.

(3) Determine whether the payment is for purchases under the simplified acquisition procedures. The acquiring agency determines whether the payment is for purchases under the simplified acquisitions procedures that do not exceed the simplified acquisition threshold as described in 48 CFR 2.101. If it is, the acquiring agency does not have an obligation to withhold under section 5000C on the payment.

(4) Determine whether the payment is for emergency acquisitions. The acquiring agency determines whether the payment is made for certain emergency acquisitions within the meaning of § 1.5000C-1(d)(2). If it is, the acquiring agency does not have an obligation to withhold under section 5000C on the payment.

(5) Determine whether the payment is for personal services under the simplified acquisition threshold. The acquiring agency determines whether payments for services under contracts with a single individual do not exceed the simplified acquisition threshold as described in 48 CFR 2.101 on an annual basis for all years of the contract. If that is the case, the acquiring agency does not have an obligation to withhold under section 5000C on the payment.

(6) Determine whether the payment is pursuant to a foreign humanitarian assistance contract. The acquiring agency determines whether the payment is made pursuant to a foreign humanitarian assistance contract described in § 1.5000C-1(d)(4). If it is, the acquiring agency does not have an obligation to withhold under section 5000C on the payment.

(7) Determine whether the foreign contracting party is entitled to relief pursuant to an international agreement. If the foreign contracting party submits a Section 5000C Certificate in accordance with paragraph (d) of this section representing that the foreign contracting party is entitled to relief from the tax imposed under section 5000C pursuant to an international agreement with the United States (such as relief pursuant to the nondiscrimination provision of a qualified income tax treaty), the acquiring agency does not have an obligation to withhold under section 5000C on the payment.

(8) Determine whether the contract is for goods manufactured or produced or services provided in the United States or in a foreign country that is a party to an international procurement agreement. If the foreign contracting party submits a Section 5000C Certificate in accordance with paragraph (d) of this section that represents that the contract is for goods manufactured or produced or services provided in the United States, or in a foreign country that is a party to an international procurement agreement, the acquiring agency does not have an obligation to withhold. If the Section 5000C Certificate provides that payments under the contract are only partially exempt from withholding under section 5000C, the acquiring agency must withhold to the extent described in paragraph (b)(8) of this section.

(9) Compute amounts to withhold. If, after evaluating each step described in this paragraph (b), the acquiring agency determines that it has an obligation to withhold, the acquiring agency computes the amount of withholding by multiplying the amount of the payment by 2 percent, unless the foreign contracting party has provided a Section 5000C Certificate or the payment is only in part for goods or services. In cases in which the Section 5000C Certificate demonstrates that the exemption in Step 8 applies, the acquiring agency generally computes the amount of withholding by multiplying the amount of the payment by the contract ratio provided on the most recent Section 5000C Certificate, the product of which is multiplied by 2 percent. However, in cases in which the exemption in Step 8 applies and the requirements of paragraph (d)(4)(iii)(B)(2) of this section are met, the acquiring agency computes the amount of withholding based on the payment for the specifically identified items, which may be identified by the contract line item number, or CLIN. In the case in which the payment is only in part for goods or services, the acquiring agency reduces the amount of the payment subject to the tax to the extent it is for something other than goods or services. The acquiring agency withholds the computed amount from the payment.

(10) Deposit and report amounts withheld. The acquiring agency deposits and reports the amounts determined in the prior step in accordance with § 1.5000C-3.

(c) Determining whether the contracting party is a U.S. person—(1) In general. An acquiring agency must rely on the provisions of this paragraph (c) to determine the status of the contracting party as a U.S. person for purposes of withholding under section 5000C.

(2) Determination based on Taxpayer Identification Number (TIN). An acquiring agency must treat a contracting party as a U.S. person if the U.S. government information system (such as the System for Award Management (SAM)) indicates that the contracting party is a corporation (for example, because the name listed in SAM contains the term “Corporation,” “Inc.,” or “Corp.”) and that it has a TIN that begins with two digits other than “98” (a limited liability company or LLC is not treated as a corporation for purposes of this paragraph (c)(2)). Further, an acquiring agency must treat a contracting party as a U.S. person if the acquiring agency has access to a U.S. government information system that indicates that the contracting party is an individual with a TIN that begins with a digit other than “9”.

(3) Determination based on the Form W-9. An acquiring agency must treat a contracting party as a U.S. person if the person has submitted to it a valid Form W-9, “Request for Taxpayer Identification Number (TIN) and Certificate” (or valid substitute form described in § 31.3406(h)-3(c)(2) of this chapter), signed under penalties of perjury.

(4) Contracting party treated as a foreign contracting party. If an acquiring agency cannot determine that a contracting party is a U.S. person based on application of paragraph (c)(2) or (3) of this section, then the contracting party is treated as a foreign contracting party for purposes of this section.

(d) Withholding when a foreign contracting party submits a Section 5000C Certificate—(1) In general. Unless the acquiring agency has reason to know that the information is incorrect or unreliable, the acquiring agency may rely on a claim that a foreign contracting party is entitled to an exemption (in whole or in part) from withholding on payments pursuant to a contract if the foreign contracting party provides a Section 5000C Certificate to the acquiring agency as prescribed in this paragraph (d). When a Section 5000C Certificate is furnished, the acquiring agency does not withhold, or must reduce the amount of withholding, on payments made to a foreign person if the certificate establishes that the foreign person is wholly or partially exempt from withholding. An acquiring agency may establish a system for a foreign contracting party to electronically furnish a Section 5000C Certificate.

(2) Exemption for a foreign contracting party entitled to the benefit of relief pursuant to certain international agreements. An acquiring agency does not withhold on payments pursuant to a contract with a foreign contracting party when the payment is entitled to relief from the tax imposed under section 5000C pursuant to an international agreement, including relief pursuant to a nondiscrimination provision of a qualified income tax treaty, because the foreign contracting party is entitled to the benefit of that agreement and the foreign contracting party has submitted a Section 5000C Certificate that includes all of the information described in paragraphs (d)(4)(i) and (ii) of this section.

(3) Exemption when goods are manufactured or produced or services provided in the United States, or in a foreign country that is a party to an international procurement agreement. An acquiring agency does not withhold on payments pursuant to a contract with a foreign contracting party to the extent that the payments are for goods manufactured or produced or services provided in the United States or in a foreign country that is a party to an international procurement agreement with the United States, provided that the foreign contracting party has submitted a Section 5000C Certificate that includes all of the information described in paragraphs (d)(4)(i) and (iii) of this section. If the Section 5000C Certificate provides that the payment is only partially exempt from withholding under section 5000C, the acquiring agency must withhold to the extent that the payment is not exempt.

(4) Information required for Section 5000C Certificate—(i) In general. The Section 5000C Certificate must be signed under penalties of perjury by the foreign contracting party and contain—

(A) The name of the foreign contracting party, country of organization (if applicable), and permanent residence address of the foreign contracting party;

(B) The mailing address of the foreign contracting party (if different than the permanent residence address);

(D) The identifying or reference number on the contract (if known);

(E) The name and address of the acquiring agency;

(F) A statement that the person signing the Section 5000C Certificate is the foreign contracting party listed in paragraph (d)(4)(i)(A) of this section (or is authorized to sign on behalf of the foreign contracting party);

(G) A statement that the foreign contracting party is not acting as an agent or nominee for another foreign person with respect to the goods manufactured or produced or services provided under the contract;

(H) A statement that the foreign contracting party agrees to pay an amount equal to any tax (including any applicable penalties and interest) due under section 5000C that the acquiring agency does not withhold under section 5000C;

(I) A statement that the foreign contracting party acknowledges and understands the rules in § 1.5000C-4 relating to procedural obligations related to section 5000C; and

(J) A statement that the foreign contracting party has not engaged in a transaction (or series of transactions) with a principal purpose of avoiding the tax imposed under section 5000C as defined in § 1.5000C-5.

(ii) Additional information required for claiming an exemption based on certain international agreements with the United States. In addition to the information required by paragraph (d)(4)(i) of this section, a foreign contracting party claiming an exemption from withholding in reliance on a provision of an international agreement with the United States, including a qualified income tax treaty, must provide—

(A) The name of the international agreement under which the foreign contracting party is claiming benefits;

(B) The specific provision of the international agreement relied upon (for example, the nondiscrimination article of a qualified income tax treaty); and

(C) The basis on which it is entitled to the benefits of that provision (for example, because the foreign contracting party is a corporation organized in a foreign country that has in force a qualified income tax treaty with the United States that covers all nationals, regardless of their residence).

(iii) Additional required information for claiming exemption based on country where goods are manufactured or services provided. (A) In general. In addition to the information required by paragraph (d)(4)(i) of this section, a foreign contracting party claiming an exemption from withholding (in whole or in part) because payments will be pursuant to a contract for goods manufactured or produced or services provided in the United States, or a foreign country that is party to an international procurement agreement, must describe on the Section 5000C Certificate the relevant goods or services and the country (or countries) in which they are manufactured or produced, or are provided, and must include the name of the international procurement agreement or agreements (if relevant).

(B) Information on allocation to exempt and nonexempt amounts. (1) In general. In situations in which a foreign contracting party claims the exemption in paragraph (d)(3) of this section with respect to only a portion of the payments received under the contract, the Section 5000C Certificate must include an explanation of the method used by the foreign contracting party to allocate the total contract price among the countries, as described in § 1.5000C-1(e)(3), if applicable. In general, the Section 5000C Certificate also must include the total contract price and the nonexempt amount; however, when necessary, an estimate of the total contract price or the nonexempt amount may be used. For example, total contract price may be estimated when a Section 5000C Certificate is being completed with respect to payments to be made pursuant to a cost-reimbursement contract that is paid on the basis of actual incurred costs and the total amount of such costs is not known at the time the certificate is provided.

(2) Specific identification of exempt items. If agreed to by the acquiring agency, the Section 5000C Certificate may identify specific exempt and nonexempt amounts. For example, specific contract line items (such as a contract line item number or CLIN) identified in the contract may be listed on the Section 5000C Certificate as exempt and nonexempt amounts (in whole or in part), as applicable. When this paragraph applies, and whether or not the contract identifies exempt and nonexempt amounts, a foreign contracting party must provide the information required by paragraphs (d)(4)(iii)(A) and (d)(4)(iii)(B)(1) of this section, on the Section 5000C Certificate to explain why the contract line items are eligible for an exemption; however, the foreign contracting party is not required to include information about the total contract price under this paragraph. In these circumstances, only one Section 5000C Certificate is required to be provided identifying the exempt and nonexempt contract line items that relate to the contract (for example, a spreadsheet may be attached to the Section 5000C Certificate that identifies the contract line items with an explanation for the treatment as exempt or nonexempt).

(5) Validity period of Section 5000C Certificate. Except as otherwise provided in paragraph (d)(6) of this section, the Section 5000C Certificate is valid for the term of the contract.

(6) Change in circumstances. A foreign contracting party must submit a revised Section 5000C Certificate within 30 days of a change in circumstances that causes the information in a Section 5000C Certificate held by the acquiring agency to be incorrect with respect to the acquiring agency's determination of whether to withhold or the amount of withholding under Section 5000C. An acquiring agency must request a new Section 5000C Certificate from a contracting party in circumstances in which it knows (or has reason to know) that a previously submitted Section 5000C Certificate becomes incorrect or unreliable. An acquiring agency may request an updated Section 5000C Certificate at any time, including when other documentation is required under the contract, such as the annual representations and certifications required in 48 CFR 4.1201. See § 1.5000C-6, Example 6, for an illustration of this paragraph (6).

(7) Form W-14. A foreign contracting party may choose to use Form W-14, “Certificate of Foreign Contracting Party Receiving Federal Procurement Payments” (or other form that the IRS may prescribe), as its Section 5000C Certificate, provided that it includes all the necessary information required by this paragraph (d).

(8) Time for submitting Section 5000C Certificate. A contracting party must submit the Section 5000C Certificate (such as Form W-14 or Form W-9) as early as practicable (for example, when the offer for the contract is submitted to the U.S. government). In all cases, however, the Section 5000C Certificate must be submitted to the acquiring agency no later than the date of execution of the contract.

(e) Offset for underwithholding or overwithholding—(1) In general. If the foreign contracting party discovers that amounts withheld on prior payments either were insufficient or in excess of the amount required to satisfy its tax liability under section 5000C, the foreign contracting party may request the acquiring agency to increase or decrease the amount of withholding on future payments for which withholding is required under section 5000C. The request must be in writing, signed under penalties of perjury, contain the amount by which the foreign contracting party requests to increase or decrease future amounts withheld under section 5000C, and explain the reason for the request. The request may be submitted in conjunction with an original or updated Section 5000C Certificate.

(2) Underwithholding. Upon receipt of a request described in paragraph (e)(1) of this section, acquiring agencies may increase the amount of withholding under this paragraph to correct underwithholding only if the payment for which the increase is applied is otherwise subject to withholding under section 5000C and made before the date that Form 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” is required to be filed (not including extensions) with respect to the payment for which the underwithholding occurred. Amounts withheld under this paragraph must be deposited and reported in the time and manner as prescribed by § 1.5000C-3. See § 1.5000C-4 for procedures for a foreign contracting party that must pay tax due when its tax liability under section 5000C was not fully satisfied by withholding by an acquiring agency.

(3) Overwithholding. Upon receipt of a request described in paragraph (e)(1) of this section, acquiring agencies may decrease the amount of withholding on subsequent payments made to the foreign contracting party that are otherwise subject to withholding under section 5000C provided that the payment for which the decrease is applied is made on or before the date on which Form 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” is required to be filed (not including extensions) with respect to the payment for which the overwithholding occurred. See § 1.5000C-4(e) for procedures for foreign contracting parties to file a claim for refund for the overwithheld amount under section 5000C.

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

§ 1.5000C-3 Payment and returns of tax withheld by the acquiring agency.

(a) In general. This section provides administrative procedures that acquiring agencies must follow to satisfy their obligations to deposit and report amounts withheld under § 1.5000C-2. An acquiring agency with a section 5000C withholding obligation must increase the amount it deducts and withholds under chapter 3 for fixed or determinable annual or periodical income (FDAP income) by the amount it must withhold under § 1.5000C-2. Accordingly, this section generally applies the administrative provisions of chapter 3 for FDAP income relating to the deposit, payment, and reporting for amounts withheld under § 1.5000C-2, and contains some variation from those provisions to take into account the nature of the tax imposed under section 5000C.

(b) Deposit rules—(1) Acquiring agency with a chapter 3 deposit requirement treats amounts withheld as under chapter 3. If an acquiring agency has a chapter 3 deposit obligation for a period, it must treat any amount withheld under § 1.5000C-2 as an additional amount of tax withheld under chapter 3 for purposes of the deposit rules of § 1.6302-2. Thus, depending on the combined amount withheld under chapter 3 and § 1.5000C-2, an acquiring agency subject to this paragraph (b)(1) must make monthly deposits, quarter-monthly deposits, or annual deposits under the rules in § 1.6302-2. To the extent provided in forms, instructions, or publications prescribed by the Internal Revenue Service (IRS), acquiring agencies must deposit all withheld amounts by electronic funds transfer, as that term is defined in § 31.6302-1(h)(4)(i) of this chapter.

(2) Acquiring agency with no chapter 3 filing obligation deposits withheld amounts monthly. If an acquiring agency has no chapter 3 deposit obligation to which the deposit rules of § 1.6302-2 apply for a calendar month, it must make monthly deposits of the amounts withheld under the rules in this paragraph (b)(2). Thus, an acquiring agency with no chapter 3 deposit obligations and that has withheld any amount under § 1.5000C-2 during any calendar month must deposit that amount by the 15th day of the month following the payment. To the extent provided in forms, instructions, or publications prescribed by the Internal Revenue Service (IRS), acquiring agencies must deposit all withheld amounts by electronic funds transfer, as that term is defined in § 31.6302-1(h)(4)(i) of this chapter.

(c) Return requirements—(1) In general. Except as provided in paragraph (c)(2) of this section, an acquiring agency that withholds an amount pursuant to section 5000C generally must file Form 1042-S, “Foreign Person's U.S. Source Income Subject to Withholding,” and Form 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” each year, or other such forms as the IRS may prescribe, to report information related to amounts withheld under section 5000C. The acquiring agency must prepare a Form 1042-S for each contracting party reporting the amount withheld under section 5000C for the preceding calendar year. The Form 1042 must show the aggregate amounts withheld under section 5000C that were required to be reported on Forms 1042-S (including those amounts withheld under section 5000C for which a Form 1042-S is not required to be filed pursuant to paragraph (c)(2) of this section). The Form 1042 must also include the information required by the form and accompanying instructions. Further, any forms required under this paragraph (c) are due at the same time, at the same place, and eligible for the same extended due dates and may be amended in the same manner as Form 1042 and Form 1042-S (or such other forms as the IRS may prescribe related to chapter 3). The acquiring agency must furnish a copy of the Form 1042-S (or such other form as the IRS may prescribe for the same purpose) to the contracting party for whom the form is prepared on or before March 15 of the calendar year following the year in which the amount subject to reporting under section 5000C was paid. It must be filed with a transmittal form as provided in the instructions for Form 1042-S and to the transmittal form. Section 5000C Certificates or other statements or information as prescribed by § 1.5000C-2 that are provided to the acquiring agency are not required to be attached to the Form 1042 filed with the IRS. However, an acquiring agency that is required to file Form 1042 must retain a copy of Form 1042, Form 1042-S, the Section 5000C Certificates, or other statements or information prescribed by § 1.5000C-2 for at least three years from the original due date of Form 1042 or the date it was filed, whichever is later. An acquiring agency that is not required to file Form 1042 must retain any Section 5000C Certificates or other statements or information as prescribed by § 1.5000C-2 for at least three years from the date the Form 1042 would have been due had the acquiring agency had an obligation to file.

(2) Classified or confidential contracts. An acquiring agency is not required to report information otherwise required by this section on Form 1042-S for payments made pursuant to classified or confidential contracts (as described in section 6050M(e)(3)), unless the acquiring agency determines that the information reported on the Form 1042-S does not compromise the safeguarding of classified information or national security.

(d) Special arrangement for certain contracts. In limited circumstances, the IRS may authorize the amount otherwise required to be withheld under section 5000C to be deposited in the time and manner mutually agreed upon by the acquiring agency and the foreign contracting party. In these circumstances, the IRS may in its sole discretion also modify any reporting or return requirements of the acquiring agency or the foreign contracting party.

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

§ 1.5000C-4 Requirement for the foreign contracting party to file a return and pay tax, and procedures for the contracting party to seek a refund.

(a) In general. For purposes of subtitle F of the Internal Revenue Code (“Procedure and Administration”), the tax imposed under section 5000C on foreign persons is treated as a tax imposed under subtitle A. Except as provided elsewhere in the regulations under section 5000C, forms, or accompanying instructions, the tax imposed on foreign contracting parties under section 5000C is administered in a manner similar to gross basis income taxes. This section provides procedures that a foreign contracting party must follow to satisfy its obligations to report and deposit tax due under § 1.5000C-1 as well as procedures for contracting parties to seek a refund of amounts overwithheld.

(b) Tax obligation of foreign contracting party independent of withholding. A foreign contracting party subject to tax under section 5000C and §§ 1.5000C-1 through 1.5000C-7 remains liable for the tax unless its tax obligation was fully satisfied by withholding by an acquiring agency in accordance with §§ 1.5000C-2 and 1.5000C-3.

(c) Return of tax by the foreign contracting party. If the tax liability under § 1.5000C-1 relating to a payment is not fully satisfied by withholding in accordance with §§ 1.5000C-2 and 1.5000C-3 (including as a result of the use of an estimated nonexempt amount or estimated total contract price in computing the contract ratio), a foreign contracting party subject to tax under § 1.5000C-1 during a calendar year must make a return of tax on, for example, Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation,” or such other form as the Internal Revenue Service (IRS) may prescribe to report the amount of tax due under section 5000C (required return). A foreign contracting party with no other U.S. tax filing obligation other than with respect to its liability for the tax imposed under section 5000C must file its required return on or before the fifteenth day of the sixth month following the close of its taxable year. The required return must include the information required by the form and accompanying instructions. The required return must be filed at the place and time (including any extension of time to file) provided by the form and accompanying instructions. Penalties for failure to file contained in Subtitle F can apply to foreign contracting parties who fail to file the required return. A foreign contracting party must attach copies of all Forms 1042-S, “Foreign Person's U.S. Source Income Subject to Withholding,” received from acquiring agencies (if any) to the required return.

(d) Time and manner of paying tax. A foreign contracting party must pay the tax imposed under section 5000C in the manner provided and in the time prescribed in the required return and accompanying instructions. In general, the foreign contracting party must pay the tax at the time that the required return is due, excluding extensions. To the extent provided in forms, instructions, or publications prescribed by the IRS, each foreign contracting party must deposit tax due under section 5000C by electronic funds transfer, as that term is defined in § 31.6302-1(h)(4)(i) of this chapter. A foreign contracting party that fails to pay tax in the time and manner prescribed in this section (or under forms, instructions, or publications prescribed by the IRS under this section) may be subject to penalties and interest under Subtitle F.

(e) Refund requests when amount withheld exceeds tax liability. After taking into account any offsets pursuant to § 1.5000C-2(e)(3), if the acquiring agency has overwithheld amounts under section 5000C and has made a deposit of the amounts under § 1.5000C-3(b), the contracting party may claim a refund of the amount overwithheld pursuant to the procedures described in chapter 65. The contracting party's claim for refund must meet the requirements of section 6402 and the regulations thereunder, as applicable, and must be filed before the expiration of the period of limitations on refund in section 6511 and the regulations thereunder. In general, the contracting party making a refund claim must file the required return to claim a refund, stating the grounds upon which the claim is based. A Section 5000C Certificate and a copy of the Form 1042-S received from the acquiring agency must be attached to the required return. For purposes of this section, an amount is overwithheld if the amount withheld from the payment pursuant to section 5000C and §§ 1.5000C-1 through 1.5000C-7 exceeds the contracting party's tax liability under § 1.5000C-1, regardless of whether the overwithholding was in error or appeared correct when it occurred. A U.S. person may seek a refund under this paragraph (e) even if it was treated as a foreign person under the rules in § 1.5000C-2 (for example, because it neither had a taxpayer identification number on file in the System for Award Management nor submitted Form W-9, “Request for Taxpayer Identification Number (TIN) and Certification,” to the acquiring agency).

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

§ 1.5000C-5 Anti-abuse rule.

If a foreign person engages in a transaction (or series of transactions) with a principal purpose of avoiding the tax imposed under section 5000C, the transaction (or series of transactions) may be disregarded or the arrangement may be recharacterized (including disregarding an intermediate entity), in accordance with its substance. If this section applies, the foreign person remains liable for any tax (including any tax obligation unsatisfied as a result of underwithholding) and the Internal Revenue Service retains all other rights and remedies under any applicable law available to collect any tax imposed on the foreign contracting party by section 5000C.

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

§ 1.5000C-6 Examples.

The rules of §§ 1.5000C-1 through 1.5000C-4 are illustrated by the following examples. For purposes of the examples: All contracts are executed with acquiring agencies on or after January 2, 2011, and are for the provision of either goods or services; none of the exemptions described in § 1.5000C-1(d) apply, unless otherwise explicitly stated; the acquiring agencies have no other withholding obligations under chapter 3 of the Code and have no other contracts subject to section 5000C; the foreign contracting parties do not have any U.S. source income or a U.S. tax return filing obligation other than a tax return filing obligation that arises based on the facts described in the particular example; and none of the contracts are classified or confidential contracts as described in section 6050M(e)(3).

Example 1. U.S. person not subject to tax; no withholding. (i) Facts. Company A Inc., a domestic corporation and the contracting party, enters into a contract with Agency L, the acquiring agency. Before making its first payment under the contract (for example, on the date of execution of the contract), pursuant to the first step in § 1.5000C-2(b), Agency L determines that the contract will be for services. Under the second step, Agency L reviews Company A Inc.'s record in the System for Award Management (SAM) and determines that Company A is a corporation and is considered to be a U.S. person because Agency L's records demonstrate that Company A Inc. is a business entity treated as a corporation for tax purposes that has a TIN that does not begin with “98.”

(ii) Analysis. Company A Inc. is a U.S. person and thus is not subject to the tax under section 5000C. Moreover, because Company A Inc. is a corporation for tax purposes that has a TIN that does not begin with “98,” Agency L is able to determine that it has no obligation to withhold any amounts under section 5000C on the payment made to Company A Inc. For purposes of section 5000C, Company A Inc. could also establish that it is a U.S. person by providing a Form W-9, “Request for Taxpayer Identification Number (TIN) and Certification,” to Agency L. Company A Inc. does not need to file a Section 5000C Certificate to demonstrate its eligibility for an exemption from withholding.

Example 2. Foreign national entitled to the benefit of a nondiscrimination provision of a treaty; no withholding. (i) Facts. Company B, a foreign contracting party and a national of Country T, provides goods to Agency M, the acquiring agency. Company B determines that it is exempt from tax under section 5000C because it is entitled to the benefit of the nondiscrimination article of a qualified income tax treaty between the United States and Country T. Company B submits a Section 5000C Certificate to Agency M when the contract is executed. Company B uses Form W-14, “Certificate of Foreign Contracting Party Receiving Federal Procurement Payments,” and properly fills the relevant sections stating the name of the treaty, the specific article relied upon, and the basis on which it is entitled to the benefits of that article. Following the steps in § 1.5000C-2, Agency M determines that the nondiscrimination provision of the Country T-United States income tax treaty applies to exempt Company B from the tax imposed under section 5000C. Agency M makes one lump sum payment of $50 million to Company B pursuant to the contract.

(ii) Analysis. Company B has no liability for tax under section 5000C because it is entitled to the benefit of a nondiscrimination article of a qualified income tax treaty. Because Company B submitted a Section 5000C Certificate meeting the requirements in § 1.5000C-2 and Agency M does not have reason to know that the submitted information is incorrect or unreliable, Agency M is not required to withhold under section 5000C. Agency M must retain the Section 5000C Certificate for at least three years pursuant to § 1.5000C-3(c)(1) from the due date for the Form 1042 (if it were required).

Example 3. Foreign treaty beneficiary does not submit Section 5000C Certificate; withholding required. (i) Facts. The facts are the same as in Example 2, except that Company B does not submit a Section 5000C Certificate to Agency M before Agency M makes the $50 million payment.

(ii) Analysis. Company B is not subject to tax under section 5000C, but Agency M must nevertheless withhold on the payment made to Company B because Agency M did not receive a Section 5000C Certificate from Company B in the time and manner required pursuant to § 1.5000C-2(d). Agency M must withhold $1 million (2 percent of $50 million) on the payment, and deposit that amount under the rules in § 1.5000C-3 no later than the 15th day of the month following the month in which the payment was made. Agency M must also complete Forms 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” and 1042-S, “Foreign Person's U.S. Source Income Subject to Withholding,” on or before the date specified on those forms and the accompanying instructions. Agency M must furnish copies of Form 1042-S to Company B. Agency M must retain a copy of the Form 1042 and the Form 1042-S for 3 years from the due date for the Form 1042 pursuant to § 1.5000C-3(c)(1). As Company B is not liable for the tax, it may later file a claim for refund pursuant to the procedures described in chapter 65.

Example 4. Foreign contracting party partially exempt from tax under section 5000C when goods are manufactured in different countries. (i) Facts. Company C, a foreign contracting party, provides goods to Agency N in 2015. The terms of the contract require that payment be made to Company C by Agency N in two $5 million installments in 2015. Company C has a TIN that begins with “98” and is not entitled to relief pursuant to an international agreement with the United States, such as relief pursuant to a nondiscrimination provision of a qualified income tax treaty. Some of the goods are manufactured in Country R, which is a party to an international procurement agreement with the United States, with the remainder being manufactured in Country S, a country that is not a party to an international procurement agreement with the United States. Company C uses a reasonable allocation method based on the information available to it at the time in accordance with § 1.5000C-1(e)(3) to estimate that $3 million is the nonexempt amount that is allocated to the goods produced in Country S. Company C submits a valid and complete Section 5000C Certificate to Agency N in the time and manner required by §§ 1.5000C-1 through 1.5000C-7 that provides that the nonexempt amount is $3 million. In 2015, Agency N pays Company C in two installments pursuant to the terms of the contract.

(ii) Analysis. Using a reasonable allocation method to determine the estimated nonexempt amount, Company C determines that pursuant to section 5000C and §§ 1.5000C-1 through 1.5000C-7, tax of $30,000 (2 percent of the $5 million payment, or $100,000 multiplied by a fraction, the numerator of which is the estimated nonexempt amount, $3 million, and the denominator of which is the estimated total contract price, or $10 million) is imposed on each payment made to Company C. Because Company C has timely submitted a Section 5000C Certificate explaining the basis for this allocation, Agency N withholds $30,000 on each payment made to Company C. Agency N must deposit each $30,000 withholding tax under the rules in § 1.5000C-3 no later than the 15th day of the month following the month in which each payment is made. Agency N must also complete Forms 1042 and 1042-S and furnish copies of Form 1042-S to Company C. Agency N must retain a copy of the Form 1042 and the Form 1042-S for at least three years from the due date for the Form 1042 pursuant to § 1.5000C-3(c)(1). Provided that Agency N properly withholds on the nonexempt portion as required under section 5000C and §§ 1.5000C-1 through 1.5000C-7 and that Company C's estimate of the nonexempt amount is the actual nonexempt amount, Company C does not have an additional tax liability or a U.S. tax return filing obligation as a result of receiving the payments.

Example 5. Foreign contracting party liable for additional tax under Section 5000C not fully withheld upon due to errors on the Section 5000C Certificate. (i) Facts. The facts are the same as in Example 4, except that the Section 5000C Certificate submitted to Agency N by Company C erroneously provides that the estimated nonexempt amount is $1.5 million instead of $3 million. As a result, Agency N only withholds $15,000 (2 percent of the $5 million payment multiplied by a fraction (the numerator of which is the estimated nonexempt amount stated on the Section 5000C Certificate, $1.5 million, and the denominator of which is the estimated total contract price, or $10 million)) on each payment made to Company C. Agency N neither discovered nor had reason to know that the information on the Section 5000C Certificate was incorrect or unreliable. After both payments have been made and after the filing due date for Form 1042 for 2015, Company C determines that the estimated nonexempt amount should have been stated as $3 million on the Section 5000C Certificate.

(ii) Analysis. The tax imposed under section 5000C on Company C as a result of the receipt of specified Federal procurement payments is $60,000 and this amount has not been fully satisfied by withholding by Agency N. Accordingly, Company C must remit additional tax of $30,000 ($60,000 tax liability less $30,000 amounts already withheld by Agency N) and file its required return, a Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation,” for 2015 to report this tax liability, as required by § 1.5000C-4. Company C must explain its corrected allocation method in its Form 1120-F. Company C must also attach a copy of the Form 1042-S it received from Agency N to Form 1120-F.

Example 6. Foreign contracting party submits revised Section 5000C Certificate due to change in circumstances. (i) Facts. The facts are the same as in Example 4, except that, after the first payment, Company C changes its business so that all of the goods manufactured with respect to the second payment are manufactured in Country R. Prior to the second payment, Company C submits a revised Section 5000C Certificate indicating this change in circumstance pursuant to § 1.5000C-2(d)(6).

(ii) Analysis. Agency N withholds $30,000 on the first payment made to Company C and does not withhold on the second payment. Company C does not have an additional tax liability or a U.S. tax return filing obligation as a result of receiving the payments.

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

§ 1.5000C-7 Effective/applicability date.

Section 5000C applies to specified Federal procurement payments received pursuant to contracts entered into on and after January 2, 2011. Sections 1.5000C-1 through 1.5000C-7 apply on and after November 16, 2016. Contracting parties and acquiring agencies may rely upon the rules in the regulations before such date. If a foreign contracting party fully satisfies its tax and filing obligations under section 5000C with respect to any payments received in tax years ending before November 16, 2016 on or before the later of November 16, 2016 or the due date for the foreign person's income tax return for the year in which the payment was received in a manner consistent with the final regulations, penalties will not be asserted on the foreign contracting parties with respect to those payments or returns.

[T.D. 9782, 81 FR 55138, Aug. 18, 2016]

Returns and Records

4 Records, Statements, and Special Returns

§ 1.6001-1 Records.

(a) In general. Except as provided in paragraph (b) of this section, any person subject to tax under subtitle A of the Code (including a qualified State individual income tax which is treated pursuant to section 6361(a) as if it were imposed by chapter 1 of subtitle A), or any person required to file a return of information with respect to income, shall keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of such tax or information.

(b) Farmers and wage-earners. Individuals deriving gross income from the business of farming, and individuals whose gross income includes salaries, wages, or similar compensation for personal services rendered, are required with respect to such income to keep such records as will enable the district director to determine the correct amount of income subject to the tax. It is not necessary, however, that with respect to such income individuals keep the books of account or records required by paragraph (a) of this section. For rules with respect to the records to be kept in substantiation of traveling and other business expenses of employees, see § 1.162-17.

(c) Exempt organizations. In addition to such permanent books and records as are required by paragraph (a) of this section with respect to the tax imposed by section 511 on unrelated business income of certain exempt organizations, every organization exempt from tax under section 501(a) shall keep such permanent books of account or records, including inventories, as are sufficient to show specifically the items of gross income, receipts and disbursements. Such organizations shall also keep such books and records as are required to substantiate the information required by section 6033. See section 6033 and §§ 1.6033-1 through 1.6033-3.

(d) Notice by district director requiring returns statements, or the keeping of records. The district director may require any person, by notice served upon him, to make such returns, render such statements, or keep such specific records as will enable the district director to determine whether or not such person is liable for tax under subtitle A of the Code, including qualified State individual income taxes, which are treated pursuant to section 6361(a) as if they were imposed by chapter 1 of subtitle A.

(e) Retention of records. The books or records required by this section shall be kept at all times available for inspection by authorized internal revenue officers or employees, and shall be retained so long as the contents thereof may become material in the administration of any internal revenue law.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 7122, 36 FR 11025, June 8, 1971; T.D. 7577, 43 FR 59357, Dec. 20, 1978; T.D. 8308, 55 FR 35593, Aug. 31, 1990]

§ 1.6001-2 Returns.

For rules relating to returns required to be made by every individual, estate, or trust which is liable for one or more qualified State individual income taxes, as defined in section 6362, for a taxable year, see paragraph (b) of § 301.6361-1 of this chapter (Regulations on procedure and Administration).

[T.D. 7577, 43 FR 59357, Dec. 20, 1978]

5 tax returns or statements

§ 1.6011-1 General requirement of return, statement, or list.

(a) General rule. Every person subject to any tax, or required to collect any tax, under Subtitle A of the Code, shall make such returns or statements as are required by the regulations in this chapter. The return or statement shall include therein the information required by the applicable regulations or forms.

(b) Use of prescribed forms. Copies of the prescribed return forms will so far as possible be furnished taxpayers by district directors. A taxpayer will not be excused from making a return, however, by the fact that no return form has been furnished to him. Taxpayers not supplied with the proper forms should make application therefor to the district director in ample time to have their returns prepared, verified, and filed on or before the due date with the internal revenue office where such returns are required to be filed. Each taxpayer should carefully prepare his return and set forth fully and clearly the information required to be included therein. Returns which have not been so prepared will not be accepted as meeting the requirements of the Code. In the absence of a prescribed form, a statement made by a taxpayer disclosing his gross income and the deductions therefrom may be accepted as a tentative return, and, if filed within the prescribed time, the statement so made will relieve the taxpayer from liability for the addition to tax imposed for the delinquent filing of the return, provided that without unnecessary delay such a tentative return is supplemented by a return made on the proper form.

(c) Tax withheld on nonresident aliens and foreign corporations. For requirements respecting the return of the tax required to be withheld under chapter 3 of the Code on nonresident aliens and foreign corporations and tax-free covenant bonds, see § 1.1461-2.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6922, 32 FR 8713, June 17, 1967]

§ 1.6011-2 Returns, etc., of DISC's and former DISC's.

(a) Records and information. Every DISC and former DISC (as defined in section 992(a)) must comply with section 6001 and the regulations thereunder, relating to required records, statements, and special returns. Thus, for example, a DISC is required to maintain the books of account or records described in § 1.6001-1(a). In addition, every DISC must furnish to each of its shareholders on or before the last day of the second month following the close of the taxable year of the DISC a copy of Schedule K (Form 1120-DISC) disclosing the amounts of actual distributions and deemed distributions from the DISC to such shareholder for the taxable year of the DISC. In the case of a deficiency distribution to meet qualification requirements, see § 1.992-3(a)(4) for requirements that distribution be designated in the form of a communication sent to a shareholder and service center at the time of distribution.

(b) Returns—(1) Requirement of return. Every DISC (as defined in section 992(a)(1)) shall make a return of income. A former DISC (as defined in section 992(a)(3)) shall also make a return of income in addition to any other return required. The return required of a DISC or former DISC under this section shall be made on Form 1120-DISC. The provisions of § 1.6011-1 shall apply with respect to a DISC and former DISC. A former DISC should indicate clearly on Form 1120-DISC that it is making a return of income as a former DISC (for example, by labeling at the top of the Form 1120-DISC “Former DISC”). In the case of a former DISC, those items on the form which pertain to the computation of taxable income shall not be completed, but Schedules J, K, L, and M must be completed. Except as otherwise specifically provided in the Code or regulations, the return of a DISC or former DISC is considered to be an income tax return.

(2) Existence of DISC. A corporation which is a DISC and which is in existence during any portion of a taxable year is required to make a return for that fractional part of its taxable year during which it was in existence.

[T.D. 7533, 43 FR 6603, Feb. 15, 1978]

§ 1.6011-3 Requirement of statement from payees of certain gambling winnings.

(a) General rule. Except as provided in paragraph (c) of this section, any person receiving a payment with respect to a wager in a sweepstakes, wagering pool, lottery, or other wagering transaction (including a parimutuel pool with respect to horse races, dog races, or jai alai) shall make a statement to the payer of such winnings upon the payer's demand. Such statements shall accompany the payer's return made with respect to the payment as required pursuant to section 3402(q) or 6041, as the case may be.

(b) Contents of statement. The statement referred to in paragraph (a) shall contain information (in addition to that required under section 6041(c)) as to the amount, if any, of winnings from identical wagers to which the recipient is entitled. If any person other than the recipient is entitled to all or a portion of the payment, the statement shall also include information as to the amount, if any, of winnings from identical wagers to which each such person is entitled. The statement shall be provided on Form W-2G or, if persons other than the recipient are entitled to all or a portion of such payment, on Form 5754.

(1) From a slot machine play, or a bingo or keno game,

(2) Which is subject to withholding under section 3402(q) without regard to the existence of winnings from identical wagers, or

(3) For which no return of information under section 6041 is required of the payer.

(d) Meaning of terms, For purposes of this section, the terms “sweepstakes”, “wagering pool”, “lottery”, “other wagering transaction” and “identical wagers” shall have the same meanings as ascribed to them under § 31.3402(q)-1.

[T.D. 7919, 48 FR 46297, Oct. 12, 1983]

§ 1.6011-4 Requirement of statement disclosing participation in certain transactions by taxpayers.

(a) In general. Every taxpayer that has participated, as described in paragraph (c)(3) of this section, in a reportable transaction within the meaning of paragraph (b) of this section and who is required to file a tax return must file within the time prescribed in paragraph (e) of this section a disclosure statement in the form prescribed by paragraph (d) of this section. The fact that a transaction is a reportable transaction shall not affect the legal determination of whether the taxpayer's treatment of the transaction is proper.

(b) Reportable transactions—(1) In general. A reportable transaction is a transaction described in any of the paragraphs (b)(2) through (7) of this section. The term transaction includes all of the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and includes any series of steps carried out as part of a plan.

(2) Listed transactions. A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction.

(3) Confidential transactions—(i) In general. A confidential transaction is a transaction that is offered to a taxpayer under conditions of confidentiality and for which the taxpayer has paid an advisor a minimum fee.

(ii) Conditions of confidentiality. A transaction is considered to be offered to a taxpayer under conditions of confidentiality if the advisor who is paid the minimum fee places a limitation on disclosure by the taxpayer of the tax treatment or tax structure of the transaction and the limitation on disclosure protects the confidentiality of that advisor's tax strategies. A transaction is treated as confidential even if the conditions of confidentiality are not legally binding on the taxpayer. A claim that a transaction is proprietary or exclusive is not treated as a limitation on disclosure if the advisor confirms to the taxpayer that there is no limitation on disclosure of the tax treatment or tax structure of the transaction.

(iii) Minimum fee. For purposes of this paragraph (b)(3), the minimum fee is—

(A) $250,000 for a transaction if the taxpayer is a corporation;

(B) $50,000 for all other transactions unless the taxpayer is a partnership or trust, all of the owners or beneficiaries of which are corporations (looking through any partners or beneficiaries that are themselves partnerships or trusts), in which case the minimum fee is $250,000.

(iv) Determination of minimum fee. For purposes of this paragraph (b)(3), in determining the minimum fee, all fees for a tax strategy or for services for advice (whether or not tax advice) or for the implementation of a transaction are taken into account. Fees include consideration in whatever form paid, whether in cash or in kind, for services to analyze the transaction (whether or not related to the tax consequences of the transaction), for services to implement the transaction, for services to document the transaction, and for services to prepare tax returns to the extent return preparation fees are unreasonable in light of the facts and circumstances. For purposes of this paragraph (b)(3), a taxpayer also is treated as paying fees to an advisor if the taxpayer knows or should know that the amount it pays will be paid indirectly to the advisor, such as through a referral fee or fee-sharing arrangement. A fee does not include amounts paid to a person, including an advisor, in that person's capacity as a party to the transaction. For example, a fee does not include reasonable charges for the use of capital or the sale or use of property. The IRS will scrutinize carefully all of the facts and circumstances in determining whether consideration received in connection with a confidential transaction constitutes fees.

(v) Related parties. For purposes of this paragraph (b)(3), persons who bear a relationship to each other as described in section 267(b) or 707(b) will be treated as the same person.

(4) Transactions with contractual protection—(i) In general. A transaction with contractual protection is a transaction for which the taxpayer or a related party (as described in section 267(b) or 707(b)) has the right to a full or partial refund of fees (as described in paragraph (b)(4)(ii) of this section) if all or part of the intended tax consequences from the transaction are not sustained. A transaction with contractual protection also is a transaction for which fees (as described in paragraph (b)(4)(ii) of this section) are contingent on the taxpayer's realization of tax benefits from the transaction. All the facts and circumstances relating to the transaction will be considered when determining whether a fee is refundable or contingent, including the right to reimbursements of amounts that the parties to the transaction have not designated as fees or any agreement to provide services without reasonable compensation.

(ii) Fees. Paragraph (b)(4)(i) of this section only applies with respect to fees paid by or on behalf of the taxpayer or a related party to any person who makes or provides a statement, oral or written, to the taxpayer or related party (or for whose benefit a statement is made or provided to the taxpayer or related party) as to the potential tax consequences that may result from the transaction.

(iii) Exceptions—(A) Termination of transaction. A transaction is not considered to have contractual protection solely because a party to the transaction has the right to terminate the transaction upon the happening of an event affecting the taxation of one or more parties to the transaction.

(B) Previously reported transaction. If a person makes or provides a statement to a taxpayer as to the potential tax consequences that may result from a transaction only after the taxpayer has entered into the transaction and reported the consequences of the transaction on a filed tax return, and the person has not previously received fees from the taxpayer relating to the transaction, then any refundable or contingent fees are not taken into account in determining whether the transaction has contractual protection. This paragraph (b)(4) does not provide any substantive rules regarding when a person may charge refundable or contingent fees with respect to a transaction. See Circular 230, 31 CFR part 10, for the regulations governing practice before the IRS.

(5) Loss transactions—(i) In general. A loss transaction is any transaction resulting in the taxpayer claiming a loss under section 165 of at least—

(A) $10 million in any single taxable year or $20 million in any combination of taxable years for corporations;

(B) $10 million in any single taxable year or $20 million in any combination of taxable years for partnerships that have only corporations as partners (looking through any partners that are themselves partnerships), whether or not any losses flow through to one or more partners; or

(C) $2 million in any single taxable year or $4 million in any combination of taxable years for all other partnerships, whether or not any losses flow through to one or more partners;

(D) $2 million in any single taxable year or $4 million in any combination of taxable years for individuals, S corporations, or trusts, whether or not any losses flow through to one or more shareholders or beneficiaries; or

(E) $50,000 in any single taxable year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership, if the loss arises with respect to a section 988 transaction (as defined in section 988(c)(1) relating to foreign currency transactions).

(ii) Cumulative losses. In determining whether a transaction results in a taxpayer claiming a loss that meets the threshold amounts over a combination of taxable years as described in paragraph (b)(5)(i) of this section, only losses claimed in the taxable year that the transaction is entered into and the five succeeding taxable years are combined.

(iii) Section 165 loss—(A) For purposes of this section, in determining the thresholds in paragraph (b)(5)(i) of this section, the amount of a section 165 loss is adjusted for any salvage value and for any insurance or other compensation received. See § 1.165-1(c)(4). However, a section 165 loss does not take into account offsetting gains, or other income or limitations. For example, a section 165 loss does not take into account the limitation in section 165(d) (relating to wagering losses) or the limitations in sections 165(f), 1211, and 1212 (relating to capital losses). The full amount of a section 165 loss is taken into account for the year in which the loss is sustained, regardless of whether all or part of the loss enters into the computation of a net operating loss under section 172 or a net capital loss under section 1212 that is a carryback or carryover to another year. A section 165 loss does not include any portion of a loss, attributable to a capital loss carryback or carryover from another year, that is treated as a deemed capital loss under section 1212.

(B) For purposes of this section, a section 165 loss includes an amount deductible pursuant to a provision that treats a transaction as a sale or other disposition, or otherwise results in a deduction under section 165. A section 165 loss includes, for example, a loss resulting from a sale or exchange of a partnership interest under section 741 and a loss resulting from a section 988 transaction.

(6) Transactions of interest. A transaction of interest is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest.

(7) [Reserved]

(8) Exceptions—(i) In general. A transaction will not be considered a reportable transaction, or will be excluded from any individual category of reportable transaction under paragraphs (b)(3) through (7) of this section, if the Commissioner makes a determination by published guidance that the transaction is not subject to the reporting requirements of this section. The Commissioner may make a determination by individual letter ruling under paragraph (f) of this section that an individual letter ruling request on a specific transaction satisfies the reporting requirements of this section with regard to that transaction for the taxpayer who requests the individual letter ruling.

(ii) Special rule for RICs. For purposes of this section, a regulated investment company (RIC) as defined in section 851 or an investment vehicle that is owned 95 percent or more by one or more RICs at all times during the course of the transaction is not required to disclose a transaction that is described in any of paragraphs (b)(3) through (5) and (b)(7) of this section unless the transaction is also a listed transaction or a transaction of interest.

(1) Taxpayer. The term taxpayer means any person described in section 7701(a)(1), including S corporations. Except as otherwise specifically provided in this section, the term taxpayer also includes an affiliated group of corporations that joins in the filing of a consolidated return under section 1501.

(2) Corporation. When used specifically in this section, the term corporation means an entity that is required to file a return for a taxable year on any 1120 series form, or successor form, excluding S corporations.

(3) Participation—(i) In general—(A) Listed transactions. A taxpayer has participated in a listed transaction if the taxpayer's tax return reflects tax consequences or a tax strategy described in the published guidance that lists the transaction under paragraph (b)(2) of this section. A taxpayer also has participated in a listed transaction if the taxpayer knows or has reason to know that the taxpayer's tax benefits are derived directly or indirectly from tax consequences or a tax strategy described in published guidance that lists a transaction under paragraph (b)(2) of this section. Published guidance may identify other types or classes of persons that will be treated as participants in a listed transaction. Published guidance also may identify types or classes of persons that will not be treated as participants in a listed transaction.

(B) Confidential transactions. A taxpayer has participated in a confidential transaction if the taxpayer's tax return reflects a tax benefit from the transaction and the taxpayer's disclosure of the tax treatment or tax structure of the transaction is limited in the manner described in paragraph (b)(3) of this section. If a partnership's, S corporation's or trust's disclosure is limited, and the partner's, shareholder's, or beneficiary's disclosure is not limited, then the partnership, S corporation, or trust, and not the partner, shareholder, or beneficiary, has participated in the confidential transaction.

(C) Transactions with contractual protection. A taxpayer has participated in a transaction with contractual protection if the taxpayer's tax return reflects a tax benefit from the transaction and, as described in paragraph (b)(4) of this section, the taxpayer has the right to the full or partial refund of fees or the fees are contingent. If a partnership, S corporation, or trust has the right to a full or partial refund of fees or has a contingent fee arrangement, and the partner, shareholder, or beneficiary does not individually have the right to the refund of fees or a contingent fee arrangement, then the partnership, S corporation, or trust, and not the partner, shareholder, or beneficiary, has participated in the transaction with contractual protection.

(D) Loss transactions. A taxpayer has participated in a loss transaction if the taxpayer's tax return reflects a section 165 loss and the amount of the section 165 loss equals or exceeds the threshold amount applicable to the taxpayer as described in paragraph (b)(5)(i) of this section. If a taxpayer is a partner in a partnership, shareholder in an S corporation, or beneficiary of a trust and a section 165 loss as described in paragraph (b)(5) of this section flows through the entity to the taxpayer (disregarding netting at the entity level), the taxpayer has participated in a loss transaction if the taxpayer's tax return reflects a section 165 loss and the amount of the section 165 loss that flows through to the taxpayer equals or exceeds the threshold amounts applicable to the taxpayer as described in paragraph (b)(5)(i) of this section. For this purpose, a tax return is deemed to reflect the full amount of a section 165 loss described in paragraph (b)(5) of this section allocable to the taxpayer under this paragraph (c)(3)(i)(D), regardless of whether all or part of the loss enters into the computation of a net operating loss under section 172 or net capital loss under section 1212 that the taxpayer may carry back or carry over to another year.

(E) Transactions of interest. A taxpayer has participated in a transaction of interest if the taxpayer is one of the types or classes of persons identified as participants in the transaction in the published guidance describing the transaction of interest.

(F) [Reserved]

(G) Shareholders of foreign corporations—(1) In general. A reporting shareholder of a foreign corporation participates in a transaction described in paragraphs (b)(2) through (5) and (b)(7) of this section if the foreign corporation would be considered to participate in the transaction under the rules of this paragraph (c)(3) if it were a domestic corporation filing a tax return that reflects the items from the transaction. A reporting shareholder of a foreign corporation participates in a transaction described in paragraph (b)(6) of this section only if the published guidance identifying the transaction includes the reporting shareholder among the types or classes of persons identified as participants. A reporting shareholder (and any successor in interest) is considered to participate in a transaction under this paragraph (c)(3)(i)(G) only for its first taxable year with or within which ends the first taxable year of the foreign corporation in which the foreign corporation participates in the transaction, and for the reporting shareholder's five succeeding taxable years.

(2) Reporting shareholder. The term reporting shareholder means a United States shareholder (as defined in section 951(b)) in a controlled foreign corporation (as defined in section 957) or a 10 percent shareholder (by vote or value) of a qualified electing fund (as defined in section 1295).

(ii) Examples. The following examples illustrate the provisions of paragraph (c)(3)(i) of this section:

Example 1.Notice 2003-55 (2003-2 CB 395), which modified and superseded Notice 95-53 (1995-2 CB 334) (see § 601.601(d)(2) of this chapter), describes a lease stripping transaction in which one party (the transferor) assigns the right to receive future payments under a lease of tangible property and treats the amount realized from the assignment as its current income. The transferor later transfers the property subject to the lease in a transaction intended to qualify as a transferred basis transaction, for example, a transaction described in section 351. The transferee corporation claims the deductions associated with the high basis property subject to the lease. The transferor's and transferee corporation's tax returns reflect tax positions described in Notice 2003-55. Therefore, the transferor and transferee corporation have participated in the listed transaction. In the section 351 transaction, the transferor will have received stock with low value and high basis from the transferee corporation. If the transferor subsequently transfers the high basis/low value stock to a taxpayer in another transaction intended to qualify as a transferred basis transaction and the taxpayer uses the stock to generate a loss, and if the taxpayer knows or has reason to know that the tax loss claimed was derived indirectly from the lease stripping transaction, then the taxpayer has participated in the listed transaction. Accordingly, the taxpayer must disclose the transaction and the manner of the taxpayer's participation in the transaction under the rules of this section. For purposes of this example, if a bank lends money to the transferor, transferee corporation, or taxpayer for use in their transactions, the bank has not participated in the listed transaction because the bank's tax return does not reflect tax consequences or a tax strategy described in the listing notice (nor does the bank's tax return reflect a tax benefit derived from tax consequences or a tax strategy described in the listing notice) nor is the bank described as a participant in the listing notice.

Example 2.XYZ is a limited liability company treated as a partnership for tax purposes. X, Y, and Z are members of XYZ. X is an individual, Y is an S corporation, and Z is a partnership. XYZ enters into a confidential transaction under paragraph (b)(3) of this section. XYZ and X are bound by the confidentiality agreement, but Y and Z are not bound by the agreement. As a result of the transaction, XYZ, X, Y, and Z all reflect a tax benefit on their tax returns. Because XYZ's and X's disclosure of the tax treatment and tax structure are limited in the manner described in paragraph (b)(3) of this section and their tax returns reflect a tax benefit from the transaction, both XYZ and X have participated in the confidential transaction. Neither Y nor Z has participated in the confidential transaction because they are not subject to the confidentiality agreement.

Example 3.P, a corporation, has an 80% partnership interest in PS, and S, an individual, has a 20% partnership interest in PS. P, S, and PS are calendar year taxpayers. In 2006, PS enters into a transaction and incurs a section 165 loss (that does not meet any of the exceptions to a section 165 loss identified in published guidance) of $12 million and offsetting gain of $3 million. On PS' 2006 tax return, PS includes the section 165 loss and the corresponding gain. PS must disclose the transaction under this section because PS' section 165 loss of $12 million is equal to or greater than $2 million. P is allocated $9.6 million of the section 165 loss and $2.4 million of the offsetting gain. P does not have to disclose the transaction under this section because P's section 165 loss of $9.6 million is not equal to or greater than $10 million. S is allocated $2.4 million of the section 165 loss and $600,000 of the offsetting gain. S must disclose the transaction under this section because S's section 165 loss of $2.4 million is equal to or greater than $2 million.

(4) Substantially similar. The term substantially similar includes any transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy. Receipt of an opinion regarding the tax consequences of the transaction is not relevant to the determination of whether the transaction is the same as or substantially similar to another transaction. Further, the term substantially similar must be broadly construed in favor of disclosure. For example, a transaction may be substantially similar to a listed transaction even though it involves different entities or uses different Internal Revenue Code provisions. (See for example, Notice 2003-54 (2003-2 CB 363), describing a transaction substantially similar to the transactions in Notice 2002-50 (2002-2 CB 98), and Notice 2002-65 (2002-2 CB 690).) The following examples illustrate situations where a transaction is the same as or substantially similar to a listed transaction under paragraph (b)(2) of this section. (Such transactions may also be reportable transactions under paragraphs (b)(3) through (7) of this section.) See § 601.601(d)(2)(ii)(b) of this chapter. The following examples illustrate the provisions of this paragraph (c)(4):

Example 1.Notice 2000-44 (2000-2 CB 255) (see § 601.601(d)(2)(ii)(b) of this chapter), sets forth a listed transaction involving offsetting options transferred to a partnership where the taxpayer claims basis in the partnership for the cost of the purchased options but does not adjust basis under section 752 as a result of the partnership's assumption of the taxpayer's obligation with respect to the options. Transactions using short sales, futures, derivatives or any other type of offsetting obligations to inflate basis in a partnership interest would be the same as or substantially similar to the transaction described in Notice 2000-44. Moreover, use of the inflated basis in the partnership interest to diminish gain that would otherwise be recognized on the transfer of a partnership asset would also be the same as or substantially similar to the transaction described in Notice 2000-44. See § 601.601(d)(2)(ii)(b).

Example 2.Notice 2001-16 (2001-1 CB 730) (see § 601.601(d)(2)(ii)(b) of this chapter), sets forth a listed transaction involving a seller (X) who desires to sell stock of a corporation (T), an intermediary corporation (M), and a buyer (Y) who desires to purchase the assets (and not the stock) of T. M agrees to facilitate the sale to prevent the recognition of the gain that T would otherwise report. Notice 2001-16 describes M as a member of a consolidated group that has a loss within the group or as a party not subject to tax. Transactions utilizing different intermediaries to prevent the recognition of gain would be the same as or substantially similar to the transaction described in Notice 2001-16. An example is a transaction in which M is a corporation that does not file a consolidated return but which buys T stock, liquidates T, sells assets of T to Y, and offsets the gain on the sale of those assets with currently generated losses. See § 601.601(d)(2)(ii)(b).

(5) Tax. The term tax means Federal income tax.

(6) Tax benefit. A tax benefit includes deductions, exclusions from gross income, nonrecognition of gain, tax credits, adjustments (or the absence of adjustments) to the basis of property, status as an entity exempt from Federal income taxation, and any other tax consequences that may reduce a taxpayer's Federal income tax liability by affecting the amount, timing, character, or source of any item of income, gain, expense, loss, or credit.

(7) Tax return. The term tax return means a Federal income tax return and a Federal information return.

(8) Tax treatment. The tax treatment of a transaction is the purported or claimed Federal income tax treatment of the transaction.

(9) Tax structure. The tax structure of a transaction is any fact that may be relevant to understanding the purported or claimed Federal income tax treatment of the transaction.

(d) Form and content of disclosure statement. A taxpayer required to file a disclosure statement under this section must file a completed Form 8886, “Reportable Transaction Disclosure Statement” (or a successor form), in accordance with this paragraph (d) and the instructions to the form. The Form 8886 (or a successor form) is the disclosure statement required under this section. The form must be attached to the appropriate tax return(s) as provided in paragraph (e) of this section. If a copy of a disclosure statement is required to be sent to the Office of Tax Shelter Analysis (OTSA) under paragraph (e) of this section, it must be sent in accordance with the instructions to the form. To be considered complete, the information provided on the form must describe the expected tax treatment and all potential tax benefits expected to result from the transaction, describe any tax result protection (as defined in § 301.6111-3(c)(12) of this chapter) with respect to the transaction, and identify and describe the transaction in sufficient detail for the IRS to be able to understand the tax structure of the reportable transaction and the identity of all parties involved in the transaction. An incomplete Form 8886 (or a successor form) containing a statement that information will be provided upon request is not considered a complete disclosure statement. If the form is not completed in accordance with the provisions in this paragraph (d) and the instructions to the form, the taxpayer will not be considered to have complied with the disclosure requirements of this section. If a taxpayer receives one or more reportable transaction numbers for a reportable transaction, the taxpayer must include the reportable transaction number(s) on the Form 8886 (or a successor form). See § 301.6111-3(d)(2) of this chapter.

(e) Time of providing disclosure—(1) In general. The disclosure statement for a reportable transaction must be attached to the taxpayer's tax return for each taxable year for which a taxpayer participates in a reportable transaction. In addition, a disclosure statement for a reportable transaction must be attached to each amended return that reflects a taxpayer's participation in a reportable transaction. A copy of the disclosure statement must be sent to OTSA at the same time that any disclosure statement is first filed by the taxpayer pertaining to a particular reportable transaction. If a reportable transaction results in a loss which is carried back to a prior year, the disclosure statement for the reportable transaction must be attached to the taxpayer's application for tentative refund or amended tax return for that prior year. In the case of a taxpayer that is a partnership, an S corporation, or a trust, the disclosure statement for a reportable transaction must be attached to the partnership, S corporation, or trust's tax return for each taxable year in which the partnership, S corporation, or trust participates in the transaction under the rules of paragraph (c)(3)(i) of this section. If a taxpayer who is a partner in a partnership, a shareholder in an S corporation, or a beneficiary of a trust receives a timely Schedule K-1 less than 10 calendar days before the due date of the taxpayer's return (including extensions) and, based on receipt of the timely Schedule K-1, the taxpayer determines that the taxpayer participated in a reportable transaction within the meaning of paragraph (c)(3) of this section, the disclosure statement will not be considered late if the taxpayer discloses the reportable transaction by filing a disclosure statement with OTSA within 60 calendar days after the due date of the taxpayer's return (including extensions). The Commissioner in his discretion may issue in published guidance other provisions for disclosure under § 1.6011-4.

(2) Special rules—(i) Listed transactions and transactions of interest. In general, if a transaction becomes a listed transaction or a transaction of interest after the filing of a taxpayer's tax return (including an amended return) reflecting the taxpayer's participation in the listed transaction or transaction of interest and before the end of the period of limitations for assessment of tax for any taxable year in which the taxpayer participated in the listed transaction or transaction of interest, then a disclosure statement must be filed, regardless of whether the taxpayer participated in the transaction in the year the transaction became a listed transaction or a transaction of interest, with OTSA within 90 calendar days after the date on which the transaction became a listed transaction or a transaction of interest. The Commissioner also may determine the time for disclosure of listed transactions and transactions of interest in the published guidance identifying the transaction.

(ii) Loss transactions. If a transaction becomes a loss transaction because the losses equal or exceed the threshold amounts as described in paragraph (b)(5)(i) of this section, a disclosure statement must be filed as an attachment to the taxpayer's tax return for the first taxable year in which the threshold amount is reached and to any subsequent tax return that reflects any amount of section 165 loss from the transaction.

(3) Multiple disclosures. The taxpayer must disclose the transaction in the time and manner provided for under the provisions of this section regardless of whether the taxpayer also plans to disclose the transaction under other published guidance, for example, § 1.6662-3(c)(2).

(4) Example. The following example illustrates the application of this paragraph (e):

Example.In January of 2008, F, a calendar year taxpayer, enters into a transaction that at the time is not a listed transaction and is not a transaction described in any of the paragraphs (b)(3) through (7) of this section. All the tax benefits from the transaction are reported on F's 2008 tax return filed timely in April 2009. On May 2, 2011, the IRS publishes a notice identifying the transaction as a listed transaction described in paragraph (b)(2) of this section. Upon issuance of the May 2, 2011 notice, the transaction becomes a reportable transaction described in paragraph (b) of this section. The period of limitations on assessment for F's 2008 taxable year is still open. F is required to file Form 8886 for the transaction with OTSA within 90 calendar days after May 2, 2011.

(f) Rulings and protective disclosures—(1) Rulings. If a taxpayer requests a ruling on the merits of a specific transaction on or before the date that disclosure would otherwise be required under this section, and receives a favorable ruling as to the transaction, the disclosure rules under this section will be deemed to have been satisfied by that taxpayer with regard to that transaction, so long as the request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed under this section. If a taxpayer requests a ruling as to whether a specific transaction is a reportable transaction on or before the date that disclosure would otherwise be required under this section, the Commissioner in his discretion may determine that the submission satisfies the disclosure rules under this section for the taxpayer requesting the ruling for that transaction if the request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed under this section. The potential obligation of the taxpayer to disclose the transaction under this section will not be suspended during the period that the ruling request is pending.

(2) Protective disclosures. If a taxpayer is uncertain whether a transaction must be disclosed under this section, the taxpayer may disclose the transaction in accordance with the requirements of this section and comply with all the provisions of this section, and indicate on the disclosure statement that the disclosure statement is being filed on a protective basis. The IRS will not treat disclosure statements filed on a protective basis any differently than other disclosure statements filed under this section. For a protective disclosure to be effective, the taxpayer must comply with these disclosure regulations by providing to the IRS all information requested by the IRS under this section.

(g) Retention of documents. (1) In accordance with the instructions to Form 8886 (or a successor form), the taxpayer must retain a copy of all documents and other records related to a transaction subject to disclosure under this section that are material to an understanding of the tax treatment or tax structure of the transaction. The documents must be retained until the expiration of the statute of limitations applicable to the final taxable year for which disclosure of the transaction was required under this section. (This document retention requirement is in addition to any document retention requirements that section 6001 generally imposes on the taxpayer.) The documents may include the following:

(i) Marketing materials related to the transaction;

(ii) Written analyses used in decision-making related to the transaction;

(iii) Correspondence and agreements between the taxpayer and any advisor, lender, or other party to the reportable transaction that relate to the transaction;

(iv) Documents discussing, referring to, or demonstrating the purported or claimed tax benefits arising from the reportable transaction; and documents, if any, referring to the business purposes for the reportable transaction.

(2) A taxpayer is not required to retain earlier drafts of a document if the taxpayer retains a copy of the final document (or, if there is no final document, the most recent draft of the document) and the final document (or most recent draft) contains all the information in the earlier drafts of the document that is material to an understanding of the purported tax treatment or tax structure of the transaction.

(h) Effective/applicability date—(1) In general. This section applies to transactions entered into on or after August 3, 2007. However, this section applies to transactions of interest entered into on or after November 2, 2006. Paragraph (f)(1) of this section applies to ruling requests received on or after November 1, 2006. Otherwise, the rules that apply with respect to transactions entered into before August 3, 2007, are contained in § 1.6011-4 in effect prior to August 3, 2007 (see 26 CFR part 1 revised as of April 1, 2007).

(2) [Reserved]

[T.D. 9350, 72 FR 43149, Aug. 3, 2007, as amended at 75 FR 26061, May 11, 2010]

§ 1.6011-5 Required use of magnetic media for corporate income tax returns.

The return of a corporation that is required to be filed on magnetic media under § 301.6011-5 of this chapter must be filed in accordance with Internal Revenue Service revenue procedures, publications, forms, or instructions, including those posted electronically. (See § 601.601(d)(2) of this chapter).

[T.D. 9364, 72 FR 63810, Nov. 13, 2007]

§ 1.6011-6 [Reserved]

§ 1.6011-7 Specified tax return preparers required to file individual income tax returns using magnetic media.

Individual income tax returns that are required to be filed on magnetic media by tax return preparers under section 6011(e)(3) and § 301.6011-7 of this chapter must be filed in accordance with Internal Revenue Service regulations, revenue procedures, revenue rulings, publications, forms or instructions, including those posted electronically.

[T.D. 9518, 76 FR 17528, Mar. 30, 2011]

§ 1.6011-8 Requirement of income tax return for taxpayers who claim the premium tax credit under section 36B.

(a) Requirement of return. Except as otherwise provided in this paragraph (a), a taxpayer who receives the benefit of advance payments of the premium tax credit (advance credit payments) under section 36B must file an income tax return for that taxable year on or before the due date for the return (including extensions of time for filing) and reconcile the advance credit payments. However, if advance credit payments are made for coverage of an individual who is not included in any taxpayer's family, as defined in § 1.36B-1(d), the taxpayer who attested to the Exchange to the intention to include such individual in the taxpayer's family as part of the advance credit payment eligibility determination for coverage of the individual must file a tax return and reconcile the advance credit payments.

(b) Applicability dates—(1) In general. Except as provided in paragraph (b)(2) of this section, paragraph (a) of this section applies for taxable years ending on or after December 31, 2020.

(2) Prior periods. Paragraph (a) of this section as contained in 26 CFR part 1 edition revised as of April 1, 2016, applies to taxable years ending after December 31, 2013, and beginning before January 1, 2017. Paragraph (a) of this section as contained in 26 CFR part 1 edition revised as of April 1, 2020, applies to taxable years beginning after December 31, 2016, and ending before December 31, 2020.

[T.D. 9912, 85 FR 76978, Dec. 1, 2020]

§ 1.6011-9 Syndicated conservation easement listed transactions.

(a) Identification as listed transaction. Transactions that are the same as, or substantially similar to, a transaction described in paragraph (b) of this section are identified as listed transactions for purposes of § 1.6011-4(b)(2).

(b) Syndicated conservation easement transaction. The term syndicated conservation easement transaction means a transaction in which the following steps occur (regardless of the order in which they occur)—

(1) A taxpayer receives promotional materials that offer investors in a pass-through entity the possibility of being allocated a charitable contribution deduction the amount of which equals or exceeds an amount that is two and one-half times the amount of the taxpayer's investment, as determined in paragraph (d)(4) of this section, in the pass-through entity, as determined under paragraph (d) of this section (2.5 times rule);

(2) The taxpayer acquires an interest, directly or indirectly through one or more tiers of pass-through entities, in the pass-through entity that owns or acquires real property (that is, becomes an investor in the entity);

(3) The pass-through entity that owns the real property contributes an easement on such real property, which it treats as a conservation easement, to a qualified organization and allocates, directly or through one or more tiers of pass-through entities, a charitable contribution deduction to the taxpayer; and

(4) The taxpayer claims a charitable contribution deduction with respect to the contribution of the real property interest on the taxpayer's Federal income tax return.

(1) Charitable contribution deduction. The term charitable contribution deduction means a deduction under section 170 of the Internal Revenue Code (Code), which includes a deduction arising from a qualified conservation contribution as defined in section 170(h)(1) of the Code.

(2) Conservation easement. The term conservation easement means a restriction (granted in perpetuity) on the use which may be made of the real property, within the meaning of section 170(h)(2)(C) of the Code, exclusively for conservation purposes, within the meaning of section 170(h)(1)(C) and (h)(4) of the Code.

(3) Pass-through entity. The term pass-through entity means a partnership, S corporation, or trust (other than a grantor trust within the meaning of subchapter J of chapter 1 of the Code).

(4) Promotional materials. The term promotional materials includes materials described in § 301.6112-1(b)(3)(iii)(B) of this chapter and any other written or oral communication regarding the transaction provided to investors, such as marketing materials, appraisals (including preliminary appraisals, draft appraisals, and the appraisal that is attached to the taxpayer's return), websites, transactional documents such as deeds of conveyance, private placement memoranda, tax opinions, operating agreements, subscription agreements, statements of the anticipated value of the conservation easement, and statements of the anticipated amount of the charitable contribution deduction.

(5) Qualified organization. The term qualified organization means an organization described in section 170(h)(3) of the Code.

(6) Real property. The term real property includes all land, structures, and buildings, including a certified historic structure defined in section 170(h)(4)(C) of the Code.

(7) Substantially similar. The term substantially similar is defined in § 1.6011-4(c)(4). For example, transactions that meet the elements of paragraph (b) of this section, except that the pass-through entity contributes a fee simple interest in real property or a real property interest described in section 170(h)(2)(A) or (B) of the Code rather than a conservation easement, are substantially similar to the listed transaction identified in this section.

(d) Application of the 2.5 times rule—(1) Bright-line rule. Transactions for which the promotional materials offer the taxpayer the possibility of being allocated a charitable contribution deduction of only an amount less than 2.5 times the taxpayer's investment and for which the taxpayer is actually allocated a charitable contribution deduction of an amount less than 2.5 times the taxpayer's investment (so that the rebuttable presumption in paragraph (d)(3) of this section does not apply) are generally not considered substantially similar to the listed transaction identified in this section. However, if a pass-through entity engages in a series of transactions with a principal purpose of avoiding the application of the bright-line rule in this paragraph (d)(1), the series of transactions may be disregarded or the arrangement may be recharacterized in accordance with its substance. Whether a series of transactions has a principal purpose of avoiding the application of this bright-line rule is determined based on all the facts and circumstances.

(2) Multiple suggested contribution amounts. If the promotional materials suggest or imply a range of possible charitable contribution deduction amounts that may be allocated to the taxpayer, the highest suggested or implied contribution amount determines whether the 2.5 times rule in this paragraph (d) is met. In addition, if one piece of promotional materials (for example, an appraisal or oral statement) states a higher charitable contribution deduction amount than stated by other promotional materials, then the highest stated charitable contribution deduction amount determines whether the 2.5 times rule is met.

(3) Rebuttable presumption. The 2.5 times rule in this paragraph (d) is deemed to be met if the pass-through entity donates a real property interest within three years following the taxpayer's investment in the pass-through entity, the pass-through entity allocates a charitable contribution deduction to the taxpayer the amount of which equals or exceeds two and one-half times the amount of the taxpayer's investment, and the taxpayer claims a charitable contribution deduction the amount of which equals or exceeds two and one-half times the amount of the taxpayer's investment. This presumption may be rebutted if the taxpayer establishes to the satisfaction of the Commissioner that none of the promotional materials contained a suggestion or implication that investors might be allocated a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of their investment in the pass-through entity.

(4) Determining the amount of the taxpayer's investment in the pass-through entity—(i) In general. A taxpayer may determine the amount of the taxpayer's investment in the pass-through entity for purposes of paragraph (b) of this section using either the anti-stuffing method in paragraph (d)(4)(ii) of this section or, for contributions made after December 29, 2022, the relevant basis method in paragraph (d)(4)(iii) of this section. No other methods may be used.

(ii) Anti-stuffing method. Under the anti-stuffing method, the amount of a taxpayer's investment in the pass-through entity is the portion of the cash or fair market value of the assets the taxpayer uses to acquire its interest in the pass-through entity that is attributable to the real property on which a conservation easement is placed (or the portion thereof, if an easement is placed on a portion of the real property) that gives rise to the charitable contribution described in paragraph (b)(3) of this section. For example, if a portion of the taxpayer's cost of acquiring the taxpayer's interest in the pass-through entity is attributable to property held directly or indirectly by the pass-through entity other than the real property on which a conservation easement is placed as described in paragraph (b)(3) of this section (such other property may include other real property, cash, cash equivalents, digital assets, marketable securities, or other tangible or intangible assets), that portion of the taxpayer's acquisition cost is not considered part of the taxpayer's investment for purposes of this section because it is not attributable to the portion of the real property on which a conservation easement is placed as described in paragraph (b)(3) of this section. For purposes of this paragraph (d)(4)(ii), assets retained to pay for costs related to the operation and maintenance of the real property on which the conservation easement is placed, including costs that may be incurred in future years, are not attributable to the real property on which a conservation easement is placed as described in paragraph (b)(3) of this section. In the case of a substantially similar transaction described in paragraph (c)(7) of this section, the rules in this paragraph (d)(4)(ii) apply except that the relevant real property that gives rise to the charitable contribution deduction described in paragraph (b)(3) of this section is the real property donated.

(iii) Relevant basis method. For contributions made after December 29, 2022, taxpayers may use their relevant basis, as determined in accordance with section 170(h)(7)(B) of the Code and § 1.170A-14(k), as the amount of their investment for purposes of paragraph (b) of this section.

(5) Examples. For the examples in this paragraph (d)(5), assume that the partnerships are respected for Federal tax purposes, and that the partnership allocations comply with the rules of subchapter K of chapter 1 of the Code.

(i) Example 1—(A) Facts. Individual A purchased an interest in P, a partnership that owns real property with a fair market value of $500,000 and marketable securities with a fair market value of $500,000. A is one of four equal investors in P, each of whom purchased its interest in P for $250,000 of cash. With respect to an investor's $250,000 payment for its interest in P, the promotional materials stated that P expected to allocate a $500,000 charitable contribution deduction to the investor (that is, a charitable contribution deduction that is two times the amount an investor paid for its interest in P). After all four investors have purchased their interests in P, P donates a conservation easement on all of its real property to a qualified organization as defined in section 170(h)(3) of the Code and reports a $2,000,000 charitable contribution on its Form 1065, U.S. Return of Partnership Income, based on P obtaining an appraisal indicating that the value of the conservation easement is $2,000,000. The Schedule K-1 (Form 1065) that P furnishes to A indicates that P allocated a charitable contribution deduction to A for the taxable year. A claims a charitable contribution deduction with respect to the charitable contribution on A's Federal income tax return.

(B) Analysis. A's cost of acquiring its interest in P is $250,000. The real property on which a conservation easement was placed and that gave rise to the charitable contribution deduction described in paragraph (b)(3) of this section was P's property valued at $500,000. P's only other asset was marketable securities worth $500,000. Accordingly, half of A's share of the value of the assets held by P was attributable to the real property on which P placed a conservation easement and that gave rise to the charitable contribution deduction described in paragraph (b)(3) of this section. Therefore, under paragraph (d)(4)(i) of this section, for purposes of paragraph (b) of this section, the amount of A's investment in P is $125,000 (that is, half of A's $250,000 acquisition cost, which is the portion of A's acquisition cost that is attributable to the real property on which P placed a conservation easement and that gave rise to the charitable contribution deduction described in paragraph (b)(3) of this section). Because A's investment for purposes of the 2.5 times rule is $125,000 and A's expected charitable contribution deduction, based on the promotional materials, is $500,000 (that is, an expected deduction that is four times A's investment), the 2.5 times rule of paragraph (b)(1) of this section is met. The transaction also meets the other elements of a syndicated conservation easement within the meaning of paragraph (b) of this section and therefore is a listed transaction for purposes of § 1.6011-4(b)(2).

(ii) Example 2—(A) Facts. Individual B acquires a ten percent interest in InvestCo, a partnership, by making a $250,000 cash contribution. Immediately after B's acquisition, InvestCo's only asset is $2,500,000 of cash. The promotional materials state that InvestCo expects to allocate a $500,000 charitable contribution deduction to B with respect to B's partnership interest. InvestCo pays $600,000 to purchase marketable securities. InvestCo also purchases an interest in another partnership, PropCo, for $1,900,000 from one of PropCo's partners. At the same time as the purchase, InvestCo also contributes $100,000 of its marketable securities to PropCo. Immediately after InvestCo's purchase and contribution, PropCo's only assets are real property worth $2,400,000 and the marketable securities worth $100,000. PropCo donates its entire interest in the real property (a fee simple interest) to a qualified organization as defined in section 170(h)(3) of the Code and reports a $6,250,000 charitable contribution on its Form 1065, U.S. Return of Partnership Income, based on PropCo obtaining an appraisal indicating that the value of the real property is $6,250,000. PropCo allocates a portion of the charitable contribution deduction to InvestCo. The Schedule K-1 (Form 1065) that InvestCo furnishes to B indicates that InvestCo allocated a charitable contribution deduction to B for the taxable year. B claims a charitable contribution deduction with respect to the contribution on B's Federal income tax return.

(B) Analysis. Immediately after InvestCo's acquisition of its interest in PropCo, InvestCo's only assets were its interest in PropCo and $500,000 in marketable securities. Accordingly, eighty percent of InvestCo's funds ($2,000,000/$2,500,000) were used to acquire its interest in PropCo. B's investment in InvestCo is $250,000; therefore, eighty percent of that amount, $200,000, is attributable to InvestCo's interest in PropCo. Immediately after InvestCo's acquisition of its interest in PropCo, PropCo had real property worth $2,400,000 and marketable securities worth $100,000. As such, ninety-six percent ($2,400,000/$2,500,000) of PropCo's assets were the real property that was subsequently donated. Therefore, under paragraph (d)(4)(i) of this section, for purposes of paragraph (b) of this section, the amount of B's investment in InvestCo that is attributable to the donated real property that gave rise to the charitable contribution deduction described in paragraph (b)(3) of this section is $200,000 multiplied by ninety-six percent, or $192,000. Because B's investment for purposes of the 2.5 times rule is $192,000 and B's expected charitable contribution deduction, based on the promotional materials, is $500,000 (that is, an expected deduction that is at least 2.5 times B's investment), the 2.5 times rule of paragraph (b)(1) of this section is met. The transaction also meets the other elements of a syndicated conservation easement within the meaning of paragraph (b) of this section, except that PropCo contributed a fee simple interest in real property rather than a conservation easement. Under paragraph (c)(7) of this section, the transaction is substantially similar to the listed transaction described in paragraph (b) of this section and, therefore, under paragraph (a) of this section, the transaction in this example is a listed transaction for purposes of § 1.6011-4(b)(2).

(e) Participation in a syndicated conservation easement transaction—(1) In general. Whether a taxpayer has participated in a syndicated conservation easement transaction described in paragraph (b) of this section is determined under § 1.6011-4(c)(3)(i)(A).

(2) Class of participants. For purposes of § 1.6011-4(c)(3)(i)(A), participants in a transaction that is the same as, or substantially similar to, a syndicated conservation easement transaction described in paragraph (b) of this section include—

(i) An owner of a pass-through entity;

(ii) A pass-through entity; and

(iii) Any other taxpayer whose Federal income tax return reflects tax consequences or a tax strategy arising from a transaction that is the same as, or substantially similar to, the transaction described in paragraph (b) of this section.

(3) Exclusion. A qualified organization to which the conservation easement is donated is not treated as a participant under § 1.6011-4(c)(3)(i)(A) in a syndicated conservation easement transaction described in paragraph (b) of this section.

(f) Application of section 4965. A qualified organization to which the real property interest is donated is not treated under section 4965 of the Code as a party to the transaction described in paragraph (b) of this section.

(g) Disclosures under Notice 2017-10. A taxpayer who disclosed their participation in a transaction pursuant to Notice 2017-10 and in accordance with § 1.6011-4 before October 8, 2024, is treated as having made the disclosure required under this section and § 1.6011-4, for the years covered by that disclosure, as of the date of the disclosure under Notice 2017-10.

(h) Applicability date—(1) In general. This section's identification of transactions that are the same as, or substantially similar to, the transactions described in paragraph (b) of this section as listed transactions for purposes of § 1.6011-4(b)(2) and sections 6111 and 6112 of the Code is effective October 8, 2024.

(2) Applicability date for material advisors. Notwithstanding § 301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after October 8, 2018.

[T.D. 10007, 89 FR 81355, Oct. 8, 2024]

§ 1.6011-10 Micro-captive listed transaction.

(a) Identification as listed transaction. Transactions that are the same as, or Substantially Similar to, transactions described in paragraph (c) of this section are identified as listed transactions for purposes of § 1.6011-4(b)(2), except as provided in paragraph (d) of this section.

(b) Definitions. The definitions in this paragraph (b) apply for purposes of this section:

(1) Captive. The term Captive means any entity that is described in each of the paragraphs (b)(1)(i), (ii), and (iii) of this section.

(i) The entity elects under section 831(b) of the Internal Revenue Code (Code) to include in taxable income only taxable investment income (defined in section 834 of the Code) in lieu of the tax imposed under section 831(a).

(ii) The entity issues a Contract to an Insured, reinsures a Contract of an Insured issued by an Intermediary, or both.

(iii) At least 20 percent of the entity's assets or the voting power or value of its outstanding stock or equity interests is directly or indirectly owned, individually or collectively, by an Insured, an Owner, or persons Related to an Insured or an Owner. For purposes of this paragraph (b)(1)(iii), the rules of paragraph (b)(1)(iii)(A) or (B) of this section apply to the extent application of a rule (or rules) would increase such direct or indirect ownership.

(A) A person that holds a derivative is treated as indirectly owning the assets referenced by the derivative.

(B) The interest of each beneficiary of a trust or estate in the assets of such trust or estate must be determined by assuming the maximum exercise of discretion by the fiduciary in favor of such beneficiary and the maximum use of the trust's or estate's interest in the company to satisfy the interests of such beneficiary.

(2) Computation periods—(i) Financing Computation Period. The term Financing Computation Period means the most recent five taxable years (including the most recent concluded taxable year) of a Captive (or all taxable years of a Captive if the Captive has been in existence for less than five taxable years).

(ii) Listed Transaction Loss Ratio Computation Period. The term Listed Transaction Loss Ratio Computation Period is the most recent ten taxable years (including the most recent concluded taxable year) of Captive. A Captive that does not have at least ten taxable years cannot have a Listed Transaction Loss Ratio Computation Period, and therefore is not described in paragraph (c)(2) of this section.

(iii) Taxable years. For purposes of paragraphs (b)(2)(i) and (ii) of this section:

(A) Each short taxable year is a separate taxable year.

(B) If the Captive is a successor to one or more other Captives, taxable years of each such other Captive are treated as taxable years of the Captive.

(iv) Successors. The term successor means any entity described in paragraph (b)(2)(iv)(A), (B), or (C) of this section.

(A) A successor corporation as defined in § 1.382-2(a)(5).

(B) An entity that, directly or indirectly, acquires (or is deemed to acquire) the assets of another entity and succeeds to and takes into account the other entity's earnings and profits or deficit in earnings and profits.

(C) An entity that receives (or is deemed to receive) any assets from another entity if such entity's basis in such assets is determined, directly or indirectly, in whole or in part, by reference to the other entity's basis in such assets.

(3) Contract. The term Contract means any contract that is treated by a party to the contract as an insurance contract or reinsurance contract for Federal income tax purposes.

(4) Insured. The term Insured means any person that conducts a trade or business, enters into a Contract with a Captive or enters into a Contract with an Intermediary that is directly or indirectly reinsured by a Captive, and treats amounts paid under the Contract as insurance premiums for Federal income tax purposes.

(5) Intermediary. The term Intermediary means any entity that issues a Contract to an Insured or reinsures a Contract that is issued to an Insured, and such Contract is reinsured, directly or indirectly, by a Captive. A transaction may have more than one Intermediary.

(6) Owner. The term Owner means any person who, directly or indirectly, holds an ownership interest in an Insured or its assets. For purposes of this paragraph (b)(6), the rules of paragraph (b)(6)(i) or (ii) of this section apply to the extent application of a rule (or rules) would increase such direct or indirect ownership.

(i) The interest of a person that holds a derivative must be determined as provided in paragraph (b)(1)(iii)(A) of this section.

(ii) The interest of each beneficiary of a trust or estate in the assets of such trust or estate must be determined as provided in paragraph (b)(1)(iii)(B) of this section.

(7) Recipient. The term Recipient means any Owner, Insured, or person Related to an Owner or an Insured engaged in a transaction described in paragraph (c)(1) of this section.

(8) Related. The term Related means having a relationship described in one or more of sections 267(b), 707(b), 2701(b)(2)(C), and 2704(c)(2) of the Code.

(9) Seller. The term Seller means a service provider, dealer (including an automobile dealer), lender, wholesaler, or retailer that sells products or services to customers who purchase insurance contracts in connection with those products or services and at least 95 percent of sales of products or services by Seller for the taxable year to persons who purchase such insurance contracts are sales to Unrelated Customers.

(10) Seller's Captive. The term Seller's Captive means a Captive Related to Seller, an owner of Seller, or individuals or entities Related to Seller or owners of Seller.

(11) Substantially Similar. The term Substantially Similar is defined in § 1.6011-4(c)(4).

(12) Unrelated Customers. The term Unrelated Customers means persons who do not own an interest in, and are not wholly or partially owned by, Seller, an owner of Seller, or individuals or entities Related to Seller or owners of Seller.

(c) Transaction description. A transaction is described in this paragraph (c) if the transaction is described in both paragraphs (c)(1) and (2) of this section.

(1) The transaction involves a Captive that, at any time during the Captive's Financing Computation Period, directly or indirectly, engages in a transaction described in paragraph (c)(1)(i) of this section, taking into account paragraph (c)(1)(ii) of this section.

(i) The Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient, in a transaction that did not result in taxable income or gain to the Recipient, in whole or in part, any portion of the amounts received under a Contract, such as through a guarantee, a loan, or other transfer of Captive's capital, or made such financings or conveyances prior to the Financing Computation Period that remain outstanding or in effect at any point in the taxable year for which disclosure is required.

(ii) Any amounts that a Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient are presumed to be portions of the amounts received under a Contract to the extent that such amounts, when made available or conveyed, are in excess of Captive's cumulative after-tax net investment earnings minus any outstanding financings or conveyances.

(2) The transaction involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is less than 30 percent of the amount described in paragraph (c)(2)(ii) of this section.

(i) The amount of liabilities incurred for insured losses and claim administration expenses during the Listed Transaction Loss Ratio Computation Period.

(ii) The amount equal to premiums earned by the Captive during the Listed Transaction Loss Ratio Computation Period, less policyholder dividends paid by the Captive during the Listed Transaction Loss Ratio Computation Period.

(d) Exceptions. A transaction described in paragraph (c) of this section is not identified as a listed transaction for purposes of this section and § 1.6011-4(b)(2) if the transaction:

(1) Provides insurance for employee compensation or benefits and is one for which the Employee Benefits Security Administration of the U.S. Department of Labor has issued a Prohibited Transaction Exemption under the procedures provided at 29 CFR 2570.30 through 2570.52; or

(2) Is an arrangement in which a Captive meets all of the requirements described in this paragraph (d)(2).

(i) The Captive is a Seller's Captive.

(ii) The Seller's Captive issues or reinsures some or all of the Contracts purchased by Unrelated Customers in connection with the products or services being sold by the Seller.

(iii) 100 percent of the business of the Seller's Captive is issuing or reinsuring Contracts in connection with products or services being sold by the Seller or persons Related to the Seller.

(iv) At least 95 percent of the Seller's Captive's business for the taxable year is issuing or reinsuring Contracts purchased by Unrelated Customers in connection with products or services sold by Seller or persons Related to Seller.

(e) Bright-line rules. A transaction is not considered Substantially Similar (as defined in paragraph (b)(11) of this section) to the listed transaction identified in this section if the transaction:

(1) Does not involve an entity that has elected under section 831(b) to include in taxable income only taxable investment income (defined in section 834) in lieu of the tax imposed under section 831(a); or

(2) Involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is 30 percent or more of the amount described in paragraph (c)(2)(ii) of this section.

(f) Special participation rules—(1) In general. Whether a taxpayer has participated in the listed transaction identified in paragraph (a) of this section, including Substantially Similar transactions, will be determined under § 1.6011-4(c)(3)(i)(A). Participants include, but are not limited to, any Owner, Insured, Captive, or Intermediary with respect to the transaction whose tax return reflects tax consequences or a tax strategy identified in paragraph (a), except as otherwise provided in paragraphs (f)(2) and (3) of this section.

(2) Disclosure safe harbor for Owners. An Owner who, solely by reason of the Owner's direct or indirect ownership interest in an Insured, has participated in the listed transaction described in this section will not be required to disclose participation in the transaction under section 6011(a) of the Code, notwithstanding § 1.6011-4(c)(3), if the Owner receives acknowledgement, in writing or electronically, from the Insured that the Insured has or will comply with the Insured's separate disclosure obligation under § 1.6011-4 with respect to the transaction and the Insured discloses the transaction in a timely manner. The acknowledgment can be a copy of the Form 8886, Reportable Transaction Disclosure Statement (or successor form), filed (or to be filed) by the Insured and must be received by the Owner prior to the time set forth in § 1.6011-4(e) in which the Owner would otherwise be required to provide disclosure. Owners who meet the requirements of the safe harbor in this paragraph (f)(2) will not be treated as having participated in an undisclosed listed transaction for purposes of § 1.6664-2(c)(3)(ii) or as having failed to include information on any return or statement with respect to a listed transaction for purposes of section 6501(c)(10) of the Code.

(3) Disclosure safe harbor for taxpayers in transactions with revoked section 831(b) elections. If the Captive has revoked its section 831(b) election, taxpayers who participated in the listed transaction with respect to that Captive, including any Insureds, Owners, and Intermediaries, will not be considered participants in the transaction under section 6011(a), notwithstanding § 1.6011-4(c)(3), for any taxable year in which the section 831(b) revocation is effective, provided that a successor Captive has not been established as described in paragraph (b)(2)(iv) of this section. In addition, if the Captive has revoked its section 831(b) election, taxpayers who meet the requirements of this safe harbor, for any taxable year in which the section 831(b) revocation is effective, will not be treated as having participated in an undisclosed listed transaction for purposes of § 1.6664-2(c)(3)(ii) or as having failed to include information on any return or statement with respect to a listed transaction for purposes of section 6501(c)(10).

(g) Disclosure requirements—(1) Information required of all participants. Participants must provide the information required under § 1.6011-4(d) and the Instructions to Form 8886 (or successor form). For all participants, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) when, how, and from whom the participant became aware of the transaction, and how the participant participated in the transaction (for example, as an Insured, a Captive, or other participant). Paragraphs (g)(2) and (3) of this section describe additional information required of a Captive and an Insured, respectively.

(2) Additional information required of a Captive. For a Captive, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) the items described in each of the paragraphs (g)(2)(i) through (v) of this section.

(i) All the type(s) of policies issued or reinsured by the Captive during the year of participation or each year of participation (if disclosure pertains to multiple years).

(ii) The amounts treated by the Captive as premiums written for coverage provided by Captive during the year of participation or each year of participation (if disclosure pertains to multiple years).

(iii) The name and contact information of each and every actuary or underwriter who assisted in the determination of the amounts treated as premiums for coverage provided by the Captive during the year or each year of participation (if disclosure pertains to multiple years).

(iv) The total amounts of claims paid by the Captive during the year of participation or each year of participation (if disclosure pertains to multiple years).

(v) The name and percentage of interest directly or indirectly held by each person whose interest in the Captive meets the 20 percent threshold or is taken into account in meeting the 20 percent threshold under paragraph (b)(1)(iii) of this section.

(3) Additional information required of Insured. For Insured, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) the amounts treated by Insured as premiums paid for coverage provided to Insured, directly or indirectly, by the Captive or by each Captive (if disclosure pertains to multiple Captives) during the year or each year of participation (if disclosure pertains to multiple years), as well as the identity of all persons identified as Owners to whom the Insured provided an acknowledgment described in paragraph (f)(2) of this section.

(h) Applicability date—(1) In general. This section identifies transactions that are the same as, or Substantially Similar to, the transactions identified in paragraph (a) of this section as listed transactions for purposes of § 1.6011-4(b)(2), effective January 14, 2025, except as otherwise provided in this paragraph (h)(1). If, on or before the date prescribed for filing disclosure statements with the Office of Tax Shelter Analysis under § 1.6011-4(e), the Captive involved in the transaction has requested the consent of the Secretary to revoke its section 831(b) election, the transaction is not identified as a listed transaction for purposes of this section and § 1.6011-4(b)(2) for taxable years ending before January 1, 2026.

(3) Obligations of material advisors with respect to prior periods. Material advisors defined in § 301.6111-3(b) of this chapter who have previously made a tax statement with respect to a transaction described in paragraph (a) of this section have disclosure and list maintenance obligations as described in §§ 301.6111-3 and 301.6112-1 of this chapter, respectively. Notwithstanding § 301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after the date that is six years before January 14, 2025. Material advisors that are uncertain whether the transaction they are required to disclose should be reported under this section or § 1.6011-11 should disclose under this section and will not be required to disclose a second time if it is later determined that the transaction should have been disclosed under § 1.6011-11.

[T.D. 10029, 90 FR 3559, Jan. 14, 2025]

§ 1.6011-11 Micro-captive transaction of interest.

(a) Identification as transaction of interest. Transactions that are the same as, or Substantially Similar to, transactions described in paragraph (c) of this section are identified as transactions of interest for purposes of § 1.6011-4(b)(6), except as provided in paragraph (d) of this section.

(b) Definitions. The definitions in this paragraph (b) apply for purposes of this section.

(1) Captive. Captive has the same meaning as provided in § 1.6011-10(b)(1).

(2) Computation periods—(i) Financing Computation Period. Financing Computation Period has the same meaning as provided in § 1.6011-10(b)(2)(i).

(ii) Transaction of Interest Loss Ratio Computation Period. The term Transaction of Interest Loss Ratio Computation Period means—

(A) The most recent ten taxable years of a Captive; or

(B) In the case of a Captive that has been in existence for less than ten taxable years, all taxable year(s) of the Captive.

(iii) Rules for computation periods. The rules provided in § 1.6011-10(b)(2)(iii) and (iv) for computation periods apply for purposes of this paragraph (b)(2).

(3) Contract. Contract has the same meaning as provided in § 1.6011-10(b)(3).

(4) Insured. Insured has the same meaning as provided in § 1.6011-10(b)(4).

(5) Intermediary. Intermediary has the same meaning as provided in § 1.6011-10(b)(5).

(6) Owner. Owner has the same meaning as provided in § 1.6011-10(b)(6).

(7) Recipient. Recipient has the same meaning as provided in § 1.6011-10(b)(7).

(8) Related. Related has the same meaning as provided in § 1.6011-10(b)(8).

(9) Seller. Seller has the same meaning as provided in § 1.6011-10(b)(9).

(10) Seller's Captive. Seller's Captive has the same meaning as provided in § 1.6011-10(b)(10).

(11) Substantially Similar. Substantially Similar has the same meaning as provided in § 1.6011-10(b)(11).

(12) Unrelated Customers. Unrelated Customers has the same meaning as provided in § 1.6011-10(b)(12).

(c) Transaction description. A transaction is described in this paragraph (c) if the transaction is described in paragraph (c)(1) of this section, paragraph (c)(2) of this section, or both.

(ii) Any amounts that a Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient are presumed to be portions of the amounts received under a Contract to the extent such amounts, when made available or conveyed are in excess of a Captive's cumulative after-tax net investment earnings minus any outstanding financings or conveyances.

(2) The transaction involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is less than 60 percent of the amount described in paragraph (c)(2)(ii) of this section.

(i) The amount of liabilities incurred for insured losses and claim administration expenses during the Transaction of Interest Loss Ratio Computation Period.

(ii) The amount equal to premiums earned by the Captive during the Transaction of Interest Loss Ratio Computation Period, less policyholder dividends paid by the Captive during the Transaction of Interest Loss Ratio Computation Period.

(d) Exceptions. A transaction described in paragraph (c) of this section is not identified as a transaction of interest for purposes of this section and § 1.6011-4(b)(6) if the transaction:

(1) Is described in § 1.6011-10(d)(1);

(2) Is described in § 1.6011-10(d)(2); or

(3) Is identified as a listed transaction in § 1.6011-10(a), in which case the transaction must be reported as a listed transaction under § 1.6011-10.

(e) Bright-line rules. A transaction is not considered Substantially Similar (as defined in paragraph (b)(11) of this section) to the transaction of interest identified in this section if the transaction:

(1) Does not involve an entity that has elected under section 831(b) of the Internal Revenue Code (Code) to include in taxable income only taxable investment income (defined in section 834 of the Code) in lieu of the tax imposed under section 831(a); or

(2) Involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is 60 percent or more of the amount described in paragraph (c)(2)(ii) of this section.

(f) Special participation rules—(1) In general. Whether a taxpayer has participated in the transaction of interest identified in paragraph (a) of this section, including Substantially Similar transactions, will be determined under § 1.6011-4(c)(3)(i)(E). Participants include, but are not limited to, any Owner, Insured, Captive, or Intermediary with respect to the transaction whose tax return reflects tax consequences or a tax strategy identified in paragraph (a), except as otherwise provided in paragraphs (f)(2) and (3) of this section.

(2) Disclosure safe harbor for Owners. An Owner who, solely by reason of the Owner's direct or indirect ownership interest in an Insured, has participated in the transaction of interest described in this section will not be required to disclose participation in the transaction under section 6011(a), notwithstanding § 1.6011-4(c)(3), if the Owner receives acknowledgment, in writing or electronically, from the Insured that the Insured has or will comply with Insured's separate disclosure obligation under § 1.6011-4 with respect to the transaction and the Insured discloses the transaction in a timely manner. The acknowledgment can be a copy of the Form 8886, Reportable Transaction Disclosure Statement (or successor form), filed (or to be filed) by the Insured and must be received by the Owner prior to the time set forth in § 1.6011-4(e) in which the Owner would otherwise be required to provide disclosure.

(g) Disclosure requirements. Participants must provide the information required under § 1.6011-4(d) and the Instructions to Form 8886 (or successor form). For all participants, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) when, how, and from whom the participant became aware of the transaction, and how the participant participated in the transaction (for example, as an Insured, a Captive, or other participant). A Captive and an Insured must also provide the information required in § 1.6011-10(g)(2) and (3), respectively.

(h) Applicability date—(1) In general. This section identifies transactions that are the same as, or Substantially Similar to, the transaction identified in paragraph (a) of this section as transactions of interest for purposes of § 1.6011-4(b)(6) effective January 14, 2025, except as otherwise provided in this paragraph (h)(1). If, on or before the date prescribed for filing disclosure statements with the Office of Tax Shelter Analysis under § 1.6011-4(e), the Captive involved in the transaction has requested the consent of the Secretary to revoke its section 831(b) election, the transaction is not identified as a transaction of interest for purposes of this section and § 1.6011-4(b)(6) for participants with respect to that Captive for taxable years ending before January 1, 2026.

(2) Obligations of participants with respect to prior periods. Pursuant to § 1.6011-4(d) and (e), taxpayers who have filed a tax return (including an amended return) reflecting their participation in transactions described in paragraph (a) of this section prior to January 14, 2025, must disclose the transactions as required by § 1.6011-4(d) and (e) provided that the period of limitations for assessment of tax (as determined under section 6501 of the Code, including section 6501(c)) for any taxable year in which the taxpayer participated has not ended on or before January 14, 2025, except as otherwise provided in this paragraph (h)(2). Taxpayers who have finalized a settlement agreement with the Internal Revenue Service with respect to the transaction, in examination or litigation, will be treated as having made the disclosure for years subject to that agreement. Taxpayers who have filed a disclosure statement regarding their participation in the transaction with the Office of Tax Shelter Analysis pursuant to Notice 2016-66, 2016-47 I.R.B. 745, will be treated as having made the disclosure pursuant to the final regulations for the taxable years for which the taxpayer filed returns before January 14, 2025. If a taxpayer described in the preceding sentence participates in the Micro-captive Transaction of Interest in a taxable year for which the taxpayer files a return on or after January 14, 2025, the taxpayer must file a disclosure statement with the Office of Tax Shelter Analysis at the same time the taxpayer files their return for the first such taxable year.

(3) Obligations of material advisors with respect to prior periods. Material advisors defined in § 301.6111-3(b) of this chapter who have previously made a tax statement with respect to a transaction described in paragraph (a) of this section have disclosure and list maintenance obligations as described in §§ 301.6111-3 and 301.6112-1 of this chapter, respectively. Notwithstanding § 301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after the date that is six years before January 14, 2025. Material advisors that are uncertain whether the transaction they are required to disclose should be reported under this section or § 1.6011-10 should disclose under § 1.6011-10 and will not be required to disclose a second time if it is later determined that the transaction should have been disclosed under this section.

[T.D. 10029, 90 FR 3562, Jan. 14, 2025]

§ 1.6011-15 Charitable remainder annuity trust listed transaction.

(a) In general. Transactions that are the same as, or substantially similar to, a transaction described in paragraph (b) of this section are identified as listed transactions for purposes of § 1.6011-4(b)(2).

(b) Charitable remainder annuity trusts. A transaction is described in this paragraph (b) if:

(1) The grantor creates a trust purporting to qualify as a charitable remainder annuity trust under section 664(d)(1) of the Internal Revenue Code (Code);

(2) The grantor funds the trust with property having a fair market value in excess of its basis (contributed property);

(3) The trustee sells the contributed property;

(4) The trustee uses some or all of the proceeds from the sale of the contributed property to purchase an annuity; and

(5) On a Federal income tax return, the beneficiary of the trust treats the annuity amount payable from the trust as if it were, in whole or in part, an annuity payment subject to section 72 of the Code, instead of as carrying out to the beneficiary amounts in the ordinary income and capital gain tiers of the trust in accordance with section 664(b).

(c) Participation—(1) In general. A taxpayer has participated in a transaction identified as a listed transaction in paragraph (a) of this section if the taxpayer's tax return reflects tax consequences or a tax strategy described in this section as provided under § 1.6011-4(c)(3)(i)(A). These tax consequences include those tax consequences that would affect any gift tax return, whether or not such gift tax return was filed. See § 25.6011-4 of this chapter.

(2) Treatment of charitable remainderman. An organization described in section 170(c) of the Code that the purported charitable remainder annuity trust designates as a recipient of the remainder interest described in section 664(d)(1) is not treated as a participant under § 1.6011-4(c)(3)(i)(A) in the transaction described in this section solely by reason of its status as a recipient of the remainder interest described in section 664(d)(1).

(d) Treatment of charitable remainderman under section 4965. A tax-exempt entity (as defined in section 4965 of the Code) that is an organization described in section 170(c) and that the purported charitable remainder annuity trust designates as a recipient of the remainder interest described in section 664(d)(1) is not treated as a party to the transaction described in this section for purposes of section 4965 solely by reason of its status as a recipient of the remainder interest described in section 664(d)(1).

(e) Applicability date. This section's identification of transactions that are the same as, or substantially similar to, the transaction described in paragraph (b) of this section as listed transactions for purposes of § 1.6011-4(b)(2) is effective on July 9, 2026.

[T.D. 10051, 91 FR 42355, July 9, 2026]

§ 1.6011-18 Certain partnership related-party basis adjustment transactions as transactions of interest.

(a) Identification as transaction of interest. Transactions that are the same as or substantially similar (within the meaning of § 1.6011-4(c)(4)) to the transactions described in paragraph (c) of this section are identified as transactions of interest for purposes of § 1.6011-4(b)(6). Transactions that are substantially similar (within the meaning of § 1.6011-4(c)(4)) to the transactions described in paragraph (c) of this section include, but are not limited to, transactions described in paragraph (d) of this section.

(b) Definitions. The following definitions apply for purposes of this section:

(1) Code means the Internal Revenue Code.

(2) Nonrecognition transaction means a nonrecognition transaction within the meaning of section 7701(a)(45) of the Code.

(3) Participating partner means—

(i) Except as provided in paragraph (b)(3)(ii), (iii), or (iv) of this section, any partner that directly receives a distribution of property from, or an interest in, a participating partnership, or directly transfers an interest in a participating partnership, in a transaction described in paragraph (c) or (d) of this section, including a person that becomes or ceases to be a partner as a result of such transaction.

(ii) In the case of a participating partnership interest held by an entity that is disregarded as separate from its owner within the meaning of § 301.7701-2(c)(2)(i) of this chapter, participating partner means the owner of the disregarded entity for Federal income tax purposes.

(iii) In the case of a participating partnership interest held by a trust for which the grantor or another person is treated as the owner of the trust that holds the participating partnership interest as provided in section 671 of the Code, participating partner means the grantor or other person designated under sections 671 through 679 of the Code as the owner of the trust that holds the participating partnership interest.

(iv) In the case of a publicly traded partnership within the meaning of section 7704 of the Code, participating partner means a partner of the publicly traded partnership but only to the extent that the partner engages in a private transfer (as described in § 1.7704-1(e)), redemption or repurchase agreement (as described in § 1.7704-1(f)), or private placement (as described in § 1.7704-1(h)) of a partnership interest with a related partner and the transaction is not otherwise excluded as a transaction described in paragraph (c) or (d) of this section.

(4) Participating partnership means any partnership—

(i) That makes a distribution of property to a participating partner in a transaction described in paragraph (c)(1) or (d)(1) of this section, or

(ii) A partnership interest in which is transferred by a participating partner in a transaction described in paragraph (c)(2) or (d)(2) of this section.

(5) Participating partnership interest means any partnership interest in a participating partnership.

(6) Recognition transaction means a transaction other than a nonrecognition transaction within the meaning of paragraph (b)(2) of this section.

(7) Recoverable property means property of a character subject to an allowance for depreciation, amortization, or depletion under subtitle A of the Code (subtitle A).

(8) Related means having a relationship described in section 267(b) of the Code (without regard to section 267(c)(3)) or section 707(b)(1) of the Code.

(9) Related partners means:

(i) In the case of a transaction described in paragraph (c)(1) of this section, two or more direct partners of a partnership that are related immediately before or immediately after a transaction described in paragraph (c)(1) of this section.

(ii) In the case of a transaction described in paragraph (c)(2) or (d)(2) of this section, a transferor and transferee of a partnership interest that are related to each other immediately before or immediately after a transaction described in paragraph (c)(2) of this section.

(10) Related subsequent transferee means any person that is related to a participating partner and directly received in a nonrecognition transaction a transfer (including a distribution) of property that was subject to an increase in basis from a transaction described in paragraph (c) or (d) of this section.

(11) Six-year lookback period means the seventy-two months immediately preceding the first month of the taxpayer's most recent taxable year that began before January 14, 2025.

(12) Tax-indifferent party means a person that is either not liable for Federal income tax by reason of the person's tax-exempt or, in certain cases, foreign status, or to which any gain, or portion of any gain, that would have resulted from a transaction described in paragraph (d)(1) of this section if the property subject to a basis decrease in such transaction were sold immediately after such transaction would not result in Federal income tax liability for the person's taxable year within which such gain would have been recognized, and whose status as a tax-indifferent party is known or should be known to any other person that participates in a transaction described in paragraph (d)(1) of this section or to a partner in a partnership that participates in such a transaction. A tax-indifferent party does not include a partnership or S corporation except in a case in which a principal purpose of the use of the partnership or S corporation is to avoid tax-indifferent party status.

(13) Transfer on the death of a partner means a transfer of a partnership interest from a partner to the partner's estate or a deemed transfer from a grantor trust owned by the partner to a trust that becomes a separate entity for Federal income tax purposes by reason of the partner's death.

(c) Transaction description. A transaction is described in this paragraph (c) if the factual elements of the transaction described in paragraph (c)(1)(i) through (iii) or (c)(2) of this section are met.

(1) Distributions by a partnership. A partnership with two or more related partners engages in any of the transactions described in paragraphs (c)(1)(i) through (iii) of this section as follows:

(i) The partnership distributes property to one of the related partners in a current or liquidating distribution, the partnership increases the basis of one or more of its remaining properties under section 734(b) and (c) of the Code, and the applicable threshold described in paragraph (c)(3) of this section is met.

(ii) The partnership distributes property to one of the related partners in liquidation of that person's partnership interest (or in complete liquidation of the partnership), the basis of one or more of those distributed properties is increased under section 732(b) and (c) of the Code, and the applicable threshold described in paragraph (c)(3) of this section is met.

(iii) The partnership distributes property to one of the related partners, the basis of one or more of those distributed properties is increased under section 732(d) of the Code, the distributee acquired all or a part of its interest in the partnership in a transaction that would have been a transaction described in paragraph (c)(2) of this section if the partnership had a section 754 election in effect for the year of transfer, and the applicable threshold described in paragraph (c)(3) of this section is met.

(2) Transfers of a partnership interest—(i) In general. Except as otherwise provided in paragraph (c)(2)(ii) or (c)(4) of this section, a partner transfers all or a portion of a partnership interest to a related partner in a nonrecognition transaction, the basis of one or more partnership properties is increased under section 743(b)(1) and (c) of the Code, and the applicable threshold described in paragraph (c)(3) of this section is met.

(ii) Subsequent nonrecognition transfers—(A) In general. If a partner receives an interest in a partnership from a person in a recognition transaction (first transfer) and the basis of one or more partnership properties is increased under section 743(b)(1) and (c) of the Code, and subsequently the partner (transferor) transfers the partnership interest to a person related to the transferor (transferee) in a transaction described in paragraph (c)(2)(i) of this section (subsequent transfer), the subsequent transfer is a transaction described in paragraph (c)(2)(i) of this section only to the extent, if any, that the transferee's basis adjustment under section 743(b)(1) and (c) resulting from the subsequent transfer exceeds the amount of the transferor's remaining basis adjustment described in paragraph (c)(2)(ii)(B) of this section that is attributable to the transferred partnership interest (excess amount), and the applicable threshold described in paragraph (c)(3) of this section is met. Only the excess amount is counted towards the applicable threshold described in paragraph (c)(3) of this section.

(B) Transferor's remaining basis adjustment. A transferor's remaining basis adjustment is equal to the amount of the transferor's basis adjustment under section 743(b)(1) and (c) resulting from the first transfer as adjusted under section 1016(a)(2) of the Code to reflect the recovery of the basis adjustment or as otherwise adjusted prior to the subsequent transfer.

(3) Applicable threshold—(i) In general. Except as otherwise provided in paragraph (c)(3)(ii) of this section, for determining whether a transaction is described in paragraph (c)(1) or (2), (d)(1) or (2) of this section, the applicable threshold is met for a taxable year if the sum of all basis increases resulting from all such transactions of a partnership or partner during the taxable year (without netting for any basis adjustment that results in a basis decrease in the same transaction or another transaction) exceeds by at least $10 million the gain recognized from such transactions during the same taxable year, if any, on which tax imposed under subtitle A is required to be paid by any of the related partners (or tax-indifferent party, in the case of a transaction described in paragraph (d)(1) of this section) who are a party to such transactions.

(ii) Six-year lookback period threshold. In the case of a transaction described in (c) or (d) of this section that occurred within the six-year lookback period, paragraph (c)(3)(i) applies by substituting “$25 million” for “$10 million” for determining whether the applicable threshold is met for a taxable year.

(iii) Basis increase under section 734(b) and (c) only for shares of basis increase to related partners. In the case of a transaction described in paragraph (c)(1)(i) of this section for determining whether the applicable threshold is met for a taxable year, a basis increase is an increase to the adjusted basis of the partnership's property under section 734(b)(1) and (c) only to the extent of a related partner's share of the basis increase. For purposes of this paragraph (c)(3)(iii), a partner's share of a basis increase is determined immediately after the distribution under rules similar to the rules of § 1.197-2(h)(12)(iv)(D).

(iv) Basis increase under sections 732(b) or (c) only for shares of corresponding basis decreases under section 734(b) to related partners or tax-indifferent parties. In the case of a transaction described in paragraph (c)(1)(ii) of this section for determining whether the applicable threshold is met for a taxable year, a basis increase is an increase to the basis of property distributed to one of the related partners under section 732(b) or (c), but excluding the amount of any basis increase that corresponds to a decrease to the basis of property distributed to unrelated partners (other than tax-indifferent parties) under section 732(b) and (c) or to unrelated partners' (other than tax-indifferent parties') shares of a corresponding decrease to the basis of the partnership's remaining property under section 734(b)(2) and (c). For purposes of this paragraph (c)(3)(iv), a partner's share of a basis decrease is determined immediately after the distribution under rules similar to the rules of § 1.197-2(h)(12)(iv)(D). In the case of a transaction described in paragraph (d)(1) of this section, for purposes of determining whether the applicable threshold is met for a taxable year, a basis increase is an increase to the basis of property distributed to one of the partners under section 732(b) or (c) only to the extent of a corresponding decrease to the basis of property distributed to a tax-indifferent party under section 732(b) and (c) or to one or more tax-indifferent party's shares of a corresponding decrease to the basis of the partnership's remaining property under section 734(b)(2) and (c).

(4) Exclusion of a transfer on the death of a partner. A transaction described in paragraph (c)(2) or (d)(2) of this section does not include a transfer of a partnership interest that is a transfer on the death of a partner within the meaning of paragraph (b)(13) of this section.

(d) Substantially similar transaction. A transaction that is substantially similar (within the meaning of § 1.6011-4(c)(4)) to a transaction described in paragraph (c) of this section includes, but is not limited to:

(1) A transaction that is described in paragraph (c)(1)(i) or (ii) of this section except that the partners of the partnership are not related and one or more partners of the partnership is a tax-indifferent party that facilitates an increase in the basis of partnership property or an increase in the basis of property held by another partner in the partnership by receiving a distribution of property from the partnership or having a share of a corresponding decrease to the basis of partnership property, and the applicable threshold described in paragraph (c)(3) of this section is met; and

(2) A transaction in which a transferor transfers an interest in a partnership to a transferee that is related to the transferor in a recognition transaction, and the applicable threshold described in paragraph (c)(3) of this section is met.

(e) Participation—(1) In general. Whether a taxpayer has participated in a transaction of interest described in paragraph (c) of this section or a substantially similar transaction described in paragraph (d) of this section during a taxable year is determined under this paragraph (e).

(2) Participating partners. A participating partner participates in a transaction of interest described in paragraph (c)(1) of this section or a substantially similar transaction described in paragraph (d)(1) of this section in any taxable year in which the partner directly receives a distribution of property, or directly transfers or receives an interest in a participating partnership, in a transaction described in paragraph (c)(2) of this section or a substantially similar transaction described in paragraph (d)(2) of this section.

(3) Participating partnerships. A participating partnership participates in a transaction of interest described in paragraph (c) or a substantially similar transaction described in paragraph (d) of this section in any taxable year in which the partnership makes a distribution of property to a participating partner in a transaction described in paragraph (c)(1) or (d)(1) of this section, or a participating partnership interest is transferred in a transaction described in paragraph (c)(2) or (d)(2) of this section.

(4) Related subsequent transferees. A related subsequent transferee participates in a transaction of interest described in paragraph (c) of this section or a substantially similar transaction described in paragraph (d) of this section in any taxable year in which the related subsequent transferee directly receives, in a nonrecognition transaction, a transfer (including a distribution) of property that was subject to an increase in basis as a result of a transaction described in paragraph (c) or (d) of this section that was required to be disclosed under paragraph (f) of this section.

(5) Subsequent realization of tax benefit. A participating partnership, participating partner, or related subsequent transferee also participates in a transaction of interest described in paragraph (c) or a substantially similar transaction described in paragraph (d) of this section in any taxable year in which its tax return reflects the tax consequences of a basis increase resulting from a transaction of interest described in paragraph (c) or (d) of this section, taking into account the limitations provided in paragraphs (c)(3)(iii) and (iv) of this section. For example, if a participating partner sells property the basis of which has been increased as a result of a transaction of interest described in paragraph (c) of this section during a taxable year after the taxable year in which the transaction of interest occurred, the participating partner participates in a transaction of interest described in paragraph (c) of this section in the taxable year of the basis increase and in the taxable year of the sale.

(f) Disclosure requirements—(1) In general. Except as otherwise provided in this paragraph (f)(1), participants must provide the information required under § 1.6011-4(d) and the Instructions to Form 8886, Reportable Transaction Disclosure Statement (or successor form), and in the manner described in § 1.6011-4(e), for each taxable year in which the participant participated in a transaction described in paragraph (c) or (d) of this section as determined under paragraph (e) of this section. For all participants, describing the transaction in sufficient detail includes describing the information described in paragraphs (f)(1)(i) through (iii) of this section, as applicable, on Form 8886 (or successor form) for the taxable year of a transaction described in paragraph (c) or (d) of this section. In the case of a participant that is a tax-indifferent party, the disclosure requirements of this paragraph (f) apply only if the tax-indifferent party is otherwise required to file a tax return (or an information return) for the taxable year of the transaction described in paragraph (d)(1) of this section.

(i) The names and identifying numbers of all participants, including the participating partnership, participating partners and any related subsequent transferees.

(ii) All basis adjustments resulting from a transaction described in paragraph (c) or (d) of this section, including—

(A) Basis information, including the participating partnership's adjusted basis in the distributed property immediately before the distribution,

(B) Any adjustments to basis under section 732(a)(2), (b), (d) or section 734(b),

(C) Any adjustments to basis under section 743(b) with respect to a participating partner that is transferred an interest in a participating partnership, and

(D) With respect to a participating partner that transfers an interest in a participating partnership, that participating partner's adjusted basis in the participating partnership interest and share of the participating partnership's adjusted basis in its property immediately before the transfer.

(iii) Any Federal income tax consequences realized during the taxable year as a result of a transaction described in paragraph (c) or (d) of this section, including any cost recovery allowances attributable to any increase in basis as a result of a transaction described in paragraph (c) of this section, and any gain or loss attributable to the disposition of property that was subject to an increase in basis as a result of a transaction described in paragraph (c) or (d) of this section. The Federal income tax consequences attributable to an increase in basis resulting from a transaction described in paragraph (c) or (d) of this section are limited to those attributable to the increase in basis, taking into account the limitations of paragraph (c)(3)(iii) or (iv) of this section. For example, in the case of a distribution of depreciable property that was subject to an increase in basis because of a transaction described in paragraph (c) or (d) of this section, the Federal income tax consequences realized during the taxable year include the basis increase and cost recovery allowances attributable to the basis increase during the taxable year.

(2) Six-year lookback period for taxable years described in special rule of § 1.6011-4(e)(2)(i). For purposes of the special rule of § 1.6011-4(e)(2)(i) (describing the disclosure requirement with respect to a transaction that is identified as a transaction of interest after the filing of the taxpayer's tax return (including an amended return) reflecting the taxpayer's participation in the transaction of interest but before the end of the period of limitations for assessment of tax for such taxable year), a participant must provide the information described in paragraph (f)(1) of this section for such open years only if the transaction described in paragraph (c) or (d) of this section occurred within the six-year lookback period described in paragraph (b)(11) of this section.

(g) Examples. The following examples illustrate the provisions of this section.

(1) Example 1: Reporting by a participating partner and participating partnership in the taxable year of the transaction, including cost recovery allowances—(i) Facts. ABC Partnership is owned by partners A, B, and C. Partners A, B, and C are related within the meaning of paragraphs (b)(8) and (9) of this section. At the beginning of taxable year 2025, ABC Partnership distributes a depreciable asset, Property X, to Partner A in liquidation of Partner A's interest in ABC Partnership. The distribution is a transaction described in paragraph (c)(1)(ii) of this section. As a result of the distribution, the basis of Property X is increased by $10 million in Partner A's hands. On its tax return for taxable year 2025, Partner A reports deductions for depreciation expense attributable to the $10 million increase in the basis of Property X resulting from the transaction under paragraph (c)(1)(ii) of this section. In addition, ABC Partnership must reduce the basis of its remaining property under section 734(b)(2) as a result of the distribution of Property X to Partner A by $10 million. ABC Partnership and Partner A use the calendar year as their taxable year.

(ii) Analysis. Partner A is a participant during taxable year 2025 within the meaning of paragraph (e) of this section because it is a participating partner within the meaning of paragraph (b)(3) of this section since it directly received a distribution of property during taxable year 2025 in a transaction described in paragraph (c) of this section. ABC Partnership is a participant during taxable year 2025 within the meaning of paragraph (e) of this section because it is a participating partnership within the meaning of paragraph (b)(4) of this section since it made a distribution of property to a participating partner during taxable year 2025 in a transaction described in paragraph (c) of this section. As part of its disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e), Partner A must disclose the distribution as a transaction of interest under this section on Form 8886 (or successor form) and file the form with its tax return for taxable year 2025. Partner A must include the information described in paragraph (f) of this section, including the amount of the deductions attributable to the $10 million increase in the basis of Property X resulting from the transaction described in paragraph (c)(1)(ii) of this section. As part of its disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e), ABC Partnership must disclose the distribution as a transaction of interest under this section on Form 8886 (or successor form) and file the form with its tax return for taxable year 2025, including the information described in paragraph (f) of this section. In addition, Partner A and ABC Partnership must send a copy of their respective Form 8886 (or successor form) to the Office of Tax Shelter Analysis (OTSA).

(2) Example 2: Reporting of the Federal income tax consequences (cost recovery allowances) of the transaction in all taxable years—(i) Facts. Under the same facts as in paragraph (g)(1)(i) of this section (Example 1), on its tax returns for taxable years 2026 through 2030, Partner A reports deductions for depreciation expense attributable to the $10 million increase in the basis of Property X related to the transaction described in paragraph (c)(1)(ii) of this section, which occurred in taxable year 2025.

(ii) Analysis. As part of its disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e), Partner A must disclose the deductions on Form 8886 (or successor form) for taxable years 2026 through 2030 as the Federal income tax consequences of the transaction described in paragraph (c)(1)(ii) of this section. As a result, for each of taxable years 2026 through 2030, Partner A must file the form with its tax return for the taxable year with the information described in paragraph (f) of this section, including the amount of the deductions for the taxable year attributable to the $10 million increase in the basis of Property X resulting from the transaction described in paragraph (c)(1)(ii) of this section.

(3) Example 3: Reporting by a participating partner, participating partnership, and related subsequent transferee in the taxable year of the transaction—(i) Facts. The facts are the same as in paragraph (g)(1)(i) of this section (Example 1), except that at the beginning of taxable year 2025, instead of distributing a depreciable asset, ABC Partnership distributes a nondepreciable asset, Land with an adjusted basis of $5 million, to Partner A in liquidation of Partner A's interest in ABC Partnership. The distribution is a transaction described in paragraph (c)(1)(ii) of this section. As a result of the distribution, the basis of Land is increased to $15 million in Partner A's hands. Subsequently in the same taxable year 2025, Partner A contributes Land to another partnership, AX Partnership, in a transfer that is treated as a contribution of property under section 721(a). Partner A and AX Partnership are related within the meaning of paragraph (b)(8) of this section. ABC Partnership, Partner A and AX Partnership use the calendar year as their taxable year.

(ii) Analysis. Partner A is a participant during taxable year 2025 within the meaning of paragraph (e) of this section because it is a participating partner within the meaning of paragraph (b)(3) of this section since Partner A directly received a distribution of property during taxable year 2025 in a transaction described in paragraph (c) of this section. ABC Partnership is a participant during taxable year 2025 within the meaning of paragraph (e) of this section because it is a participating partnership within the meaning of paragraph (b)(4) of this section since it made a distribution of property to a participating partner during taxable year 2025 in a transaction described in paragraph (c) of this section. AX Partnership is a participant during taxable year 2025 within the meaning of paragraph (e) of this section because it is a related subsequent transferee within the meaning of paragraph (b)(10) of this section since it directly received in a nonrecognition transaction a transfer of property during taxable year 2025 that was subject to an increase in basis because of a transaction described in paragraph (c) of this section. As part of its disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e), Partner A must disclose the distribution as a transaction of interest under this section on Form 8886 (or successor form) and file the form with its tax return for taxable year 2025. Partner A must include the information described in paragraph (f) of this section. As part of its disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e), ABC Partnership must disclose the distribution as a transaction of interest under this section on Form 8886 (or successor form) and file the form with its tax return for taxable year 2025, including the information described in paragraph (f) of this section. Further, AX Partnership is subject to the disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e). AX Partnership must disclose that it is a related subsequent transferee within the meaning of paragraph (b)(10) of this section that received, in a nonrecognition transaction, a transfer of property that was distributed in a transaction of interest under this section on Form 8886 (or successor form) and file the form with its tax return for taxable year 2025. In addition, Partner A, ABC Partnership and AX Partnership must send a copy of their respective Form 8886 (or successor form) to the OTSA.

(4) Example 4: Reporting of the Federal income tax consequences (reduced taxable gain) of the transaction in the taxable year of disposition of the property—(i) Facts. Under the same facts as in paragraph (g)(3)(i) of this section (Example 3), in taxable year 2026, AX Partnership disposes of Land in a taxable sale for its fair market value of $15 million and recognizes no gain or loss.

(ii) Analysis. As part of its disclosure requirements under paragraph (f) of this section and § 1.6011-4(d) and (e), AX Partnership must disclose the taxable gain (zero) on the disposition of Land on Form 8886 (or successor form) for taxable year 2026 as the Federal income tax consequences of the transaction described in paragraph (c)(1)(ii) of this section. AX Partnership must file the form with its tax return for taxable year 2026. Partner A does not have a disclosure requirement with respect to AX Partnership's disposition of Land because the disposition is a subsequent realization of a tax benefit within the meaning of paragraph (e)(5) of this section with respect to AX Partnership.

(5) Example 5. Reporting of a transaction of interest that occurred within the six-year lookback period—(i) Facts. The facts are the same as in paragraph (g)(1)(i) of this section (Example 1), except that instead of ABC Partnership distributing Property X in taxable year 2025, the distribution is made in May of taxable year 2022, which is within the six-year lookback period described in paragraph (b)(11) of this section. That is, the distribution occurred within the seventy-two months immediately preceding January 2025, the first month of the taxpayer's most recent taxable year that began before January 14, 2025. Further, taxable year 2022 is an open taxable year subject to the special rule of § 1.6011-4(e)(2)(i). Additionally, neither Partner A nor ABC Partnership engages in any other transaction described in paragraph (c) or (d) of this section for taxable year 2022.

(ii) Analysis. Because the transaction occurred within the six-year lookback period described in paragraph (b)(11) of this section, the applicable threshold described in paragraph (c)(3)(i) of this section is $25 million as provided in paragraph (c)(3)(ii) of this section. The distribution of Property X to Partner A is not a transaction described in paragraph (c)(1)(ii) of this section with respect to either Partner A or ABC Partnership because the applicable threshold is not met for taxable year 2022. Had the applicable threshold for taxable year 2022 been met, all the information required by paragraph (f)(1) of this section must be reported in its disclosure for taxable year 2022 and for any subsequent taxable year for which the taxpayer's return reflected the tax consequences of the transaction.

(6) Example 6. No reporting of a transaction of interest for transaction that occurred prior to the six-year lookback period—(i) Facts. The facts are the same as in paragraph (g)(1)(i) of this section (Example 1), except that as a result of the distribution of Property X to Partner A, the basis of Property X is increased by $30 million, and the distribution occurred in December of taxable year 2018, which is prior to the six-year lookback period described in paragraph (b)(11) of this section. That is, the transaction occurred prior to January 2019, which is the beginning of the seventy-two-month period that ends in December 2024. In addition, taxable year 2018 is an open taxable year subject to the special rule of § 1.6011-4(e)(2)(i). Further, Partner A realized Federal income tax consequences (depreciation expense) in taxable year 2019 attributable to the $30 million increase to the basis of Property X and taxable year 2019 is an open taxable year subject to the special rule of § 1.6011-4(e)(2)(i).

(ii) Analysis. Because taxable year 2018 is not within the six-year lookback period, under paragraph (f)(2) of this section, neither the distribution of Property X to Partner A, nor any of the Federal income tax consequences arising in that taxable year or later taxable years (such as depreciation expense in taxable year 2019 or any later taxable year) from such distribution, is required to be disclosed under paragraph (f) of this section and §§ 1.6011-4(d) and (e).

(7) Example 7. Corresponding basis decrease under section 734(b)(2)(B) shared by an unrelated partner—(i) Facts. The facts are the same as in paragraph (g)(1)(i) of this section (Example 1), except Partner C is unrelated to Partners A and B and is not a tax-indifferent party. As a result of the distribution of Property X to Partner A, and the increase to the basis of Property X by $10 million in Partner A's hands, ABC Partnership is required to reduce the adjusted basis of its remaining properties under section 734(b)(2)(B) by $10 million. Partner B's and Partner C's share of ABC Partnership's basis decrease to its remaining properties is $5 million each. Neither Partner A nor ABC Partnership engages in any other transaction described in paragraph (c) of this section for taxable year 2025.

(ii) Analysis. For purposes of paragraphs (c)(1)(ii) and (c)(3)(i) of this section, under paragraph (c)(3)(iv) of this section, only $5 million of the $10 million basis increase to Property X counts toward the applicable threshold because $5 million of the basis increase corresponds to unrelated Partner C's share of the decrease to the basis of ABC Partnership's remaining properties under section 734(b)(2)(B) and thus, is excluded from the calculation of the applicable threshold. Thus, the distribution of Property X to Partner A is not a transaction described in paragraph (c)(1)(ii) of this section with respect to either Partner A or ABC Partnership because the applicable threshold is not met for taxable year 2025.

(h) Extension of time—(1) Taxpayer disclosures. Taxpayers will be treated as having met their requirements to disclose timely under § 1.6011-4(e)(2)(i) if they file their disclosure with the OTSA by July 14, 2025.

(2) Material advisor disclosures. Material advisors who have made a tax statement before January 14, 2025 will be treated as having met their requirements to disclose timely under § 301.6111-3(e) of this chapter if they file their disclosure with the OTSA by the date that is an additional 90 days beyond the last day for filing specified in § 301.6111-3(e) of this chapter.

(i) Applicability date—(1) In general. This section's identification of transactions that are the same as or substantially similar (within the meaning of § 1.6011-4(c)(4)) to the transactions described in paragraph (c) of this section as transactions of interest for purposes of § 1.6011-4(b)(6) and sections 6111 and 6112 of the Code is effective January 14, 2025.

(2) Material advisors. Notwithstanding § 301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after January 14, 2019.

[T.D. 10028, 90 FR 2972, Jan. 14, 2025]

§ 1.6012-1 Individuals required to make returns of income.

(a) Individual citizen or resident—(1) In general. Except as provided in subparagraph (2) of this paragraph, an income tax return must be filed by every individual for each taxable year beginning before January 1, 1973, during which he receives $600 or more of gross income, and for each taxable year beginning after December 31, 1972, during which he receives $750 or more of gross income, if such individual is:

(i) A citizen of the United States, whether residing at home or abroad,

(ii) A resident of the United States even though not a citizen thereof, or

(iii) An alien bona fide resident of Puerto Rico or any section 931 possession, as defined in § 1.931-1(c)(1), during the entire taxable year

(2) Special rules. (i) For taxable years beginning before January 1, 1970, an individual who is described in subparagraph (1) of this paragraph and who has attained the age of 65 before the close of his taxable year must file an income tax return only if he receives $1,200 or more of gross income during his taxable year.

(ii) For taxable years beginning after December 31, 1969, and before January 1, 1973, an individual described in subparagraph (1) of this paragraph (other than an individual referred to in section 142(b)):

(a) Who is not married (as determined by applying section 143(a) and the regulations thereunder) must file an income tax return only if he receives $1,700 or more of gross income during his taxable year, except that if such an individual has attained the age of 65 before the close of his taxable year an income tax return must be filed by such individual only if he receives $2,300 or more of gross income during his taxable year.

(b) Who is entitled to make a joint return under section 6013 and the regulations thereunder must file an income tax return only if his gross income received during his taxable year, when combined with the gross income of his spouse received during his taxable year, is $2,300 or more. However, if such individual or his spouse has attained the age of 65 before the close of the taxable year an income tax return must be filed by such individual only if their combined gross income is $2,900 or more. If both the individual and his spouse have attained the age of 65 before the close of the taxable year such return must be filed only if their combined gross income is $3,500 or more. However, this subdivision (ii)(b) shall not apply if the individual and his spouse did not have the same household as their home at the close of their taxable year, if such spouse files a separate return for a taxable year which includes any part of such individual's taxable year, or if any other taxpayer is entitled to an exemption for such individual or his spouse under section 151(e) for such other taxpayer's taxable year beginning in the calendar year in which such individual's taxable year begins. For example, a married student more than half of whose support is furnished by his father must file an income tax return if he receives $600 or more of gross income during his taxable year.

(iii) For taxable years beginning after December 31, 1972, an individual described in subparagraph (1) of this paragraph (other than an individual referred to in section 142(b)):

(a) Who is not married (as determined by applying section 143(a) and the regulations thereunder) must file an income tax return only if he receives $1,750 or more of gross income during his taxable year, except that if such an individual has attained the age of 65 before the close of his taxable year an income tax return must be filed by such individual only if he receives $2,500 or more of gross income during his taxable year.

(b) Who is entitled to make a joint return under section 6013 and the regulations thereunder must file an income tax return only if his gross income received during his taxable year, when combined with the gross income of his spouse received during his taxable year, is $2,500 or more. However, if such individual or his spouse has attained the age of 65 before the close of the taxable year an income tax return must be filed by such individual only if their combined gross income is $3,250 or more. If both the individual and his spouse attain the age of 65 before the close of the taxable year such return must be filed only if their combined gross income is $4,000 or more. However, this subdivision (iii)(b) shall not apply if the individual and his spouse did not have the same household as their home at the close of their taxable year, if such spouse files a separate return for a taxable year which includes any part of such individual's taxable year, or if any other taxpayer is entitled to an exemption for the taxpayer or his spouse under section 151(e) for such other taxpayer's taxable year beginning in the calendar year in which such individual's taxable year begins. For example, a married student more than half of whose support is furnished by his father must file an income tax return if he receives $750 or more of gross income during the taxable year.

(iv) For purposes of section 6012(a)(1)(A)(ii) and subdivisions (ii)(b) and (iii)(b) of this subparagraph, an individual and his spouse are considered to have the same household as their home at the close of a taxable year if the same household constituted the principal place of abode of both the individual and his spouse at the close of such taxable year (or on the date of death, if the individual or his spouse died within the taxable year). The individual and his spouse will be considered to have the same household as their home at the close of the taxable year notwithstanding a temporary absence from the household due to special circumstances, as, for example, in the case of a nonpermanent failure on the part of the individual and his spouse to have a common abode by reason of illness, education, business, vacation, or military service. For example, A, a calendar-year individual under 65 years of age, is married to B, also under 65 years of age, and is a member of the Armed Forces of the United States. During 1970 A is transferred to an overseas base. A and B give up their home, which they had jointly occupied until that time; B moves to the home of her parents for the duration of A's absence. They fully intend to set up a new joint household upon A's return. Neither A nor B must file a return for 1970 if their combined gross income for the year is less than $2,300 and if no other taxpayer is entitled to a dependency exemption for A or B under section 151(e).

(v) In the case of a short taxable year referred to in section 443(a)(1), an individual described in subparagraph (1) of this paragraph shall file an income tax return if his gross income received during such short taxable year equals or exceeds his own personal exemption allowed by section 151(b) (prorated as provided in section 443(c)) and, when applicable, his additional exemption for age 65 or more allowed by section 151(c)(1) (prorated as provided in section 443(c)).

(vi) For rules relating to returns required to be made by every individual who is liable for one or more qualified State individual income taxes, as defined in section 6362, for a taxable year, see paragraph (b) of § 301.6361-1 of this chapter (Regulations on Procedure and Administration).

(vii) For taxable years beginning after December 31, 1978, an individual who receives payments during the calendar year in which the taxable year begins under section 3507 (relating to advance payment of earned income credit) must file an income tax return.

(viii) For rules relating to returns required of taxpayers who receive advance payments of the premium tax credit under section 36B, see § 1.6011-8(a).

(3) Earned income from without the United States and gain from sale of residence. For the purpose of determining whether an income tax return must be filed for any taxable year beginning after December 31, 1957, gross income shall be computed without regard to the exclusion provided for in section 911 (relating to earned income from sources without the United States). For the purpose of determining whether an income tax return must be filed for any taxable year ending after December 31, 1963, gross income shall be computed without regard to the exclusion provided for in section 121 (relating to sale of residence by individual who has attained age 65). In the case of an individual claiming an exclusion under section 121, he shall attach Form 2119 to the return required under this paragraph and in the case of an individual claiming an exclusion under section 911, he shall attach Form 2555 to the return required under this paragraph.

(4) Return of income of minor. A minor is subject to the same requirements and elections for making returns of income as are other individuals. Thus, for example, for a taxable year beginning after December 31, 1972, a return must be made by or for a minor who has an aggregate of $1,750 of gross income from funds held in trust for him and from his personal services, regardless of the amount of his taxable income. The return of a minor must be made by the minor himself or must be made for him by his guardian or other person charged with the care of the minor's person or property. See paragraph (b)(3) of § 1.6012-3. See § 1.73-1 for inclusion in the minor's gross income of amounts received for his personal services. For the amount of tax which is considered to have been properly assessed against the parent, if not paid by the child, see section 6201(c) and paragraph (c) of § 301.6201-1 of this chapter (Regulations on Procedure and Administration).

(5) Returns made by agents. The return of income may be made by an agent if, by reason of disease or injury, the person liable for the making of the return is unable to make it. The return may also be made by an agent if the taxpayer is unable to make the return by reason of continuous absence from the United States (including Puerto Rico as if a part of the United States) for a period of at least 60 days prior to the date prescribed by law for making the return. In addition, a return may be made by an agent if the taxpayer requests permission, in writing, of the district director for the internal revenue district in which is located the legal residence or principal place of business of the person liable for the making of the return, and such district director determines that good cause exists for permitting the return to be so made. However, assistance in the preparation of the return may be rendered under any circumstances. Whenever a return is made by an agent it must be accompanied by a power of attorney (or copy thereof) authorizing him to represent his principal in making, executing, or filing the return. A form 2848, when properly completed, is sufficient. In addition, where one spouse is physically unable by reason of disease or injury to sign a joint return, the other spouse may, with the oral consent of the one who is incapacitated, sign the incapacitated spouse's name in the proper place on the return followed by the words “By __________ Husband (or Wife),” and by the signature of the signing spouse in his own right, provided that a dated statement signed by the spouse who is signing the return is attached to and made a part of the return stating:

(i) The name of the return being filed,

(ii) The taxable year,

(iii) The reason for the inability of the spouse who is incapacitated to sign the return, and

(iv) That the spouse who is incapacitated consented to the signing of the return.

The taxpayer and his agent, if any, are responsible for the return as made and incur liability for the penalties provided for erroneous, false, or fraudulent returns.

(6) Form of return. Form 1040 is prescribed for general use in making the return required under this paragraph. Form 1040A is an optional short form which, in accordance with paragraph (a)(7) of this section, may be used by certain taxpayers. A taxpayer otherwise entitled to use Form 1040A as his return for any taxable year may not make his return on such form if he elects not to take the standard deduction provided in section 141, and in such case he must make his return on Form 1040. For taxable years beginning before January 1, 1970, a taxpayer entitled under section 6014 and § 1.6014-1 to elect not to show his tax on his return must, if he desires to exercise such election, make his return on Form 1040A. Form 1040W is an optional short form which, in accordance with paragraph (a)(8) of this section, may be used only with respect to taxable years beginning after December 31, 1958, and ending before December 31, 1961.

(7)(i) Use of Form 1040A. Form 1040A may be filed only by those individuals entitled to use such form as provided by and in accordance with the instructions for such form.

(ii) Computation and payment of tax. Unless a taxpayer is entitled to elect under section 6014 and § 1.6014-1 not to show the tax on Form 1040A and does so elect, he shall compute and show on his return on Form 1040A the amount of the tax imposed by subtitle A of the Code and shall, without notice and demand therefor, pay any unpaid balance of such tax not later than the date fixed for filing the return.

(iii) Change of election to use Form 1040A. A taxpayer who has elected to make his return on Form 1040A may change such election. Such change of election shall be within the time and subject to the conditions prescribed in section 144(b) and § 1.144-2 relating to change of election to take, or not to take the standard deduction.

(8) Use of Form 1040W for certain taxable years—(i) In general. An individual may use Form 1040W as his return for any taxable year beginning after December 31, 1958, and ending before December 31, 1961, in which the gross income of the individual, regardless of the amount thereof:

(a) Consists entirely of remuneration for personal services performed as an employee (whether or not such remuneration constitutes wages as defined in section 3401(a)), dividends, or interest, and

(b) Does not include more than $200 from dividends and interest.

For purposes of determining whether gross income from dividends and interest exceeds $200, dividends from domestic corporations are taken into account to the extent that they are includible in gross income. For purposes of this subparagraph, any reference to Form 1040 in §§ 1.4-2, 1.142-1, and 1.144-1 and this section shall also be deemed a reference to Form 1040W.

(ii) Change of election to use Form 1040W. A taxpayer who has elected to make his return on Form 1040W may change such election. Such change of election shall be within the time and subject to the conditions prescribed in section 144(b) and § 1.144-2, relating to change of election to take, or not to take, the standard deduction.

(iii) Joint return of husband and wife on Form 1040W. A husband and wife, eligible under section 6013 and the regulations thereunder to file a joint return for the taxable year, may, subject to the provisions of this subparagraph, make a joint return on Form 1040W for any taxable year beginning after December 31, 1958, and ending before December 31, 1961, in which the aggregate gross income of the spouses (regardless of amount) consists entirely of remuneration for personal services performed as an employee (whether or not such remuneration constitutes wages as defined in section 3401(a)), dividends, or interest, and does not include more than $200 from dividends and interest. For purposes of determining whether gross income from sources to which the $200 limitation applies exceeds such amount in cases where both spouses receive dividends from domestic corporations, the amount of such dividends received by each spouse is taken into account to the extent that such dividends are includible in gross income. See section 116 and §§ 1.116-1 and 1.116-2. If a joint return is made by husband and wife on Form 1040W, the liability for the tax shall be joint and several.

(9) Items of tax preference. For a taxable year ending after December 31, 1969, an individual shall attach Form 4625 to the return required by this paragraph if during the year the individual:

(i) Has items of tax preference (described in section 57) in excess of its minimum tax exemption (determined under § 1.58-1) or

(ii) Uses a net operating loss carryover from a prior taxable year in which it deferred minimum tax under section 56(b).

(b) Return of nonresident alien individual—(1) Requirement of return—(i) In general. Except as otherwise provided in subparagraph (2) of this paragraph, every nonresident alien individual (other than one treated as a resident under section 6013 (g) or (h)) who is engaged in trade or business in the United States at any time during the taxable year or who has income which is subject to taxation under subtitle A of the Code shall make a return on Form 1040NR. For this purpose it is immaterial that the gross income for the taxable year is less than the minimum amount specified in section 6012(a) for making a return. Thus, a nonresident alien individual who is engaged in a trade or business in the United States at any time during the taxable year is required to file a return on Form 1040 NR even though (a) he has no income which is effectively connected with the conduct of a trade or business in the United States, (b) he has no income from sources within the United States, or (c) his income is exempt from income tax by reason of an income tax convention or any section of the Code. However, if the nonresident alien individual has no gross income for the taxable year, he is not required to complete the return schedules but must attach a statement to the return indicating the nature of any exclusions claimed and the amount of such exclusions to the extent such amounts are readily determinable.

(ii) Treaty income. If the gross income of a nonresident alien individual includes treaty income, as defined in paragraph (b)(1) of § 1.871-12, a statement shall be attached to the return on Form 1040NR showing with respect to that income:

(a) The amounts of tax withheld,

(b) The names and post office addresses of withholding agents, and

(c) Such other information as may be required by the return form, or by the instructions issued with respect to the form, to show the taxpayer's entitlement to the reduced rate of tax under the tax convention.

(2) Exceptions—(i) Return not required when tax is fully paid at source. A nonresident alien individual (other than one treated as a resident under section 6013 (g) or (h)) who at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if his tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code. This subdivision does not apply to a nonresident alien individual who has income for the taxable year which is treated under section 871 (c) or (d) and § 1.871-9 (relating to students or trainees) or § 1.871-10 (relating to real property income) as income which is effectively connected for the taxable year with the conduct of a trade or business in the United States by that individual, or to a nonresident alien individual making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year. In addition, this subdivision does not apply to a nonresident alien individual who has income for the taxable year that is treated under section 871(b)(1) as effectively connected with the conduct of a trade or business within the United States by reason of the operation of section 897. For purposes of this subdivision, some of the items of income from sources within the United States upon which the tax liability will not have been fully satisfied by the withholding of tax at source under chapter 3 of the Code are:

(a) Interest upon so-called tax-free covenant bonds upon which, in accordance with section 1451 and § 1.1451-1, a tax of only 2 percent is required to be withheld at the source,

(b) In the case of bonds or other evidences of indebtedness issued after September 28, 1965, amounts described in section 871(a)(1)(C),

(d) Accrued interest received in connection with the sale of bonds between interest dates, which, in accordance with paragraph (h) of § 1.1441-4, is not subject to withholding of tax at the source.

(ii) Return of individual for taxable year of change of U.S. citizenship or residence—(a) If an alien individual becomes a citizen or resident of the United States during the taxable year and is a citizen or resident of the United States on the last day of such year, he must make a return on Form 1040 for the taxable year. However, a separate schedule is required to be attached to this return to show the income tax computation for the part of the taxable year during which the alien was neither a citizen nor resident of the United States, unless an election under section 6013 (g) or (h) is in effect for the alien. A Form 1040NR, clearly marked “Statement” across the top, may be used as such a separate schedule.

(b) If an individual abandons his U.S. citizenship or residence during the taxable year and is not a citizen or resident of the United States on the last day of such year, he must make a return on Form 1040NR for the taxable year, even if an election under section 6013(g) was in effect for the taxable year preceding the year of abandonment. However, a separate schedule is required to be attached to this return to show the income tax computation for the part of the taxable year during which the individual was a citizen or resident of the United States. A Form 1040, clearly marked “Statement” across the top, may be used as such a separate schedule.

(c) A return is required under this subdivision (ii) only if the individual is otherwise required to make a return for the taxable year.

(iii) Beneficiaries of estates or trusts. A nonresident alien individual who is a beneficiary of an estate or trust which is engaged in trade or business in the United States is not required to make a return for the taxable year merely because he is deemed to be engaged in trade or business within the United States under section 875(2). However, such nonresident alien beneficiary will be required to make a return if he otherwise satisfies the conditions of subparagraph (1)(i) of this paragraph for making a return.

(iv) Certain alien residents of Puerto Rico. This paragraph does not apply to a nonresident alien individual who is a bona fide resident of Puerto Rico during the taxable year. See section 876 and paragraph (a)(1)(iii) of this section.

(3) Representative or agent for nonresident alien individual—(i) Cases where power of attorney is not required. The responsible representative or agent within the United States of a nonresident alien individual shall make on behalf of his nonresident alien principal a return of, and shall pay the tax on, all income coming within his control as representative or agent which is subject to the income tax under subtitle A of the Code. The agency appointment will determine how completely the agent is substituted for the principal for tax purposes. Any person who collects interest or dividends on deposited securities of a nonresident alien individual, executes ownership certificates in connection therewith, or sells such securities under special instructions shall not be deemed merely by reason of such acts to be the responsible representative or agent of the nonresident alien individual. If the responsible representative or agent does not have a specific power of attorney from the nonresident alien individual to file a return in his behalf, the return shall be accompanied by a statement to the effect that the representative or agent does not possess specific power of attorney to file a return for such individual but that the return is being filed in accordance with the provisions of this subdivision.

(ii) Cases where power of attorney is required. Whenever a return of income of a nonresident alien individual is made by an agent acting under a duly authorized power of attorney for that purpose, the return shall be accompanied by the power of attorney in proper form, or a copy thereof, specifically authorizing him to represent his principal in making, executing, and filing the income tax return. Form 2848 may be used for this purpose. The agent, as well as the taxpayer, may incur liability for the penalties provided for erroneous, false, or fraudulent returns. For the requirements regarding signing of returns, see § 1.6061-1. The rules of paragraph (e) of § 601.504 of this chapter (Statement of Procedural Rules) shall apply under this subparagraph in determining whether a copy of a power of attorney must be certified.

(iii) Limitation. A return of income shall be required under this subparagraph only if the nonresident alien individual is otherwise required to make a return in accordance with this paragraph.

(4) Disallowance of deductions and credits. For provisions disallowing deductions and credits when a return of income has not been filed by or on behalf of a nonresident alien individual, see section 874(a) and the regulations thereunder.

(5) Effective date. This paragraph shall apply for taxable years beginning after December 31, 1966, except that it shall not be applied to require (i) the filing of a return for any taxable year ending before January 1, 1974, which, pursuant to instructions applicable to the return, is not required to be filed or (ii) the amendment of a return for such a taxable year which, pursuant to such instructions, is required to be filed. For corresponding rules applicable to taxable years beginning before January 1, 1967, see 26 CFR 1.6012-1(b) (Revised as of January 1, 1967).

(Sec. 1445 (98 Stat. 655; 26 U.S.C. 1445), sec. 6012 (68A Stat. 732; 26 U.S.C. 6012), and 7805 (68A Stat. 917; 26 U.S.C. 7805) of the Internal Revenue Code of 1954)

[T.D. 6500, 25 FR 12108, Nov. 26, 1960]

Editorial Note:For Federal Register citations affecting § 1.6012-1, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6012-2 Corporations required to make returns of income.

(a) In general—(1) Requirement of return. Except as provided in paragraphs (e) and (g)(1) of this section with respect to charitable and other organizations having unrelated business income and to certain foreign corporations, respectively, every corporation, as defined in section 7701(a)(3), subject to taxation under subtitle A of the Code shall make a return of income regardless of whether it has taxable income or regardless of the amount of its gross income.

(2) Existence of corporation. A corporation in existence during any portion of a taxable year is required to make a return. If a corporation was not in existence throughout an annual accounting period (either calendar year or fiscal year), the corporation is required to make a return for that fractional part of a year during which it was in existence. A corporation is not in existence after it ceases business and dissolves, retaining no assets, whether or not under State law it may thereafter be treated as continuing as a corporation for certain limited purposes connected with winding up its affairs, such as for the purpose of suing and being sued. If the corporation has valuable claims for which it will bring suit during this period, it has retained assets and therefore continues in existence. A corporation does not go out of existence if it is turned over to receivers or trustees who continue to operate it. If a corporation has received a charter but has never perfected its organization and has transacted no business and has no income from any source, it may upon presentation of the facts to the district director be relieved from the necessity of making a return. In the absence of a proper showing of such facts to the district director, a corporation will be required to make a return.

(3) Form of return. The return required of a corporation under this section shall be made on Form 1120 unless the corporation is a type for which a special form is prescribed. The special forms of returns and schedules required of particular types of corporations are set forth in paragraphs (b) to (g), inclusive, of this section.

(4) Disclosure of uncertain tax positions. A corporation required to make a return under this section shall attach Schedule UTP, Uncertain Tax Position Statement, or any successor form, to such return, in accordance with forms, instructions, or other appropriate guidance provided by the IRS.

(5) Effective/applicability date. Paragraph (a)(4) of this section applies to returns filed for tax years beginning on or after January 1, 2010.

(b) Personal holding companies. A personal holding company, as defined in section 542, including a foreign corporation within the definition of such section, shall attach Schedule PH, Computation of U.S. Personal Holding Company Tax, to the return required by paragraph (a) or (g), as the case may be, of this section.

(c) Insurance companies—(1) Domestic life insurance companies—(i) In general. A life insurance company subject to tax under section 801 shall make a return on Form 1120-L, “U.S. Life Insurance Company Income Tax Return.” Except as provided in paragraph (c)(4) of this section, such company shall file with its return—

(A) A copy of its annual statement which shows the reserves used by the company in computing the taxable income reported on its return; and

(B) A copy of Schedule A (real estate) and of Schedule D (bonds and stocks), or any successor thereto, of such annual statement.

(ii) Mutual savings banks. Mutual savings banks conducting life insurance business and meeting the requirements of section 594 are subject to partial tax computed on Form 1120, “U.S. Corporation Income Tax Return,” and partial tax computed on Form 1120-L. The Form 1120-L is attached as a schedule to Form 1120, together with the annual statement and schedules required to be filed with Form 1120-L.

(2) Domestic nonlife insurance companies. Every domestic insurance company other than a life insurance company shall make a return on Form 1120-PC, “U.S. Property and Casualty Insurance Company Income Tax Return.” This includes organizations described in section 501(m)(1) that provide commercial-type insurance and organizations described in section 833. Except as provided in paragraph (c)(4) of this section, such company shall file with its return a copy of its annual statement (or a pro forma annual statement), including the underwriting and investment exhibit (or any successor thereto) for the year covered by such return.

(3) Foreign insurance companies. The provisions of paragraphs (c)(1) and (c)(2) of this section concerning the returns and statements of insurance companies subject to tax under section 801 or section 831 also apply to foreign insurance companies subject to tax under those sections, except that the copy of the annual statement required to be submitted with the return shall, in the case of a foreign insurance company that is not required to file an annual statement, be a copy of the pro forma annual statement relating to the United States business of such company.

(4) Special rule for insurance companies filing their Federal income tax returns electronically. If an insurance company described in paragraph (c)(1), (2), or (3) of this section files its Federal income tax return electronically, it must include on or with such return its annual statement (or pro forma annual statement), or a portion thereof, as and to the extent required by forms or instructions. If the full annual statement is not required to be included with the return, such statement must be available at all times for inspection by authorized Internal Revenue Service officers or employees and retained for so long as such statements may be material in the administration of any internal revenue law. See § 1.6001-1(e).

(5) Definition. For purposes of this section, the term annual statement means the annual statement, the form of which is approved by the National Association of Insurance Commissioners (NAIC), which is filed by an insurance company for the year with the insurance departments of States, Territories, and the District of Columbia. The term annual statement also includes a pro forma annual statement if the insurance company is not required to file the NAIC annual statement.

(d) Affiliated groups. For the forms to be used by affiliated corporations filing a consolidated return, see § 1.1502-75.

(e) Charitable and other organizations with unrelated business income. Every organization described in section 511(a)(2) which is subject to the tax imposed by section 511(a)(1) on its unrelated business taxable income shall make a return on Form 990-T for each taxable year if it has gross income, included in computing unrelated business taxable income for such taxable year, of $1,000 or more. The filing of a return of unrelated business income does not relieve the organization of the duty of filing other required returns.

(f) Subchapter T cooperatives—(1) In general. For taxable years ending on or after December 31, 2007, a cooperative organization described in section 1381 (including a farmers' cooperative exempt from tax under section 521) is required to make a return, whether or not it has taxable income and regardless of the amount of its gross income, on Form 1120-C, “U.S. Income Tax Return for Cooperative Associations,” or such other form as may be designated by the Commissioner.

(2) Farmers' cooperatives. For taxable years ending before December 31, 2007, a farmers' cooperative organization described in section 521(b)(1) (including a farmers' cooperative that is not exempt from tax under section 521) is required to make a return on Form 990-C, “Farmers' Cooperative Association Income Tax Return.”

(3) Effective/applicability date. This paragraph (f) is applicable on or after July 30, 2007.

(g) Returns by foreign corporations—(1) Requirement of return—(i) In general. Except as otherwise provided in subparagraph (2) of this paragraph, every foreign corporation which is engaged in trade or business in the United States at any time during the taxable year or which has income which is subject to taxation under subtitle A of the Code (relating to income taxes) shall make a return on Form 1120-F. Thus, for example, a foreign corporation which is engaged in trade or business in the United States at any time during the taxable year is required to file a return on Form 1120-F even though (a) it has no income which is effectively connected with the conduct of a trade or business in the United States, (b) it has no income from sources within the United States, or (c) its income is exempt from income tax by reason of an income tax convention or any section of the Code. However, if the foreign corporation has no gross income for the taxable year, it is not required to complete the return schedules but must attach a statement to the return indicating the nature of any exclusions claimed and the amount of such exclusions to the extent such amounts are readily determinable.

(ii) Treaty income. If the gross income of a foreign corporation includes treaty income, as defined in paragraph (b)(1) of § 1.871-12, a statement shall be attached to the return on Form 1120-F showing with respect to that income:

(a) The amounts of tax withheld,

(b) The names and post office addresses of withholding agents, and

(c) Such other information as may be required by the return form or by the instructions issued with respect to the form, to show the taxpayer's entitlement to the reduced rate of tax under the tax convention.

(iii) Balance sheet and reconciliation of income. At the election of the taxpayer, the balance sheets and reconciliation of income, as shown on Form 1120-F, may be limited to:

(a) The assets of the corporation located in the United States and to its other assets used in the trade or business conducted in the United States, and

(b) Its income effectively connected with the conduct of a trade or business in the United States and its other income from sources within the United States.

(2) Exceptions—(i) Return not required when tax is fully paid at source—(a) In general. A foreign corporation which at no time during the taxable year is engaged in a trade or business in the United States is not required to make a return for the taxable year if its tax liability for the taxable year is fully satisfied by the withholding of tax at source under chapter 3 of the Code. For purposes of this subdivision, some of the items of income from sources within the United States upon which the tax liability will not have been fully satisfied by the withholding of tax at source under chapter 3 of the Code are:

(1) Interest upon so-called tax-free covenant bonds upon which, in accordance with section 1451 and § 1.1451-1, a tax of only 2 percent is required to be withheld at source,

(2) In the case of bonds or other evidence of indebtedness issued after September 25, 1965, amounts described in section 881(a)(3),

(3) Accrued interest received in connection with the sale of bonds between interest dates, which, in accordance with paragraph (h) of § 1.1441-4, is not subject to withholding of tax at source.

(b) Corporations not included. This subdivision (i) shall not apply:

(1) To a foreign corporation which has income for the taxable year which is treated under section 882(d) or (e) and § 1.882-2 as income which is effectively connected for the taxable year with the conduct of a trade or business in the United States by that corporation,

(2) To a foreign corporation making a claim under § 301.6402-3 of this chapter (Procedure and Administration Regulations) for the refund of an overpayment of tax for the taxable year, or

(3) To a foreign corporation described in paragraph (c)(2)(i) of § 1.532-1 whose accumulated taxable income for the taxable year is determined under paragraph (b)(2) of § 1.535-1.

(ii) Beneficiaries of estates or trusts. A foreign corporation which is a beneficiary of an estate or trust which is engaged in trade or business in the United States is not required to make a return for the taxable year merely because it is deemed to be engaged in trade or business within the United States under section 875(2). However, such foreign corporation will be required to make a return if it otherwise satisfies the conditions of subparagraph (1)(i) of this paragraph for making a return.

(iii) Special returns and schedules. The provisions of paragraphs (b) through (f) of this section shall apply to a foreign corporation except that a foreign corporation which is an insurance company to which paragraph (c)(3) of this section applies shall make a return on Form 1120-F and not on Form 1120. If a foreign corporation which is an insurance company to which paragraph (c) (1) or (2) of this section applies has income for the taxable year from sources within the United States which is not effectively connected for that year with the conduct of a trade or business in the United States by that corporation, the corporation shall attach to its return on Form 1120L or 1120M, as the case may be, a separate schedule showing the nature and amount of the items of such income, the rate of tax applicable thereto, and the amount of tax withheld therefrom under chapter 3 of the Code.

(3) Representative or agent for foreign corporation—(i) Cases where power of attorney is not required. The responsible representative or agent within the United States of a foreign corporation shall make on behalf of his principal a return of, and shall pay the tax on, all income coming within his control as representative or agent which is subject to the income tax under subtitle A of the Code. The agency appointment will determine how completely the agent is substituted for the principal for tax purposes. Any person who collects interest or dividends on deposited securities of a foreign corporation, executes ownership certificates in connection therewith, or sells such securities under special instructions shall not be deemed merely by reason of such acts to be the responsible representative or agent of the foreign corporation. If the responsible representative or agent does not have a specific power of attorney from the foreign corporation to file a return in its behalf, the return shall be accompanied by a statement to the effect that the representative or agent does not possess specific power of attorney to file a return for such corporation but that the return is being filed in accordance with the provisions of this subdivision.

(ii) Cases where power of attorney is required. Whenever a return of income of a foreign corporation is made by an agent acting under a duly authorized power of attorney for that purpose, the return shall be accompanied by the power of attorney in proper form, or a copy thereof specifically authorizing him to represent his principal in making, executing, and filing the income tax return. Form 2848 may be used for this purpose. The agent, as well as the taxpayer, may incur liability for the penalties provided for erroneous, false, or fraudulent returns. For the requirements regarding signing of returns, see § 1.6062-1. The rules of paragraph (e) of § 601.504 of this chapter (Statement of Procedural Rules) shall apply under this subparagraph in determining whether a copy of a power of attorney must be certified.

(iii) Limitation. A return of income shall be required under this subparagraph only if the foreign corporation is otherwise required to make a return in accordance with this paragraph.

(4) Disallowance of deductions and credits. For provisions disallowing deductions and credits when a return of income has not been filed by or on behalf of a foreign corporation, see section 882(c)(2) and the regulations thereunder, and paragraph (b) (2) and (3) of § 1.535-1.

(h) Electing small business corporations. An electing small business corporation, whether or not subject to the tax imposed by section 1378, shall make a return on Form 1120-S. See also section 6037 and the regulations thereunder.

(i) Hospital organizations with noncompliant hospital facilities. Every hospital organization (as defined in § 1.501(r)-1(b)(18)) that is subject to the tax imposed by § 1.501(r)-2(d) shall make a return on Form 990-T. The filing of a return to pay the tax described in § 1.501(r)-2(d) does not relieve the organization of the duty of filing other required returns.

(j) Items of tax preference—(1) In general. Every corporation required to make a return under this section, and having items of tax preference (described in section 57 and the regulation thereunder) in an amount specified by Form 4626, shall file such form as part of its return.

(2) Organizations with unrelated business income and foreign corporations. Regardless of the provisions of paragraphs (e) and (g) of this section, any organization described in either such paragraph having items of tax preference (described in section 57 and the regulations thereunder) in any amount entering into the computation or unrelated business income is required to make a return on form 990-T or form 120F, respectively, and to attach the required form as part of such return.

(k) Other provisions. For returns by fiduciaries or corporations, see § 1.6012-3. For information returns by corporations regarding payments of dividends, see §§ 1.6042-1 through 1.6042-3, inclusive; regarding corporate dissolutions or liquidations, see § 1.6043-1; regarding distributions in liquidation, see § 1.6043-2; regarding payments of patronage dividends, see §§ 1.6044-1 through 1.6044-4, inclusive; and regarding certain payments of interest, see §§ 1.6049-1 and 1.6049-1. For returns as to formation or reorganization of foreign corporations, see §§ 1.6046-1 through 1.6046-3, inclusive.

(l) Applicability date. Paragraph (c) of this section applies to any taxable year beginning after October 13, 2020. For taxable years beginning on or before October 13, 2020, see paragraph (c) of this section as contained in 26 CFR part 1 in effect on April 1, 2020.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960]

Editorial Note:For Federal Register citations affecting § 1.6012-2, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6012-3 Returns by fiduciaries.

(a) For estates and trusts—(1) In general. Every fiduciary, or at least one of joint fiduciaries, must make a return of income on form 1041 (or by use of a composite return pursuant to § 1.6012-5) and attach the required form if the estate or trust has items of tax preference (as defined in section 57 and the regulations thereunder) in any amount:

(i) For each estate for which he acts if the gross income of such estate for the taxable year is $600 or more;

(ii) For each trust for which he acts, except a trust exempt under section 501(a), if such trust has for the taxable year any taxable income, or has for the taxable year gross income of $600 or more regardless of the amount of taxable income; and

(iii) For each estate and each trust for which he acts, except a trust exempt under section 501(a), regardless of the amount of income for the taxable year, if any beneficiary of such estate or trust is a nonresident alien.

(iv) For each trust electing to be taxed as, or as part of, an estate under section 645 for which a trustee acts, and for each related estate joining in a section 645 election for which an executor acts, if the aggregate gross income of the electing trust(s) and related estate, if any, joining in the election for the taxable year is $600 or more. (For the respective filing requirements of the trustee of each electing trust and executor of any related estate, see § 1.645-1).

(2) Wills and trust instruments. At the request of the Internal Revenue Service, a copy of the will or trust instrument (including any amendments), accompanied by a written declaration of the fiduciary under the penalties of perjury that it is a true and complete copy, shall be filed together with a statement by the fiduciary indicating the provisions of the will or trust instrument (including any amendments) which, in the fiduciary's opinion, determine the extent to which the income of the estate or trust is taxable to the estate or trust, the beneficiaries, or the grantor, respectively.

(3) Domiciliary and ancillary representatives. In the case of an estate required to file a return under subparagraph (1) of this paragraph, having both domiciliary and ancillary representatives, the domiciliary and ancillary representatives must each file a return on Form 1041. The domiciliary representative is required to include in the return rendered by him as such domiciliary representative the entire income of the estate. The return of the ancillary representative shall be filed with the district director for his internal revenue district and shall show the name and address of the domiciliary representative, the amount of gross income received by the ancillary representative, and the deductions to be claimed against such income, including any amount of income properly paid or credited by the ancillary representative to any legatee, heir, or other beneficiary. If the ancillary representative for the estate of a nonresident alien is a citizen or resident of the United States, and the domiciliary representative is a nonresident alien, such ancillary representative is required to render the return otherwise required of the domiciliary representative.

(4) Two or more trusts. A trustee of two or more trusts must make a separate return for each trust, even though such trusts were created by the same grantor for the same beneficiary or beneficiaries.

(5) Trusts with unrelated business income. Every fiduciary for a trust described in section 511(b)(2) which is subject to the tax imposed on its unrelated business taxable income by section 511(b)(1) shall make a return on Form 990-T for each taxable year if the trust has gross income, included in computing unrelated business taxable income for such taxable year, of $1,000 or more. The filing of a return of unrelated business income does not relieve the fiduciary of such trust from the duty of filing other required returns.

(6) Charitable remainder trusts. Every fiduciary for a charitable remainder annuity trust (as defined in § 1.664-2) or a charitable remainder unitrust (as defined in § 1.664-3) shall make a return on Form 1041-B for each taxable year of the trust even though it is nonexempt because it has unrelated business taxable income. The return on Form 1041-B shall be made in accordance with the instructions for the form and shall be filed with the designated Internal Revenue office on or before the 15th day of the fourth month following the close of the taxable year of the trust. A copy of the instrument governing the trust, accompanied by a written declaration of the fiduciary under the penalties of perjury that it is a true and complete copy, shall be attached to the return for the first taxable year of the trust.

(7) Certain trusts described in section 4947(a)(1). For taxable years beginning after December 31, 1980, in the case of a trust described in section 4947(a)(1) which has no taxable income for a taxable year, the filing requirements of section 6012 and this section shall be satisfied by the filing, pursuant to § 53.6011-1 of this chapter (Foundation Excise Tax Regulations) and § 1.6033-2(a), by the fiduciary of such trust of—

(i) Form 990-PF if such trust is treated as a private foundation, or

(ii) Form 990 if such trust is not treated as a private foundation.

When the provisions of this paragraph (a)(7) are met, the fiduciary shall not be required to file Form 1041.

(8) Estate and trusts liable for qualified tax. In the case of an estate or trust which is liable for one or more qualified State individual income taxes, as defined in section 6362, for a taxable year, see paragraph (b) of § 301.6361-1 of this chapter (Regulations on Procedure and Administration) for rules relating to returns required to be made.

(9) A trust any portion of which is treated as owned by the grantor or another person pursuant to sections 671 through 678. In the case of a trust any portion of which is treated as owned by the grantor or another person under the provisions of subpart E (section 671 and following) part I, subchapter J, chapter 1 of the Internal Revenue Code see § 1.671-4.

(10) Hospital organizations organized as trusts with noncompliant hospital facilities. Every fiduciary for a hospital organization (as defined in § 1.501(r)-1(b)(18)) organized as a trust described in section 511(b)(2) that is subject to the tax imposed by § 1.501(r)-2(d) shall make a return on Form 990-T. The filing of a return to pay the tax described in § 1.501(r)-2(d) does not relieve the organization of the duty of filing other required returns.

(b) For other persons—(1) Decedents. The executor or administrator of the estate of a decedent, or other person charged with the property of a decedent, shall make the return of income required in respect of such decedent. For the decedent's taxable year which ends with the date of his death, the return shall cover the period during which he was alive. For the filing of returns of income for citizens and alien residents of the United States, and alien residents of Puerto Rico, see paragraph (a) of § 1.6012-1. For the filing of a joint return after death of spouse, see paragraph (d) of § 1.6013-1.

(2) Nonresident alien individuals—(i) In general. A resident or domestic fiduciary or other person charged with the care of the person or property of a nonresident alien individual shall make a return for that individual and pay the tax unless:

(a) The nonresident alien individual makes a return of, and pays the tax on, his income for the taxable year,

(b) A responsible representative or agent in the United States of the nonresident alien individual makes a return of, and pays the tax on, the income of such alien individual for the taxable year, or

(c) The nonresident alien individual has appointed a person in the United States to act as his agent for the purpose of making a return of income and, if such fiduciary is required to file a Form 1041 for an estate or trust of which such alien individual is a beneficiary, such fiduciary attaches a copy of the agency appointment to his return on Form 1041.

(ii) Income to be returned. A return of income shall be required under this subparagraph only if the nonresident alien individual is otherwise required to make a return in accordance with paragraph (b) of § 1.6012-1. The provisions of that paragraph shall apply in determining the form of return to be used and the income to be returned.

(iii) Disallowance of deductions and credits. For provisions disallowing deductions and credits when a return of income has not been filed by or on behalf of a nonresident alien individual, see section 874 and the regulations thereunder.

(iv) Alien resident of Puerto Rico. This subparagraph shall not apply to the return of a nonresident alien individual who is a bona fide resident of Puerto Rico during the entire taxable year. See § 1.876-1.

(v) Cross reference. For requirements of withholding tax at source on nonresident alien individuals and of returns with respect to such withheld taxes, see §§ 1.1441-1 to 1.1465-1, inclusive.

(3) Persons under a disability. A fiduciary acting as the guardian of a minor, or as the guardian or committee of an insane person, must make the return of income required in respect of such person unless, in the case of a minor, the minor himself makes the return or causes it to be made.

(4) Corporations. A receiver, trustee in dissolution, trustee in bankruptcy, or assignee, who, by order of a court of competent jurisdiction, by operation of law or otherwise, has possession of or holds title to all or substantially all the property or business of a corporation, shall make the return of income for such corporation in the same manner and form as corporations are required to make such returns. Such return shall be filed whether or not the receiver, trustee, or assignee is operating the property or business of the corporation. A receiver in charge of only a small part of the property of a corporation, such as a receiver in mortgage foreclosure proceedings involving merely a small portion of its property, need not make the return of income. See also § 1.6041-1, relating to returns regarding information at source; §§ 1.6042-1 to 1.6042-3, inclusive, relating to returns regarding payments of dividends; §§ 1.6044-1 to 1.6044-4, inclusive, relating to returns regarding payments of patronage dividends; and §§ 1.6049-1 and 1.6049-2, relating to returns regarding certain payments of interest.

(5) Individuals in receivership. A receiver who stands in the place of an individual must make the return of income required in respect of such individual. A receiver of only part of the property of an individual need not file a return, and the individual must make his own return.

(c) Joint fiduciaries. In the case of joint fiduciaries, a return is required to be made by only one of such fiduciaries. A return made by one of joint fiduciaries shall contain a statement that the fiduciary has sufficient knowledge of the affairs of the person for whom the return is made to enable him to make the return, and that the return is, to the best of his knowledge and belief, true and correct.

(d) Other provisions. For the definition of the term “fiduciary”, see section 7701(a)(6) and the regulations thereunder. For information returns required to be made by fiduciaries under section 6041, see § 1.6041-1. As to further duties and liabilities of fiduciaries, see section 6903 and § 301.6903-1 of this chapter (Regulations on Procedure and Administration).

[T.D. 6500, 25 FR 12108, Nov. 26, 1960]

Editorial Note:For Federal Register citations affecting § 1.6012-3, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6012-4 Miscellaneous returns.

For returns by regulated investment companies of tax on undistributed capital gain designated for special treatment under section 852(b)(3)(D), see § 1.852-9. For returns with respect to tax withheld on nonresident aliens and foreign corporations and on tax-free covenant bonds, see §§ 1.1461-1 to 1.1465-1, inclusive. For the requirement of an annual report by persons completing a Government contract, see 26 CFR (1939) 17.16 (Treasury Decision 4906, approved June 23, 1939), and 26 CFR (1939) 16.15 (Treasury Decision 4909, approved June 28, 1939) , as made applicable to section 1471 of the 1954 Code by Treasury Decision 6091, approved August 16, 1954 (19 FR 5167, C.B. 1954-2, 47). See also § 1.1471-1.

[T.D. 7332, 39 FR 44231, Dec. 23, 1974, as amended by T.D. 9849, 84 FR 9237, Mar. 14, 2019]

Editorial Note:For the convenience of the user §§ 16.15 and 17.16 of 26 CFR (1939) are set forth below:

§ 16.15 Annual reports for income taxable years.

(b) Time for filing annual reports. Annual reports of contracts and subcontracts coming within the scope of the act and the regulations in this part completed by a contracting party within an income-taxable year must be filed on or before the 15th day of the ninth month following the close of the contracting party's income-taxable year. It is important that the contracting party render on or before the due date an annual report as nearly complete and final as it is possible for the contracting party to prepare. An extension of time granted the contracting party for filing its Federal income tax return does not serve to extend the time for filing the annual report required by this section. Authority consistent with authorizations for granting extensions of time for filing Federal income tax returns is hereby delegated to the various collectors of internal revenue for granting extensions of time for filing the reports required by this section. Application for extensions of time for filing such reports should be addressed to the district director of internal revenue for the district in which the contracting party files its Federal income tax returns and must contain a full recital of the causes for the delay.

§ 17.16 Annual reports for income-taxable years.

(a) General requirements. Every contracting party completing a contract or subcontract within the contracting party's income-taxable year ending after April 3, 1939 shall file, with the district director of internal revenue for the internal revenue district in which the contracting party's Federal income tax return is required to be filed, annual reports on the prescribed forms of the profit and excess profit on all contracts and subcontracts coming within the scope of the act. If any contracts or subcontracts so completed by the contracting party were entered into for the construction or manufacture of any complete naval vessel or any portion thereof, the profit and excess profit on all such contracts and subcontracts completed within the income-taxable year ending after April 3, 1939 shall be computed in accordance with the provisions of § 17.6. If any contracts or subcontracts so completed by the contracting party were entered into for the construction or manufacture of any complete naval aircraft or any portion thereof, the profit and excess profit on all such contracts and subcontracts completed within the income-taxable year ending after April 3, 1939 shall be computed in accordance with the provisions of § 17.7. There shall be included as a part of the annual report a statement, preferably in columnar form, showing separately for each contract or subcontract completed by the contracting party within the income-taxable year and covered by the report, the total contract price, the cost of performing the contract or subcontract and resulting profit or loss on each contract or subcontract together with a summary statement showing in detail the computation of the net profit or net loss upon each group of contracts and subcontracts covered by the report and the amount of the excess profit, if any, with respect to each group of contracts and subcontracts covered by the report. A copy of the report made to the Secretary of the Navy (see § 17.15) with respect to each contract or subcontract covered in the annual report, shall be filed as a part of such annual report. In case the income-taxable year of the contracting party is a period of less than twelve months (see § 17.1), the reports required by this section shall be made for such period and not for a full year.

(b) Time for filing annual reports. Annual reports of contracts and subcontracts completed by a contracting party within an income-taxable year ending after April 3, 1939 shall be filed on or before the 15th day of the ninth month following the close of the contracting party's income-taxable year. It is important that the contracting party render on or before the due date annual reports as nearly complete and final as it is possible for the contracting party to prepare. An extension of time granted the contracting party for filing its Federal income tax return does not serve to extend the time for filing the annual reports required by this section. Authority consistent with authorizations for granting extensions of time for filing Federal income tax returns is hereby delegated to the various district directors of internal revenue for granting extensions of time for filing the reports required by this section. Application for extension of time for filing such reports should be addressed to the district director of internal revenue for the district in which the contracting party files its Federal income tax returns and must contain a full recital of the causes for the delay.

§ 1.6012-5 Composite return in lieu of specified form.

The Commissioner may authorize the use, at the option of a person required to make a return, of a composite return in lieu of any form specified in this part for use by such a person, subject to such conditions, limitations, and special rules governing the preparation, execution, filing, and correction thereof as the Commissioner may deem appropriate. Such composite return shall consist of a form prescribed by the Commissioner and an attachment or attachments of magnetic tape or other approved media. Notwithstanding any provisions in this part to the contrary, a single form and attachment may comprise the returns of more than one such person. To the extent that the use of a composite return has been authorized by the Commissioner, references in this part to a specific form for use by such a person shall be deemed to refer also to a composite return under this section.

[T.D. 7200, 37 FR 16544, Aug. 16, 1972]

§ 1.6012-6 Returns by political organizations.

(a) Requirement of return—(1) In general. For taxable years beginning after December 31, 1974, every political organization described in section 527(e)(1), and every fund described in section 527(f)(3) or section 527(g), and every organization described in section 501(c) and exempt from taxation under section 501(a) shall, if a tax is imposed on such an organization or fund by section 527(b), make a return of income on or before the fifteenth day of the fourth month following the close of the taxable year.

(2) Taxable years beginning after December 31, 1971, and before January 1, 1975. For taxable years beginning after December 31, 1971, and before January 1, 1975, any political organization which would be described in section 527(e)(1) if such section applied to such years shall not be required to make a return if such organization would not be required to make a return under paragraph (a)(1) of this section.

(b) Form of return. The return required by an organization or fund upon which a tax is imposed by section 527(b) shall be made on Form 1120-POL.

(c) Applicability date. This section applies to returns filed on or after January 30, 2020. Section 1.6012-6T (as contained in 26 CFR part 1, revised April 2019) applies to returns filed before January 30, 2020.

[T.D. 7516, 42 FR 57312, Nov. 2, 1977; 43 FR 2721, Jan. 19, 1978; T.D. 9821, 82 FR 33444, July 20, 2017; T.D. 9892, 85 FR 5324, Jan. 30, 2020]

§ 1.6013-1 Joint returns.

(a) In general. (1) A husband and wife may elect to make a joint return under section 6013(a) even though one of the spouses has no gross income or deductions. For rules for determining whether individuals occupy the status of husband and wife for purposes of filing a joint return, see paragraph (a) of § 1.6013-4. For any taxable year with respect to which a joint return has been filed, separate returns shall not be made by the spouses after the time for filing the return of either has expired. See, however, paragraph (d)(5) of this section for the right of an executor to file a late separate return for a deceased spouse and thereby disaffirm a timely joint return made by the surviving spouse.

(2) A joint return of a husband and wife (if not made by an agent of one or both spouses) shall be signed by both spouses. The provisions of paragraph (a)(5) of § 1.6012-1, relating to returns made by agents, shall apply where one spouse signs a return as agent for the other, or where a third party signs a return as agent for one or both spouses.

(b) Nonresident alien. A joint return shall not be made if either the husband or wife at any time during the taxable year is a nonresident alien, unless an election is in effect for the taxable year under section 6013 (g) or (h) and the regulations thereunder.

(c) Different taxable years. Except as otherwise provided in this section, a husband and wife shall not file a joint return if they have different taxable years.

(d) Joint return after death. (1) Section 6013(a)(2) provides that a joint return may be made for the survivor and the deceased spouse or for both deceased spouses if the taxable years of such spouses begin on the same day and end on different days only because of the death of either or both. Thus, if a husband and wife make this return on a calendar year basis, and the wife dies on August 1, 1956, a joint return may be made with respect to the calendar year 1956 of the husband and the taxable year of the wife beginning on January 1, 1956, and ending with her death on August 1, 1956. Similarly, if husband and wife both make their returns on the basis of a fiscal year beginning on July 1 and the wife dies on October 1, 1956, a joint return may be made with respect to the fiscal year of the husband beginning on July 1, 1956, and ending on June 30, 1957, and with respect to the taxable year of the wife beginning on July 1, 1956, and ending with her death on October 1, 1956.

(2) The provision allowing a joint return to be made for the taxable year in which the death of either or both spouses occurs is subject to two limitations. The first limitation is that if the surviving spouse remarries before the close of his taxable year, he shall not make a joint return with the first spouse who died during the taxable year. In such a case, however, the surviving spouse may make a joint return with his new spouse provided the other requirements with respect to the filing of a joint return are met. The second limitation is that the surviving spouse shall not make a joint return with the deceased spouse if the taxable year of either spouse is a fractional part of a year under section 443(a)(1) resulting from a change of accounting period. For example, if a husband and wife make their returns on the calendar year basis and the wife dies on March 1, 1956, and thereafter the husband receives permission to change his annual accounting period to a fiscal year beginning July 1, 1956, no joint return shall be made for the short taxable year ending June 30, 1956. Similarly, if a husband and wife who make their returns on a calendar year basis receive permission to change to a fiscal year beginning July 1, 1956, and the wife dies on June 1, 1956, no joint return shall be made for the short taxable year ending June 30, 1956.

(3) Section 6013(a)(3) provides for the method of making a joint return in the case of the death of one spouse or both spouses. The general rule is that, in the case of the death of one spouse, or of both spouses, the joint return with respect to the decedent may be made only by his executor or administrator, as defined in paragraph (c) of § 1.6013-4. An exception is made to this general rule whereby, in the case of the death of one spouse, the joint return may be made by the surviving spouse with respect to both him and the decedent if all the following conditions exist:

(i) No return has been made by the decedent for the taxable year in respect of which the joint return is made;

(ii) No executor or administrator has been appointed at or before the time of making such joint return; and

(iii) No executor or administrator is appointed before the last day prescribed by law for filing the return of the surviving spouse.

These conditions are to be applied with respect to the return for each of the taxable years of the decedent for which a joint return may be made if more than one such taxable year is involved. Thus, in the case of husband and wife on the calendar year basis, if the wife dies in February 1957, a joint return for the husband and wife for 1956 may be made if the conditions set forth in this subparagraph are satisfied with respect to such return. A joint return also may be made by the survivor for both himself and the deceased spouse for the calendar year 1957 if it is separately determined that the conditions set forth in this subparagraph are satisfied with respect to the return for such year. If, however, the deceased spouse should, prior to her death, make a return for 1956, the surviving spouse may not thereafter make a joint return for himself and the deceased spouse for 1956.

(4) If an executor or administrator is appointed at or before the time of making the joint return or before the last day prescribed by law for filing the return of the surviving spouse, the surviving spouse cannot make a joint return for himself and the deceased spouse whether or not a separate return for the deceased spouse is made by such executor or administrator. In such a case, any return made solely by the surviving spouse shall be treated as his separate return. The joint return, if one is to be made, must be made by both the surviving spouse and the executor or administrator. In determining whether an executor or administrator is appointed before the last day prescribed by law for filing the return of the surviving spouse, an extension of time for making the return is included.

(5) If the surviving spouse makes the joint return provided for in subparagraph (3) of this paragraph and thereafter an executor or administrator of the decedent is appointed, the executor or administrator may disaffirm such joint return. This disaffirmance, in order to be effective, must be made within one year after the last day prescribed by law for filing the return of the surviving spouse (including any extension of time for filing such return) and must be made in the form of a separate return for the taxable year of the decedent with respect to which the joint return was made. In the event of such proper disaffirmance the return made by the survivor shall constitute his separate return, that is, the joint return made by him shall be treated as his return and the tax thereon shall be computed by excluding all items properly includible in the return of the deceased spouse. The separate return made by the executor or administrator shall constitute the return of the deceased spouse for the taxable year.

(6) The time allowed the executor or administrator to disaffirm the joint return by the making of a separate return does not establish a new due date for the return of the deceased spouse. Accordingly, the provisions of sections 6651 and 6601, relating to delinquent returns and delinquency in payment of tax, are applicable to such return made by the executor in disaffirmance of the joint return.

(e) Return of surviving spouse treated as joint return. For provisions relating to the treatment of the return of a surviving spouse as a joint return for each of the next two taxable years following the year of the death of the spouse, see section 2 and § 1.2-2.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 7274, 38 FR 11345, May 7, 1973; T.D. 7670, 45 FR 6929, Jan. 31, 1980]

§ 1.6013-2 Joint return after filing separate return.

(a) In general. (1) Where an individual has filed a separate return for a taxable year for which a joint return could have been made by him and his spouse under section 6013(a), and the time prescribed by law for filing the return for such taxable year has expired, such individual and his spouse may, under conditions hereinafter set forth, make a joint return for such taxable year. The joint return filed pursuant to section 6013(b) shall constitute the return of the husband and wife for such year, and all payments, credits, refunds, or other repayments, made or allowed with respect to the separate return of either spouse are to be taken into account in determining the extent to which the tax based on the joint return has been paid.

(2) If a joint return is made under section 6013(b), any election, other than the election to file a separate return, made by either spouse in his separate return for the taxable year with respect to the treatment of any income, deduction, or credit of such spouse shall not be changed in the making of the joint return where such election would have been irrevocable if the joint return had not been made. Thus, if one spouse has made an irrevocable election to adopt and use the last-in, first-out inventory method under section 472, this election may not be changed upon making the joint return under section 6013(b).

(3) A joint return made under section 6013(b) after the death of either spouse shall, with respect to the decedent, be made only by his executor or administrator. Thus, where no executor or administrator has been appointed, a joint return cannot be made under section 6013(b).

(4) A nonresidential alien treated as a resident under section 6013 (g) or (h) for any taxable year ending on or after December 31, 1975, and the alien's U.S. citizen or resident spouse may file a joint return for that taxable year, even though one or both of the spouses have previously filed separate returns for that taxable year. In this case, the rule in paragraph (a)(3) of this section does not apply.

(b) Limitations with respect to making of election. A joint return shall not be made under section 6013(b)(1) with respect to a taxable year:

(1) Beginning on or before July 30, 1996, unless there is paid in full at or before the time of the filing of the joint return the amount shown as tax upon such joint return; or

(2) After the expiration of three years from the last day prescribed by law for filing the return for such taxable year determined without regard to any extension of time granted to either spouse; or

(3) After there has been mailed to either spouse, with respect to such taxable year, a notice of deficiency under section 6212, if the spouse, as to such notice, files a petition with the Tax Court of the United States within the time prescribed in section 6213; or

(4) After either spouse has commenced a suit in any court for the recovery of any part of the tax for such taxable year; or

(5) After either spouse has entered into a closing agreement under section 7121 with respect to such taxable year, or after any civil or criminal case arising against either spouse with respect to such taxable year has been compromised under section 7122.

(c) When return deemed filed; assessment and collection; credit or refund. (1) For the purpose of section 6501, relating to the period of limitations upon assessment and collection, and section 6651, relating to delinquent returns, a joint return made under section 6013(b) shall be deemed to have been filed, giving due regard to any extension of time granted to either spouse, on the following date:

(i) Where both spouses filed separate returns, prior to making the joint return under section 6013(b), on the date the last separate return of either spouse was filed for the taxable year, but not earlier than the last date prescribed by law for the filing of the return of either spouse;

(ii) Where only one spouse was required and did file a return prior to the making of the joint return under section 6013(b), on the date of the filing of the separate return, but not earlier than the last day prescribed by law for the filing of such return; or

(iii) Where both spouses were required to file a return, but only one spouse did so file, on the date of the filing of the joint return under section 6013(b).

(2) For the purpose of section 6511, relating to refunds and credits, a joint return made under section 6013(b) shall be deemed to have been filed on the last date prescribed by law for filing the return for such taxable year, determined without regard to any extension of time granted to either spouse for filing the return or paying the tax.

(d) Additional time for assessment. In the case of a joint return made under section 6013(b), the period of limitations provided in sections 6501 and 6502 shall not be less than one year after the date of the actual filing of such joint return. The expiration of the one year is to be determined without regard to the rules provided in paragraph (c)(1) of this section, relating to the application of sections 6501 and 6651 with respect to a joint return made under section 6013(b).

(e) Additions to the tax and penalties. (1) Where the amount shown as the tax by the husband and wife on a joint return made under section 6013(b) exceeds the aggregate of the amounts shown as tax on the separate return of each spouse, and such excess is attributable to negligence, intentional disregard of rules and regulations, or fraud at the time of the making of such separate return, there shall be assessed, collected, and paid in the same manner as if it were a deficiency an additional amount as provided by the following:

(i) If any part of such excess is attributable to negligence, or intentional disregard of rules and regulations, at the time of the making of such separate return, but without any intent to defraud, this additional amount shall be 5 percent of the total amount of the excess.

(ii) If any part of such excess is attributable to fraud with intent to evade tax at the time of the making of such separate return, this additional amount shall be 50 percent of the total amount of the excess. The latter addition is in lieu of the 50 percent addition to the tax provided in section 6653(b).

(2) For purposes of section 7206 (1) and (2) and section 7207 (relating to criminal penalties in the case of fraudulent returns), the term “return” includes a separate return filed by a spouse with respect to a taxable year for which a joint return is made under section 6013(b) after the filing of a separate return.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 7670, 45 FR 6929, Jan. 31, 1980; T.D. 8725, 62 FR 39117, July 22, 1997]

§ 1.6013-3 Treatment of joint return after death of either spouse.

For purposes of section 21 (relating to change in rates during a taxable year), section 443 (relating to returns for a period of less than 12 months), and section 7851(a)(1)(A) (relating to the applicability of certain provisions of the Internal Revenue Code of 1954 and the Internal Revenue Code of 1939), where the husband and wife have different taxable years because of death of either spouse, the joint return shall be treated as if the taxable years of both ended on the date of the closing of the surviving spouse's taxable year. Thus, in cases where the Internal Revenue Code of 1939 otherwise would apply to the taxable year of the decedent spouse and the Internal Revenue Code of 1954 would apply to the taxable year of the surviving spouse, this provision makes the Internal Revenue Code of 1954 applicable to the taxable years of both spouses if a joint return is filed.

§ 1.6013-4 Applicable rules.

(a) Status as husband and wife. For the purpose of filing a joint return under section 6013, the status as husband and wife of two individuals having taxable years beginning on the same day shall be determined:

(1) If the taxable year of each individual is the same, as of the close of such year; and

(2) If the close of the taxable year is different by reason of the death of one spouse, as of the time of such death.

An individual legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married. However, the mere fact that spouses have not lived together during the course of the taxable year shall not prohibit them from making a joint return. A husband and wife who are separated under an interlocutory decree of divorce retain the relationship of husband and wife until the decree becomes final. The fact that the taxpayer and his spouse are divorced or legally separated at any time after the close of the taxable year shall not deprive them of their right to file a joint return for such taxable year under section 6013.

(b) Computation of income, deductions, and tax. If a joint return is made, the gross income and adjusted gross income of husband and wife on the joint return are computed in an aggregate amount and the deductions allowed and the taxable income are likewise computed on an aggregate basis. Deductions limited to a percentage of the adjusted gross income, such as the deduction for charitable, etc., contributions and gifts, under section 170, will be allowed with reference to such aggregate adjusted gross income. A similar rule is applied in the case of the limitation of section 1211(b) on the allowance of losses resulting from the sale or exchange of capital assets (see § 1.1211-1). Although there are two taxpayers on a joint return, there is only one taxable income. The tax on the joint return shall be computed on the aggregate income and the liability with respect to the tax shall be joint and several. For computation of tax in the case of a joint return, see § 1.2-1. For tax in the case of a joint return of husband and wife electing to pay the optional tax under section 3, see § 1.3-1. For the election not to show on a joint return the amount of tax due in connection therewith, see paragraph (c) of § 1.6014-1 and paragraph (d) of § 1.6014-2. For separate computations of the self-employment tax of each spouse on a joint return, see paragraph (b) of § 1.6017-1.

(c) Definition of executor or administrator. For purposes of section 6013 the term “executor or administrator” means the person who is actually appointed to such office and not a person who is merely in charge of the property of the decedent.

(d) Return signed under duress. If an individual asserts and establishes that he or she signed a return under duress, the return is not a joint return. The individual who signed such return under duress is not jointly and severally liable for the tax shown on the return or any deficiency in tax with respect to the return. The return is adjusted to reflect only the tax liability of the individual who voluntarily signed the return, and the liability is determined at the applicable rates in section 1(d) for married individuals filing separate returns. Section 6212 applies to the assessment of any deficiency in tax on such return.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 7102, 36 FR 5497, Mar. 24, 1971; T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6013-6 Election to treat nonresident alien individual as resident of the United States.

(a) Election for special treatment—(1) In general. Two individuals who are husband and wife at the close of a taxable year ending on or after December 31, 1975, may make an election under this section for that taxable year if, at the close of that year, one spouse is a citizen or resident of the United States and the other spouse is a nonresident alien. The effect of the election is that each spouse is treated as a resident of the United States for purposes of chapters 1, 5, and 24 and sections 6012, 6013, 6072, and 6091 of the Code for the entire taxable year. An election made under this section is in effect for the taxable year for which made and for all subsequent years of the husband and wife, except:

(i) Any taxable year for which the election is suspended, as described in paragraph (a)(3) of this section, and

(ii) Any taxable year for which the election is terminated in accordance with paragraph (b) of this section and all subsequent taxable years.

A husband and wife may not make an election if an election previously made under this section by either spouse has been terminated under paragraph (b) of this section.

(2) Particular rules. (i) As used in paragraph (a)(3) of this section, the term “U.S. spouse” means any married individual who is a citizen or resident of the United States at any time during a taxable year.

(ii) An individual's residence is determined by application of the principles of §§ 301.7701(b)-1 through 301.7701(b)-9 of this chapter relating to what constitutes residence in the United States by an alien individual.

(iii) Whether two individuals are married at the close of a taxable year is determined by application of the rules in § 1.6013-4(a).

(iv) The provisions of section 879 and the regulations thereunder shall not apply for any taxable year for which an election under this section is in effect.

(v) An individual who makes an election under this section may not, for United States income tax purposes, claim under any United States income tax treaty not to be a U.S. resident. The relationship of U.S. income tax treaties and the election under this section is illustrated by the following example.

Example.H, a U.S. citizen, is married to W, a nonresident alien of the United States and a domiciliary of country X. H and W maintain their only permanent home in country X. W receives both U.S. source and country X source interest during the taxable year. The interest is not effectively connected with a permanent establishment or a fixed base in any country. H and W make the section 6013 (g) election. Under article ii (1) of the United States—country X Income Tax Convention interest derived and beneficially owned by a resident of one contracting state is exempt from tax in the other contracting state. Article 4 (1) of the treaty provides that an individual is a resident of a contracting state if subject to tax in that country by reason of the individual's domicile, residence, or citizenship. Under article 4 (1) of the treaty, W is a resident of country X by virtue of her domicile in country X and also of the United States by virtue of the section 6013 (g) election. Article 4 (2) of the treaty provides that if an individual is a resident of both the United States and country X by reason of article 4 (1), the individual shall be deemed to be a resident of the contracting state in which he or she has a permanent home available. Because W's sole permanent home is in country X, under article 4 (2) of the treaty W is treated as a resident of country X for purposes of the treaty. Because W has elected under section 6013(g) to be treated as a U.S. resident (and thus to be taxed on worldwide income), W may not, for U.S. income tax purposes, claim under the treaty not to be a U.S. resident. W, therefore, is subject to U.S. income tax on the interest. For purposes of country X income tax, W is considered a resident of country X under the treaty.

(3) Suspension of election. (i) An election made under this section is suspended and is not in effect for a taxable year subsequent to the first taxable year for which made if neither spouse is a U.S. spouse during that subsequent taxable year. Thus, for example, the election is in suspense if both spouses are nonresident aliens for the entire taxable year.

(ii) If either spouse dies during any taxable year for which the election under this section is in effect, other than the first taxable year for which the election is to be in effect, the taxable year shall include, solely for purposes of this paragraph (a)(3), only those days during the taxable year on which both spouses are alive. Thus, for example, if the U.S. spouse dies during the taxable year, the election is not suspended for that year even if the surviving nonresident alien spouse never acquires U.S. citizenship or residency. Similarly, if the nonresident alien spouse dies during the taxable year, the election is not suspended for that year even if the surviving U.S. spouse subsequently abandons U.S. citizenship or residency. However, if neither spouse was a U.S. spouse at any time during the period of the taxable year when both spouses were alive, the election is suspended for that year even if the surviving spouse subsequently acquires U.S. citizenship or residency.

For the effect of the death of either spouse on the status of the election in subsequent taxable years, see paragraph (b)(2) of this section.

(4) Time and manner of making an election. (i) A husband and wife shall make the election under this section by attaching a statement to a joint return for the first taxable year for which the election is to be in effect. The election must be made before the expiration of the period prescribed by section 6511(a) (or section 6511(c) if the period is extended by agreement) for making a claim for credit or refund. If either or both spouses die after the close of the taxable year but before the joint return is filed, the election may be made by the executor, administrator, or other person charged with the property of the deceased spouse. If the election is made with a joint amended return, the amended return should be made on Form 1040 or 1040A, the word “Amended” should be written clearly on the front of the return, and an amended return also must be filed for each subsequent taxable year as to which a return previously has been filed by either spouse.

(ii) The statement must contain a declaration that the election is being made and that the requirements of paragraph (a)(1) of this section are met for the taxable year. The statement must also contain the name, address, and taxpayer identifying number of each spouse. If the election is being made on behalf of a deceased spouse, the statement must contain the name and address of the executor, administrator, or other person making the election on behalf of the decreased spouse. The statement must be signed by both persons making the election.

(b) Termination of election—(1) Revocation. (i) An election under this section shall terminate if either spouse revokes the election. An election that is revoked terminates as of the first taxable year for which the last day prescribed by section 6072(a) and 6081(a) for filing the return of tax has not yet occurred.

(ii) Revocation of the election is made by filing a statement of revocation in the following manner. If the spouse revoking the election is required to file a return under section 6012, the statement is filed by attaching it to the return for the first taxable year to which the revocation applies. If the spouse revoking the election is not required to file a return under section 6012, but files a claim for refund under section 6511, the statement is filed by attaching it to the claim for refund. If the spouse revoking the election is not required to file a return and does not file a claim for refund, the statement is filed by submitting it to the service center director with whom was filed the most recent joint return of the spouses. The revocation may, if the revoking spouse dies after the close of the first taxable year to which the revocation applies but before the return, claim for refund, or statement of revocation is filed, be made by the executor, administrator or other person charged with the property of the deceased spouse.

(iii) A revocation of the election is effective as of a particular taxable year if it is filed on or before the last day prescribed by section 6072(a) and 6081(a) for filing the return of tax for that taxable year. However, the revocation is not final until that last day.

(iv) The statement of revocation must contain a declaration that the election under this section is being revoked. The statement must also contain the name, address, and taxpayer identifying number of each spouse. If the revocation is being made on behalf of a deceased spouse, the statement must contain the name and address of the executor, administrator, or other person revoking the election on behalf of the deceased spouse. The statement must also include a list of the States, foreign countries, and possessions of the United States which have community property laws and in which:

(A) Each spouse is domiciled, or

(B) real property is located from which either of the spouses receives income.

The statement must be signed by the person revoking the election.

(2) Death. An election under this section shall terminate if either spouse dies. An election that terminates on account of death terminates as of the first taxable year of the surviving spouse following the taxable year in which the death occurred. However, if the surviving spouse is a citizen or resident of the United States who is entitled to the benefits of section 2, the election terminates as of the first taxable year following the last taxable year for which the surviving spouse is entitled to the benefits of section 2. If both spouses die within the same taxable year, the election terminates as of the first day after the close of the taxable year in which the deaths occurred.

(3) Legal separation. An election under this section terminates if the spouses legally separate under a degree of divorce or of separate maintenance. An election that terminates on account of legal separation terminates as of the close of the taxable year preceding the taxable year in which the separation occurs. The rules in § 1.6013-4(a) are relevant in determining whether two spouses are legally separated.

(4) Inadequate records. An election under this section may be terminated by the Commissioner if it is determined that either spouse has failed to keep adequate records. An election that is terminated on account of inadequate records terminates as of the close of the taxable year preceding the taxable year for which the Commissioner determines that the election should be terminated. Adequate records are the books, records, and other information reasonably necessary to ascertain the amount of liability for taxes under chapters 1, 5, and 24 of the code of either spouse for the taxable year. Adequate records also includes the granting of access to the books and records.

(c) Illustrations. The application of this section is illustrated by the following examples. In each case the individual's taxable year is the calendar year and the spouses are not legally separated.

Example 1.W, a U.S. citizen for the entire taxable year 1979, is married to H, a nonresident alien individual. W and H may make the section 6013(g) election for 1979 by filing the statement of election with a joint return. If W and H make the election, income from sources within and without the United States received by W and H in 1979 and subsequent years must be included in gross income for each taxable year unless the election later is terminated or suspended. While W and H must file a joint return for 1979, joint or separate returns may be filed for subsequent years.

Example 2.H and W are husband and wife and are both nonresident alien individuals. In June 1980 H becomes a U.S. resident and remains a resident for the balance of the year. H and W may make the section 6013(g) election for 1980. If H and W make the election, income from sources within and without the United States received by H and W for the entire taxable year 1980 and subsequent years must be included in gross income for each taxable year, unless the election later is terminated or suspended.

Example 3.W, a U.S. resident on December 31, 1981, is married to H, a nonresident alien. W and H make the section 6013(g) election and file joint returns for 1981 and succeeding years. On January 10, 1987, W becomes a nonresident alien. H has remained a nonresident alien. W and H may file a joint return or separate returns for 1987. As neither W or H is a U.S. resident at any time during 1988, their election is suspended for 1988. If W and H have U.S. source or foreign source income effectively connected with the conduct of a U.S. trade or business in 1988, they must file separate returns as nonresident aliens. W becomes a U.S. resident again on January 5, 1990. Their election no longer is in suspense. Income from sources within and without the United States received by W or H in the years their election is not suspended must be included in gross income for each taxable year.

Example 4.H, a U.S. citizen for the entire taxable year 1979, is married to W, who is not a U.S. citizen. While W believes that she is a U.S. resident, H and W make the section 6013(g) election for 1979 to cover the possibility that later it would be determined that she is a nonresident alien during 1979. The election for 1979 will not be considered evidence that W was a nonresident alien in prior years. Income from sources within and without the United States received by H and W in 1979 and subsequent years must be included in gross income for each taxable year, unless the election later is terminated or suspended.

[T.D. 7670, 45 FR 6929, Jan. 31, 1980, as amended by T.D. 7842, 47 FR 49842, Nov. 3, 1982; T.D. 8411, 57 FR 15241, Apr. 27, 1992]

§ 1.6013-7 Joint return for year in which nonresident alien becomes resident of the United States.

(a) Election for special treatment—(1) In general. Two individuals who are husband and wife at the close of a taxable year ending on or after December 31, 1975, may make an election under this section for that taxable year if one spouse is a citizen or resident of the United States on the last day of that taxable year and the other spouse is a nonresident alien at the beginning of that taxable year and a citizen or resident of the United States at the close of that taxable year. Two married individuals who are nonresident aliens at the beginning of a taxable year and who are U.S. citizens or residents on the last day of that taxable year qualify for the election. The effect of the election is that each spouse is treated as a resident of the United States for purposes of chapters 1, 5, and 24 and sections 6012, 6013, 6072, and 6091 of the code for all of that taxable year. A husband and wife may not make an election if an election has previously been made under this section by either spouse.

(2) Particular rules. The rules in subdivisions (ii) through (v) of § 1.6013-6(a)(2) are applicable to this section.

(3) Time and manner of making an election. A husband and wife shall make the election under this section in accordance with the rules in § 1.6013-6(a)(4).

(b) Section 6013(g) election in effect. If an election under section 6013(g) is in effect for a year subsequent to the first taxable year for which made and during that subsequent year the husband and wife meet the requirements of section 6013(h) and paragraph (a)(1) of this section, then the election under section 6013(g) shall apply to that subsequent taxable year. A separate election under section 6013(h) is not required for that subsequent taxable year.

[T.D. 7670, 45 FR 6931, Jan. 31, 1980]

§ 1.6014-1 Tax not computed by taxpayer for taxable years beginning before January 1, 1970.

(a) In general. If an individual is entitled under paragraph (a)(7) of § 1.6012-1 to use as his return Form 1040A, he may elect not to show thereon the amount of the tax due in connection with such return if his gross income is less than $5,000.

(b) Computation and payment of tax. A taxpayer who, in accordance with paragraph (a) of this section, elects not to show the tax on Form 1040A is not required to pay the unpaid balance of such tax at the time he files the return. In such case, the tax will be computed for the taxpayer by the Internal Revenue Service, and a notice will be mailed to the taxpayer stating the amount of tax due. Where it is determined that a refund of tax is due, the Internal Revenue Service will send such refund to the taxpayer. See paragraph (c) of § 301.6402-3 of this chapter (Regulations on Procedure and Administration).

(c) Joint return. (1) A husband and wife who, pursuant to paragraph (a)(7) of § 1.6012-1, file a joint return on Form 1040A may elect not to show the tax on such return if their aggregate gross income for the taxable year is less than $5,000.

(2) The tax computed for the taxpayer who files Form 1040A and elects not to show thereon the tax due shall be the lesser of the following amounts:

(i) A tax computed as though the return on Form 1040A constituted the separate returns of the spouses, or

(ii) A tax computed as though the return on Form 1040A constituted a joint return.

(d) Married individuals filing separate returns. In the case of a married individual who files a separate return and who elects under this section not to show his tax on Form 1040A his tax shall be computed with reference to the 10-percent standard deduction rather than the minimum standard deduction.

(e) This section shall apply to taxable years beginning before January 1, 1970.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6581, 26 FR 11678, Dec. 6, 1961; T.D. 6792, 30 FR 531, Jan. 15, 1965; T.D. 7102, 36 FR 5497, Mar. 24, 1971]

§ 1.6014-2 Tax not computed by taxpayer for taxable years beginning after December 31, 1969.

(a) In general. An individual subject to the tax imposed by section 1 of the Code may, in accordance with the instructions applicable to the income tax return to be filed, elect, for any taxable year beginning after December 31, 1969, not to show on his income tax return for such year the amount of tax due in connection with such return.

(b) Restriction on making an election. The election pursuant to this section shall not be made by an individual who does not file his return (or amended return) making such election on or before the date prescribed in section 6072(a) for the filing of the original return (determined without regard to any extension of time).

(c) Effects of election. (1) A taxpayer who, in accordance with the provisions of this section, elects not to show the tax on his income tax return is not required to pay the unpaid balance of such tax at the time he files the return. In such case, the tax will be computed for the taxpayer by the Internal Revenue Service, and a notice will be mailed to the taxpayer stating the amount of tax due. Where it is determined that a refund of tax is due, the Internal Revenue Service will send such refund to the taxpayer. See paragraph (c) of § 301.6402-3 of this chapter (Regulations on Procedure and Administration). The computation of tax by the Internal Revenue Service shall be treated for purposes of this chapter as if made by the taxpayer, and such computation or the issuance of a notice or refund pursuant thereto shall not relieve the taxpayer of liability for any deficiency (although the deficiency is based upon an amount of tax different from that computed for the taxpayer by the Internal Revenue Service) or affect the rights of the Internal Revenue Service with respect to any subsequent audit or other review of the taxpayer's return.

(2) Where the election provided for in this section is made by a taxpayer who takes the standard deduction and who has adjusted gross income of less than $10,000, such election constitutes an election to pay the tax imposed by section 3.

(3) A taxpayer who makes an election under section 6014 shall not be precluded from claiming:

(i) Status as a head of household or a surviving spouse;

(ii) The credit under section 31 (relating to tax withheld on wages);

(iii) The credit under section 37 (relating to retirement income);

(iv) The credit under section 38 (relating to investment in certain depreciable property);

(v) The credit under section 39 (relating to certain uses of gasoline and lubricating oil);

(vi) The credit under section 41 (relating to contributions to candidates for public office);

(vii) The credit under section 42 (relating to personal exemptions);

(viii) The credit under section 43 (relating to earned income);

(ix) The credit under section 44 (relating to purchase of new principal residence); or

(x) The credit under section 45 (relating to overpayments of tax).

(d) Joint returns. (1) A husband and wife who file a joint return may elect not to show the tax on such return in accordance with the rules prescribed in paragraphs (a) and (b) of this section.

(2) The tax computed for a husband and wife who elect pursuant to this section not to show their tax on their joint income tax return shall be the lesser of the following amounts:

(i) A tax computed as though the return of income constituted a joint return, or

(ii) If sufficient information is provided for the taxable income of each spouse to be determined, a tax computed as though the return of income constituted the separate returns of the spouses.

(e) Married individuals filing separate returns. This section shall apply to married individuals filing separate returns unless otherwise provided in the instructions accompanying a return. The instructions may require the taxpayer to attach to his return a statement to the effect that his tax and the tax of his spouse were determined in accordance with the rules of sections 141(d) and 142(a).

(f) Revocation of election. An election pursuant to this section may be revoked on an amended return (whether such return is filed before or after the date prescribed in section 6072(a) for filing the original return).

[T.D. 7102, 36 FR 5497, Mar. 24, 1971, as amended by T.D. 7298, 38 FR 35234, Dec. 26, 1973; T.D. 7391, 40 FR 55856, Dec. 2, 1975]

§ 1.6015-0 Table of contents.

This section lists captions contained in §§ 1.6015-1 through 1.6015-9.

§ 1.6015-1 Relief from joint and several liability on a joint return.

(a) In general.

(b) Duress.

(1) In general.

(2) Exception for agreements relating to TEFRA partnership proceedings.

(3) Examples.

(d) Fraudulent scheme.

(e) Res judicata and collateral estoppel.

(f) Community property laws.

(1) In general.

(2) Example.

(g) Scope of this section and §§ 1.6015-2 through 1.6015-9.

(h) Definitions.

(1) Requesting spouse.

(2) Nonrequesting spouse.

(3) Item.

(4) Erroneous item.

(5) Election or request.

(i) [Reserved]

(j) Transferee liability.

(1) In general.

(2) Example.

§ 1.6015-2 Relief from liability applicable to all qualifying joint filers.

(a) In general.

(b) Understatement.

(d) Inequity.

(e) Partial relief.

(1) In general.

(2) Example.

§ 1.6015-3 Allocation of liability for individuals who are no longer married, are legally separated, or are not members of the same household.

(a) Election to allocate liability.

(b) Definitions.

(1) Divorced.

(2) Legally separated.

(3) Members of the same household.

(i) Temporary absences.

(ii) Separate dwellings.

(1) No refunds.

(2) Actual knowledge.

(i) In general.

(A) Omitted income.

(B) Deduction or credit.

(1) Erroneous deductions in general.

(2) Fictitious or inflated deduction.

(ii) Partial knowledge.

(iii) Knowledge of the source not sufficient.

(iv) Factors supporting actual knowledge.

(v) Abuse exception.

(3) Disqualified asset transfers.

(i) In general.

(ii) Disqualified asset defined.

(iii) Presumption.

(4) Examples.

(d) Allocation.

(1) In general.

(2) Allocation of erroneous items.

(i) Benefit on the return.

(ii) Fraud.

(iii) Erroneous items of income.

(iv) Erroneous deduction items.

(3) Burden of proof.

(4) General allocation method.

(i) Proportionate allocation.

(ii) Separate treatment items.

(iii) Child's liability.

(iv) Allocation of certain items.

(A) Alternative minimum tax.

(B) Accuracy-related and fraud penalties.

(5) Examples.

(6) Alternative allocation methods.

(i) Allocation based on applicable tax rates.

(ii) Allocation methods provided in subsequent published guidance.

(iii) Example.

§ 1.6015-4 Equitable relief. § 1.6015-5 Time and manner for requesting relief.

(a) Requesting relief.

(b) Time period for filing a request for relief.

(1) In general.

(2) Definitions.

(i) Collection activity.

(ii) Section 6330 notice.

(3) Requests for relief made before commencement of collection activity.

(4) Examples.

(5) Premature requests for relief.

§ 1.6015-6 Nonrequesting spouse's notice and opportunity to participate in administrative proceedings.

(a) In general.

(b) Information submitted.

(2) Waiver of the restrictions on collection.

§ 1.6015-7 Tax Court review.

(a) In general.

(b) Time period for petitioning the Tax Court.

(1) Restrictions on collection under § 1.6015-2 or 1.6015-3.

(2) Waiver of the restrictions on collection.

(3) Suspension of the running of the period of limitations.

(i) Relief under § 1.6015-2 or 1.6015-3.

(ii) Relief under § 1.6015-4.

(4) Definitions.

(i) Levy.

(ii) Proceedings in court.

(iii) Assessment to which the election relates.

§ 1.6015-8 Applicable liabilities.

(a) In general.

(b) Liabilities paid on or before July 22, 1998.

§ 1.6015-9 Effective date.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-1 Relief from joint and several liability on a joint return.

(a) In general. (1) An individual who qualifies and elects under section 6013 to file a joint Federal income tax return with another individual is jointly and severally liable for the joint Federal income tax liabilities for that year. A spouse or former spouse may be relieved of joint and several liability for Federal income tax for that year under the following three relief provisions:

(i) Innocent spouse relief under § 1.6015-2.

(ii) Allocation of deficiency under § 1.6015-3.

(iii) Equitable relief under § 1.6015-4.

(2) A requesting spouse may submit a single claim electing relief under both or either §§ 1.6015-2 and 1.6015-3, and requesting relief under § 1.6015-4. However, equitable relief under § 1.6015-4 is available only to a requesting spouse who fails to qualify for relief under §§ 1.6015-2 and 1.6015-3. If a requesting spouse elects the application of either § 1.6015-2 or 1.6015-3, the Internal Revenue Service will consider whether relief is appropriate under the other elective provision and, to the extent relief is unavailable under either, under § 1.6015-4. If a requesting spouse seeks relief only under § 1.6015-4, the Secretary may not grant relief under § 1.6015-2 or 1.6015-3 in the absence of an affirmative election made by the requesting spouse under either of those sections. If in the course of reviewing a request for relief only under § 1.6015-4, the IRS determines that the requesting spouse may qualify for relief under § 1.6015-2 or 1.6015-3 instead of § 1.6015-4, the Internal Revenue Service will correspond with the requesting spouse to see if the requesting spouse would like to amend his or her request to elect the application of § 1.6015-2 or 1.6015-3. If the requesting spouse chooses to amend the claim for relief, the requesting spouse must submit an affirmative election under § 1.6015-2 or 1.6015-3. The amended claim for relief will relate back to the original claim for purposes of determining the timeliness of the claim.

(3) Relief is not available for liabilities that are required to be reported on a joint Federal income tax return but are not income taxes imposed under Subtitle A of the Internal Revenue Code (e.g., domestic service employment taxes under section 3510).

(b) Duress. For rules relating to the treatment of returns signed under duress, see § 1.6013-4(d).

(c) Prior closing agreement or offer in compromise—(1) In general. A requesting spouse is not entitled to relief from joint and several liability under § 1.6015-2, 1.6015-3, or 1.6015-4 for any tax year for which the requesting spouse has entered into a closing agreement with the Commissioner that disposes of the same liability that is the subject of the claim for relief. In addition, a requesting spouse is not entitled to relief from joint and several liability under § 1.6015-2, 1.6015-3, or 1.6015-4 for any tax year for which the requesting spouse has entered into an offer in compromise with the Commissioner. For rules relating to the effect of closing agreements and offers in compromise, see sections 7121 and 7122, and the regulations thereunder.

(2) Exception for agreements relating to TEFRA partnership proceedings. The rule in paragraph (c)(1) of this section regarding the unavailability of relief from joint and several liability when the liability to which the claim for relief relates was the subject of a prior closing agreement entered into by the requesting spouse, shall not apply to an agreement described in section 6224(c) with respect to partnership items (or any penalty, addition to tax, or additional amount that relates to adjustments to partnership items) that is entered into while the requesting spouse is a party to a pending partnership-level proceeding conducted under the provisions of subchapter C of chapter 63 of subtitle F of the Internal Revenue Code (TEFRA partnership proceeding). If, however, a requesting spouse enters into a closing agreement pertaining to any penalty, addition to tax, or additional amount that relates to adjustments to partnership items, at a time when the requesting spouse is not a party to a pending TEFRA partnership proceeding (e.g., in connection with an affected items proceeding), then the provisions of paragraph (c)(1) shall apply. Similarly, if a requesting spouse enters into a closing agreement with respect to both partnership items (including affected items) and nonpartnership items, while the requesting spouse is a party to a pending TEFRA partnership proceeding, the provisions of paragraph (c)(1) shall apply to the portion of the closing agreement that relates to nonpartnership items and the provisions of this paragraph (c)(2) shall apply to the remainder of the closing agreement.

(3) Examples. The following examples illustrate the rules of this paragraph (c):

Example 1.H and W file joint returns for taxable years 2002-2004, on which they claim losses attributable to H's limited partnership interest in Partnership A. In January 2006, the Internal Revenue Service commences an audit under the provisions of subchapter C of chapter 63 of subtitle F of the Internal Revenue Code (TEFRA partnership proceeding) regarding Partnership A's 2002-2004 taxable years, and sends H and W a notice under section 6223(a)(1). In September 2007, H files a bankruptcy petition under chapter 7 of the Bankruptcy Code and receives a discharge in April 2008. In August 2008, H and W enter into a closing agreement with the Internal Revenue Service, in which H and W agree to the disallowance of some of the claimed losses from Partnership A for taxable years 2002 through 2007. W may not later claim relief from joint and several liability under section 6015 as to the disallowed losses attributable to Partnership A for taxable years 2002 to 2007. This is because at the time W entered into the closing agreement, H's partnership items attributable to Partnership A had converted to nonpartnership items as a result of H's filing of the bankruptcy petition. The conversion of H's items also terminated W's status as a partner in the TEFRA partnership proceeding regarding Partnership A. Consequently, the closing agreement did not pertain to partnership items and W was not a party to a pending partnership-level proceeding regarding Partnership A when she entered into the closing agreement. Accordingly, the exception in paragraph (c)(2) of this section for agreements relating to TEFRA partnership proceedings does not apply.

Example 2.H and W file a joint return for taxable year 2002, on which they claim $25,000 in losses attributable to H's general partnership interest in Partnership B. In November 2003, the Service proposes a deficiency in tax relating to H's and W's 2002 joint return arising from omitted taxable interest income in the amount of $2,000 that is attributable to H. In July 2005, the Internal Revenue Service commences a TEFRA partnership proceeding regarding Partnership B's 2002 and 2003 taxable years, and sends H and W a notice under section 6223(a)(1). In March 2006, H and W enter into a closing agreement with the Service. The closing agreement provides for the disallowance of the claimed losses from Partnership B in excess of H's and W's out-of-pocket expenditures relating to Partnership B for taxable year 2002 and any subsequent year(s) in which H and W claimed losses from Partnership B. In addition, H and W agree to the imposition of the accuracy-related penalty under section 6662 with respect to the disallowed losses attributable to partnership B. In the closing agreement, H and W also agree to the deficiency resulting from the omitted interest income for taxable year 2002. W may not later claim relief from joint and several liability under section 6015 as to the deficiency in tax attributable to the omitted income of $2,000 for taxable year 2002, because this portion of the closing agreement pertains to nonpartnership items. In contrast, W may claim relief from joint and several liability as to the disallowed losses and accuracy-related penalty attributable to Partnership B for taxable year 2002 or any subsequent year(s). This is because this portion of the closing agreement pertains to partnership and affected items and was entered into at a time when W was a party to the pending partnership-level proceeding regarding Partnership B. Consequently, W never had the opportunity to raise the innocent spouse defense in the course of that TEFRA partnership proceeding. (See § 1.6015-5(b)(5) relating to premature claims).

(d) Fraudulent scheme. If the Secretary establishes that a spouse transferred assets to the other spouse as part of a fraudulent scheme, relief is not available under section 6015, and section 6013(d)(3) applies to the return. For purposes of this section, a fraudulent scheme includes a scheme to defraud the Service or another third party, including, but not limited to, creditors, ex-spouses, and business partners.

(e) Res judicata and collateral estoppel. A requesting spouse is barred from relief from joint and several liability under section 6015 by res judicata for any tax year for which a court of competent jurisdiction has rendered a final decision on the requesting spouse's tax liability if relief under section 6015 was at issue in the prior proceeding, or if the requesting spouse meaningfully participated in that proceeding and could have raised relief under section 6015. A requesting spouse has not meaningfully participated in a prior proceeding if, due to the effective date of section 6015, relief under section 6015 was not available in that proceeding. Also, any final decisions rendered by a court of competent jurisdiction regarding issues relevant to section 6015 are conclusive and the requesting spouse may be collaterally estopped from relitigating those issues.

(f) Community property laws—(1) In general. In determining whether relief is available under § 1.6015-2, 1.6015-3, or 1.6015-4, items of income, credits, and deductions are generally allocated to the spouses without regard to the operation of community property laws. An erroneous item is attributed to the individual whose activities gave rise to such item. See § 1.6015-3(d)(2).

(2) Example. The following example illustrates the rule of this paragraph (f):

Example. (i) H and W are married and have lived in State A (a community property state) since 1987. On April 15, 2003, H and W file a joint Federal income tax return for the 2002 taxable year. In August 2005, the Internal Revenue Service proposes a $17,000 deficiency with respect to the 2002 joint return. A portion of the deficiency is attributable to $20,000 of H's unreported interest income from his individual bank account. The remainder of the deficiency is attributable to $30,000 of W's disallowed business expense deductions. Under the laws of State A, H and W each own 1/2 of all income earned and property acquired during the marriage.

(ii) In November 2005, H and W divorce and W timely elects to allocate the deficiency. Even though the laws of State A provide that 1/2 of the interest income is W's, for purposes of relief under this section, the $20,000 unreported interest income is allocable to H, and the $30,000 disallowed deduction is allocable to W. The community property laws of State A are not considered in allocating items for this purpose.

(g) Scope of this section and §§ 1.6015-2 through 1.6015-9. This section and §§ 1.6015-2 through 1.6015-9 do not apply to any portion of a liability for any taxable year for which a claim for credit or refund is barred by operation of law or rule of law.

(h) Definitions—(1) Requesting spouse. A requesting spouse is an individual who filed a joint return and elects relief from Federal income tax liability arising from that return under § 1.6015-2 or 1.6015-3, or requests relief from Federal income tax liability arising from that return under § 1.6015-4.

(2) Nonrequesting spouse. A nonrequesting spouse is the individual with whom the requesting spouse filed the joint return for the year for which relief from liability is sought.

(3) Item. An item is that which is required to be separately listed on an individual income tax return or any required attachments. Items include, but are not limited to, gross income, deductions, credits, and basis.

(4) Erroneous item. An erroneous item is any item resulting in an understatement or deficiency in tax to the extent that such item is omitted from, or improperly reported (including improperly characterized) on an individual income tax return. For example, unreported income from an investment asset resulting in an understatement or deficiency in tax is an erroneous item. Similarly, ordinary income that is improperly reported as capital gain resulting in an understatement or deficiency in tax is also an erroneous item. In addition, a deduction for an expense that is personal in nature that results in an understatement or deficiency in tax is an erroneous item of deduction. An erroneous item is also an improperly reported item that affects the liability on other returns (e.g., an improper net operating loss that is carried back to a prior year's return). Penalties and interest are not erroneous items. Rather, relief from penalties and interest will generally be determined based on the proportion of the total erroneous items from which the requesting spouse is relieved. If a penalty relates to a particular erroneous item, see § 1.6015-3(d)(4)(iv)(B).

(5) Election or request. A qualifying election under § 1.6015-2 or 1.6015-3, or request under § 1.6015-4, is the first timely claim for relief from joint and several liability for the tax year for which relief is sought. A qualifying election also includes a requesting spouse's second election to seek relief from joint and several liability for the same tax year under § 1.6015-3 when the additional qualifications of paragraphs (h)(5)(i) and (ii) of this section are met—

(i) The requesting spouse did not qualify for relief under § 1.6015-3 when the Internal Revenue Service considered the first election solely because the qualifications of § 1.6015-3(a) were not satisfied; and

(ii) At the time of the second election, the qualifications for relief under § 1.6015-3(a) are satisfied.

(i) [Reserved]

(j) Transferee liability—(1) In general. The relief provisions of section 6015 do not negate liability that arises under the operation of other laws. Therefore, a requesting spouse who is relieved of joint and several liability under § 1.6015-2, 1.6015-3, or 1.6015-4 may nevertheless remain liable for the unpaid tax (including additions to tax, penalties, and interest) to the extent provided by Federal or state transferee liability or property laws. For the rules regarding the liability of transferees, see sections 6901 through 6904 and the regulations thereunder. In addition, the requesting spouse's property may be subject to collection under Federal or state property laws.

(2) Example. The following example illustrates the rule of this paragraph (j):

Example.H and W timely file their 1998 joint income tax return on April 15, 1999. H dies in March 2000, and the executor of H's will transfers all of the estate's assets to W. In July 2001, the Internal Revenue Service assesses a deficiency for the 1998 return. The items giving rise to the deficiency are attributable to H. W is relieved of the liability under section 6015, and H's estate remains solely liable. The Internal Revenue Service may seek to collect the deficiency from W to the extent permitted under Federal or state transferee liability or property laws.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-2 Relief from liability applicable to all qualifying joint filers.

(a) In general. A requesting spouse may be relieved of joint and several liability for tax (including additions to tax, penalties, and interest) from an understatement for a taxable year under this section if the requesting spouse elects the application of this section in accordance with §§ 1.6015-1(h)(5) and 1.6015-5, and—

(1) A joint return was filed for the taxable year;

(2) On the return there is an understatement attributable to erroneous items of the nonrequesting spouse;

(3) The requesting spouse establishes that in signing the return he or she did not know and had no reason to know of the understatement; and

(4) It is inequitable to hold the requesting spouse liable for the deficiency attributable to the understatement.

(b) Understatement. The term understatement has the meaning given to such term by section 6662(d)(2)(A) and the regulations thereunder.

(c) Knowledge or reason to know. A requesting spouse has knowledge or reason to know of an understatement if he or she actually knew of the understatement, or if a reasonable person in similar circumstances would have known of the understatement. For rules relating to a requesting spouse's actual knowledge, see § 1.6015-3(c)(2). All of the facts and circumstances are considered in determining whether a requesting spouse had reason to know of an understatement. The facts and circumstances that are considered include, but are not limited to, the nature of the erroneous item and the amount of the erroneous item relative to other items; the couple's financial situation; the requesting spouse's educational background and business experience; the extent of the requesting spouse's participation in the activity that resulted in the erroneous item; whether the requesting spouse failed to inquire, at or before the time the return was signed, about items on the return or omitted from the return that a reasonable person would question; and whether the erroneous item represented a departure from a recurring pattern reflected in prior years' returns (e.g., omitted income from an investment regularly reported on prior years' returns).

(d) Inequity. All of the facts and circumstances are considered in determining whether it is inequitable to hold a requesting spouse jointly and severally liable for an understatement. One relevant factor for this purpose is whether the requesting spouse significantly benefitted, directly or indirectly, from the understatement. A significant benefit is any benefit in excess of normal support. Evidence of direct or indirect benefit may consist of transfers of property or rights to property, including transfers that may be received several years after the year of the understatement. Thus, for example, if a requesting spouse receives property (including life insurance proceeds) from the nonrequesting spouse that is beyond normal support and traceable to items omitted from gross income that are attributable to the nonrequesting spouse, the requesting spouse will be considered to have received significant benefit from those items. Other factors that may also be taken into account, if the situation warrants, include the fact that the requesting spouse has been deserted by the nonrequesting spouse, the fact that the spouses have been divorced or separated, or that the requesting spouse received benefit on the return from the understatement. For guidance concerning the criteria to be used in determining whether it is inequitable to hold a requesting spouse jointly and severally liable under this section, see Rev. Proc. 2000-15 (2000-1 C.B. 447), or other guidance published by the Treasury and IRS (see § 601.601(d)(2) of this chapter).

(e) Partial relief—(1) In general. If a requesting spouse had no knowledge or reason to know of only a portion of an erroneous item, the requesting spouse may be relieved of the liability attributable to that portion of that item, if all other requirements are met with respect to that portion.

(2) Example. The following example illustrates the rules of this paragraph (e):

Example.H and W are married and file their 2004 joint income tax return in March 2005. In April 2006, H is convicted of embezzling $2 million from his employer during 2004. H kept all of his embezzlement income in an individual bank account, and he used most of the funds to support his gambling habit. H and W had a joint bank account into which H and W deposited all of their reported income. Each month during 2004, H transferred an additional $10,000 from the individual account to H and W's joint bank account. W paid the household expenses using this joint account, and regularly received the bank statements relating to the account. W had no knowledge or reason to know of H's embezzling activities. However, W did have knowledge and reason to know of $120,000 of the $2 million of H's embezzlement income at the time she signed the joint return because that amount passed through the couple's joint bank account. Therefore, W may be relieved of the liability arising from $1,880,000 of the unreported embezzlement income, but she may not be relieved of the liability for the deficiency arising from $120,000 of the unreported embezzlement income of which she knew and had reason to know.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-3 Allocation of deficiency for individuals who are no longer married, are legally separated, or are not members of the same household.

(a) Election to allocate deficiency. A requesting spouse may elect to allocate a deficiency if, as defined in paragraph (b) of this section, the requesting spouse is divorced, widowed, or legally separated, or has not been a member of the same household as the nonrequesting spouse at any time during the 12-month period ending on the date an election for relief is filed. For purposes of this section, the marital status of a deceased requesting spouse will be determined on the earlier of the date of the election or the date of death in accordance with section 7703(a)(1). Subject to the restrictions of paragraph (c) of this section, an eligible requesting spouse who elects the application of this section in accordance with §§ 1.6015-1(h)(5) and 1.6015-5 generally may be relieved of joint and several liability for the portion of any deficiency that is allocated to the nonrequesting spouse pursuant to the allocation methods set forth in paragraph (d) of this section. Relief may be available to both spouses filing the joint return if each spouse is eligible for and elects the application of this section.

(b) Definitions—(1) Divorced. A determination of whether a requesting spouse is divorced for purposes of this section will be made in accordance with section 7703 and the regulations thereunder. Such determination will be made as of the date the election is filed.

(2) Legally separated. A determination of whether a requesting spouse is legally separated for purposes of this section will be made in accordance with section 7703 and the regulations thereunder. Such determination will be made as of the date the election is filed.

(3) Members of the same household—(i) Temporary absences. A requesting spouse and a nonrequesting spouse are considered members of the same household during either spouse's temporary absences from the household if it is reasonable to assume that the absent spouse will return to the household, and the household or a substantially equivalent household is maintained in anticipation of such return. Examples of temporary absences may include, but are not limited to, absence due to incarceration, illness, business, vacation, military service, or education.

(ii) Separate dwellings. A husband and wife who reside in the same dwelling are considered members of the same household. In addition, a husband and wife who reside in two separate dwellings are considered members of the same household if the spouses are not estranged or one spouse is temporarily absent from the other's household within the meaning of paragraph (b)(3)(i) of this section.

(c) Limitations—(1) No refunds. Relief under this section is only available for unpaid liabilities resulting from understatements of liability. Refunds are not authorized under this section.

(2) Actual knowledge—(i) In general. If, under section 6015(c)(3)(C), the Secretary demonstrates that, at the time the return was signed, the requesting spouse had actual knowledge of an erroneous item that is allocable to the nonrequesting spouse, the election to allocate the deficiency attributable to that item is invalid, and the requesting spouse remains liable for the portion of the deficiency attributable to that item. The Service, having both the burden of production and the burden of persuasion, must establish, by a preponderance of the evidence, that the requesting spouse had actual knowledge of the erroneous item in order to invalidate the election.

(A) Omitted income. In the case of omitted income, knowledge of the item includes knowledge of the receipt of the income. For example, assume W received $5,000 of dividend income from her investment in X Co. but did not report it on the joint return. H knew that W received $5,000 of dividend income from X Co. that year. H had actual knowledge of the erroneous item (i.e., $5,000 of unreported dividend income from X Co.), and no relief is available under this section for the deficiency attributable to the dividend income from X Co. This rule applies equally in situations where the other spouse has unreported income although the spouse does not have an actual receipt of cash (e.g., dividend reinvestment or a distributive share from a flow-through entity shown on Schedule K-1, “Partner's Share of Income, Credits, Deductions, etc.”).

(B) Deduction or credit—(1) Erroneous deductions in general. In the case of an erroneous deduction or credit, knowledge of the item means knowledge of the facts that made the item not allowable as a deduction or credit.

(2) Fictitious or inflated deduction. If a deduction is fictitious or inflated, the IRS must establish that the requesting spouse actually knew that the expenditure was not incurred, or not incurred to that extent.

(ii) Partial knowledge. If a requesting spouse had actual knowledge of only a portion of an erroneous item, then relief is not available for that portion of the erroneous item. For example, if H knew that W received $1,000 of dividend income and did not know that W received an additional $4,000 of dividend income, relief would not be available for the portion of the deficiency attributable to the $1,000 of dividend income of which H had actual knowledge. A requesting spouse's actual knowledge of the proper tax treatment of an item is not relevant for purposes of demonstrating that the requesting spouse had actual knowledge of an erroneous item. For example, assume H did not know W's dividend income from X Co. was taxable, but knew that W received the dividend income. Relief is not available under this section. In addition, a requesting spouse's knowledge of how an erroneous item was treated on the tax return is not relevant to a determination of whether the requesting spouse had actual knowledge of the item. For example, assume that H knew of W's dividend income, but H failed to review the completed return and did not know that W omitted the dividend income from the return. Relief is not available under this section.

(iii) Knowledge of the source not sufficient. Knowledge of the source of an erroneous item is not sufficient to establish actual knowledge. For example, assume H knew that W owned X Co. stock, but H did not know that X Co. paid dividends to W that year. H's knowledge of W's ownership in X Co. is not sufficient to establish that H had actual knowledge of the dividend income from X Co. In addition, a requesting spouse's actual knowledge may not be inferred when the requesting spouse merely had reason to know of the erroneous item. Even if H's knowledge of W's ownership interest in X Co. indicates a reason to know of the dividend income, actual knowledge of such dividend income cannot be inferred from H's reason to know. Similarly, the IRS need not establish that a requesting spouse knew of the source of an erroneous item in order to establish that the requesting spouse had actual knowledge of the item itself. For example, assume H knew that W received $1,000, but he did not know the source of the $1,000. W and H omit the $1,000 from their joint return. H has actual knowledge of the item giving rise to the deficiency ($1,000), and relief is not available under this section.

(iv) Factors supporting actual knowledge. To demonstrate that a requesting spouse had actual knowledge of an erroneous item at the time the return was signed, the IRS may rely upon all of the facts and circumstances. One factor that may be relied upon in demonstrating that a requesting spouse had actual knowledge of an erroneous item is whether the requesting spouse made a deliberate effort to avoid learning about the item in order to be shielded from liability. This factor, together with all other facts and circumstances, may demonstrate that the requesting spouse had actual knowledge of the item, and the requesting spouse's election would be invalid with respect to that entire item. Another factor that may be relied upon in demonstrating that a requesting spouse had actual knowledge of an erroneous item is whether the requesting spouse and the nonrequesting spouse jointly owned the property that resulted in the erroneous item. Joint ownership is a factor supporting a finding that the requesting spouse had actual knowledge of an erroneous item. For purposes of this paragraph, a requesting spouse will not be considered to have had an ownership interest in an item based solely on the operation of community property law. Rather, a requesting spouse who resided in a community property state at the time the return was signed will be considered to have had an ownership interest in an item only if the requesting spouse's name appeared on the ownership documents, or there otherwise is an indication that the requesting spouse asserted dominion and control over the item. For example, assume H and W live in State A, a community property state. After their marriage, H opens a bank account in his name. Under the operation of the community property laws of State A, W owns 1/2 of the bank account. However, W does not have an ownership interest in the account for purposes of this paragraph (c)(2)(iv) because the account is not held in her name and there is no other indication that she asserted dominion and control over the item.

(v) Abuse exception. If the requesting spouse establishes that he or she was the victim of domestic abuse prior to the time the return was signed, and that, as a result of the prior abuse, the requesting spouse did not challenge the treatment of any items on the return for fear of the nonrequesting spouse's retaliation, the limitation on actual knowledge in this paragraph (c) will not apply. However, if the requesting spouse involuntarily executed the return, the requesting spouse may choose to establish that the return was signed under duress. In such a case, § 1.6013-4(d) applies.

(3) Disqualified asset transfers—(i) In general. The portion of the deficiency for which a requesting spouse is liable is increased (up to the entire amount of the deficiency) by the value of any disqualified asset that was transferred to the requesting spouse. For purposes of this paragraph (c)(3), the value of a disqualified asset is the fair market value of the asset on the date of the transfer.

(ii) Disqualified asset defined. A disqualified asset is any property or right to property that was transferred from the nonrequesting spouse to the requesting spouse if the principal purpose of the transfer was the avoidance of tax or payment of tax (including additions to tax, penalties, and interest).

(iii) Presumption. Any asset transferred from the nonrequesting spouse to the requesting spouse during the 12-month period before the mailing date of the first letter of proposed deficiency (e.g., a 30-day letter or, if no 30-day letter is mailed, a notice of deficiency) is presumed to be a disqualified asset. The presumption also applies to any asset that is transferred from the nonrequesting spouse to the requesting spouse after the mailing date of the first letter of proposed deficiency. The presumption does not apply, however, if the requesting spouse establishes that the asset was transferred pursuant to a decree of divorce or separate maintenance or a written instrument incident to such a decree. If the presumption does not apply, but the Internal Revenue Service can establish that the purpose of the transfer was the avoidance of tax or payment of tax, the asset will be disqualified, and its value will be added to the amount of the deficiency for which the requesting spouse remains liable. If the presumption applies, a requesting spouse may still rebut the presumption by establishing that the principal purpose of the transfer was not the avoidance of tax or payment of tax.

(4) Examples. The following examples illustrate the rules in this paragraph (c):

Example 1. Actual knowledge of an erroneous item. (i) H and W file their 2001 joint Federal income tax return on April 15, 2002. On the return, H and W report W's self-employment income, but they do not report W's self-employment tax on that income. H and W divorce in July 2003. In August 2003, H and W receive a 30-day letter from the Internal Revenue Service proposing a deficiency with respect to W's unreported self-employment tax on the 2001 return. On November 4, 2003, H files an election to allocate the deficiency to W. The erroneous item is the self-employment income, and it is allocable to W. H knows that W earned income in 2001 as a self-employed musician, but he does not know that self-employment tax must be reported on and paid with a joint return.

(ii) H's election to allocate the deficiency to W is invalid because, at the time H signed the joint return, H had actual knowledge of W's self-employment income. The fact that H was unaware of the tax consequences of that income (i.e., that an individual is required to pay self-employment tax on that income) is not relevant.

Example 2. Actual knowledge not inferred from a requesting spouse's reason to know. (i) H has long been an avid gambler. H supports his gambling habit and keeps all of his gambling winnings in an individual bank account, held solely in his name. W knows about H's gambling habit and that he keeps a separate bank account, but she does not know whether he has any winnings because H does not tell her, and she does not otherwise know of H's bank account transactions. H and W file their 2001 joint Federal income tax return on April 15, 2002. On October 31, 2003, H and W receive a 30-day letter proposing a $100,000 deficiency relating to H's unreported gambling income. In February 2003, H and W divorce, and in March 2004, W files an election under section 6015(c) to allocate the $100,000 deficiency to H.

(ii) While W may have had reason to know of the gambling income because she knew of H's gambling habit and separate account, W did not have actual knowledge of the erroneous item (i.e., the gambling winnings). The Internal Revenue Service may not infer actual knowledge from W's reason to know of the income. Therefore, W's election to allocate the $100,000 deficiency to H is valid.

Example 3. Actual knowledge and failure to review return. (i) H and W are legally separated. In February 1999, W signs a blank joint Federal income tax return for 1998 and gives it to H to fill out. The return was timely filed on April 15, 1999. In September 2001, H and W receive a 30-day letter proposing a deficiency relating to $100,000 of unreported dividend income received by H with respect to stock of ABC Co. owned by H. W knew that H received the $100,000 dividend payment in August 1998, but she did not know whether H reported that payment on the joint return.

(ii) On January 30, 2002, W files an election to allocate the deficiency from the 1998 return to H. W claims she did not review the completed joint return, and therefore, she had no actual knowledge that there was an understatement of the dividend income. W's election to allocate the deficiency to H is invalid because she had actual knowledge of the erroneous item (dividend income from ABC Co.) at the time she signed the return. The fact that W signed a blank return is irrelevant. The result would be the same if W had not reviewed the completed return or if W had reviewed the completed return and had not noticed that the item was omitted.

Example 4. Actual knowledge of an erroneous item of income. (i) H and W are legally separated. In June 2004, a deficiency is proposed with respect to H's and W's 2002 joint Federal income tax return that is attributable to $30,000 of unreported income from H's plumbing business that should have been reported on a Schedule C. No Schedule C was attached to the return. At the time W signed the return, W knew that H had a plumbing business but did not know whether H received any income from the business. W's election to allocate to H the deficiency attributable to the $30,000 of unreported plumbing income is valid.

(ii) Assume the same facts as in paragraph (i) of this Example 5 except that, at the time W signed the return, W knew that H received $20,000 of plumbing income. W's election to allocate to H the deficiency attributable to the $20,000 of unreported plumbing income (of which W had actual knowledge) is invalid. W's election to allocate to H the deficiency attributable to the $10,000 of unreported plumbing income (of which W did not have actual knowledge) is valid.

(iii) Assume the same facts as in paragraph (i) of this Example 5 except that, at the time W signed the return, W did not know the exact amount of H's plumbing income. W did know, however, that H received at least $8,000 of plumbing income. W's election to allocate to H the deficiency attributable to $8,000 of unreported plumbing income (of which W had actual knowledge) is invalid. W's election to allocate to H the deficiency attributable to the remaining $22,000 of unreported plumbing income (of which W did not have actual knowledge) is valid.

(iv) Assume the same facts as in paragraph (i) of this Example 5 except that H reported $26,000 of plumbing income on the return and omitted $4,000 of plumbing income from the return. At the time W signed the return, W knew that H was a plumber, but she did not know that H earned more than $26,000 that year. W's election to allocate to H the deficiency attributable to the $4,000 of unreported plumbing income is valid because she did not have actual knowledge that H received plumbing income in excess of $26,000.

(v) Assume the same facts as in paragraph (i) of this Example 5 except that H reported only $20,000 of plumbing income on the return and omitted $10,000 of plumbing income from the return. At the time W signed the return, W knew that H earned at least $26,000 that year as a plumber. However, W did not know that, in reality, H earned $30,000 that year as a plumber. W's election to allocate to H the deficiency attributable to the $6,000 of unreported plumbing income (of which W had actual knowledge) is invalid. W's election to allocate to H the deficiency attributable to the $4,000 of unreported plumbing income (of which W did not have actual knowledge) is valid.

Example 5. Actual knowledge of a deduction that is an erroneous item. (i) H and W are legally separated. In February 2005, a deficiency is asserted with respect to their 2002 joint Federal income tax return. The deficiency is attributable to a disallowed $1,000 deduction for medical expenses H claimed he incurred. At the time W signed the return, W knew that H had not incurred any medical expenses. W's election to allocate to H the deficiency attributable to the disallowed medical expense deduction is invalid because W had actual knowledge that H had not incurred any medical expenses.

(ii) Assume the same facts as in paragraph (i) of this Example 6 except that, at the time W signed the return, W did not know whether H had incurred any medical expenses. W's election to allocate to H the deficiency attributable to the disallowed medical expense deduction is valid because she did not have actual knowledge that H had not incurred any medical expenses.

(iii) Assume the same facts as in paragraph (i) of this Example 6 except that the Internal Revenue Service disallowed $400 of the $1,000 medical expense deduction. At the time W signed the return, W knew that H had incurred some medical expenses but did not know the exact amount. W's election to allocate to H the deficiency attributable to the disallowed medical expense deduction is valid because she did not have actual knowledge that H had not incurred medical expenses (in excess of the floor amount under section 213(a)) of more than $600.

(iv) Assume the same facts as in paragraph (i) of this Example 6 except that H claims a medical expense deduction of $10,000 and the Internal Revenue Service disallows $9,600. At the time W signed the return, W knew H had incurred some medical expenses but did not know the exact amount. W also knew that H incurred medical expenses (in excess of the floor amount under section 213(a)) of no more than $1,000. W's election to allocate to H the deficiency attributable to the portion of the overstated deduction of which she had actual knowledge ($9,000) is invalid. W's election to allocate the deficiency attributable to the portion of the overstated deduction of which she had no knowledge ($600) is valid.

Example 6. Disqualified asset presumption. (i) H and W are divorced. In May 1999, W transfers $20,000 to H, and in April 2000, H and W receive a 30-day letter proposing a $40,000 deficiency on their 1998 joint Federal income tax return. The liability remains unpaid, and in October 2000, H elects to allocate the deficiency under this section. Seventy-five percent of the net amount of erroneous items are allocable to W, and 25% of the net amount of erroneous items are allocable to H.

(ii) In accordance with the proportionate allocation method (see paragraph (d)(4) of this section), H proposes that $30,000 of the deficiency be allocated to W and $10,000 be allocated to himself. H submits a signed statement providing that the principal purpose of the $20,000 transfer was not the avoidance of tax or payment of tax, but he does not submit any documentation indicating the reason for the transfer. H has not overcome the presumption that the $20,000 was a disqualified asset. Therefore, the portion of the deficiency for which H is liable ($10,000) is increased by the value of the disqualified asset ($20,000). H is relieved of liability for $10,000 of the $30,000 deficiency allocated to W, and remains jointly and severally liable for the remaining $30,000 of the deficiency (assuming that H does not qualify for relief under any other provision).

Example 7. Disqualified asset presumption inapplicable.On May 1, 2001, H and W receive a 30-day letter regarding a proposed deficiency on their 1999 joint Federal income tax return relating to unreported capital gain from H's sale of his investment in Z stock. W had no actual knowledge of the stock sale. The deficiency is assessed in November 2001, and in December 2001, H and W divorce. According to a decree of divorce, H must transfer 1/2 of his interest in mutual fund A to W. The transfer takes place in February 2002. In August 2002, W elects to allocate the deficiency to H. Although the transfer of 1/2 of H's interest in mutual fund A took place after the 30-day letter was mailed, the mutual fund interest is not presumed to be a disqualified asset because the transfer of H's interest in the fund was made pursuant to a decree of divorce.

Example 8. Overcoming the disqualified asset presumption. (i) H and W are married for 25 years. Every September, on W's birthday, H gives W a gift of $500. On February 28, 2002, H and W receive a 30-day letter from the Internal Revenue Service relating to their 1998 joint individual Federal income tax return. The deficiency relates to H's Schedule C business, and W had no knowledge of the items giving rise to the deficiency. H and W are legally separated in June 2003, and, despite the separation, H continues to give W $500 each year for her birthday. H is not required to give such amounts pursuant to a decree of divorce or separate maintenance.

(ii) On January 27, 2004, W files an election to allocate the deficiency to H. The $1,500 transferred from H to W from February 28, 2001 (a year before the 30-day letter was mailed) to the present is presumed disqualified. However, W may overcome the presumption that such amounts were disqualified by establishing that such amounts were birthday gifts from H and that she has received such gifts during their entire marriage. Such facts would show that the amounts were not transferred for the purpose of avoidance of tax or payment of tax.

(d) Allocation—(1) In general. (i) An election to allocate a deficiency limits the requesting spouse's liability to that portion of the deficiency allocated to the requesting spouse pursuant to this section.

(ii) Only a requesting spouse may receive relief. A nonrequesting spouse who does not also elect relief under this section remains liable for the entire amount of the deficiency. Even if both spouses elect to allocate a deficiency under this section, there may be a portion of the deficiency that is not allocable, for which both spouses remain jointly and severally liable.

(2) Allocation of erroneous items. For purposes of allocating a deficiency under this section, erroneous items are generally allocated to the spouses as if separate returns were filed, subject to the following four exceptions:

(i) Benefit on the return. An erroneous item that would otherwise be allocated to the nonrequesting spouse is allocated to the requesting spouse to the extent that the requesting spouse received a tax benefit on the joint return.

(ii) Fraud. The Internal Revenue Service may allocate any item between the spouses if the Internal Revenue Service establishes that the allocation is appropriate due to fraud by one or both spouses.

(iii) Erroneous items of income. Erroneous items of income are allocated to the spouse who was the source of the income. Wage income is allocated to the spouse who performed the services producing such wages. Items of business or investment income are allocated to the spouse who owned the business or investment. If both spouses owned an interest in the business or investment, the erroneous item of income is generally allocated between the spouses in proportion to each spouse's ownership interest in the business or investment, subject to the limitations of paragraph (c) of this section. In the absence of clear and convincing evidence supporting a different allocation, an erroneous income item relating to an asset that the spouses owned jointly is generally allocated 50% to each spouse, subject to the limitations in paragraph (c) of this section and the exceptions in paragraph (c)(2)(iv) of this section. For rules regarding the effect of community property laws, see § 1.6015-1(f) and paragraph (c)(2)(iv) of this section.

(iv) Erroneous deduction items. Erroneous deductions related to a business or investment are allocated to the spouse who owned the business or investment. If both spouses owned an interest in the business or investment, an erroneous deduction item is generally allocated between the spouses in proportion to each spouse's ownership interest in the business or investment. In the absence of clear and convincing evidence supporting a different allocation, an erroneous deduction item relating to an asset that the spouses owned jointly is generally allocated 50% to each spouse, subject to the limitations in paragraph (c) of this section and the exceptions in paragraph (d)(4) of this section. Deduction items unrelated to a business or investment are also generally allocated 50% to each spouse, unless the evidence shows that a different allocation is appropriate.

(3) Burden of proof. Except for establishing actual knowledge under paragraph (c)(2) of this section, the requesting spouse must prove that all of the qualifications for making an election under this section are satisfied and that none of the limitations (including the limitation relating to transfers of disqualified assets) apply. The requesting spouse must also establish the proper allocation of the erroneous items.

(4) General allocation method—(i) Proportionate allocation. (A) The portion of a deficiency allocable to a spouse is the amount that bears the same ratio to the deficiency as the net amount of erroneous items allocable to the spouse bears to the net amount of all erroneous items. This calculation may be expressed as follows:

where X = the portion of the deficiency allocable to the spouse.

(B) The proportionate allocation applies to any portion of the deficiency other than—

(1) Any portion of the deficiency attributable to erroneous items allocable to the nonrequesting spouse of which the requesting spouse had actual knowledge;

(2) Any portion of the deficiency attributable to separate treatment items (as defined in paragraph (d)(4)(ii) of this section);

(3) Any portion of the deficiency relating to the liability of a child (as defined in paragraph (d)(4)(iii) of this section) of the requesting spouse or nonrequesting spouse;

(4) Any portion of the deficiency attributable to alternative minimum tax under section 55;

(5) Any portion of the deficiency attributable to accuracy-related or fraud penalties;

(6) Any portion of the deficiency allocated pursuant to alternative allocation methods authorized under paragraph (d)(6) of this section.

(ii) Separate treatment items. Any portion of a deficiency that is attributable to an item allocable solely to one spouse and that results from the disallowance of a credit, or a tax or an addition to tax (other than tax imposed by section 1 or section 55) that is required to be included with a joint return (a separate treatment item) is allocated separately to that spouse. If such credit or tax is attributable in whole or in part to both spouses, then the IRS will determine on a case by case basis how such item will be allocated. Once the proportionate allocation is made, the liability for the requesting spouse's separate treatment items is added to the requesting spouse's share of the liability.

(iii) Child's liability. Any portion of a deficiency relating to the liability of a child of the requesting and nonrequesting spouse is allocated jointly to both spouses. For purposes of this paragraph, a child does not include the taxpayer's stepson or stepdaughter, unless such child was legally adopted by the taxpayer. If the child is the child of only one of the spouses, and the other spouse had not legally adopted such child, any portion of a deficiency relating to the liability of such child is allocated solely to the parent spouse.

(iv) Allocation of certain items—(A) Alternative minimum tax. Any portion of a deficiency relating to the alternative minimum tax under section 55 will be allocated appropriately.

(B) Accuracy-related and fraud penalties. Any accuracy-related or fraud penalties under section 6662 or 6663 are allocated to the spouse whose item generated the penalty.

(5) Examples. The following examples illustrate the rules of this paragraph (d). In each example, assume that the requesting spouse or spouses qualify to elect to allocate the deficiency, that any election is timely made, and that the deficiency remains unpaid. In addition, unless otherwise stated, assume that neither spouse has actual knowledge of the erroneous items allocable to the other spouse. The examples are as follows:

Example 1. Allocation of erroneous items. (i) H and W file a 2003 joint Federal income tax return on April 15, 2004. On April 28, 2006, a deficiency is assessed with respect to their 2003 return. Three erroneous items give rise to the deficiency—

(A) Unreported interest income, of which W had actual knowledge, from H's and W's joint bank account;

(B) A disallowed business expense deduction on H's Schedule C; and

(ii) H and W divorce in May 2006, and in September 2006, W timely elects to allocate the deficiency. The erroneous items are allocable as follows:

(A) The interest income would be allocated 1/2 to H and 1/2 to W, except that W has actual knowledge of it. Therefore, W's election to allocate the portion of the deficiency attributable to this item is invalid, and W remains jointly and severally liable for it.

(B) The business expense deduction is allocable to H.

Example 2. Proportionate allocation. (i) W and H timely file their 2001 joint Federal income tax return on April 15, 2002. On August 16, 2004, a $54,000 deficiency is assessed with respect to their 2001 joint return. H and W divorce on October 14, 2004, and W timely elects to allocate the deficiency. Five erroneous items give rise to the deficiency—

(A) A disallowed $15,000 business deduction allocable to H;

(B) $20,000 of unreported income allocable to H;

(D) A disallowed $40,000 charitable contribution deduction allocable to W; and

(E) A disallowed $40,000 interest deduction allocable to W.

(ii) In total, there are $120,000 worth of erroneous items, of which $80,000 are attributable to W and $40,000 are attributable to H.

W's items | H's items

$40,000 | charitable deduction | $15,000 | business deduction

40,000 | interest deduction | 20,000 | unreported income

5,000 | education deduction

$80,000 | $40,000

(iii) The ratio of erroneous items allocable to W to the total erroneous items is 2/3 ($80,000/$120,000). W's liability is limited to $36,000 of the deficiency ( 2/3 of $54,000). The Internal Revenue Service may collect up to $36,000 from W and up to $54,000 from H (the total amount collected, however, may not exceed $54,000). If H also made an election, there would be no remaining joint and several liability, and the Internal Revenue Service would be permitted to collect $36,000 from W and $18,000 from H.

Example 3. Proportionate allocation with joint erroneous item. (i) On September 4, 2001, W elects to allocate a $3,000 deficiency for the 1998 tax year to H. Three erroneous items give rise to the deficiency—

(A) Unreported interest in the amount of $4,000 from a joint bank account;

(B) A disallowed deduction for business expenses in the amount of $2,000 attributable to H's business; and

(ii) The erroneous items total $12,000. Generally, income, deductions, or credits from jointly held property that are erroneous items are allocable 50% to each spouse. However, in this case, both spouses had actual knowledge of the unreported interest income. Therefore, W's election to allocate the portion of the deficiency attributable to this item is invalid, and W and H remain jointly and severally liable for this portion. Assume that this portion is $1,000. W may allocate the remaining $2,000 of the deficiency.

H's items | W's items

$2,000 | business deduction | $6,000 | wage income

Total allocable items: $8,000

(iii) The ratio of erroneous items allocable to W to the total erroneous items is 3/4 ($6,000/$8,000). W's liability is limited to $1,500 of the deficiency ( 3/4 of $2,000) allocated to her. The Internal Revenue Service may collect up to $2,500 from W ( 3/4 of the total allocated deficiency plus $1,000 of the deficiency attributable to the joint bank account interest) and up to $3,000 from H (the total amount collected, however, cannot exceed $3,000).

(iv) Assume H also elects to allocate the 1998 deficiency. H is relieved of liability for 3/4 of the deficiency, which is allocated to W. H's relief totals $1,500 ( 3/4 of $2,000). H remains liable for $1,500 of the deficiency ( 1/4 of the allocated deficiency plus $1,000 of the deficiency attributable to the joint bank account interest).

Example 4. Separate treatment items (STIs). (i) On September 1, 2006, a $28,000 deficiency is assessed with respect to H's and W's 2003 joint return. The deficiency is the result of 4 erroneous items—

(A) A disallowed Lifetime Learning Credit of $2,000 attributable to H;

(B) A disallowed business expense deduction of $8,000 attributable to H;

(D) Unreported self-employment tax of $14,000 attributable to W.

(ii) H and W both elect to allocate the deficiency.

(iii) The $2,000 Lifetime Learning Credit and the $14,000 self-employment tax are STIs totaling $16,000. The amount of erroneous items included in computing the proportionate allocation ratio is $32,000 ($24,000 unreported income and $8,000 disallowed business expense deduction). The amount of the deficiency subject to proportionate allocation is reduced by the amount of STIs ($28,000−$16,000 = $12,000).

(iv) Of the $32,000 of proportionate allocation items, $24,000 is allocable to W, and $8,000 is allocable to H.

W's share of allocable items | H's share of allocable items

3/4 ($24,000/$32,000) | 1/4 ($8,000/$32,000)

(v) W's liability for the portion of the deficiency subject to proportionate allocation is limited to $9,000 ( 3/4 of $12,000) and H's liability for such portion is limited to $3,000 ( 1/4 of $12,000).

(vi) After the proportionate allocation is completed, the amount of the STIs is added to each spouse's allocated share of the deficiency.

W's share of total deficiency | H's share of total deficiency

$ 9,000 | allocated deficiency | $3,000 | allocated deficiency

14,000 | self-employment tax | 2,000 | Lifetime Learning Credit

$23,000 | $5,000

(vii) Therefore, W's liability is limited to $23,000 and H's liability is limited to $5,000.

Example 5. Requesting spouse receives a benefit on the joint return from the nonrequesting spouse's erroneous item. (i) In 2001, H reports gross income of $4,000 from his business on Schedule C, and W reports $50,000 of wage income. On their 2001 joint Federal income tax return, H deducts $20,000 of business expenses resulting in a net loss from his business of $16,000. H and W divorce in September 2002, and on May 22, 2003, a $5,200 deficiency is assessed with respect to their 2001 joint return. W elects to allocate the deficiency. The deficiency on the joint return results from a disallowance of all of H's $20,000 of deductions.

(ii) Since H used only $4,000 of the disallowed deductions to offset gross income from his business, W benefitted from the other $16,000 of the disallowed deductions used to offset her wage income. Therefore, $4,000 of the disallowed deductions are allocable to H and $16,000 of the disallowed deductions are allocable to W. W's liability is limited to $4,160 ( 4/5 of $5,200). If H also elected to allocate the deficiency, H's election to allocate the $4,160 of the deficiency to W would be invalid because H had actual knowledge of the erroneous items.

Example 6. Calculation of requesting spouse's benefit on the joint return when the nonrequesting spouse's erroneous item is partially disallowed.Assume the same facts as in Example 5, except that H deducts $18,000 for business expenses on the joint return, of which $16,000 are disallowed. Since H used only $2,000 of the $16,000 disallowed deductions to offset gross income from his business, W received benefit on the return from the other $14,000 of the disallowed deductions used to offset her wage income. Therefore, $2,000 of the disallowed deductions are allocable to H and $14,000 of the disallowed deductions are allocable to W. W's liability is limited to $4,550 ( 7/8 of $5,200).

(6) Alternative allocation methods—(i) Allocation based on applicable tax rates. If a deficiency arises from two or more erroneous items that are subject to tax at different rates (e.g., ordinary income and capital gain items), the deficiency will be allocated after first separating the erroneous items into categories according to their applicable tax rate. After all erroneous items are categorized, a separate allocation is made with respect to each tax rate category using the proportionate allocation method of paragraph (d)(4) of this section.

(ii) Allocation methods provided in subsequent published guidance. Additional alternative methods for allocating erroneous items under section 6015(c) may be prescribed by the Treasury and IRS in subsequent revenue rulings, revenue procedures, or other appropriate guidance.

(iii) Example. The following example illustrates the rules of this paragraph (d)(6):

Example. Allocation based on applicable tax rates.H and W timely file their 1998 joint Federal income tax return. H and W divorce in 1999. On July 13, 2001, a $5,100 deficiency is assessed with respect to H's and W's 1998 return. Of this deficiency, $2,000 results from unreported capital gain of $6,000 that is attributable to W and $4,000 of capital gain that is attributable to H (both gains being subject to tax at the 20% marginal rate). The remaining $3,100 of the deficiency is attributable to $10,000 of unreported dividend income of H that is subject to tax at a marginal rate of 31%. H and W both timely elect to allocate the deficiency, and qualify under this section to do so. There are erroneous items subject to different tax rates; thus, the alternative allocation method of this paragraph (d)(6) applies. The three erroneous items are first categorized according to their applicable tax rates, then allocated. Of the total amount of 20% tax rate items ($10,000), 60% is allocable to W and 40% is allocable to H. Therefore, 60% of the $2,000 deficiency attributable to these items (or $1,200) is allocated to W. The remaining 40% of this portion of the deficiency ($800) is allocated to H. The only 31% tax rate item is allocable to H. Accordingly, H is liable for $3,900 of the deficiency ($800 + $3,100), and W is liable for the remaining $1,200.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-4 Equitable relief.

(a) A requesting spouse who files a joint return for which a liability remains unpaid and who does not qualify for full relief under § 1.6015-2 or 1.6015-3 may request equitable relief under this section. The Internal Revenue Service has the discretion to grant equitable relief from joint and several liability to a requesting spouse when, considering all of the facts and circumstances, it would be inequitable to hold the requesting spouse jointly and severally liable.

(b) This section may not be used to circumvent the limitation of § 1.6015-3(c)(1) (i.e., no refunds under § 1.6015-3). Therefore, relief is not available under this section to obtain a refund of liabilities already paid, for which the requesting spouse would otherwise qualify for relief under § 1.6015-3.

(c) For guidance concerning the criteria to be used in determining whether it is inequitable to hold a requesting spouse jointly and severally liable under this section, see Rev. Proc. 2000-15 (2000-1 C.B. 447), or other guidance published by the Treasury and IRS (see § 601.601(d)(2) of this chapter).

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-5 Time and manner for requesting relief.

(a) Requesting relief. To elect the application of § 1.6015-2 or 1.6015-3, or to request equitable relief under § 1.6015-4, a requesting spouse must file Form 8857, “Request for Innocent Spouse Relief” (or other specified form); submit a written statement containing the same information required on Form 8857, which is signed under penalties of perjury; or submit information in the manner prescribed by the Treasury and IRS in forms, relevant revenue rulings, revenue procedures, or other published guidance (see § 601.601(d)(2) of this chapter).

(b) Time period for filing a request for relief—(1) In general. To elect the application of § 1.6015-2 or 1.6015-3, or to request equitable relief under § 1.6015-4, a requesting spouse must file Form 8857 or other similar statement with the Internal Revenue Service no later than two years from the date of the first collection activity against the requesting spouse after July 22, 1998, with respect to the joint tax liability.

(2) Definitions—(i) Collection activity. For purposes of this paragraph (b), collection activity means a section 6330 notice; an offset of an overpayment of the requesting spouse against a liability under section 6402; the filing of a suit by the United States against the requesting spouse for the collection of the joint tax liability; or the filing of a claim by the United States in a court proceeding in which the requesting spouse is a party or which involves property of the requesting spouse. Collection activity does not include a notice of deficiency; the filing of a Notice of Federal Tax Lien; or a demand for payment of tax. The term property of the requesting spouse, for purposes of this paragraph (b), means property in which the requesting spouse has an ownership interest (other than solely through the operation of community property laws), including property owned jointly with the nonrequesting spouse.

(ii) Section 6330 notice. A section 6330 notice refers to the notice sent, pursuant to section 6330, providing taxpayers notice of the Service's intent to levy and of their right to a collection due process (CDP) hearing.

(3) Requests for relief made before commencement of collection activity. An election or request for relief may be made before collection activity has commenced. For example, an election or request for relief may be made in connection with an audit or examination of the joint return or a demand for payment, or pursuant to the CDP hearing procedures under section 6320 in connection with the filing of a Notice of Federal Tax Lien. For more information on the rules regarding collection due process for liens, see the Treasury regulations under section 6320. However, no request for relief may be made before the date specified in paragraph (b)(5) of this section.

(4) Examples. The following examples illustrate the rules of this paragraph (b):

Example 1.On January 11, 2000, a section 6330 notice is mailed to H and W regarding their 1997 joint Federal income tax liability. The Internal Revenue Service levies on W's employer on June 5, 2000. The Internal Revenue Service levies on H's employer on July 10, 2000. An election or request for relief must be made by January 11, 2002, which is two years after the Internal Revenue Service sent the section 6330 notice.

Example 2.The Internal Revenue Service offsets an overpayment against a joint liability for 1995 on January 12, 1998. The offset only partially satisfies the liability. The Internal Revenue Service takes no other collection actions. On July 24, 2001, W elects relief with respect to the unpaid portion of the 1995 liability. W's election is timely because the Internal Revenue Service has not taken any collection activity after July 22, 1998; therefore, the two-year period has not commenced.

Example 3.Assume the same facts as in Example 2, except that the Internal Revenue Service sends a section 6330 notice on January 22, 1999. W's election is untimely because it is filed more than two years after the first collection activity after July 22, 1998.

Example 4.H and W do not remit full payment with their timely filed joint Federal income tax return for the 1989 tax year. No collection activity is taken after July 22, 1998, until the United States files a suit against both H and W to reduce the tax assessment to judgment and to foreclose the tax lien on their jointly-held business property on July 1, 1999. H elects relief on October 2, 2000. The election is timely because it is made within two years of the filing of a collection suit by the United States against H.

Example 5.W files a Chapter 7 bankruptcy petition on July 10, 2000. On September 5, 2000, the United States files a proof of claim for her joint 1998 income tax liability. W elects relief with respect to the 1998 liability on August 20, 2002. The election is timely because it is made within two years of the date the United States filed the proof of claim in W's bankruptcy case.

(5) Premature requests for relief. The Internal Revenue Service will not consider premature claims for relief under § 1.6015-2, 1.6015-3, or 1.6015-4. A premature claim is a claim for relief that is filed for a tax year prior to the receipt of a notification of an audit or a letter or notice from the IRS indicating that there may be an outstanding liability with regard to that year. Such notices or letters do not include notices issued pursuant to section 6223 relating to TEFRA partnership proceedings. A premature claim is not considered an election or request under § 1.6015-1(h)(5).

(c) Effect of a final administrative determination—(1) In general. A requesting spouse is entitled to only one final administrative determination of relief under § 1.6015-1 for a given assessment, unless the requesting spouse properly submits a second request for relief that is described in § 1.6015-1(h)(5).

(2) Example. The following example illustrates the rule of this paragraph (c):

Example:In January 2001, W becomes a limited partner in partnership P, and in February 2001, she starts her own business from which she earns $100,000 of net income for the year. H and W file a joint return for tax year 2001, on which they claim $20,000 in losses from their investment in P, and they omit W's self-employment tax. In March 2003, the Internal Revenue Service commences an audit under the provisions of subchapter C of chapter 63 of subtitle F of the Internal Revenue Code (TEFRA partnership proceeding) and sends H and W a notice under section 6223(a)(1). In September 2003, the Internal Revenue Service audits H's and W's 2001 joint return regarding the omitted self-employment tax. H may file a claim for relief from joint and several liability for the self-employment tax liability because he has received a notification of an audit indicating that there may be an outstanding liability on the joint return. However, his claim for relief regarding the TEFRA partnership proceeding is premature under paragraph (b)(5) of this section. H will have to wait until the Internal Revenue Service sends him a notice of computational adjustment or assesses the liability resulting from the TEFRA partnership proceeding before he files a claim for relief with respect to any such liability. The assessment relating to the TEFRA partnership proceeding is separate from the assessment for the self-employment tax; therefore, H's subsequent claim for relief for the liability from the TEFRA partnership proceeding is not precluded by his previous claim for relief from the self-employment tax liability under this paragraph (c).

[T.D. 9003, 67 FR 47285, July 18, 2002, as amended at 67 FR 54735, Aug. 26, 2002]

§ 1.6015-6 Nonrequesting spouse's notice and opportunity to participate in administrative proceedings.

(a) In general. (1) When the Internal Revenue Service receives an election under § 1.6015-2 or 1.6015-3, or a request for relief under § 1.6015-4, the Internal Revenue Service must send a notice to the nonrequesting spouse's last known address that informs the nonrequesting spouse of the requesting spouse's claim for relief. For further guidance regarding the definition of last known address, see § 301.6212-2 of this chapter. The notice must provide the nonrequesting spouse with an opportunity to submit any information that should be considered in determining whether the requesting spouse should be granted relief from joint and several liability. A nonrequesting spouse is not required to submit information under this section. Upon the request of either spouse, the Internal Revenue Service will share with one spouse the information submitted by the other spouse, unless such information would impair tax administration.

(2) The Internal Revenue Service must notify the nonrequesting spouse of the Service's preliminary and final determinations with respect to the requesting spouse's claim for relief under section 6015.

(b) Information submitted. The Internal Revenue Service will consider all of the information (as relevant to each particular relief provision) that the nonrequesting spouse submits in determining whether relief from joint and several liability is appropriate, including information relating to the following—

(1) The legal status of the requesting and nonrequesting spouses' marriage;

(2) The extent of the requesting spouse's knowledge of the erroneous items or underpayment;

(3) The extent of the requesting spouse's knowledge or participation in the family business or financial affairs;

(4) The requesting spouse's education level;

(5) The extent to which the requesting spouse benefitted from the erroneous items;

(6) Any asset transfers between the spouses;

(7) Any indication of fraud on the part of either spouse;

(8) Whether it would be inequitable, within the meaning of §§ 1.6015-2(d) and 1.6015-4, to hold the requesting spouse jointly and severally liable for the outstanding liability;

(9) The allocation or ownership of items giving rise to the deficiency; and

(10) Anything else that may be relevant to the determination of whether relief from joint and several liability should be granted.

(c) Effect of opportunity to participate. The failure to submit information pursuant to paragraph (b) of this section does not affect the nonrequesting spouse's ability to seek relief from joint and several liability for the same tax year. However, information that the nonrequesting spouse submits pursuant to paragraph (b) of this section is relevant in determining whether relief from joint and several liability is appropriate for the nonrequesting spouse should the nonrequesting spouse also submit an application for relief.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-7 Tax Court review.

(a) In general. Requesting spouses may petition the Tax Court to review the denial of relief under § 1.6015-1.

(b) Time period for petitioning the Tax Court. Pursuant to section 6015(e), the requesting spouse may petition the Tax Court to review a denial of relief under § 1.6015-1 within 90 days after the date notice of the Service's final determination is mailed by certified or registered mail (90-day period). If the IRS does not mail the requesting spouse a final determination letter within 6 months of the date the requesting spouse files an election under § 1.6015-2 or 1.6015-3, the requesting spouse may petition the Tax Court to review the election at any time after the expiration of the 6-month period, and before the expiration of the 90-day period. The Tax Court also may review a claim for relief if Tax Court jurisdiction has been acquired under another section of the Internal Revenue Code such as section 6213(a) or 6330(d).

(c) Restrictions on collection and suspension of the running of the period of limitations—(1) Restrictions on collection under § 1.6015-2 or 1.6015-3. Unless the Internal Revenue Service determines that collection will be jeopardized by delay, no levy or proceeding in court shall be made, begun, or prosecuted against a requesting spouse electing the application of § 1.6015-2 or 1.6015-3 for the collection of any assessment to which the election relates until the expiration of the 90-day period described in paragraph (b) of this section, or if a petition is filed with the Tax Court, until the decision of the Tax Court becomes final under section 7481. For more information regarding the date on which a decision of the Tax Court becomes final, see section 7481 and the regulations thereunder. Notwithstanding the above, if the requesting spouse appeals the Tax Court's decision, the Internal Revenue Service may resume collection of the liability from the requesting spouse on the date the requesting spouse files the notice of appeal, unless the requesting spouse files an appeal bond pursuant to the rules of section 7485. Jeopardy under this paragraph (c)(1) means conditions exist that would require an assessment under section 6851 or 6861 and the regulations thereunder.

(2) Waiver of the restrictions on collection. A requesting spouse may, at any time (regardless of whether a notice of the Service's final determination of relief is mailed), waive the restrictions on collection in paragraph (c)(1) of this section.

(3) Suspension of the running of the period of limitations—(i) Relief under § 1.6015-2 or 1.6015-3. The running of the period of limitations in section 6502 on collection against the requesting spouse of the assessment to which an election under § 1.6015-2 or 1.6015-3 relates is suspended for the period during which the Internal Revenue Service is prohibited by paragraph (c)(1) of this section from collecting by levy or a proceeding in court and for 60 days thereafter. However, if the requesting spouse signs a waiver of the restrictions on collection in accordance with paragraph (c)(2) of this section, the suspension of the period of limitations in section 6502 on collection against the requesting spouse will terminate on the date that is 60 days after the date the waiver is filed with the Internal Revenue Service.

(ii) Relief under § 1.6015-4. If a requesting spouse seeks only equitable relief under § 1.6015-4, the restrictions on collection of paragraph (c)(1) of this section do not apply. Accordingly, the request for relief does not suspend the running of the period of limitations on collection.

(4) Definitions—(i) Levy. For purposes of this paragraph (c), levy means an administrative levy or seizure described by section 6331.

(ii) Proceedings in court. For purposes of this paragraph (c), proceedings in court means suits filed by the United States for the collection of Federal tax. Proceedings in court does not refer to the filing of pleadings and claims and other participation by the Internal Revenue Service or the United States in suits not filed by the United States, including Tax Court cases, refund suits, and bankruptcy cases.

(iii) Assessment to which the election relates. For purposes of this paragraph (c), the assessment to which the election relates is the entire assessment of the deficiency to which the election relates, even if the election is made with respect to only part of that deficiency.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-8 Applicable liabilities.

(a) In general. Section 6015 applies to liabilities that arise after July 22, 1998, and to liabilities that arose prior to July 22, 1998, that were not paid on or before July 22, 1998.

(b) Liabilities paid on or before July 22, 1998. A requesting spouse seeking relief from joint and several liability for amounts paid on or before July 22, 1998, must request relief under section 6013(e) and the regulations thereunder.

Example 1.H and W file a joint Federal income tax return for 1995 on April 15, 1996. There is an understatement on the return attributable to an omission of H's wage income. On October 15, 1998, H and W receive a 30-day letter proposing a deficiency on the 1995 joint return. W pays the outstanding liability in full on November 30, 1998. In March 1999, W files Form 8857, requesting relief from joint and several liability under section 6015(b). Although W's liability arose prior to July 22, 1998, it was unpaid as of that date. Therefore, section 6015 is applicable.

Example 2.H and W file their 1995 joint Federal income tax return on April 15, 1996. On October 14, 1997, a deficiency of $5,000 is assessed regarding a disallowed business expense deduction attributable to H. On June 30, 1998, the Internal Revenue Service levies on the $3,000 in W's bank account in partial satisfaction of the outstanding liability. On August 31, 1998, W files a request for relief from joint and several liability. The liability arose prior to July 22, 1998. Section 6015 is applicable to the $2,000 that remained unpaid as of July 22, 1998, and section 6013(e) is applicable to the $3,000 that was paid prior to July 22, 1998.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6015-9 Effective date.

Sections 1.6015-0 through 1.6015-9 are applicable for all elections under § 1.6015-2 or 1.6015-3 or any requests for relief under § 1.6015-4 filed on or after July 18, 2002.

[T.D. 9003, 67 FR 47285, July 18, 2002]

§ 1.6016-1 Declarations of estimated income tax by corporations.

(a) Requirement. For taxable years ending on or after December 31, 1955, a declaration of estimated tax shall be made by every corporation (including unincorporated business enterprises electing to be taxed as domestic corporations under section 1361), which is subject to taxation under section 11 or 1201(a), or subchapter L, chapter 1 of the Code (relating to insurance companies), if its income tax under such sections or such subchapter L for the taxable year can reasonably be expected to exceed the sum of $100,000 plus the amount of any estimated credits allowable under section 32 (relating to tax withheld at source on nonresident aliens and foreign corporations and on tax-free covenant bonds), section 33 (relating to taxes of foreign countries and possessions of the United States), and section 38 (relating to investment in certain depreciable property).

(b) Definition of estimated tax. The term “estimated tax”, in the case of a corporation, means the excess of the amount which such corporation estimates as its income tax liability for the taxable year under section 11 or 1201(a), or subchapter L, chapter 1 of the Code, over the sum of $100,000 and any estimated credits under sections 32, 33, and 38. However, for the rule with respect to the limitation upon the $100,000 exemption for members of certain electing affiliated groups, see section 243(b)(3)(C)(v) and the regulations thereunder.

Example 1.M, a corporation subject to tax under section 11, reasonably anticipates that it will have taxable income of $224,000 for the calendar year 1964. The normal tax and surtax result in an expected liability of $105,000. M determines that it will not have any allowable credits under sections 32, 33, and 38 for 1964. Since M's expected tax ($105,000) exceeds the exemption ($100,000), a declaration of estimated tax is required to be filed, reporting an estimated tax of $5,000 ($105,000−$100,000) for the calendar year 1964.

Example 2.Under the facts stated in example (1), except that M estimates it will have an allowable foreign tax credit under section 33 in the amount of $4,000 and an allowable investment credit under section 38 in the amount of $3,000, no declaration is required, since M's expected tax ($105,000) does not exceed the $100,000 plus the allowable credits totaling $7,000.

[T.D. 6768, 29 FR 14921, Nov. 4, 1964]

§ 1.6016-2 Contents of declaration of estimated tax.

(a) In general. The declaration of estimated tax by a corporation shall be made on Form 1120-ES. For the purpose of making the declaration, the estimated tax should be based upon the amount of gross income which the taxpayer can reasonably be expected to receive or accrue as the case may be, depending upon the method of accounting upon the basis of which the taxable income is computed, and the amount of the estimated allowable deductions and credits to be taken into account. Such amounts of gross income, deductions, and credits should be determined upon the basis of facts and circumstances existing as at the time prescribed for the filing of the declaration as well as those reasonably to be anticipated for the taxable year.

(b) Use of prescribed form. Copies of Form 1120-ES will so far as possible be furnished taxpayers by district directors. A taxpayer will not be excused from making a declaration, however, by the fact that no form has been furnished. Taxpayers not supplied with the proper form should make application therefor to the district director in ample time to have their declarations prepared, verified, and filed with the district director on or before the date prescribed for filing the declaration. If the prescribed form is not available a statement disclosing the estimated income tax after the exemption and the credits, if any, should be filed as a tentative declaration within the prescribed time, accompanied by the payment of the required installment. Such tentative declaration should be supplemented, without unnecessary delay, by a declaration made on the proper form.

§ 1.6016-3 Amendment of declaration.

In the making of a declaration of estimated tax the corporation is required to take into account the then existing facts and circumstances as well as those reasonably to be anticipated relating to prospective gross income, allowable deductions, and estimated credits for the taxable year. Amended or revised declarations may be made in any case in which the corporation estimates that its gross income, deductions, or credits will materially change the estimated tax reported in the previous declaration. However, for the rule with respect to the number of amended declarations which may be filed for taxable years beginning after December 31, 1963, see paragraph (d)(2) of § 1.6074-1. Such amended declaration may be made on either Form 1120-ES (marked “Amended”) or on the reverse side of the installment notice furnished the corporation by the district director. See, however, paragraph (b) of § 1.6016-2 for procedure to be followed if the prescribed form is not available.

[T.D. 6768, 29 FR 14922, Nov. 4, 1964]

§ 1.6016-4 Short taxable year.

(a) Requirement of declaration. No declaration may be made for a period of more than 12 months. For purposes of this section a taxable year of 52 or 53 weeks, in the case of a corporation which computes its taxable income in accordance with the election permitted by section 441(f), shall be deemed a period of 12 months. For special rules affecting the time for filing declarations and paying estimated tax by such corporation, see paragraph (b) of § 1.441-2. A separate declaration is required where a corporation is required to submit an income tax return for a period of less than 12 months, but only if such short period ends on or after December 31, 1955. However, no declaration is required if the short taxable year:

(1) Begins on or before December 31, 1963, and is:

(i) A period of less than 9 months, or

(ii) A period of 9 or more months but less than 12 months and the requirements of section 6016(a) are not met before the 1st day of the last month in the short taxable year, or

(2) Begins after December 31, 1963, and is:

(i) A period of less than 4 months, or

(ii) A period of 4 or more months but less than 12 months and the requirements of section 6016(a) are not met before the 1st day of the last month in the short taxable year.

(b) Income placed on an annual basis. In cases where the short taxable year results from a change of annual accounting period, for the purpose of determining whether the anticipated income for a short taxable year will result in an estimated tax liability requiring the filing of a declaration, such income shall be placed on an annual basis in the manner prescribed in section 443(b)(1). If a tax computed on such annualized income exceeds the sum of $100,000 and any credits under part IV, of subchapter A, chapter 1 of the Code, the estimated tax shall be the same part of the excess so computed as the number of months in the short period is of 12 months. Thus, for example, a corporation which changes from a calendar year basis to a fiscal year basis beginning October 1, 1956, will have a short taxable year beginning January 1, 1956, and ending September 30, 1956. If on or before August 31, 1956, the taxpayer anticipates that it will have income of $264,000 for the 9-month taxable year the estimated tax is computed as follows:

(1) Anticipated taxable income for 9 months | $264,000

(2) Annualized income ($264,000 × 12 ÷ 9) | 352,000

(3) Tax liability on item (2) | 177,540

(4) Item (3) reduced by $100,000 (there are no credits under part IV, subchapter A, chapter 1 of the Code) | 77,540

(5) Estimated tax for 9-month period ($77,540 × 9 ÷ 12) | 58,155

Since the tax liability on the annualized income is in excess of $100,000, a declaration is required to be filed, reporting an estimated tax of $58,155 for the 9-month taxable period. This paragraph has no application where the short taxable year does not result from a change in the taxpayer's annual accounting period.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6768, 29 FR 14922, Nov. 4, 1964]

§ 1.6017-1 Self-employment tax returns.

(a) In general. (1) Every individual, other than a nonresident alien, having net earnings from self-employment, as defined in section 1402, of $400 or more for the taxable year shall make a return of such earnings. For purposes of this section, an individual who is a resident of the Virgin Islands, Puerto Rico, or (for any taxable year beginning after 1960) Guam or American Samoa is not to be considered a nonresident alien individual. See paragraph (d) of § 1.1402(b)-1. A return is required under this section if an individual has self-employment income, as defined in section 1402(b), even though he may not be required to make a return under section 6012 for purposes of the tax imposed by section 1 or 3. Provisions applicable to returns under section 6012(a) shall be applicable to returns under this section.

(2) Except as otherwise provided in this subparagraph, the return required by this section shall be made on Form 1040. The form to be used by residents of the Virgin Islands, Guam, or American Samoa is From 1040SS. In the case of a resident of Puerto Rico who is not required to make a return of income under section 6012(a), the form to be used is Form 1040SS, except that Form 1040PR shall be used if it is furnished by the Internal Revenue Service to such resident for use in lieu of Form 1040SS.

(b) Joint returns. (1) In the case of a husband and wife filing a joint return under section 6013, the tax on self-employment income is computed on the separate self-employment income of each spouse, and not on the aggregate of the two amounts. The requirement of section 6013(d)(3) that in the case of a joint return the tax is computed on the aggregate income of the spouses is not applicable with respect to the tax on self-employment income. Where the husband and wife each has net earnings from self-employment of $400 or more, it will be necessary for each to complete separate schedules of the computation of self-employment tax with respect to the net earnings of each spouse, despite the fact that a joint return is filed. If the net earnings from self-employment of either the husband or the wife are less than $400, such net earnings are not subject to the tax on self-employment income, even though they must be shown on the joint return for purposes of the tax imposed by section 1 or 3.

(2) Except as otherwise expressly provided, section 6013 is applicable to the return of the tax on self-employment income; therefore, the liability with respect to such tax in the case of a joint return is joint and several.

(c) Social security account numbers. (1) Every individual making a return of net earnings from self-employment for any period commencing before January 1, 1962, is required to show thereon his social security account number, or, if he has no such account number, to make application therefor on Form SS-5 before filing such return. However, the failure to apply for or receive a social security account number will not excuse the individual from the requirement that he file such return on or before the due date thereof. Form SS-5 may be obtained from any district office of the Social Security Administration or from any district director. The application shall be filed with a district office of the Social Security Administration or, in the case of an individual not in the United States, with the district office of the Social Security Administration at Baltimore, Md. An individual who has previously secured a social security account number as an employee shall use that account number on his return of net earnings from self-employment.

(2) For provisions applicable to the securing of identifying numbers and the reporting thereof on returns and schedules for periods commencing after December 31, 1961, see § 1.6109-1.

(d) Declaration of estimated tax with respect to taxable years beginning after December 31, 1966. For taxable years beginning after December 31, 1966, section 6015 provides that the term “estimated tax” includes the amount which an individual estimates as the amount of self-employment tax imposed by chapter 2 for the taxable year. Thus, individuals upon whom self-employment tax is imposed by section 1401 must make a declaration of estimated tax if they meet the requirements of section 6015(a); except as otherwise provided under section 6015(i).

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6691, 28 FR 12816, Dec. 3, 1963; T.D. 7427, 41 FR 34028, Aug. 12, 1976]

6 information returns

§ 1.6031(a)-1 Return of partnership income.

(a) Domestic partnerships—(1) Return required. Except as provided in paragraphs (a)(3) and (c) of this section, every domestic partnership must file a return of partnership income under section 6031 (partnership return) for each taxable year on the form prescribed for the partnership return. The partnership return must be filed for the taxable year of the partnership regardless of the taxable years of the partners. For taxable years of a partnership and of a partner, see section 706 and § 1.706-1. For the rules governing partnership statements to partners and nominees, see § 1.6031(b)-1T. For the rules requiring the disclosure of certain transactions, see § 1.6011-4T.

(2) Content of return. The partnership return must contain the information required by the prescribed form and the accompanying instructions.

(3) Special rule. (i) A partnership that has no income, deductions, or credits for federal income tax purposes for a taxable year is not required to file a partnership return for that year.

(ii) The Commissioner may, in guidance published in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter), provide for an exception to partnership reporting under section 6031 and for conditions for the exception, if all or substantially all of a partnership's income is derived from the holding or disposition of tax-exempt obligations (as defined in section 1275(a)(3) and § 1.1275-1(e)) or shares in a regulated investment company (as defined in section 851(a)) that pays exempt-interest dividends (as defined in section 852(b)(5)).

(4) Failure to file. For the consequences of a failure to comply with the requirements of section 6031(a) and this paragraph (a), see sections 6229(a), 6231(f), 6698, and 7203.

(b) Foreign partnerships—(1) General rule. (i) Filing requirement. A foreign partnership is not required to file a partnership return, if the foreign partnership does not have gross income that is (or is treated as) effectively connected with the conduct of a trade or business within the United States (ECI) and does not have gross income (including gains) derived from sources within the United States (U.S.-source income). Except as provided in paragraphs (b)(2) and (3) of this section, a foreign partnership that has ECI or has U.S.-source income that is not ECI must file a partnership return for its taxable year in accordance with the rules for domestic partnerships in paragraph (a) of this section.

(ii) Special rule. For purposes of this paragraph (b)(1) and paragraph (b)(3)(iii) of this section, a foreign partnership will not be considered to have derived income from sources within the United States solely because a U.S. partner marks to market his pro rata share of PFIC stock held by the foreign partnership pursuant to an election under section 1296.

(2) Foreign partnerships with de minimis U.S.-source income and de minimis U.S. partners. A foreign partnership (other than a withholding foreign partnership, as defined in § 1.1441-5(c)(2)(i)) that has $20,000 or less of U.S.-source income and has no ECI during its taxable year is not required to file a partnership return if, at no time during the partnership taxable year, one percent or more of any item of partnership income, gain, loss, deduction, or credit is allocable in the aggregate to direct United States partners. The United States partners must directly report their shares of the allocable items of partnership income, gain, loss, deduction, and credit.

(3) Filing obligations for certain other foreign partnerships with no ECI—(i) General requirements for modified filing obligations. A foreign partnership will be subject to the modified filing obligations in paragraphs (b)(3)(ii) and (iii) of this section if, in addition to satisfying the requirements contained in paragraphs (b)(3)(ii) and (iii) of this section—

(A) The partnership is not a withholding foreign partnership as defined in § 1.1441-5(c)(2)(i);

(B) Forms 1042 and 1042-S are filed by the partnership with respect to the amounts subject to reporting under § 1.1461-1(b) and (c), unless the partnership is not required to file such returns under § 1.1461-1(b)(2) and (c)(4), in which case Forms 1042 and 1042-S must be filed by another withholding agent or agents; and

(C) The tax liability of the partners with respect to such amounts has been fully satisfied by the withholding of tax at the source, if applicable, under chapter 3 of the Internal Revenue Code.

(ii) Foreign partnerships with U.S.-source income but no U.S. partners. A foreign partnership that has U.S.-source income is not required to file a partnership return if the partnership has no ECI and no United States partners at any time during the partnership's taxable year.

(iii) Foreign partnerships with U.S.-source income and U.S. partners. Except as provided in paragraph (b)(2) of this section, a foreign partnership with one or more United States partners that has U.S.-source income but no ECI must file a partnership return. However, such a foreign partnership need not file Statements of Partner's Share of Income, Credit, Deduction, etc. (Schedules K-1) for any partners other than its direct United States partners and its passthrough partners (whether U.S. or foreign) through which United States partners hold an interest in the foreign partnership. Schedules K-1 that are not excepted from filing under this paragraph (b)(3)(iii) must contain the same information required of a domestic partnership filing under paragraph (a) of this section.

(4) Information or returns required of partners who are United States persons—(i) In general. If a United States person is a partner in a partnership that is not required to file a partnership return, the district director or director of the relevant service center may require that person to render the statements or provide the information necessary to verify the accuracy of the reporting by that person of any items of partnership income, gain, loss, deduction, or credit.

(ii) Controlled foreign partnerships. Certain United States persons who are partners in a foreign partnership controlled (within the meaning of section 6038(e)(1)) by United States persons may be required to provide information with respect to the partnership under section 6038.

(5) Certain partnership elections. For a partnership that is not otherwise required to file a partnership return, if an election that can only be made by the partnership under section 703 (affecting the computation of taxable income derived from a partnership) is to be made by or for the partnership, a return on the form prescribed for the partnership return must be filed for the partnership. Unless otherwise provided in the form or the accompanying instructions, a return filed solely to make an election need only contain a written statement citing paragraph (b)(5)(ii) of this section, listing the name and address of the partnership making the election, and clearly identifying the specific election being made. A return filed under paragraph (b)(5)(ii) of this section solely to make an election is not a partnership return. Thus, such a return is not a return filed under section 6031(a) for purposes of sections 6501 (except regarding the specific election issue), 6231(a)(1)(A), and 6233. The return must be signed by—

(i) Each partner that is a partner in the partnership at the time the election is made; or

(ii) Any partner of the partnership who is authorized (under local law or the partnership's organizational documents) to make the election and who represents to having such authorization under penalties of perjury.

(6) Exclusion for certain organizations. The return requirement of section 6031 and this section does not apply to the International Telecommunications Satellite Organization, the International Maritime Satellite Organization, or any organization that is a successor of either.

(7) Filing obligation for certain partners of certain foreign partnerships with respect to base erosion payments. If a foreign partnership is not required to file a partnership return and the foreign partnership has made a payment or accrual that is treated as a base erosion payment of a partner as provided in § 1.59A-7(c), a partner in the foreign partnership who is a person required to file a Form 8991 (or successor) must include the information necessary to report those base erosion payments and base erosion tax benefits on Form 8991 (or successor) in accordance with the related instructions. A partner with a Form 8991 (or successor) filing requirement who is a partner in a foreign partnership that is not required to file a partnership return must obtain the necessary information to report any base erosion payments on Form 8991 (or successor) from the foreign partnership or from any other reliable records of these payments. This paragraph does not apply to any partner described in § 1.59A-7(d)(2).

(c) Partnerships excluded from the application of subchapter K of the Internal Revenue Code—(1) Wholly excluded—(i) Year of election. An eligible partnership as described in § 1.761-2(a) that elects to be excluded from all the provisions of subchapter K of chapter 1 of the Internal Revenue Code in the manner specified by § 1.761-2(b)(2)(i) must timely file the form prescribed for the partnership return for the taxable year for which the election is made. In lieu of the information otherwise required, the return must contain or be accompanied by the information required by § 1.761-2(b)(2)(i).

(ii) Subsequent years. Except as otherwise provided in paragraph (c)(1)(i) of this section, an eligible partnership that elects to be wholly excluded from the application of subchapter K is not required to file a partnership return.

(2) Deemed excluded. An eligible partnership that is deemed to have elected exclusion from the application of subchapter K beginning with its first taxable year, as specified in § 1.761-2(b)(2)(ii), is not required to file a partnership return.

(d) Definitions—(1) Partnership. For the meaning of the term partnership, see § 1.761-1(a).

(2) United States person. In applying this section, a United States person is a person described in section 7701(a)(30); the government of the United States, a State, or the District of Columbia (including an agency or instrumentality thereof); or a corporation created or organized in Guam, the Commonwealth of Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa, if the requirements of section 881(b)(1)(A), (B), and (C) are met for such corporation. The term does not include an alien individual who is a resident of Puerto Rico, Guam, the Commonwealth of Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa, as determined under § 301.7701(b)-1(d) of this chapter.

(3) United States partner. In applying this section, a United States partner is any United States person who holds a direct or indirect interest in the partnership.

(4) Indirect interest. An indirect interest is any interest held through one or more passthrough partners, as defined in section 6231(a)(9).

(e) Procedural requirements—(1) Place for filing. The return of a partnership must be filed with the service center prescribed in the relevant IRS revenue procedure, publication, form, or instructions to the form (see § 601.601(d)(2)).

(2) Time for filing. The return of a partnership must be filed on or before the date prescribed by section 6072(b).

(3) Magnetic media filing. For magnetic media filing requirements with respect to partnerships, see section 6011(e)(2) and the regulations thereunder.

(f)(1) Applicability date. This section applies to returns filed on or after January 30, 2020. Section 1.6031(a)-1T (as contained in 26 CFR part 1, revised April 2019) applies to returns filed before January 30, 2020.

(2) Applicability date. Paragraph (b)(7) of this section applies to taxable years ending on or after October 9, 2020.

[T.D. 8841, 64 FR 61500, Nov. 12, 1999, as amended by T.D. 9000, 67 FR 41328, June 18, 2002; T.D. 9094, 68 FR 63734, Nov. 10, 2003; 68 FR 70584, Dec. 18, 2003; T.D. 9123, 69 FR 24078, May 3, 2004; T.D. 9177, 70 FR 7176, Feb. 11, 2005; T.D. 9821, 82 FR 33444, July 20, 2017; T.D. 9892, 85 FR 5324, Jan. 30, 2020; T.D. 9910, 85 FR 64369, Oct. 9, 2020]

§ 1.6031(b)-1T Statements to partners (temporary).

(a) Statement required to be furnished to partners—(1) In general. Except as provided in this paragraph (a)(1) and paragraph (a)(2)(ii) of this section, any partnership required under section 6031(a) and the regulations thereunder to file a partnership return for a taxable year shall furnish to every person who was a partner (within the meaning of section 7701(a)(2)) at any time during the taxable year a written statement containing the information described in paragraph (a)(3) of this section. This section shall not apply to a real estate mortgage investment conduit (REMIC) treated as a partnership under subtitle F of the Code by reason of section 860F(e). For the reporting requirements applicable to REMICs see § 1.6031(b)-2T.

(2) Special rules applicable to partnership interests held by nominees—(i) Statements furnished to nominees. For any partnership taxable year beginning after October 22, 1986, a partnership shall provide a person that holds (directly or indirectly) an interest in such partnership as a nominee on behalf of another person at any time during such year with a statement under paragraph (a)(1) of this section with respect to such interest if—

(A) Such nominee has not furnished the statement required under § 1.6031(c)-1T(a)(1)(i) to the partnership with respect to such other person;

(B) Such nominee either holds legal title to such partnership interest in its own name or is identified in a statement provided to the partnership pursuant to § 1.6031(c)-1T(a)(1)(i) by another nominee as the person on whose behalf such other nominee holds such interest; and

In such case, the partnership shall assume, for purposes of this section, that the nominee is the beneficial owner of the partnership interest.

(ii) Statements not required to be furnished to partners holding partnership interests through nominees. A partnership shall not be required to furnish a statement under paragraph (a)(1) of this section to a partner with respect to any portion of such partner's interest in the partnership that is owned through a nominee if—

(A) Such nominee has not furnished (or is not required to furnish under § 1.6031(c)-1T(a)(2)), a statement to the partnership under § 1.6031(c)-1T(a)(1)(i) with respect to such partner; and

(B) Such partner has not furnished (or is not required to furnish) a statement to the partnership under § 1.6031(c)-1T(a)(3), with respect to such interest in the partnership.

(3) Contents of statement. The statement required under paragraph (a)(1) of this section shall include the following information:

(i) The partner's distributive share of partnership income, gain, loss, deduction, or credit required to be shown on the partnership return (or, for taxable years beginning before January 1, 1987, the partner's distributive share of partnership income, gain, loss, deduction, or credit shown on the partnership return); and

(ii) To the extent provided by form or the accompanying instructions, any additional information that may be required to apply particular provisions of subtitle A of the Code to the partner with respect to items related to the partnership.

(b) Time for furnishing statement. The statement required to be furnished by the partnership under paragraph (a)(1) of this section shall be furnished on or before the day on which the partnership return for that taxable year is required to be filed (determined with regard to extensions). For partnership returns the due date for which (determined without regard to extensions) is before January 1, 1987, the statement required to be furnished by the partnership under paragraph (a)(1) of this section shall be furnished on or before the day on which the partnership return is filed.

(c) Statement may be provided to agent. If a partner designates another person, such as an attorney or an investment advisor, as the partner's (or nominee's) agent in dealing with the partnership, the partnership may provide the statement required under paragraph (a)(1) of this section with respect to such partner to such other person instead of the partner.

(d) Penalties. For penalties for failure to comply with the requirements of section 6031(b) and paragraph (a) of this section, see section 6722(a).

(e) Effective date. Except as otherwise provided in this section, the provisions of this section apply to partnership taxable years beginning after September 3, 1982.

[T.D. 8225, 53 FR 34490, Sept. 7, 1988]

§ 1.6031(b)-2T REMIC reporting requirements (temporary). [Reserved]

§ 1.6031(c)-1T Nominee reporting of partnership information (temporary).

(a) Statements required to be furnished to partnership—(1) Statement from nominee—(i) In general. Except as otherwise provided in this section, any person who holds, directly or indirectly, an interest in a partnership (required under section 6031(a) and the regulations thereunder to file a partnership return for a taxable year) as a nominee on behalf of another person at any time during the partnership taxable year shall furnish to the partnership a written statement (or statements) for that taxable year with respect to such other person containing the information described in paragraph (a)(1)(ii) of this section.

(ii) Contents of statement. The statement required under paragraph (a)(1)(i) of this section shall, except as otherwise provided in paragraph (a)(4) of this section, include the following information:

(A) The name, address, and taxpayer identification number of the nominee;

(B) The name, address, and taxpayer identification number of such other person;

(1) A person that is not a United States person;

(2) A foreign government, an international organization, or any wholly-owned agency or instrumentality of either of the foregoing; or

(3) A tax-exempt entity (within the meaning of section 168(h)(2));

(D) A description of any interest in the partnership held by the nominee on behalf of such other person at the beginning of the partnership taxable year;

(E) A description of any interest in the partnership that the nominee acquires (within the meaning of paragraph (g)(1) of this section) on behalf of such other person during the partnership taxable year, the method of acquisition (e.g., purchase, exchange, acquisition at death, gift, or commencement of nominee relationship) and acquisition cost (within the meaning of paragraph (g)(2) of this section) of such interest, and the date of the acquisition of such interest; and

(F) A description of any interest in the partnership that the nominee transfers (within the meaning of paragraph (g)(5) of this section) on behalf of such other person during the partnership taxable year, the net proceeds from the transfer (within the meaning of paragraph (g)(6) of this section) of such interest, and the date of the transfer of such interest.

A description of a partnership interest must include sufficient detail to enable the partnership to furnish to such other person the statement required under § 1.6031(b)-1T (a).

(2) Special rule for clearing agencies. A clearing agency registered pursuant to the provisions of section 17A of the Securities Exchange Act of 1934 (or its nominee) that holds an interest in a partnership as a nominee on behalf of another person shall not be required to furnish any statement described in paragraph (a)(1)(i) of this section with respect to such interest.

(3) Special rule for brokers and financial institutions—(i) Additional statement required. Any broker (within the meaning of paragraph (g)(3) of this section) or financial institution (within the meaning of paragraph (g)(4) of this section) that holds an interest in a partnership indirectly through a nominee described in paragraph (a)(2) of this section at any time during a partnership taxable year shall furnish (in addition to any statement (or statements) required under paragraph (a)(1)(i) of this section) to the partnership a written statement (or statements) containing the information described in paragraph (a)(3)(ii) of this section with respect to any interest in such partnership that it holds (directly or indirectly) for its own account at any time during such partnership taxable year.

(ii) Contents of statement. The statement required under paragraph (a)(3)(i) of this section shall, except as otherwise provided in paragraph (a)(4) of this section, include the following information:

(A) The name, address, and taxpayer identification number of the broker or financial institution;

(B) Whether such broker of financial institution is a person that is not a United States person;

(C) A description of any interest in the partnership held by the broker or financial institution for its own account at the beginning of the partnership taxable year;

(D) A description of any interest in the partnership that the broker or financial institution acquires for its own account during the partnership taxable year, the method of acquisition and acquisition cost of such interest, and the date of the acquisition of such interest; and

(E) A description of any interest in the partnership that the broker or financial institution transfers for its own account during the partnership taxable year, the net proceeds from the transfer of such interest, and the date of the transfer of such interest.

A description of a partnership interest held by a broker or financial institution for its own account must include sufficient detail to enable the partnership to furnish to the broker or financial institution the statement required under § 1.6031(b)-1T (a).

(4) Exception—(i) In general. Except as otherwise provided in this paragraph (a)(4), any statement required under paragraph (a) (1)(i) or (3)(i) of this section for a taxable year is not required to include—

(A) That part of the information described in paragraph (a) (1)(ii)(E) and (3)(ii)(D) of this section regarding the method of acquisition and acquisition cost; or

(B) That part of the information described in paragraph (a)(1)(ii)(F) and (3)(ii)(E) of this section regarding the net proceeds from the transfer;

to the extent that, prior to the beginning of the partnership taxable year, the partnership has provided the nominee with a written statement that the nominee need not provide such information to the partnership, and the partnership has not modified or revoked such statement. For purposes of the preceding sentence, the modification or revocation of a statement furnished to a nominee is effective for a partnership taxable year if and only if the partnership notifies the nominee of such modification or revocation by a written statement more than 60 days before the beginning of the partnership taxable year. The nominee shall retain a copy of any statement that is furnished to it by the partnership under this paragraph (a)(4) in the nominee's records so long as the contents thereof may become material in the administration of any internal revenue law.

(ii) Effect of election under section 754. Paragraph (a)(4)(i)(A) of this section shall not apply to a partnership taxable year if—

(A) The partnership has an election in effect under section 754 (relating to optional adjustment to basis of partnership property) for such taxable year; and

(B) The nominee knows or has reason to know of such election more than 60 days before the beginning of such taxable year.

(5) Examples. The following examples illustrate the application of this paragraph (a):

Example 1.B, a broker, holds 50 units of interest in Partnership P, a calendar year partnership, in street name for customer A, the beneficial owner. B holds the units on behalf of A at all times during 1989. B must furnish a statement to P for calendar year 1989 under paragraph (a)(1)(i) of this section that includes the information required under paragraph (a)(1)(ii) (A) through (D) of this section. The description of the partnership interest held by B on A's behalf on January 1, 1989, must identify the number of units of P held by B on A's behalf at that time (50), and the class of the partnership interest (including the Committee on Uniform Security Identification Procedures (CUSIP) number of the partnership interest, if known).

Example 2.The facts are the same as in example (1), except that pursuant to A's instructions, B sells 25 of A's units of interest in P on August 1, 1989, receiving net proceeds from the transfer of $500. In addition to the information described in example (1), the statement that B must furnish to P must include the class of the partnership interest transferred (including the CUSIP number of the partnership interest, if known), the number of units transferred (25), the net proceeds from the transfer ($500), and the date of the transfer (August 1, 1989.)

Example 3.The facts are the same as in example (1), except that A is not the beneficial owner, but rather holds the units as a nominee on behalf of C, the beneficial owner, at all times during 1989. In addition to the statement that B must furnish to P (as described in Example (1) of this paragraph (a)(5)), A must furnish a statement to P for calendar year 1989 under paragraph (a)(1)(i) of this section that includes the information required under paragraph (a)(1)(ii) (A) through (D) of this section. If both A and B provide P with the statement required under paragraph (a)(1)(i) of this section, P must provide C with the statement required under § 1.6031(b)-1T (a)(1).

(b) Time for furnishing statements. A nominee may furnish to the partnership any statement required under paragraph (a) of this section annually, quarterly, monthly, or on any other basis, provided that all statements required to be furnished under paragraph (a) of this section for a partnership taxable year shall be furnished on or before the last day of the first month following the close of such partnership taxable year.

(c) Use of magnetic media. A nominee required to furnish a written statement under paragraph (a) of this section, may, in lieu of furnishing such written statement, furnish the required information on magnetic tape or by other media if the partnership and the nominee so agree.

(d) Use of single document. Any person who holds interests in a partnership as a nominee on behalf of more than one other person during the partnership taxable year, may, in lieu of furnishing to the partnership a separate statement for each such other person, furnish to the partnership a single document which includes, for each such other person, the information described in paragraph (a)(1)(ii) of this section. To the extent that a single document is used, references in this section to the statement required under paragraph (a)(1)(i) of this section shall be deemed to refer also to the information included in a single document under this paragraph (d).

(e) Retention of information. The nominee shall retain a copy of any statement that is furnished to the partnership under this section in the nominee's records so long as the contents thereof may become material in the administration of any internal revenue law.

(f) Use of agent. If a partnership has designated another person, such as a clearing organization, as the partnership's agent for purposes of receiving the statements required under paragraph (a) of this section, such statements may be furnished to that other person instead of the partnership. If a nominee has designated another person as its agent for purposes of furnishing to the partnership (or its agent) the statements required under paragraph (a) of this section, that other person may furnish such statements to the partnership (or its agent) on behalf of the nominee.

(g) Meaning of terms. For purposes of this section, the following terms have the meanings set forth below:

(1) The term acquires means—

(i) A purchase or other acquisition of a partnership interest; or

(ii) The commencement of a nominee relationship, including the substitution of one nominee for another.

(2) The term acquisition cost means the sum of any money paid and the fair market value of any property (other than money) transferred to acquire a partnership interest increased by any expenses paid or incurred with respect to the acquisition (such as broker's fees or commissions).

(3) The term broker shall have the meaning set forth in paragraph (a)(1) of § 1.6045ca-1.

(4) The term financial institution means a financial institution such as a bank, mutual savings bank, savings and loan association, building and loan association, cooperative bank, homestead association, credit union, industrial loan association or bank or other similar organization.

(5) The term transfer means—

(i) A sale, exchange, or other disposition of a partnership interest; or

(ii) The termination of a nominee relationship, including the substitution of one nominee for another.

(6) The term net proceeds from the transfer means the sum of any money and the fair market value of any property (other than money) received in connection with a transfer of a partnership interest reduced by any expenses paid or incurred with respect to the transfer (such as broker's fees or commissions).

(7) The term person includes the United States, a State, the District of Columbia, a foreign government, a political subdivision of a State or foreign government, or an international organization.

(h) Statement required by nominees that do not comply with § 1.6031(c)-1T (a)—(1) In general. Any person that—

(i) Holds an interest in a partnership as a nominee (other than a nominee described in paragraph (a)(3) of this section) on behalf of another person at any time during the partnership taxable year;

(ii) Does not furnish to such partnership the statement required under paragraph (a)(1)(i) of this section for such other person with respect to such interest in the partnership; and

(iii) Receives from such partnership the statement described in paragraph (a)(1) of § 1.6031(b)-1T with respect to such interest in the partnership;

shall furnish to such other person a written statement containing the information described in paragraph (h)(2) of this section with respect to such interest in the partnership.

(2) Contents of statement. The statement required under paragraph (h)(1) of this section shall contain the following information:

(i) The distributive share of partnership income, gain, loss, deduction or credit required to be shown on the partnership return that is allocable to such interest in the partnership; and

(ii) Any additional information that may be required to apply particular provisions of subtitle A of the Code to the beneficial owner of such interest in the partnership in connection with items related to the partnership.

(3) Time for furnishing statements. A nominee shall furnish the statement required under paragraph (h)(1) of this section within 30 days after receiving the statement described in paragraph (a) of § 1.6031(b)-1T.

(i) REMICs. This section shall not apply with respect to any interest in a real estate mortgage investment conduit (REMIC) treated as a partnership under subtitle F of the Code by reason of section 860F(e). For the nominee reporting requirements with respect to REMICs see § 1.6031(c)-2T.

(j) Penalties. [Reserved]

(k) Effective date—(1) In general. Except as otherwise provided in paragraph (k)(2) of this section, the provisions of this section shall apply to partnership taxable years beginning after October 22, 1986.

(2) Transitional rule for taxable years beginning before January 1, 1989. For partnership taxable years beginning before January 1, 1989,—

(i) Any statement that a nominee is required to furnish to a partnership under paragraph (a)(1) of this section shall not be required to include the following information:

(A) The information described in paragraph (a)(1)(ii)(C) of this section;

(B) That part of the information described in paragraph (a)(1)(ii)(E) of this section regarding the method of acquisition and acquisition cost of a partnership interest; or

(C) That part of the information described in paragraph (a)(1)(ii)(F) of this section regarding the net proceeds from the transfer of a partnership interest.

(ii) A broker or financial institution shall not be required to furnish the additional statement described in paragraph (a)(3)(i) of this section.

[T.D. 8225, 53 FR 34491, Sept. 7, 1988]

§ 1.6031(c)-2T Nominee reporting of REMIC information (temporary). [Reserved]

§ 1.6032-1 Returns of banks with respect to common trust funds.

(a) Every bank (as defined in section 581) maintaining a common trust fund shall make a return of income of the common trust fund, regardless of the amount of its taxable income. Member banks of an affiliated group that serve as co-trustees with respect to a common trust fund must act jointly in making a return for the fund. If a bank maintains more than one common trust fund, a separate return shall be made for each. No particular form is prescribed for making the return under this section, but Form 1065 may be used if it is designated by the bank as the return of a common trust fund. The return shall be made for the taxable year of the common trust fund and shall be filed on or before the date prescribed by section 6072(b) with the service center prescribed in the relevant Internal Revenue Service revenue procedure, publication, form, or instructions to the form (see § 601.601(d)(2) of this chapter). Such return shall state specifically with respect to the fund the items of gross income and the deductions allowed by subtitle A of the Internal Revenue Code, shall include each participant's name and address, the participant's proportionate share of taxable income or net loss (exclusive of gains and losses from sales or exchanges of capital assets), the participant's proportionate share of gains and losses from sales or exchanges of capital assets, and the participant's share of items which enter into the determination of the tax imposed by section 56. See §§ 1.584-2 and 1.58-5. If the common trust fund is maintained by two or more banks that are members of the same affiliated group, the return must also identify the member bank in the group that has contributed each participant's property or money to the fund. A copy of the plan of the common trust fund must be filed with the return. If, however, a copy of such plan has once been filed with a return, it need not again be filed if the return contains a statement showing when and where it was filed. If the plan is amended in any way after such copy has been filed, a copy of the amendment must be filed with the return for the taxable year in which the amendment was made. For the signing of a return of a bank with respect to common trust funds, see § 1.6062-1, relating to the manner prescribed for the signing of a return of a corporation.

(b) This section applies to returns filed on or after January 30, 2020. Section 1.6032-1T (as contained in 26 CFR part 1, revised April 2019) applies to taxable years beginning before January 30, 2020.

[T.D. 9892, 85 FR 5324, Jan. 30, 2020]

§ 1.6033-1 Returns by exempt organizations; taxable years beginning before January 1, 1970.

(a) In general. (1) Except as provided in section 6033(a) and paragraph (g) of this section, every organization exempt from taxation under section 501(a) shall file an annual return of information specifically stating its items of gross income, receipts and disbursements, and such other information as may be prescribed in the instructions issued with respect to the return. Such information return shall be filed annually regardless of the amount or source of the income or receipts of the organization. Except as provided in paragraph (d) of this section, such return shall be filed annually regardless of whether such organization is chartered by, or affiliated or associated with, any central, parent, or other organization.

(2)(i) Except as otherwise provided in this subparagraph, every organization exempt from taxation under section 501 (a), and required to file a return under section 6033 and this section, other than an organization described in section 401 (a), 501(c)(3), or 501(d), shall file its annual return on Form 990. However, such an exempt organization, instead of filing Form 990, may file its annual return on Form 990 (SF), a short form, if its gross receipts for the taxable year do not exceed $10,000 and its total assets on the last day of its taxable year do not exceed $10,000.

(ii) For purposes of this subparagraph and subparagraph (4) of this paragraph, “gross receipts” means the gross amount received by the organization during its annual accounting period from all sources without reduction for any costs or expenses including, for example, cost of goods or assets sold, cost of operations, or expenses of earning, raising, or collecting such amounts. Thus, “gross receipts” includes, but is not limited to, (a) the gross amount received as contributions, gifts, grants, and similar amounts without reduction for the expenses of raising and collecting such amounts, (b) the gross amount received as dues or assessments from members or affiliated organizations without reduction for expenses attributable to the receipt of such amounts, (c) gross sales or receipts from business activities (including business activities unrelated to the purpose for which the organization received an exemption, the net income or loss from which may be required to be reported on Form 990-T), (d) the gross amount received from the sale of assets without reduction for cost or other basis and expenses of sale, and (e) the gross amount received as investment income such as interest, dividends, rents, and royalties.

(3) Every employees' trust described in section 401 (a) which is exempt from taxation under section 501 (a) shall file an annual return on Form 990-P. The return shall include the information required by paragraph (b)(5)(ii) of § 1.401-1. In addition, the trust must file the information required to be filed by the employer pursuant to the provisions of § 1.404(a)-2, unless the employer has notified the trustee in writing that he has or will timely file such information. If the trustee has received such notification from the employer, then such notification, or a copy thereof, shall be retained by the trust as a part of its records.

(4) Except as otherwise provided in this subparagraph, every organization described in section 501(c)(3), which is required to file a return under section 6033 and this section, shall file its annual return on Form 990-A. However, such an exempt organization, instead of filing Form 990-A, may file its annual return on Form 990-A (SF), a short form, if its gross receipts for the taxable year do not exceed $10,000 and its total assets on the last day of its taxable year do not exceed $10,000. For purposes of this subparagraph, “gross receipts” shall be defined in the manner prescribed in subparagraph (2)(ii) of this paragraph. The forms prescribed by this subparagraph shall be as follows:

(i) Form 990-A shall consist of parts I and II. Part I shall contain, in addition to information required in part II, such information as may be prescribed in the return and instructions which is required to be furnished by section 6033(a) or which is necessary to show whether or not such organization is exempt from tax under section 501(a). Part II, which shall be open to public inspection pursuant to section 6104 and other applicable sections and the regulations thereunder, shall contain principally the information required by section 6033(b) and the regulations thereunder. The information contained in part II, to be furnished by the organization in duplicate in the manner prescribed by the instructions issued with respect to the return, is as follows:

(a) Its gross income for the year. For this purpose, gross income includes tax-exempt income, but does not include contributions, gifts, grants, and similar amounts received. Whether or not an item constitutes a contribution, gift, grant, or similar amount, depends upon all the surrounding facts and circumstances.

(b) Its expenses attributable to such income and incurred within the year.

(c) Its disbursements out of income (including prior years' accumulations) made within the year for the purposes for which it is exempt. Information shall be included as to the class of activity with a separate total for each activity as well as the name, address, and amount received by each individual or organization receiving cash, other property, or services within the taxable year. If the donee is related by blood, marriage, adoption, or employment (including children of employees) to any person or corporation having an interest in the exempt organization, such as a creator, donor, director, trustee, or officer, the relationship of the donee shall be stated. Activities shall be classified according to purpose in greater detail than merely charitable, educational, religious, or scientific. For example, payments for nursing service, for laboratory construction, for fellowships, or for assistance to indigent families shall be so identified. Where the fair market value of the property at the time of disbursement is used as the measure of the disbursement, the book value of such property (and a statement of how book value was determined) shall also be furnished, and any difference between the fair market value at the time of disbursement and the book value should be reflected in the books of account. The expenses allocable to making the disbursements shall be set forth in such detail as is prescribed by the form or instructions.

(d) Its accumulation of income within the year. The amount of such accumulation is obtained by subtracting from the amount in (a) of this subdivision the sum of the amounts determined in (b) and (c) of this subdivision and the expenses allocable to carrying out the purposes for which it is exempt.

(e) Its aggregate accumulation of income at the beginning and end of the year. The aggregate accumulation of income shall be divided between that which is attributable to the gain or loss on the sale of assets (excluding inventory items) and that which is attributable to all other income. For this purpose expenses and disbursements shall be allocated on the basis of accounting records, the governing instrument, or applicable local law.

(f) Its disbursements out of principal in the current and prior years for the purposes for which it is exempt. In addition, the same type of information shall be required with respect to disbursements out of principal made in the current year as is prescribed by (c) of this subdivision with respect to disbursements out of income.

(g) A balance sheet showing its assets, liabilities, and net worth as of the beginning and end of such year. Detailed information on the assets, liabilities, and net worth shall be furnished on the schedule provided for this purpose on the Form 990-A. Such schedule shall be supplemented by attachments where appropriate.

(h) The total of the contributions and gifts received by it during the year. A statement shall be included showing the gross amount of contributions and gifts collected by the organization, the expenses incurred by the organization in collecting such amount, and the net proceeds.

(i) In addition to the information required in (a) through (h) of this subdivision, the organization shall furnish such specific information and answer such specific questions as are required by the form or instructions.

(ii) Form 990-A (SF) is a short form consisting of a single part which contains such information as may be prescribed in the return and instructions which is required to be furnished by section 6033(a) or which is necessary to show whether or not such organization is exempt from tax under section 501(a). In addition, Form 990-A (SF) shall contain the information required by section 6033(b) which must be furnished in the manner prescribed in the instructions issued with respect to the return. Form 990-A (SF) shall be open to public inspection pursuant to section 6104 and other applicable sections and the regulations thereunder.

(5)(i) Every religious or apostolic association or corporation described in section 501 (d) which is exempt from taxation under section 501(a) shall file a return on Form 1065 for each taxable year, stating specifically the items of gross income and deductions, and its taxable income. There shall be attached to the return as a part thereof a statement showing the name and address of each member of the association or corporation and the amount of his distributive share of the taxable income of the association or corporation for such year.

(ii) If the taxable year of any member is different from the taxable year of the association or corporation, the distributive share of the taxable income of the association or corporation to be included in the gross income of the member for his taxable year shall be based upon the taxable income of the association or corporation for its taxable year ending with or within the taxable year of the member.

(b) Accounting period for filing return. A return on Form 990, 990-A, 990 (SF), 990-A (SF), or 990-P shall be on the basis of the established annual accounting period of the organization. If the organization has no such established accounting period, such return shall be on the basis of the calendar year.

(c) Returns when exempt status not established. An information return on Form 990, 990-A, 990 (SF), or 990-A (SF) is not required to be filed by an organization claiming an exempt status under section 501(a) prior to the establishment by the organization of such exempt status under section 501 and § 1.501(a)-1. If the date for filing an income tax return and paying the tax occurs before the tax-exempt status of the organization has been established, the organization is required to file the income tax return and pay the tax. However, see sections 6081 and 6161 and the regulations thereunder for extensions of time for filing the return and paying the tax. Upon establishment of its exempt status, the organization may file a claim for a refund of income taxes paid for the period for which its exempt status is established.

(d) Group returns. (1) A central, parent, or like organization (referred to in this paragraph as “central organization”), exempt under section 501(a) and described in section 501(c), although required to file a separate annual return for itself under section 6033 and paragraph (a) of this section, may file annually, in addition to such separate annual return, a group return on Form 990 or 990-A, 990 (SF), or 990-A (SF), as may be appropriate. Form 990 (SF) or 990-A (SF) may be used where each local organization qualifies under paragraph (a) of this section. Such group return may be filed for two or more of the local organizations, chapters, or the like (referred to in this paragraph as “local organizations”) which are (i) affiliated with such central organization at the close of its annual accounting period, (ii) subject to the general supervision or control of the central organization, and (iii) exempt from taxation under the same paragraph of section 501(c) of the Code, although the local organizations are not necessarily exempt under the paragraph under which the central organization is exempt.

(2)(i) The filing of the group return shall be in lieu of the filing of a separate return by each of the local organizations included in the group return. The group return shall include only those local organizations which in writing have authorized the central organization to include them in the group return, and which have made and filed, with the central organization, their statements, specifically stating their items of gross income, receipts, and disbursements, and such other information relating to them as is required to be stated in the group return. Such an authorization by a local organization shall be made annually, under the penalties of perjury, and shall be signed by a duly authorized officer of the local organization in his official capacity and shall contain the following statement, or a statement of like import: “I hereby declare under the penalties of perjury that this authorization (including any accompanying schedules and statements) has been examined by me and to the best of my knowledge and belief is true, correct and complete and made in good faith for the taxable year stated.” Such authorizations and statements shall be permanently retained by the central organization.

(ii) There shall be attached to the group return and made a part thereof a schedule showing the name and address of each of the local organizations and the total number thereof included in such return, and a schedule showing the name and address of each of the local organizations and the total number thereof not included in the group return.

(3) The group return shall be on the basis of the established annual accounting period of the central organization. Where such central organization has no established annual accounting period, such return shall be on the basis of the calendar year. The same income, receipts, and disbursements of a local organization shall not be included in more than one group return.

(4) The group return shall be filed in accordance with these regulations and the instructions issued with respect to Form 990, 990-A, 990 (SF), or 990-A (SF), whichever is appropriate, and shall be considered the return of each local organization included therein. The tax-exempt status of a local organization must be established under a group exemption letter issued to the central organization before a group return including the local organization will be considered as the return of the local organization. See § 1.501(a)-1 for requirements for establishing a tax-exempt status.

(e) Time and place for filing. The annual return of information on Form 990, 990-A, 990 (SF), 990-A (SF), or 990-P shall be filed on or before the 15th day of the fifth calendar month following the close of the period for which the return is required to be filed. The annual return on Form 1065 required to be filed by a religious or apostolic association or corporation shall be filed on or before the 15th day of the fourth month following the close of the taxable year for which the return is required to be filed. Each such return shall be filed in accordance with the instructions applicable thereto.

(f) Penalties. For criminal penalties for failure to file a return and filing a false or fraudulent return, see sections 7203, 7206, and 7207.

(g) Organizations not required to file annual returns. (1)(i) Annual returns on Form 990-A or Form 990-A (SF) are not required to be filed by an organization described in section 501(c)(3) which has established its right to exemption from taxation under section 501 (a) and which is:

(a) Organized and operated exclusively for religious purposes;

(b) Operated, supervised, or controlled by or in connection with an organization which is organized and operated exclusively for religious purposes;

(c) An educational organization which normally maintains a regular faculty and curriculum and normally has a regularly organized body of pupils or students in attendance at the place where its educational activities are regularly carried on; or

(d) A charitable organization, or an organization for the prevention of cruelty to children or animals, which is supported, in whole or in part, by funds contributed by the United States or any State or political subdivision thereof, or which is primarily supported by contributions of the general public.

(ii) An educational organization which normally maintains and has a regular faculty, curriculum, and student body and meets the conditions of subdivision (i)(c) of this subparagraph, which relieves it from the requirement of filing annual returns, shall not be considered as having thereafter failed to continue meeting such conditions if it is temporarily compelled to curtail or discontinue its normal and regular activities during the existence of abnormal circumstances and conditions.

(iii) An organization organized and operated exclusively for charitable purposes or for the prevention of cruelty to children or animals is “primarily supported by contributions of the general public” for any accounting period if more than 50 percent of its income and receipts for such period is actually derived from voluntary contributions and gifts made by the general public, as distinguished from a few contributors or donors or from related or associated persons. For purposes of this subdivision, the words “related or associated persons” refer to persons of a particular group who are connected with or are interested in the activities of the organization, such as founders, incorporators, shareholders, members, fiduciaries, officers, employees, or the like, or who are connected with such persons by family or business relationships. An organization claiming an exception from the filing of an information return under this subdivision must maintain adequate records in order to substantiate such claim. Furthermore, if it is doubtful to an organization that it falls within this exception for filing annual information returns, it must file the return on Form 990-A or Form 990-A (SF).

(2) The annual return on Form 990 or Form 990 (SF) need not be filed by:

(i) A fraternal beneficiary society, order, or association, described in section 501(c)(8), or

(ii) An organization described in section 501(c)(1) if it is a corporation wholly owned by the United States or any agency or instrumentality thereof, or is a wholly owned subsidiary of such a corporation,

which has established its exemption from tax under section 501(a).

(3) The provisions of section 6033(a) relieving certain specified types of organizations exempt from tax under section 501(a) from filing annual returns do not abridge or impair in any way the powers and authority of district directors or directors of service centers provided for in other provisions of the Code and in the regulations thereunder to require the filing of such returns by such organizations. See section 6001 and § 1.6001-1.

(h) Records, statements, and other returns of tax-exempt organizations. (1) An organization which has established its right to exemption from tax under section 501(a) and has also established that it is not required to file annually the return of information on Form 990, 990-A, 990 (SF), or 990-A (SF) shall immediately notify in writing the district director for the internal revenue district in which its principal office is located of any changes in its character, operations, or purpose for which it was originally created.

(2) Every organization which has established its right to exemption from tax, whether or not it is required to file an annual return of information, shall submit such additional information as may be required by the district director for the purpose of enabling him to inquire further into its exempt status and to administer the provisions of subchapter F (section 501 and following), chapter 1 of the Code, and of section 6033. See section 6001 and § 1.6001-1 with respect to the authority of the district director or directors of service centers to require such additional information and with respect to the permanent books of account or records to be kept by such organizations.

(3) An organization which has established its right to exemption from tax under section 501(a), including an organization which is relieved under section 6033 and this section from filing annual returns of information, is not, however, relieved from the duty of filing other returns of information. See, for example, sections 6041 and 6051 and the regulations thereunder.

(i) Unrelated business tax returns. In addition to the foregoing requirements of this section, certain organizations otherwise exempt from tax under section 501(a) and described in section 501(c) (2), (3), (5), (6), or (17) or section 401(a) which are subject to tax on unrelated business taxable income are also required to file returns on Form 990-T. See paragraph (e) of § 1.6012-2 and paragraph (a)(5) of § 1.6012-3 for requirements with respect to such returns.

(j) Effective date. The provisions of this section shall apply with respect to returns filed for taxable years beginning before January 1, 1970.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6722, 29 FR 5075, Apr. 14, 1964; T.D. 6972, 33 FR 12907, Sept. 12, 1968; T.D. 6980, 33 FR 16446, Nov. 9, 1968; T.D. 7122, 36 FR 11026, June 8, 1971]

§ 1.6033-2 Returns by exempt organizations and returns by certain nonexempt organizations.

(a) In general. (1) Except as provided in section 6033(a)(3) and paragraph (g) of this section, every organization exempt from taxation under section 501(a) shall file an annual information return specifically setting forth its items of gross income, gross receipts and disbursements, and such other information as may be prescribed in the instructions, issued with respect to the return. Except as provided in paragraph (d) of this section, such return shall be filed annually regardless of whether such organization is chartered by, or affiliated or associated with, any central, parent, or other organization.

(2)(i) Except as otherwise provided in this paragraph and paragraph (g) of this section, every organization exempt from taxation under section 501(a), and required to file a return under section 6033 and this section (including, for taxable years ending before December 31, 1972, private foundations, as defined in section 509(a)), other than an organization described in section 401(a) or 501(d), shall file its annual return on Form 990. For taxable years ending on or after December 31, 1972, every private foundation shall file Form 990-PF as its annual information return. For taxable years beginning after December 31, 1977, every section 501(c)(21) black lung trust shall file an annual information return on Form 990-BL or any other form prescribed by the Internal Revenue Service for that purpose.

(ii) Subject to paragraph (a)(1) of this section, the information generally required to be furnished by an organization exempt under section 501(a) is:

(A) Its gross income for the year. For this purpose, gross income includes tax-exempt income, but does not include contributions, gifts, grants, and similar amounts received. Whether an item constitutes a contribution, gift, grant, or similar amount depends upon all the surrounding facts and circumstances. The computation of gross income shall be made by subtracting the cost of goods sold from all receipts other than gross contributions, gifts, grants, and similar amounts received and nonincludible dues and assessments from members and affiliates.

(B) To the extent not included in gross income, its dues and assessments from members and affiliates for the year.

(D) Its disbursements (including prior years' accumulations) made within the year for the purposes for which it is exempt.

(E) A balance sheet showing its assets, liabilities, and net worth as of the beginning and end of such year. Detailed information relating to the assets, liabilities, and net worth shall be furnished on the schedule provided for this purpose on the return required by this section. Such schedule shall be supplemented by attachments where appropriate.

(F) The total of the contributions, gifts, grants, and similar amounts received by it during the taxable year, and, in the case of an organization described in section 501(c)(3), the names and addresses of all persons that contributed, bequeathed, or devised $5,000 or more (in money or other property) during the taxable year. In the case of a private foundation (as defined in section 509(a)), the names and addresses of all persons who became substantial contributors (as defined in section 507(d)(2)) during the taxable year shall be furnished. In addition, for its first taxable year beginning after December 31, 1969, each private foundation shall furnish the names and addresses of all persons who became substantial contributors before such taxable year. For special rules with respect to contributors and donors, see paragraph (a)(2)(iii) of this section.

(G) The names and addresses of all officers, directors, or trustees (or any person having responsibilities or powers similar to those of officers, directors or trustees) of the organization, and, in the case of a private foundation, all persons who are foundation managers, within the meaning of section 4946(b)(1). Organizations must also attach a schedule showing the names and addresses and/or total numbers of key employees, highly compensated employees, and independent contractors as prescribed by publication, form, or instructions.

(H) A schedule showing the compensation and other payments made to each person whose name is required to be listed pursuant to paragraph (a)(2)(ii)(G) of this section during the calendar year ending within the organization's annual accounting period, or during such other period as prescribed by publication, form, or instructions.

(I) For any taxable year ending on or after December 31, 1971, such information as is required by Forms 4848 and 4849 and, only with respect to any such taxable year ending before December 31, 1972, such information as is required by Form 2950. Such forms are required by this section to be filed by an organization exempt from tax under section 501(a) which is an employer who maintains a funded pension or annuity plan for its employees. See paragraph (g) of this section for exceptions from filing. Form 4849 need not be filed by the organization if the fiduciary for the plan has given written notification to the organization that such form will be filed as an attachment to Form 990-P filed by the fiduciary. Form 4848 (and Form 4849 if required to be filed by the organization) shall be filed as a separate return on or before the due date for Form 990. For rules relating to the extension of time for filing, see section 6081 and the regulations thereunder and the instructions for Form 4848. A central organization which files Form 990 as a group return under paragraph (d) of this section may also file Form 4848 as a group return. The rules provided by paragraph (d) of this section with respect to a group return filed on Form 990 shall apply to a group return filed on Form 4848. Unless otherwise expressly provided therein, an authorization to include a local organization in a group for purposes of filing Form 990 as a group return shall be treated as an authorization to include such local organization in a group for purposes of filing Form 4848 as a group return. A group return on Form 4848 shall be filed in accordance with this section and the instructions to Form 4848 and shall be considered the return of each local organization included therein. In addition to the information required to be furnished by Forms 4848 and 4849, the district director may require any further information that he considers necessary to determine qualification of the plan under section 401 or the taxability under section 403(b) of a beneficiary under an annuity purchased by a section 501(c)(3) organization.

(J) In the case of a private foundation liable for tax imposed under chapter 42, such information as is required by Form 4720.

(K) In the case of an organization described in section 501(c)(3), the respective amounts (if any) of the taxes imposed on the organization, or any organization manager of the organization, during the taxable year under any of the following provisions (and the respective amounts (if any) of reimbursements paid by the organization during the taxable year with respect to taxes imposed on any such organization manager under any of such provisions):

(1) Section 4911 (relating to tax on excess expenditures to influence legislation);

(2) Section 4912 (relating to tax on disqualifying lobbying expenditures of certain organizations); and

(3) Section 4955 (relating to taxes on political expenditures of section 501(c)(3) organizations), except to the extent that, by reason of section 4962, the taxes imposed under such section are not required to be paid or are credited or refunded.

(L) In the case of organizations described in section 501(c)(3), (4), or (29), the respective amounts (if any) of—

(1) The taxes imposed with respect to the organization on any organization manager, or any disqualified person, during the taxable year under section 4958 (relating to taxes on excess benefit transactions); and

(2) Reimbursements paid by the organization during the taxable year with respect to taxes imposed under such section, except to the extent that, by reason of section 4962, the taxes imposed under such section are not required to be paid or are credited or refunded.

(M) Its lobbying expenditures, grass roots expenditures, exempt purpose expenditures, lobbying nontaxable amount, and grass roots nontaxable amount for the taxable year and for prior taxable years that are base years (within the meaning of § 1.501(h)-3(c)(7)), if the organization has an election under section 501(h) in effect for the taxable year. An organization that is a member of an affiliated group of organizations (as defined in § 56.4911-7(e)) but that is not a member of a limited affiliated group (as defined in § 56.4911-10(b)) shall report this information based on the expenditures of all members of the group during the taxable year of the group that ends with or within the member's taxable year and for prior taxable years of the group that are base years (within the meaning of § 56.4911-9(b)). For additional information required to be furnished by members of an affiliated group of organizations, and by controlling members in a limited affiliated group, see §§ 56.4911-9(d) and 56.4911-10(f)(1), respectively.

(N) In the case of a hospital organization (as defined in § 1.501(r)-1(b)(18)) described in section 501(c)(3) during the taxable year—

(1) A copy of its audited financial statements for the taxable year (or, in the case of an organization the financial statements of which are included in consolidated financial statements with other organizations, such consolidated financial statements);

(2) Either a copy of the most recently adopted implementation strategy, within the meaning of § 1.501(r)-3(c), for each hospital facility it operates or the URL of each Web page where it has made each such implementation strategy widely available on a Web site within the meaning of § 1.501(r)-1(b)(29) along with or as part of the report documenting the community health needs assessment (CHNA) to which the implementation strategy relates;

(3) For each hospital facility it operates, a description of the actions taken during the taxable year to address the significant health needs identified through its most recently conducted CHNA, within the meaning of § 1.501(r)-3(b), or, if no actions were taken with respect to one or more of these health needs, the reason(s) why no actions were taken; and

(4) The amount of the excise tax imposed on the organization under section 4959 during the taxable year.

(iii) Special rules. In providing the names and addresses of contributors and donors under paragraph (a)(2)(ii)(F) of this section:

(A) An organization described in section 501(c)(3) which meets the 33 1/3 percent-of-support test of the regulations under section 170(b)(1)(A)(vi) (without regard to whether such organization otherwise qualifies as an organization described in section 170(b)(1)(A)) is required to provide the name and address of a person who contributed, bequeathed, or devised $5,000 or more during the year only if his amount is in excess of 2 percent of the total contributions, bequests and devises received by the organization during the year.

(B) An organization other than a private foundation is required to report only the names and addresses of contributors of whom it has actual knowledge. For instance, an organization need not require an employer who withholds contributions from the compensation of employees and pays over to the organization periodically the total amounts withheld, to specify the amounts paid over with respect to a particular employee. In such case, unless the organization has actual knowledge that a particular employee gave more than $5,000 (and in excess of 2 percent if paragraph (a)(2)(iii)(A) of this section is applicable), the organization need report only the name and address of the employer, and the total amount paid over by the employer.

(C) Separate and independent gifts made by one person in a particular year need be aggregated to determine whether his contributions and bequests exceed $5,000 (and are in excess of 2 percent if paragraph (a)(2)(iii)(A) of this section is applicable), only if such gifts are of $1,000 or more.

(D)(1) Organizations described in section 501(c)(7), (8), or (10) that receive contributions or bequests to be used exclusively for purposes described in section 170(c)(4), 2055(a)(3), or 2522(a)(3), must attach a schedule with respect to all gifts that aggregate more than $1,000 from any one person showing the total amount of the contributions or bequests from each such person, the specific purpose or purposes for which such amount was received, and the specific use or uses to which such amount was put. In the case of an amount set aside for such purposes, the organization shall indicate the manner in which such amount is held (for instance, whether such amount is commingled with amounts held for other purposes). If the contribution or bequest was transferred to another organization, the schedule must include the name of the transferee organization, a description of the nature of such organization, and a description of the relationship between the transferee and transferor organizations.

(2) For taxable years beginning after December 31, 1970, such organizations must also attach a statement showing the total dollar amount of contributions and bequests received for such purposes which are $1,000 or less.

(iv) Listing of States. A private foundation is required to attach to its return required by this section a list of all States:

(A) To which the organization reports in any fashion concerning its organization, assets, or activities, or

(B) With which the organization has registered (or which it has otherwise notified in any manner) that it intends to be, or is, a charitable organization or a holder of property devoted to a charitable purpose.

(3)(i) For taxable years beginning after December 31, 1969, and ending before December 31, 1971, every employee's trust described in section 401(a) which is exempt from taxation under section 501(a) shall file an annual return on Form 990-P. The return shall include the information required by paragraph (b)(5)(ii) of § 1.401-1. For such years, in addition, the trust must file the information required to be filed by the employer pursuant to the provisions of § 1.404(a)-2, unless the employer has notified the trustee in writing that he has filed or will timely file such information. If the trustee has received such notification from the employer, then such notification, or a copy thereof, shall be retained by the trust as a part of its records.

(ii) For taxable years ending on or after December 31, 1971, and before December 31, 1975, every employee's trust described in section 401(a) which is exempt from taxation under section 501(a) shall file an annual return on Form 990-P. The trust shall furnish such information as is required by such form and the instructions issued with respect thereto.

(4) For taxable years beginning after December 31, 1980, trusts described in section 4947(a)(1) and nonexempt private foundations shall comply with the requirements of section 6033 and this section in the same manner as organizations described in section 501(c)(3) which are exempt from tax under section 501(a). This section shall be applied for taxable years beginning after December 31, 1980 as if trusts described in section 4947(a)(1) and nonexempt private foundations were described in section 501(c)(3). Therefore, for purposes of this section, all references to exempt organizations shall include section 4947(a)(1) trusts and nonexempt private foundations and all references to private foundations shall include section 4947(a)(1) trusts that would be private foundations if they were described in section 501(c)(3) and all nonexempt private foundations. Similarly, for purposes of paragraph (a)(2)(ii)(d), the purposes for which a section 4947(a)(1) trust or a nonexempt private foundation is organized shall be treated as the purposes for which it is exempt. Similarly, for purposes of paragraph (a)(2)(ii)(D) of this section, the purposes for which a section 4947(a)(1) trust or a nonexempt private foundation is organized shall be treated as the purposes for which it is exempt. See section 509(b) and § 1.509(b)-1. See also section 642(c)(6) and § 1.642(c)-4.

(5) Political organizations, as defined by section 527(e)(1), that have gross receipts of $25,000 or more for the taxable year (or in the case of a qualified State or local political organization, as defined in section 527(e)(5), that has gross receipts of $100,000 or more for the taxable year) generally must comply with the requirements of section 6033 and this section in the same manner as organizations exempt from tax under section 501(a), except to the extent that the Commissioner may modify such requirements through forms, instructions to forms, or guidance published in the Internal Revenue Bulletin as appropriate for carrying out the purposes of section 527. For the purposes of this section, all references to organizations exempt from tax under section 501(a) shall include political organizations referred to in section 6033(g), other than those referred to in section 6033(g)(3) and except to the extent the Commissioner exercises discretion under section 6033(g)(4). This discretion may be exercised through forms, instructions to forms, or guidance published in the Internal Revenue Bulletin. In addition to the reporting requirements applicable to organizations exempt under section 501(a), such political organizations generally must report the names and addresses of all persons that contributed, bequeathed, or devised $5,000 or more (in money or other property) during the taxable year.

(6) Each controlling organization (within the meaning of section 512(b)(13)) that is subject to the requirements of section 6033(a) shall include on its annual return such information required by that return regarding—

(i) Any interest, annuities, royalties, or rents received from each controlled entity (within the meaning of section 512(b)(13));

(ii) Any loans made to each such controlled entity; and

(iii) Any transfers of funds between such controlling organization and each such controlled entity.

(7) Every organization described in section 4966(d)(1) shall, on its annual return for the taxable year—

(i) List the total number of donor advised funds (as defined in section 4966(d)(2)) it owns at the end of such taxable year;

(ii) Report the aggregate value of assets held in such funds at the end of such taxable year; and

(iii) Report the aggregate contributions to and grants made from such funds during such taxable year.

(8) Every organization described in section 509(a)(3) shall, on its annual return—

(i) List the supported organizations (as defined in section 509(f)(3)) with respect to which such organization provides support;

(ii) Specify whether the organization meets the requirements of clause (i), (ii), or (iii) of section 509(a)(3)(B); and

(iii) Certify that the organization meets the requirements of section 509(a)(3)(C).

(b) Accounting period for filing return. A return required by this section shall be on the basis of the established annual accounting period of the organization. If the organization has no such established accounting period, such return shall be on the basis of the calendar year.

(c) Returns when exempt status not established. An organization claiming an exempt status under section 501(a) prior to the establishment of such exempt status under section 501 and § 1.501(a)-1, shall file a return required by this section in accordance with the instructions applicable thereto. In such case the organization must indicate on such return that it is being filed in the belief that the organization is exempt under section 501(a), but that the Internal Revenue Service has not yet recognized such exemption.

(d) Group returns. (1) A central, parent, or like organization (referred to in this paragraph as “central organization”), exempt under section 501(a) and described in section 501(c) (other than a private foundation), although required to file a separate annual return for itself under section 6033 and paragraph (a) of this section, may file annually, in addition to such separate annual return, a group return on Form 990. Such group return may be filed for two or more of the local organizations, chapters, or the like (referred to in this paragraph as “local organizations”) which are (i) affiliated with such central organization at the close of its annual accounting period, (ii) subject to the general supervision or control of the central organization, and (iii) exempt from taxation under the same paragraph of section 501(c) of the Code, although the local organizations are not necessarily exempt under the paragraph under which the central organization is exempt. Such group return may not be filed for a local organization which is a private foundation.

(2)(i) The filing of the group return shall be in lieu of the filing of a separate return by each of the local organizations included in the group return. The group return shall include only those local organizations which in writing have authorized the central organization to include them in the group return, and which have made and filed, with the central organization, their statements, specifically stating their items of gross income, receipts, and disbursements, and such other information relating to them as is required to be stated in the group return. Such an authorization and statement by a local organization shall be made under the penalties of perjury, shall be signed by a duly authorized officer of the local organization in his official capacity, and shall contain the following statement, or a statement of like import: “I hereby declare under the penalties of perjury that this authorization (including any accompanying schedules and statements) has been examined by me and to the best of my knowledge and belief is true, correct and complete and made in good faith.” Such authorization and statement with respect to a local organization shall be retained by the central organization until the expiration of 6 years after the last taxable year for which a group return filed by such central organization includes such local organization.

(ii) There shall be attached to the group return and made a part thereof a schedule showing the name, address, and employer identification number of each of the local organizations and the total number thereof included in such return, and a schedule showing the name, address, and employer identification number of each of the local organizations and the total number thereof not included in the group return.

(4) The group return shall be filed in accordance with these regulations and the instructions issued with respect to Form 990, and shall be considered the return of each local organization included therein. The tax exempt status of a local organization must be established under a group exemption letter issued to the central organization before a group return including the local organization will be considered as the return of the local organization. See § 1.501(a)-1 for requirements for establishing a tax-exempt status.

(5) In providing the information required by paragraphs (a)(2)(ii)(F), (G), and (H) of this section, such information may be provided:

(i) With respect to the central or parent organization on its Form 990, and with respect to the local organizations on separate schedules attached to the group return for the year, or

(ii) On a consolidated basis for all the local organizations and the central or parent organization on the group return.

Such information need be provided only with respect to those local organizations which are not excepted from filing under the provisions of paragraph (g) of this section. A central or parent organization shall indicate whether it has provided such information in the manner described in paragraphs (d)(5)(i) or (ii) of this section, and may not change the manner in which it provides such information without the consent of the Commissioner.

(e) Time and place for filing. The annual return required by this section shall be filed on or before the 15th day of the fifth month following the close of the period for which the return is required to be filed. The annual return on Form 1065 required to be filed by a religious or apostolic association or corporation shall be filed on or before the date prescribed by section 6072(b). Each such return shall be filed in accordance with the instructions applicable thereto.

(f) Penalties and additions to tax. For penalties and additions to tax for failure to file a return and filing a false or fraudulent return, see sections 6652, 7203, 7206, and 7207.

(g) Organizations not required to file annual returns. (1) Annual returns required by this section are not required to be filed by an organization exempt from taxation under section 501(a) which is:

(i) A church, an interchurch organization of local units of a church, a convention or association of churches, or an integrated auxiliary of a church (as defined in paragraph (h) of this section);

(ii) An exclusively religious activity of any religious order;

(iii) Except as provided in paragraph (g)(1)(viii) of this section, an organization described in section 501(c) (other than a private foundation or a supporting organization described in section 509(a)(3)) the gross receipts of which in each taxable year are normally not more than $50,000 (as described in paragraph (g)(3) of this section);

(iv) A mission society (other than an organization described in section 509(a)(3)) sponsored by or affiliated with one or more churches or church denominations, more than one-half of the activities of which society are conducted in, or directed at persons in foreign countries;

(v) A State institution, the income of which is excluded from gross income under section 115(a);

(vi) An organization described in section 501(c)(1);

(vii) An educational organization (below college level) that is described in section 170(b)(1)(A)(ii), that has a program of a general academic nature, and that is affiliated (within the meaning of paragraph (h)(2) of this section) with a church or operated by a religious order; or

(viii) A foreign organization (described in paragraph (k)(1) of this section) or a United States possession organization (described in paragraph (k)(2) of this section) (other than a private foundation or a supporting organization described in section 509(a)(3))—

(A) The gross receipts of which in each taxable year from sources within the United States (as determined under paragraph (k)(3) of this section) are normally not more than $50,000 (as described in paragraph (g)(3) of this section); and

(B) That has no significant activity (including lobbying and political activity and the operation of a trade or business, but excluding investment activity) in the United States.

(2) The provisions of section 6033(a) relieving certain specified types of organizations exempt from taxation under section 501(a) from filing annual returns do not abridge or impair in any way the powers and authority of district directors or directors of service centers provided for in other provisions of the Code and in regulations thereunder to require the filing of returns or notices by such organizations. See section 6001 and § 1.6001-1.

(3) For purposes of paragraphs (g)(1)(iii) and (viii) of this section, the gross receipts (as defined in paragraph (g)(4) of this section) of an organization are normally not more than $50,000 if:

(i) In the case of an organization that has been in existence for 1 year or less, the organization has received, or donors have pledged to give, gross receipts of $75,000 or less during the first taxable year of the organization;

(ii) In the case of an organization that has been in existence for more than one but less than 3 years, the average of the gross receipts received by the organization in its first 2 taxable years is $60,000 or less; and

(iii) In the case of an organization that has been in existence for 3 years or more, the average of the gross receipts received by the organization in the immediately preceding 3 taxable years, including the year for which the return would be required to be filed, is $50,000 or less.

(4) For purposes of this paragraph and paragraph (a)(2) of this section, “gross receipts” means the gross amount received by the organization during its annual accounting period from all sources without reduction for any costs or expenses including, for example, cost of goods or assets sold, cost of operations, or expenses of earning, raising, or collecting such amounts. Thus “gross receipts” includes, but is not limited to (i) the gross amount received as contributions, gifts, grants, and similar amounts without reduction for the expenses of raising and collecting such amounts, (ii) the gross amount received as dues or assessments from members or affiliated organizations without reduction for expenses attributable to the receipt of such amounts, (iii) gross sales or receipts from business activities (including business activities unrelated to the purpose for which the organization qualifies for exemption, the net income or loss from which may be required to be reported on Form 990-T), (iv) the gross amount received from the sale of assets without reduction for cost or other basis and expenses of sale, and (v) the gross amount received as investment income, such as interest, dividends, rents, and royalties.

(5) An organization that is not required to file an annual return by virtue of paragraphs (g)(1)(iii) and (viii) of this section must submit an annual electronic notification as described in section 6033(i). See § 1.6033-6.

(6) The Commissioner may relieve any organization or class of organizations (other than an organization described in section 509(a)(3)) from filing, in whole or in part the annual return required by this section where he determines that such returns are not necessary for the efficient administration of the internal revenue laws. This discretion may be exercised through forms, instructions to forms, or guidance published in the Internal Revenue Bulletin.

(h) Integrated auxiliary—(1) In general. For purposes of this title, the term integrated auxiliary of a church means an organization that is—

(i) Described both in sections 501(c)(3) and 509(a) (1), (2), or (3);

(ii) Affiliated with a church or a convention or association of churches; and

(iii) Internally supported.

(2) Affiliation. An organization is affiliated with a church or a convention or association of churches, for purposes of paragraph (h)(1)(ii) of this section, if—

(i) The organization is covered by a group exemption letter issued under applicable administrative procedures, (such as Rev. Proc. 80-27 (1980-1 C.B. 677); See § 601.601(a)(2)(ii)(b)), to a church or a convention or association of churches;

(ii) The organization is operated, supervised, or controlled by or in connection with (as defined in § 1.509(a)-4) a church or a convention or association of churches; or

(iii) Relevant facts and circumstances show that it is so affiliated.

(3) Facts and circumstances. For purposes of paragraph (h)(2)(iii) of this section, relevant facts and circumstances that indicate an organization is affiliated with a church or a convention or association of churches include the following factors. However, the absence of one or more of the following factors does not necessarily preclude classification of an organization as being affiliated with a church or a convention or association of churches—

(i) The organization's enabling instrument (corporate charter, trust instrument, articles of association, constitution or similar document) or by-laws affirm that the organization shares common religious doctrines, principles, disciplines, or practices with a church or a convention or association of churches;

(ii) A church or a convention or association of churches has the authority to appoint or remove, or to control the appointment or removal of, at least one of the organization's officers or directors;

(iii) The corporate name of the organization indicates an institutional relationship with a church or a convention or association of churches;

(iv) The organization reports at least annually on its financial and general operations to a church or a convention or association of churches;

(v) An institutional relationship between the organization and a church or a convention or association of churches is affirmed by the church, or convention or association of churches, or a designee thereof; and

(vi) In the event of dissolution, the organization's assets are required to be distributed to a church or a convention or association of churches, or to an affiliate thereof within the meaning of this paragraph (h).

(4) Internal support. An organization is internally supported, for purposes of paragraph (h)(1)(iii) of this section, unless it both—

(i) Offers admissions, goods, services or facilities for sale, other than on an incidental basis, to the general public (except goods, services, or facilities sold at a nominal charge or for an insubstantial portion of the cost); and

(ii) Normally receives more than 50 percent of its support from a combination of governmental sources, public solicitation of contributions, and receipts from the sale of admissions, goods, performance of services, or furnishing of facilities in activities that are not unrelated trades or businesses.

(5) Special rule. Men's and women's organizations, seminaries, mission societies, and youth groups that satisfy paragraphs (h)(1) (i) and (ii) of this section are integrated auxiliaries of a church regardless of whether such an organization meets the internal support requirement under paragraph (h)(1)(iii) of this section.

(6) Effective date. This paragraph (h) applies for returns filed for taxable years beginning after December 31, 1969. For returns filed for taxable years beginning after December 31, 1969 but beginning before December 20, 1995, the definition for the term integrated auxiliary of a church set forth in § 1.6033-2(g)(5) (as contained in the 26 CFR edition revised as of April 1, 1995) may be used as an alternative definition to such term set forth in this paragraph (h).

(7) Examples of internal support. The internal support test of this paragraph (h) is illustrated by the following examples, in each of which it is assumed that the organization's provision of goods and services does not constitute an unrelated trade or business:

Example 1.Organization A is described in sections 501(c)(3) and 509(a)(2) and is affiliated (within the meaning of this paragraph (h)) with a church. Organization A publishes a weekly newspaper as its only activity. On an incidental basis, some copies of Organization A's publication are sold to nonmembers of the church with which it is affiliated. Organization A advertises for subscriptions at places of worship of the church. Organization A is internally supported, regardless of its sources of financial support, because it does not offer admissions, goods, services, or facilities for sale, other than on an incidental basis, to the general public. Organization A is an integrated auxiliary.

Example 2.Organization B is a retirement home described in sections 501(c)(3) and 509(a)(2). Organization B is affiliated (within the meaning of this paragraph (h)) with a church. Admission to Organization B is open to all members of the community for a fee. Organization B advertises in publications of general distribution appealing to the elderly and maintains its name on non-denominational listings of available retirement homes. Therefore, Organization B offers its services for sale to the general public on more than an incidental basis. Organization B receives a cash contribution of $50,000 annually from the church. Fees received by Organization B from its residents total $100,000 annually. Organization B does not receive any government support or contributions from the general public. Total support is $150,000 ($100,000 + $50,000), and $100,000 of that total is from receipts from the performance of services (66 2/3% of total support). Therefore, Organization B receives more than 50 percent of its support from receipts from the performance of services. Organization B is not internally supported and is not an integrated auxiliary.

Example 3.Organization C is a hospital that is described in sections 501(c)(3) and 509(a)(1). Organization C is affiliated (within the meaning of this paragraph (h)) with a church. Organization C is open to all persons in need of hospital care in the community, although most of Organization C's patients are members of the same denomination as the church with which Organization C is affiliated. Organization C maintains its name on hospital listings used by the general public, and participating doctors are allowed to admit all patients. Therefore, Organization C offers its services for sale to the general public on more than an incidental basis. Organization C annually receives $250,000 in support from the church, $1,000,000 in payments from patients and third party payors (including Medicare, Medicaid and other insurers) for patient care, $100,000 in contributions from the public, $100,000 in grants from the federal government (other than Medicare and Medicaid payments) and $50,000 in investment income. Total support is $1,500,000 ($250,000 + $1,000,000 + $100,000 + $100,000 + $50,000), and $1,200,000 ($1,000,000 + $100,000 + $100,000) of that total is support from receipts from the performance of services, government sources, and public contributions (80% of total support). Therefore, Organization C receives more than 50 percent of its support from receipts from the performance of services, government sources, and public contributions. Organization C is not internally supported and is not an integrated auxiliary.

(i) Records, statements, and other returns of tax-exempt organizations. (1) An organization that is exempt from taxation under section 501(a) and is not required to file annually an information return required by this section shall immediately notify in writing Exempt Organizations Determinations, at an address prescribed by publication (including publication on the Internal Revenue Service Web site), of any changes in its character, operations, or purpose for which it was originally created.

(2) Every organization which is exempt from tax, whether or not it is required to file an annual information return, shall submit such additional information as may be required by the Internal Revenue Service for the purpose of inquiring into its exempt status and administering the provisions of subchapter F (section 501 and following), chapter 1 of subtitle A of the Code, section 6033, and chapter 42 of subtitle D of the Code. See section 6001 and § 1.6001-1 with respect to the authority of the district directors or directors of service centers to require such additional information and with respect to the books of account or records to be kept by such organizations.

(3) An organization which has established its exemption from taxation under section 501(a), including an organization which is relieved under section 6033 and this section from filing annual returns of information, is not relieved of the duty of filing other returns of information. See, for example, sections 6041, 6043, 6051, 6057, and 6058 and the regulations thereunder.

(j) Unrelated business tax returns. In addition to the foregoing requirements of this section, certain organizations otherwise exempt from tax under section 501(a) which are subject to tax on unrelated business taxable income are also required to file returns on Form 990-T. See paragraph (e) of § 1.6012-2 and paragraph (a)(5) of § 1.6012-3 for requirements with respect to such returns.

(k) Foreign organizations and United States possession organizations—(1) Foreign organization. For purposes of this section, a foreign organization is any organization not described in section 170(c)(2)(A).

(2) United States possession organization. For purposes of this section, a United States possession organization is any organization created or organized in a possession of the United States.

(3) Source of funds. For purposes of paragraph (g)(1)(viii) of this section, the source of an organization's gross receipts from gifts, grants, contributions or membership fees is determined by applying the rules found in § 53.4948-1(b) of this chapter. For purposes of paragraph (g)(1)(viii) of this section, the source of an organization's gross receipts other than gifts, grants, contributions, and membership fees is determined by applying the rules in sections 861 through 865 and the regulations in this part issued under section 861 through 865. For purposes of applying this paragraph (k)(3) regarding United States possession organizations, a United States person does not include individuals who are bona fide residents of a United States possession.

(l) Applicability date—(1) Generally. This section applies to returns filed on or after January 30, 2020. Section 1.6033-2T (as contained in 26 CFR part 1, revised April 2019) applies to returns filed before January 30, 2020.

(2) Paragraphs (a)(2)(ii)(F), (a)(2)(iii)(D)(1), (g)(1)(iii) and (viii), and (g)(3) of this section apply to annual information returns filed after May 28, 2020. Under section 7805(b)(7) an organization may choose to apply the paragraphs listed in this paragraph (l)(2) to returns filed after September 6, 2019.

[T.D. 7122, 36 FR 11026, June 8, 1971]

Editorial Note:For Federal Register citations affecting § 1.6033-2, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6033-3 Additional provisions relating to private foundations.

(a) In general. The foundation managers (as defined in section 4946(b)) of every organization (including a trust described in section 4947(a)(1)) which is (or is treated as) a private foundation (as defined in section 509) the assets of which are at least $5,000 at any time during a taxable year shall include the following information on its annual return in addition to that information required under § 1.6033-2(a):

(1) An itemized statement of its securities and all other assets at the close of the year, showing both book and market value,

(2) An itemized list of all grants and contributions made or approved for future payment during the year, showing the amount of each such grant or contribution, the name and address of the recipient (other than a recipient who is not a disqualified person and who receives, from the foundation, grants to indigent or needy persons that, in the aggregate, do not exceed $1,000 during the year), any relationship between any individual recipient and the foundation's managers or substantial contributors, and a concise statement of the purpose of each such grant or contribution,

(3) The address of the principal office of the foundation and (if different) of the place where its books and records are maintained,

(4) The names and addresses of its foundation managers (within the meaning of section 4946(b)), that are substantial contributors (within the meaning of section 507(d)(2)) or that own 10 percent or more of the stock of any corporation of which the foundation owns 10 percent or more of the stock, or corresponding interests in partnerships or other entities, in which the foundation has a 10 percent or greater interest.

For purposes of subparagraph (2) of this paragraph, the business address of an individual grant recipient or foundation manager may be used by the foundation in its annual return in lieu of the home address of such recipient or manager, and the term “relationship” shall include, but is not limited to, any case in which an individual recipient of a grant or contribution by a private foundation is (i) a member of the family (as defined in section 4946(d)) of a substantial contributor or foundation manager of such foundation, (ii) a partner of such substantial contributor or foundation manager, or (iii) an employee of such substantial contributor or foundation manager or of an organization which is effectively controlled (within the meaning of section 4946(a)(1)(H)(i) and the regulations thereunder), directly or indirectly, by one or more such substantial contributors or foundation managers.

(b) Notice to public of availability of annual return. A copy of the notice required by section 6104(d) (relating to public inspection of private foundations' annual returns), and proof of publication thereof, shall be filed with the annual return required by § 1.6033-2(a). A copy of such notice as published, and a statement signed by a foundation manager stating that such notice was published, setting forth the date of publication and the publication in which it appeared, shall be sufficient proof of publication for purposes of this paragraph.

(c) Special rules—(1) Furnishing of copies to State officers. The foundation managers of a private foundation shall furnish a copy of the annual return required by section 6033 and § 1.6033-2 to the Attorney General of:

(i) Each State which the foundation is required to list on its return pursuant to § 1.6033-2(a)(2)(iv),

(ii) The State in which is located the principal office of the foundation, and

(iii) The State in which the foundation was incorporated or created.

The annual return shall be sent to each Attorney General described in paragraphs (c)(1) (i), (ii), or (iii) of this section at the same time as it is sent to the Internal Revenue Service. Upon request the foundation managers shall also furnish a copy of the annual return to the Attorney General or other appropriate State officer (within the meaning of section 6104 (c)(2)) of any State. The foundation managers shall attach to each copy of the annual return sent to State officers under this subparagraph a copy of the Form 4720, if any, filed by the foundation for the year.

(2) Cross-reference. For additional rules with respect to private foundations' returns and the public inspection of such returns, see section 6104(d) and the regulations thereunder.

(d) Special rules for certain foreign organizations. The provisions of paragraphs (b) and (c) of this section shall not apply with respect to an organization described in section 4948(b). The foundation managers of such organizations are not required to publish notice of availability of the annual return for inspection, to make the annual return available at the principal office of the foundation for public inspection under section 6104(d), or to send copies of the annual return to State officers.

(e) Effective date. The provisions of this section shall apply with respect to returns filed for taxable years beginning after December 31, 1980.

[T.D. 8026, 50 FR 20756, May 20, 1985]

§ 1.6033-4 Required filing in electronic form for returns by organizations required to file returns under section 6033.

(a) In general. The return of an organization that is required to be filed in electronic form under § 301.6033-4 of this chapter must be filed in accordance with IRS revenue procedures, publications, forms, instructions, or other guidance.

(b) Applicability date. The rules of this section apply for returns required to be filed for taxable years ending on or after February 23, 2023.

[T.D. 9972, 88 FR 11764, Feb. 23, 2023]

§ 1.6033-5 Disclosure by tax-exempt entities that are parties to certain reportable transactions.

(a) In general. Every tax-exempt entity (as defined in section 4965(c)) shall file with the IRS on Form 8886-T, “Disclosure by Tax-Exempt Entity Regarding Prohibited Tax Shelter Transaction” (or a successor form), in accordance with this section and the instructions to the form, a disclosure of—

(1) Such entity's being a party (as defined in § 53.4965-4 of this chapter) to a prohibited tax shelter transaction (as defined in section 4965(e)); and

(2) The identity of any other party (whether taxable or tax-exempt) to such transaction that is known to the tax-exempt entity.

(b) Frequency of disclosure. A single disclosure is required for each prohibited tax shelter transaction.

(c) By whom disclosure is made—(1) Tax-exempt entities referred to in section 4965(c)(1), (2) or (3). In the case of tax-exempt entities referred to in section 4965(c)(1), (2) or (3), the disclosure required by this section must be made by the entity.

(2) Tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7). In the case of tax-exempt entities referred to in section 4965(c)(4), (5), (6) or (7), including a fully self-directed qualified plan, IRA, or other savings arrangement, the disclosure required by this section must be made by the entity manager (as defined in section 4965(d)(2)) of the entity.

(d) Time and place for filing—(1) In general. The disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the tax-exempt entity entered into the prohibited tax shelter transaction.

(2) Subsequently listed transactions. In the case of subsequently listed transactions (as defined in section 4965(e)(2)), the disclosure required by this section shall be filed on or before May 15 of the calendar year following the close of the calendar year during which the transaction was identified by the Secretary as a listed transaction.

(3) Transition rule. If a tax-exempt entity entered into a prohibited tax shelter transaction after May 17, 2006, and before January 1, 2007, the disclosure required by this section shall be filed on or before November 2, 2007.

(4) No disclosure. Disclosure is not required with respect to any prohibited tax shelter transaction entered into by a tax-exempt entity on or before May 17, 2006.

(e) Penalty for failure to provide disclosure statement. See section 6652(c)(3) for the penalty applicable to the failure to disclose a prohibited tax shelter transaction in accordance with this section.

(f) Effective date/applicability date. This section applies with respect to transactions entered into by a tax-exempt entity after May 17, 2006.

[T.D. 9492, 75 FR 38702, July 6, 2010]

§ 1.6033-6 Notification requirement for entities not required to file an annual information return under section 6033(a)(1) (taxable years beginning after December 31, 2006).

(a) In general. Except as otherwise provided in this paragraph, every organization exempt from taxation under section 501(a) that is not required to file a return described in § 1.6033-2(a)(2), other than an organization described in section 401(a) or 501(d), shall submit annually, in electronic form, a notification setting forth the items described in paragraph (c) of this section and such other information as may be prescribed in the instructions and publications issued with respect to the notification.

(b) Organizations not required to submit annual electronic notification. (1) An organization exempt from taxation under section 501(a) that is required to file or files an annual information return under section 6033(a)(1) shall not submit an annual electronic notification under section 6033(i). This includes the following types of organizations:

(i) Any organization included in a group return for that year under § 1.6033-2(d).

(ii) All private foundations required to file under § 1.6033-2(a)(2)(i) Form 990-PF, “Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation.”

(iii) Section 509(a)(3) supporting organizations required to file under § 1.6033-2(a)(2)(i) Form 990, “Return of Organization Exempt From Income Tax,” or Form 990-EZ, “Short Form Return of Organization Exempt From Income Tax.”

(iv) A section 501(c)(21) black lung trust required to file under § 1.6033-2(a)(2)(i) Form 990-BL, “Information and Initial Excise Tax Return for Black Lung Benefit Trusts and Certain Related Persons.”

(v) Any organization that is required to file or files an annual information return under section 6033(a)(1) on any other form prescribed by the Internal Revenue Service for that purpose.

(2) An organization exempt from taxation under section 501(a) that is not required to file a return under section 6033(a)(1) is also not required to submit an annual electronic notification under section 6033(i). This includes the following types of organizations:

(i) A church, an interchurch organization of local units of a church, a convention or association of churches, or an integrated auxiliary of a church (as defined in § 1.6033-2(h)).

(ii) An exclusively religious activity of any religious order.

(iii) A mission society sponsored by or affiliated with one or more churches or church denominations, more than one-half of the activities of which society are conducted in, or directed at persons in, foreign countries.

(iv) An educational organization (below college level) described in section 170(b)(1)(A)(ii), that has a program of a general academic nature, and that is affiliated (within the meaning of § 1.6033-2(h)(2)) with a church or operated by a religious order.

(v) A State institution, the income of which is excluded from gross income under section 115(a).

(vi) An organization described in section 501(c)(1).

(vii) An organization that is a governmental unit or an affiliate of a governmental unit exempt from Federal income tax under section 501(a).

(3) If an organization exempt from taxation under section 501(a) is not described in paragraph (b)(1) or (2) of this section, the organization must submit an annual electronic notification. Thus, a black lung trust that normally has gross receipts of $25,000 or less is not required to file Form 990-BL but is required to submit an annual electronic notification. A section 509(a)(3) supporting organization of a religious organization that normally has gross receipts of $5,000 or less is not required to file Form 990 or Form 990-EZ but is required to submit an annual electronic notification.

(c) Additional notification requirements—(1) In general. Any organization described in paragraph (a) of this section shall submit an annual electronic notification described in section 6033(i)(1). The annual electronic notification shall—

(i) Be in electronic form; and

(ii) Set forth—

(A) The legal name of the organization;

(B) Any name under which the organization operates or does business;

(D) The organization's taxpayer identification number;

(E) The name and address of a principal officer;

(F) Evidence of the continuing basis for the organization's exemption from the filing requirements under section 6033(a)(1); and

(G) Additional information necessary to process the notification.

(2) The mailing address required by section 6033(i)(1)(C) and submitted in the annual electronic notification shall be the organization's last known address as provided by § 301.6212-2(a) of this chapter. This last known address may be updated as provided under § 301.6212-2 of this chapter, or by clear and concise notification. The Internal Revenue Service will use this last known address as the organization's address of record and will direct all mailings to this address.

(3) By submitting the annual electronic notification described in paragraph (c)(1) of this section, an organization acknowledges that it is not required to file a return under section 6033(a) because its annual gross receipts are not normally in excess of $25,000. In order to make this determination, the organization must keep records that enable it to calculate its gross receipts. All organizations are required to maintain records under section 6001. These records will provide evidence of the continuing basis for the organization's exemption from the filing requirements under section 6033(a)(1).

(4) If an organization that is required to submit an annual electronic notification files a complete Form 990 or Form 990-EZ, the annual electronic notification requirement shall be deemed satisfied. The annual electronic notification requirement is not satisfied if the Form 990 or Form 990-EZ contains only those items of information that would have been required by submitting the notification in electronic form. Also, the filing of a complete Form 990 or Form 990-EZ, rather than the submission of an annual electronic notification, is the filing of a return that starts the period of limitations for assessment under section 6501(g)(2).

(d) No effect on other filing requirements. An organization that is relieved from filing an information return under section 6033(a) is still subject to the requirements of §§ 1.6033-2(i) and (j), concerning: notice regarding changes in character, operations, or purpose; provision of additional information; duty to file other returns of information; and duty to file unrelated business tax returns. If an organization is required to file an unrelated business tax return, Form 990-T, “Exempt Organization Business Income Tax Return,” the filing of that return does not relieve the organization from the requirement of submitting an annual electronic notification under section 6033(i).

(e) Accounting period for submitting annual electronic notification. An annual electronic notification required by this section shall be on the basis of the established annual accounting period of the organization. If the organization has no established accounting period, the annual electronic notification shall be on the basis of the calendar year.

(f) Time and place for submitting annual electronic notification. The annual electronic notification required by this section shall be submitted on or before the 15th day of the fifth calendar month following the close of the period for which the notification is required to be submitted. Thus, an organization with an accounting period ending December 31, 2007, is required to submit an annual electronic notification by May 15, 2008. The notification shall be submitted in accordance with instructions and publications, including those provided at the Internal Revenue Service Web site for exempt organizations.

(g) Effective/applicability date. These regulations are applicable to annual periods beginning after 2006.

[T.D. 9454, 74 FR 36396, July 23, 2009]

§ 1.6034-1 Information returns required of trusts described in section 4947(a)(2) or claiming charitable or other deductions under section 642(c).

(a) In general. Every trust (other than a trust described in paragraph (b) of this section) claiming a charitable or other deduction under section 642(c) for the taxable year shall file, with respect to such taxable year, a return of information on form 1041-A. In addition, for taxable years beginning after December 31, 1969, every trust (other than a trust described in paragraph (b) of this section) described in section 4947(a)(2) (including trusts described in section 664) shall file such return for each taxable year, unless all transfers in trust occurred before May 27, 1969. The return shall set forth the name and address of the trust and the following information concerning the trust in such detail as is prescribed by the form or in the instructions issued with respect to such form:

(1) The amount of the charitable or other deduction taken under section 642(c) for the taxable year (and, for taxable years beginning prior to January 1, 1970, showing separately for each class of activity for which disbursements were made (or amounts were permanently set aside) the amounts which, during such year, were paid out (or which were permanently set aside) for charitable or other purposes under section 642(c));

(2) The amount paid out during the taxable year which represents amounts permanently set aside in prior years for which charitable or other deductions have been taken under section 642(c), and separately listing for each class of activity, for which disbursements were made, the total amount paid out;

(3) The amount for which charitable or other deductions have been taken in prior years under section 642(c) and which had not been paid out at the beginning of the taxable year;

(4)(i) The amount paid out of principal in the taxable year for charitable, etc., purposes, and separately listing for each such class of activity, for which disbursements were made, the total amount paid out;

(ii) The total amount paid out of principal in prior years for charitable, etc., purposes;

(5) The gross income of the trust for the taxable year and the expenses attributable thereto, in sufficient detail to show the different categories of income and of expense; and

(6) A balance sheet showing the assets, liabilities, and net worth of the trust as of the beginning of the taxable year.

(b) Exceptions—(1) In general. A trust is not required to file a Form 1041-A for any taxable year with respect to which the trustee is required by the terms of the governing instrument and applicable local law to distribute currently all of the income of the trust. For this purpose, the income of the trust shall be determined in accordance with section 643(b) and §§ 1.643(b)-1 and 1.643(b)-2.

(2) Trusts described in section 4947(a)(1). For taxable years beginning after December 31, 1980, a trust described in section 4947(a)(1) is not required to file a Form 1041-A.

(c) Time and place for filing return. The return on form 1041-A shall be filed on or before the 15th day of the 4th month following the close of the taxable year of the trust, with the internal revenue officer designated by the instructions applicable to such form. For extensions of time for filing returns under this section, see § 1.6081-1.

(d) Other provisions. For publicity of information on Form 1041-A, see section 6104 and the regulations thereunder in part 301 of this chapter. For provisions relating to penalties for failure to file a return required by this section, see section 6652(d). For the criminal penalties for a willful failure to file a return and filing a false or fraudulent return, see sections 7203, 7206, and 7207.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 7563, 43 FR 40221, Sept. 11, 1978; T.D. 8026, 50 FR 20757, May 20, 1985]

§ 1.6035-0 Table of contents.

This section lists the captions contained in §§ 1.6035-1 and 1.6035-2.

§ 1.6035-1 Basis information to persons acquiring property from decedent.

(a) Overview.

(b) Applicability of section 6035 reporting requirements.

(1) In general.

(2) Executor(s) subject to section 6035 reporting requirements.

(3) Examples.

(1) Required Information Return.

(2) Required Statement(s).

(3) Due dates.

(4) Acquiring an interest in property.

(5) Option to furnish Statement(s) prior to the acquisition of property by a beneficiary.

(6) Example.

(d) Duty to supplement.

(1) Duty to supplement to report changes to the information reported on the Information Return or Statement(s).

(2) Changes requiring supplemental reporting.

(3) Exceptions; no duty to supplement despite certain changes.

(4) Due date of supplemental reporting.

(5) Duration of duty to supplement.

(6) Examples.

(e) Property for which reporting is required.

(1) In general.

(2) Examples.

(f) Excepted property requiring only limited reporting.

(1) Excepted property.

(2) List of excepted property.

(3) United States dollars defined.

(4) Examples.

(g) Beneficiaries.

(1) In general.

(2) Required Statement to beneficiary trust.

(3) Required Statement to the holder of a split interest in property, not in trust.

(4) Reporting for a missing beneficiary.

(h) Reporting requirements applicable to trustees.

(1) Circumstances under which trustees of beneficiary trusts and other trusts are subject to reporting.

(2) Required reporting.

(3) Example.

(i) Penalties.

(j) Applicability date.

§ 1.6035-2 Transitional relief.

(a) Statements due before June 30, 2016.

(b) Applicability date.

[T.D. 9991, 89 FR 76379, Sept. 17, 2024]

§ 1.6035-1 Basis information to persons acquiring property from decedent.

(a) Overview. This section implements the reporting requirements under section 6035 of the Internal Revenue Code (Code) applicable to executors and certain trustees. In general, the reporting requirements of this section require providing information to the IRS on the identity of persons acquiring property from a decedent and providing basis information to persons acquiring that property from the decedent. Basis information is needed by certain persons acquiring property from a decedent in order to comply with the consistent basis requirement of section 1014(f) of the Code. See § 1.1014-10 for rules applicable to the consistent basis requirement.

(b) Applicability of section 6035 reporting requirements—(1) In general. The reporting requirements under section 6035 of the Code apply only in the case of an estate in which the executor is required to file an estate tax return under section 6018 of the Code (determined without regard to § 20.2010-2(a)(1) of this chapter) (required estate tax return) and the executor files that return after July 31, 2015. The requirements do not apply in the case of an estate whose required estate tax return is filed on or before July 31, 2015, even if the due date of the return is after July 31, 2015, or if one or more supplements to that return are filed with the IRS after July 31, 2015. Whether an estate tax return is a required estate tax return depends on the relevant factors identified in section 6018 and the corresponding regulations, including the date of death value of property includible in the decedent's gross estate, the amount of adjusted taxable gifts, and the applicable filing threshold. An election under section 2032 or 2032A of the Code to determine the value of the gross estate in accordance with those respective provisions is not relevant to whether an executor is required to file an estate tax return under section 6018. If an estate tax return is not required to be filed under section 6018 based on the relevant factors identified in section 6018, then an estate tax return filed for another purpose (such as to make a portability election under section 2010(c)(5) of the Code, an allocation or election under section 2632 of the Code with regard to a decedent's generation-skipping transfer tax exemption, or a protective filing to avoid a penalty or satisfy a State law requirement) is not a required estate tax return for purposes of this section.

(2) Executor(s) subject to section 6035 reporting requirements. For purposes of this section, the term executor has the same meaning as in section 2203 of the Code, as expanded to include all persons required under section 6018(b) to file an estate tax return. Thus, more than one person may be subject to the reporting requirements for the same decedent's estate. If one executor is unable to file a complete estate tax return (for example, if the executor has insufficient information about property in the decedent's gross estate that is not in the possession of that executor), each person required to file a return is subject to the reporting requirements of this section only with regard to the property reported (or required to be reported) on the estate tax return required to be filed by that person. Similarly, if no executor is appointed by a court, each person in actual or constructive possession of any property of the decedent is an executor for purposes of this section and is subject to the reporting requirements of this section, but only with regard to the property reported or required to be reported on the estate tax return required to be filed by that executor under section 6018(b).

(3) Examples. The following examples, in which the decedent D was a United States citizen at the time of the decedent's death, illustrates the application of this paragraph (b).

(i) Example 1—Executor required to file a return under section 6018. The value at death of property includible in D's gross estate exceeds the basic exclusion amount in effect for the year of D's death under section 2010(c). On the timely-filed estate tax return, D's executor makes a valid alternate valuation election under section 2032 to value the property of D's gross estate as of a date subsequent to the date of death. As a result, the value of property includible in D's gross estate is decreased to a value that is less than the basic exclusion amount in effect for the year of D's death. Because D's executor is required to file an estate tax return under section 6018, D's executor also is subject to the reporting requirements of section 6035. This is true even though no estate tax liability was incurred, and the requirements of section 1014(f) do not apply to any property includible in D's gross estate. See § 1.1014-10(c)(1).

(ii) Example 2—Executor not required to file a return under section 6018. The value at death of property includible in D's gross estate does not exceed the basic exclusion amount in effect for the year of D's death under section 2010(c) of the Code. In accordance with the terms of D's will, D's executor distributes D's entire estate to D's only child. D's executor files an estate tax return solely for the purpose of making a portability election under section 2010(c)(5). Because D's executor is not required to file an estate tax return under section 6018, D's executor is not subject to the reporting requirements of section 6035.

(iii) Example 3—No executor appointed. The value at death of property includible in D's gross estate exceeds the basic exclusion amount in effect for the year of D's death under section 2010(c) and consists entirely of D's interests in Property A and Property B that D owned with Nephew A and Nephew B, respectively, as joint tenants with rights of survivorship. Pursuant to local law, Nephew A becomes the sole owner of Property A and Nephew B becomes the sole owner of Property B upon D's death. No executor or administrator is appointed, qualified, or acting within the United States for D's estate on the due date of D's estate tax return. Because Nephew A has actual or constructive possession of Property A, Nephew A is an executor described in paragraph (b)(2) of this section with regard to D's interest in Property A. Because Nephew A is required to file an estate tax return under section 6018 with regard to D's interest in Property A, Nephew A also is subject to the reporting requirements of section 6035 with respect to Property A. Similarly, because Nephew B has actual or constructive possession of Property B on the due date of D's estate tax return, Nephew B is an executor described in paragraph (b)(2) of this section with regard to D's interest in Property B. Because Nephew B is required to file an estate tax return under section 6018 with regard to D's interest in Property B, Nephew B also is subject to the reporting requirements of section 6035 with respect to Property B.

(iv) Example 4—Executor unable to make a complete return. The value at death of property includible in D's gross estate exceeds the basic exclusion amount in effect for the year of D's death under section 2010(c). E is appointed the executor of D's estate. During the administration of D's estate, E discovers that D has made transfers each year for the past ten years to T as trustee of Trust. E contacts T, but T refuses to provide E with any information regarding Trust. E timely files D's estate tax return reporting the value of all of the property in D's gross estate except Trust. Pursuant to § 20.6018-2 of this chapter, E includes with the return a statement that gives T's name and contact information and the date and amount of each transfer from D to T as trustee of Trust, which is all the information E has about Trust. The IRS provides notice to T of T's obligation to make D's estate return as to Trust. Because E is required to file an estate tax return under section 6018, E is subject to the reporting requirements of section 6035 as to the property reported on the estate tax return filed by E. Because T is required to file an estate tax return under section 6018, T is subject to the reporting requirements of section 6035 as to Trust.

(c) Required Information Return and Statement(s)—(1) Required Information Return. An executor required to file an estate tax return under section 6018 must file with the IRS an Information Return by the date required under paragraph (c)(3) of this section. The term Information Return refers to the Form 8971, Information Regarding Beneficiaries Acquiring Property from a Decedent, and all required attachments. Required attachments include a copy of each Statement described in paragraph (c)(2) of this section (if any) required to be furnished to a beneficiary who acquires property within the meaning of paragraph (c)(4) of this section on or before the due date of the estate tax return or, if earlier, the date on which the estate tax return is filed with the IRS. Required attachments also include a copy of each Statement (if any) furnished pursuant to paragraph (c)(5) of this section before the filing of the Information Return. The term Information Return also refers to any successor form or procedure designated by the IRS for this purpose. The Information Return must identify each beneficiary who has acquired or will acquire property subject to reporting (under paragraph (e) of this section), as well as other information prescribed by the Information Return and the instructions for that form. For the duty to supplement the Information Return in the event such property is acquired by a beneficiary after the filing of the estate tax return, see paragraph (c)(3)(ii) of this section. For the duty to supplement the Information Return in the event of a change to the information required to be reported, see paragraph (d) of this section.

(2) Required Statement(s). An executor required to file an estate tax return under section 6018 also must furnish a Statement to each beneficiary who acquires property subject to reporting under paragraph (e) of this section. For purposes of this section, the term Statement refers to the payee statement described as Schedule A of the Information Return to be furnished to a beneficiary, or any successor form, schedule, or procedure designated by the IRS for this purpose. The Statement furnished to a beneficiary must identify that beneficiary's acquired property and its value and other information prescribed by the Statement and the instructions for that form. For each property reported on a Statement, the value the executor reports on that Statement is the value of the property as reported on the estate tax return filed with the IRS. Generally, this is the value of the property on the date of the decedent's death, except in the case of an election in which the value is determined under section 2032 or 2032A, in which case it is the value determined under the applicable provision. If different interests in the same property pass from the decedent to one or more income beneficiaries or life tenants and remaindermen, the value to be reported is the value of the entire property and each recipient will be responsible for identifying his or her respective share of uniform basis. For the duty to supplement the Statement in the event of a change to the information required to be reported, including a change in the identified value of property reported on a Statement, see paragraph (d) of this section.

(3) Due dates—(i) General rule. Except as provided in paragraphs (c)(3)(ii) and (iii) of this section and in § 1.6035-2, the executor must file the Information Return with the IRS on or before the due date specified in this paragraph (c)(3)(i). In addition, each Statement, a copy of which is required to be attached to the Information Return, must be furnished to the named beneficiary on or before this same due date. The Information Return must be filed, and each such Statement (if any) must be furnished to its named beneficiary, on or before the earlier of—

(A) The date that is 30 days after the due date of the estate tax return required under section 6018 (including extensions, if any); or

(B) The date that is 30 days after the date on which that estate tax return is filed with the IRS.

(ii) Due date and applicable rules if property is acquired subsequently by beneficiary. If a beneficiary acquires property subject to reporting after the due date of the estate tax return (or the earlier filing of the Information Return), the executor must furnish a Statement to that beneficiary with regard to that acquired property on or before January 31 of the year following the beneficiary's acquisition of that property. By that same January 31, the executor also must attach a copy of the Statement to a supplement to the Information Return (a supplemental Information Return) and must file the supplemental Information Return with the IRS. The supplemental Information Return must include a copy of each Statement required to be furnished for that year pursuant to this paragraph (c)(3)(ii), as well as a copy of each Statement (if any) furnished in accordance with paragraph (c)(5) of this section that has not already been filed with the IRS as an attachment to the Information Return or a supplement to the Information Return. The requirements of this paragraph (c)(3)(ii) do not apply if the property already has been reported on a Statement furnished pursuant to paragraph (c)(5) of this section. See this paragraph (c)(3) and paragraph (d)(4) of this section for the due date of other required supplements to this reporting.

(iii) Transition rule. If the due date of an estate tax return required to be filed by section 6018 is on or before July 31, 2015, but the executor does not file the estate tax return with the IRS until after July 31, 2015, then the Information Return and all required Statements are due on or before the date that is 30 days after the date on which the estate tax return is filed, except as provided in § 1.6035-2.

(4) Acquiring an interest in property. For purposes of this section, the term acquired property refers to property subject to reporting under paragraph (e) of this section that a beneficiary acquires. A beneficiary acquires such property when, under local law, title vests in the beneficiary or when the beneficiary otherwise has sufficient control over or connection with the property that the beneficiary is able to take action related to the property for which basis is relevant for Federal income tax purposes (such as, for example, to sell or depreciate the property). In many cases, a beneficiary's acquisition of property occurs upon an executor's or trustee's distribution of the property. For property passing by contract or by operation of law, the beneficiary's acquisition of that property generally occurs automatically upon the death of the decedent.

(5) Option to furnish Statement(s) prior to the acquisition of property by a beneficiary. An executor may satisfy the requirement in paragraph (c)(2) of this section to furnish a Statement to a beneficiary by furnishing the Statement to the beneficiary prior to the beneficiary's acquisition of the property subject to reporting under paragraph (e) of this section, provided that the executor has reason to believe that the beneficiary will acquire that property. The Statement furnished to such a beneficiary must identify the property the beneficiary is expected to acquire as well as the value of that property and other information prescribed by the Statement and the instructions for that form (and must include information relating to other property actually acquired by such beneficiary as may be required under paragraph (c)(2) of this section). If, after satisfying the requirements of this paragraph (c)(5), the property is acquired by a different beneficiary, the executor must update the beneficiary information in the Information Return and furnish a Statement to that beneficiary pursuant to the duty to supplement to report a change in beneficiary information as described in paragraph (d)(2)(i) of this section. The executor additionally is subject to the duty to supplement to report other changes to the information required to be reported as identified in paragraph (d) of this section.

(6) Example. The following example illustrates the application of this paragraph (c).

(i) The decedent D was a United States citizen at the time of D's death and the executor of D's estate E is required to file an estate tax return under section 6018. The terms of D's will provide for D's entire estate to be distributed to a marital trust. Prior to timely filing the estate tax return for D's estate, E funded the marital trust with a portion of the property, the value of which is included in D's gross estate. Under paragraph (c)(4) of this section, the marital trust has acquired this property upon the funding of the trust by E. Under paragraphs (c)(1) and (c)(3)(i) of this section, within 30 days of filing the estate tax return, E must file with the IRS the Information Return identifying the marital trust as the beneficiary (as well as other information prescribed by the Information Return or instructions) and must include with the Information Return all required attachments. Under paragraphs (c)(2) and (c)(3)(i) of this section, by the same date, E must furnish to the marital trust the Statement identifying the portion of the property distributed to the marital trust and its estate tax value (as well as any other information prescribed by the Statement or instructions). A copy of the Statement is a required attachment to be included with the Information Return. Pursuant to paragraph (c)(5) of this section, E may choose to expand the property identified on the Statement to also include the property the marital trust is expected to acquire subsequently. If E so chooses, the Statement to be furnished to the marital trust will identify all such property and its value at the date of death and, except in the case of any changes to the information required to be reported, no further Statement will be required at the time of the completion of the funding of the trust.

(ii) However, if E chooses not to expand the reporting to property not yet acquired by the marital trust, then, once the marital trust has acquired additional property, E is subject to further reporting. Under paragraph (c)(3)(ii) of this section, in each year that E distributes additional property to the marital trust, E must furnish, by January 31 of the following year, a Statement to the marital trust identifying all of the property the marital trust has acquired from D's estate that year and the property's estate tax value (as well as any other information prescribed by the Statement or instructions). By the same date, E must file with the IRS a supplemental Information Return and attach a copy of that Statement as well as any other required attachments.

(d) Duty to supplement—(1) Duty to supplement to report changes to the information reported on the Information Return or Statement(s). An executor to whom the reporting requirements of this section apply must file a supplemental Information Return with the IRS and furnish a Statement or supplemental Statement to each affected beneficiary if a change to the information required to be reported on the Information Return or Statement (or supplement to either) causes the information as reported to be incorrect or incomplete. The executor must file the supplemental Information Return with the IRS, including copies of each Statement or supplemental Statement furnished to affected beneficiaries, and must furnish a Statement or supplemental Statement to each affected beneficiary, by the due date described in paragraph (d)(4) of this section.

(2) Changes requiring supplement. This paragraph (d)(2) provides a nonexhaustive list of changes that require supplemental reporting under paragraph (d)(1) of this section.

(i) Change in beneficiary information. The receipt, discovery, or acquisition by the executor of information that changes the beneficiary to whom property is to be distributed (pursuant to a death, disclaimer, bankruptcy, or otherwise), or corrects or completes other beneficiary information originally reported, will give rise to a duty to supplement.

(ii) Change in the identified value of property. The supplementing of an estate tax return to report a corrected estate tax value of property that was previously reported on an estate tax return and a Statement will give rise to a duty to supplement. In addition, a final determination of value of property for Federal estate tax purposes (within the meaning of § 1.1014-10(b)(1)) that differs from the value provided on a Statement or supplement to a Statement will give rise to a duty to supplement.

(iii) Change or addition of property subject to reporting. The supplementing of an estate tax return to report the estate tax value of property subject to reporting under paragraph (e) of this section, if that property and/or its value previously was not reported on an estate tax return or supplement to the estate tax return, will give rise to a duty to supplement. A duty to supplement also will arise if such property or its value that previously was not reported on an estate tax return or supplement to the estate tax return is included in the decedent's gross estate pursuant to an examination by the IRS or otherwise.

(iv) Change in property to be acquired by beneficiary. A duty to supplement will arise if an executor furnishes a Statement to a beneficiary prior to the beneficiary's acquisition of property pursuant to paragraph (c)(5) of this section and the beneficiary ultimately acquires property different from the property identified on that Statement. A beneficiary's acquisition of different property may occur for any reason, including an executor's receipt of different property in a transaction in which the basis of the new property received by the executor is determined, in whole or in part, by reference to the final value of property acquired from or as a result of the death of the decedent (for example, as the result of a like-kind exchange under section 1031 or an involuntary conversion).

(3) Exceptions; no duty to supplement despite certain changes. Notwithstanding paragraph (d)(2) of this section, no supplemental reporting under this section is required for:

(i) Inconsequential errors or omissions within the meaning of § 301.6722-1(b) of this chapter;

(ii) Changes resulting from an event that triggers an additional estate tax under section 2032A, including changes in value in the event of a beneficiary election under section 1016(c) of the Code;

(iii) Adjustments to the basis of property pursuant to sections of the Code other than section 1014(f); and

(iv) Any other change that is identified as requiring no supplemental reporting under this section in published guidance in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter).

(4) Due date of supplemental reporting. The supplemental reporting required by this paragraph (d) must be filed with the IRS and furnished to each affected beneficiary on or before 30 days after the date on which information becomes available to the executor from which the executor can conclude that a change to the information provided on the Information Return or Statement (or supplement to either) requires supplemental reporting. For changes occurring as a result of supplementing the estate tax return, the date on which the information becomes available to the executor is deemed to be the filing date of the supplemental information. Therefore, for changes occurring as a result of supplementing the estate tax return, the due date of the supplemental reporting required by this paragraph (d) is 30 days after the filing date of the supplemental information. For changes occurring as a result of a determination of final value, the date on which the information becomes available to the executor is deemed to be the date a value becomes the final value under § 1.1014-10(b)(1). Therefore, for changes occurring as a result of a determination of final value, the due date of the supplemental reporting required by this paragraph (d) is 30 days after the date a value becomes the final value under § 1.1014-10(b)(1). However, with regard to property that has not been acquired by a beneficiary on or before the due date described in this paragraph (d)(4) and for which a Statement was not provided to the beneficiary pursuant to paragraph (c)(5) of this section, the due date may be delayed until the due date described in paragraph (c)(3)(ii) of this section.

(5) Duration of duty to supplement. An executor's duty to supplement as described in this section continues to apply until a final determination of value for Federal estate tax purposes (a final value within the meaning of § 1.1014-10(b)(1)) is determined for all property subject to reporting (under paragraph (e) of this section) or, if later, until such property has been acquired by a beneficiary. Therefore, the executor's final supplemental reporting is the reporting to the IRS and the furnishing of Statements to beneficiaries with regard to the last to occur of these two events, assuming that either event would create a change requiring supplemental reporting.

(6) Examples. The following examples illustrate the application of this paragraph (d). In each case, the decedent D was a U.S. citizen and D's executor E was required under section 6018 to file an estate tax return.

(i) Example 1—Change in identified value of property. D's estate includes stock in a closely-held corporation. E distributes the stock to a beneficiary B of the estate before the due date of the estate tax return. D's executor reports the value of the stock at $14 million on D's estate tax return and on the Statement furnished to B. On examination of D's estate tax return, the IRS adjusts the value of the closely-held stock to $18 million. A court subsequently determines that the fair market value of the closely-held stock for Federal estate tax purposes is $17 million and the court's decision becomes final on June 15th. On or before July 15th of the same year, E must furnish a supplemental Statement to B showing the final value of $17 million for the closely-held stock, and must attach a copy of that supplemental Statement to a supplemental Information Return and file it with the IRS.

(ii) Example 2—Duration of the duty to supplement. D's gross estate includes stock in closely-held corporation X, stock in closely-held corporation Y, and cash. D's will directs E to distribute 50% of the value of D's estate to A and 50% to B in any manner to which A and B agree. A and B agree that A will take the stock in corporation X and B will take stock in corporation Y and they will divide the cash in such amounts as to cause each to take an equal share of the value D's estate. E timely files D's estate tax return and furnishes a Statement to A and to B pursuant to paragraph (c)(5) of this section. The IRS accepts the return as filed and the period of limitations on assessment of estate tax expires. Thereafter, A and B agree to revise their agreement. E distributes the stock in corporation X to B and the stock in corporation Y to A in accordance with a revised agreement between A and B. E's final supplemental reporting is the filing of a supplemental Information Return and furnishing of a supplemental Statement to A describing the shares and value of stock distributed to A and a supplemental Statement to B describing the shares and value of stock distributed to B.

(e) Property for which reporting is required—(1) In general. Except for excepted property subject to only limited reporting as described in paragraph (f) of this section, the property subject to reporting under this section is included property and any other property the basis of which is determined, in whole or in part, by reference to the basis of the included property (for example, property acquired in a like-kind exchange or an involuntary conversion). For purposes of this section, included property is property the value of which is included in the value of the decedent's gross estate as defined in section 2031 or 2103. Generally, included property refers to property whose value is reported on an estate tax return, but it also refers to property whose value otherwise is included in the total value of the gross estate (for example, during examination by the IRS). Thus, included property includes property that qualified, in whole or in part, for an estate tax marital deduction under section 2056, 2056A, or 2106(a)(3) or for an estate tax charitable deduction under section 2055 or 2106(a)(2). It further includes property included in the decedent's gross estate that is distributed to a surviving spouse in satisfaction of that surviving spouse's interest in community property not included in the gross estate that the executor has distributed to a non-spouse pursuant to State law properly applied. However, included property does not include property whose value is not reported on an estate tax return and whose value is not otherwise included in the value of the decedent's gross estate, such as the property of a deceased nonresident noncitizen that is not subject to United States estate tax, and the surviving spouse's share of community property described in section 1014(b)(6).

(2) Examples. The following examples illustrate the application of this paragraph (e). In each case, the decedent D was a U.S. citizen and D's executor E was required under section 6018 to file an estate tax return.

(i) Example 1—Included property. Pursuant to the terms of D's will, a trust is established and funded with property, the value of which is includible in D's gross estate under section 2031. The trust is a charitable remainder annuity trust described in section 664(d)(1). The terms of the trust provide that, in each taxable year during the lifetime of D's surviving spouse S, the trustee must pay to S an annuity of 5% of the initial net fair market value of all property passing to the trust as finally determined for Federal estate tax purposes. Upon the death of S, the trustee must distribute all of the then-principal and income of the trust to organizations described in sections 170(c), 2055(a) and 2522(a) as the trustee selects, in the trustee's sole discretion. The property used to fund the trust is included property and is subject to the reporting requirements of this section. This is true whether or not the requirements of section 1014(f) apply to the property transferred to the trust. See § 1.1014-10(d)(4).

(ii) Example 2—Property the basis of which is determined by reference to the basis of included property. D's gross estate includes the value of Property A. Before the due date for filing the estate tax return, E exchanges Property A for Property B in a like-kind exchange pursuant to section 1031, for which D's estate recognizes no gain or loss. Property B is property subject to reporting as prescribed in this section. With respect to Property B, the value E reports on the Statement is the value reported for Property A on the estate tax return filed with the IRS.

(f) Excepted property requiring only limited reporting—(1) Excepted property. Certain included property that is described in paragraph (f)(2) of this section (excepted property) is subject to more limited reporting than the reporting required under paragraph (c) of this section. The requirement to file an Information Return with the IRS as described in paragraph (c)(1) of this section remains the same even if all property subject to reporting under paragraph (e) of this section is excepted property. However, the executor is not required to identify or provide any other information for excepted property on the Information Return, and the executor is not required to furnish a Statement to the beneficiary with regard to that property. Instead, the executor is required only to report on the Information Return, in accordance with the instructions for that form, that some or all of the property subject to reporting is excepted property described in this paragraph (f). Further, the executor is not required to identify or provide any other information for excepted property on any Statement furnished to a beneficiary and, if this property is the only property that a beneficiary has acquired, an executor is not required to furnish a Statement to that beneficiary.

(2) List of excepted property. Excepted property includes—

(i) United States dollars (as defined in paragraph (f)(3) of this section).

(ii) United States dollar-denominated demand deposits.

(iii) Certificates of deposit denominated in United States dollars.

(iv) Cash collateral denominated in United States dollars held by a third party to secure a liability (such as a deposit of purchase money or a security deposit).

(v) Shares of a registered investment company priced in United States dollars that is a money market fund under Rule 2a-7 under the Investment Company Act of 1940 (17 CFR 270.2a).

(vi) Life insurance proceeds on the life of the decedent payable in a lump sum in United States dollars.

(vii) Federal, State, and local tax refunds and other refunds payable in United States dollars.

(viii) Notes that are forgiven in full by the decedent upon the decedent's death, whether or not denominated in United States dollars.

(ix) Household and personal effects for which an appraisal is not required under § 20.2031-6(b) of this chapter.

(x) Property that, prior to distribution from the estate or the decedent's revocable trust, is completely sold, exchanged, or otherwise disposed of in one or more transactions that are recognition events for Federal income tax purposes (whether or not resulting in a gain or loss, and whether or not any gain is capital or ordinary). Such property includes, but is not limited to—

(A) Property distributed in satisfaction of a pecuniary bequest on which the estate recognizes any gain or loss pursuant to § 1.661(a)-2(f);

(B) Property for which an election under section 643(e)(3) has been made for the estate to recognize any gain or loss;

(C) Interests in a business entity that are redeemed for United States dollars prior to being distributed to the beneficiary;

(D) Property disposed of in a transaction described in section 267(a) and (b)(13); and

(E) Property subject to the mark to market accounting method at the time of distribution from the estate or from the decedent's revocable trust.

(xi) Other property having an initial basis that is not in any way determined with regard to or derived from the property's fair market value for Federal estate tax purposes. For purposes of this section, such property includes but is not limited to—

(A) Annuity contracts subject to section 72 and amounts received as an annuity subject to section 72;

(B) An interest in property that consists entirely of the right to receive an item of income in respect of a decedent as defined in section 691;

(C) Amounts received under installment obligations arising from a transaction for which the installment method for determining gain under section 453 applies;

(D) Appreciated property described in section 1014(e) that is acquired by the decedent within 1 year of death;

(E) Stock of a passive foreign investment company subject to section 1296(i), but only if the basis of such stock is the adjusted basis in the hands of the decedent immediately before the decedent's death; and

(F) Interests in and distributions from retirement plans and deferred compensation plans, including individual retirement arrangements as defined in sections 408 and 408A, that are expressed entirely in United States dollars.

(xii) Bonds to the extent that they are redeemed by the issuer for United States dollars prior to being distributed to a beneficiary so that any resulting gain or loss is recognized by the estate.

(xiii) Property included in the gross estate of a beneficiary who died before the due date of the Information Return.

(xiv) Any other property that is identified as excepted property in published guidance in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii)(b) of this chapter).

(3) United States dollars defined. For purposes of this paragraph (f), the term United States dollars means the official currency of the United States. The term United States dollars includes physical bills and coins for which the value of each bill or coin is equivalent to the face amount of that bill or coin. This definition does not include other physical United States bills or coins with numismatic value because these bills or coins typically do not have a value equal to their face value.

(4) Examples. The following examples illustrate the application of this paragraph (f). In each case, the decedent D was a U.S. citizen and D's executor E is required under section 6018 to file an estate tax return.

(i) Example 1—Reporting household and personal effects. Included in D's gross estate are D's household and personal effects. The only item included in D's household and personal effects with a value in excess of $3,000 is a painting. E attaches to D's estate tax return an appraisal of the painting prepared in accordance with § 20.2031-6(b) of this chapter and a room-by-room itemization of D's other household and personal effects prepared in accordance with § 20.2031-6(a) of this chapter. E must furnish to the beneficiary of the painting the Statement required by paragraph (c)(2) of this section. E is not required to report on a Statement furnished to any beneficiary any information about D's other household and personal effects. If a beneficiary of D's household effects, other than the beneficiary of the painting, has acquired no other property, E is not required to furnish a Statement to that beneficiary. E is required to file the Information Return required by section (c)(1) of this section and attach to that Information Return a copy of the Statement furnished to the beneficiary of the painting. E must disclose on the Information Return that some or all of the property included in D's gross estate is excepted property described in this paragraph (f).

(ii) Example 2—Reporting if property is disposed of in taxable transaction. Included in D's estate are shares in X, a publicly traded company. Shortly after D's death but prior to the filing of the estate tax return for D's estate, X is acquired by T, also a publicly traded company. In exchange for the shares in X, the estate receives shares in T and cash in a fully taxable transaction. E is required to report on the Information Return required by paragraph (c)(1) of this section that some or all of the property included in D's gross estate is excepted property described in this paragraph (f). E is not required to furnish a Statement to any recipient with respect to the cash, X stock, or T stock.

(iii) Example 3—Reporting if estate is liquidated prior to distribution. Property A is the only property in D's estate. Prior to filing the estate tax return for D's estate, E sells Property A for $15,000,000. D's estate recognizes gain on the sale of Property A for income tax purposes. E distributes the $15,000,000 among the beneficiaries of D's estate. E must file the Information Return required by paragraph (c)(1) of this section even though all of the property included in D's gross estate is excepted property within the meaning of this paragraph (f). E is not required to furnish to the beneficiaries of D's estate a Statement with regard to Property A, and therefore is not required to attach a copy of any Statement to the Information Return. E is required to file an Information Return with the IRS indicating that all of the property included in D's gross estate is excepted property described in this paragraph (f), and must provide other information as required by the Information Return and the instructions.

(g) Beneficiaries—(1) In general. Each person who acquires (or will acquire) property from a decedent or by reason of the decedent's death that is subject to the reporting described in paragraph (e) of this section is a beneficiary for purposes of this section and thus is a person to be listed on the Information Return and, except with respect to excepted property (described in paragraph (f) of this section), is a person to whom the executor must furnish a required Statement. Thus, a beneficiary may be:

(i) An individual, including one who is both the executor and a beneficiary, who acquires (or will acquire) property subject to reporting not in trust;

(ii) The estate of a deceased individual who survived the decedent if such individual or estate acquires (or will acquire) property subject to reporting not in trust;

(iii) A trust, whether foreign or domestic, including without limitation a grantor retained annuity trust, charitable remainder trust, and charitable lead trust (each referred to in this section as beneficiary trusts); or

(iv) An entity other than a trust, including without limitation a business entity or an organization described in section 501(c).

(2) Required Statement to beneficiary trust—(i) In general. If a beneficiary trust is the beneficiary to be identified on the Information Return pursuant to paragraph (g)(1) of this section, the executor must furnish the Statement described in paragraph (c)(2) of this section to the trustee rather than to the beneficiaries of the trust. However, if the executor reasonably believes that it is unlikely that the beneficiary trust will depreciate, sell, or otherwise dispose of the property subject to reporting in a recognition event for income tax purposes but instead will distribute the property in kind to the trust beneficiaries, the executor instead may furnish the Statement described in paragraph (c)(2) of this section to each of the trust beneficiaries, with copies of the Statements to the trustee. For this purpose, the trust beneficiaries include all potential current income beneficiaries and each remainderman who would have had a current interest in the trust if one or more of the income beneficiaries had died immediately after the decedent. For purposes of determining the due date of such Statements, each trust beneficiary will be deemed to have acquired the trust property when the trust acquired that property.

(ii) Beneficiary trust not yet established. If, by the date required for filing the Information Return with the IRS, a beneficiary trust does not have at least one trustee and a tax identification number, an executor must report on the Information Return that the beneficiary trust has not yet been established in accordance with the instructions. Once the beneficiary trust has been established and the trust information becomes available to the executor, the executor must supplement the required reporting as described in paragraph (d) of this section to update the beneficiary information on the Information Return and Statement.

(3) Required Statement to the holder of a split interest in property, not in trust. The beneficiary of a life estate not in trust, and thus the beneficiary to whom the executor is to furnish any required Statement, is the life tenant. Similarly, the beneficiary of a remainder interest not in trust is each remainderman identified as if the life tenant were to die immediately after the decedent. For purposes of determining the due date of the Statements reporting these interests under paragraph (c)(3) of this section, each beneficiary will be deemed to have acquired the property subject to reporting on the date of the decedent's death. The beneficiary of a contingent interest, not in trust, is a beneficiary only if the contingency occurs before the end of the period during which the executor has an obligation to supplement the reporting as provided in paragraph (d)(5) of this section. If the contingency occurs during this period, the executor must update the beneficiary information on the Information Return and furnish a Statement to that beneficiary pursuant to the executor's duty to supplement to report a change in beneficiary information as described in paragraph (d) of this section. Usufruct interests are treated in the same manner.

(4) Reporting for a missing beneficiary. If the executor is unable to locate a beneficiary by the date required for filing the Information Return with the IRS, the executor must report on the Information Return the failure to locate the beneficiary and the efforts the executor has made to locate the beneficiary. The executor must supplement the Information Return and must furnish the required Statement, as provided in paragraph (d) of this section, to report the subsequent location of the beneficiary or, if the beneficiary is not located, to report the distribution of the property subject to reporting to a different beneficiary.

(h) Reporting requirements applicable to trustees—(1) Circumstances under which trustees of beneficiary trusts and other trusts are subject to reporting. Trustees of beneficiary trusts making a distribution of property that was reported on a Statement furnished to those trustees, or of any other property the basis of which is determined, in whole or in part, by reference to the basis of property subject to reporting under paragraph (e) of this section, are subject to the reporting requirements described in paragraph (h)(2) of this section and the supplemental reporting requirements described in paragraph (d) of this section (to the extent applicable) with respect to such property. In addition, trustees of trusts that receive a distribution of such property, whether from a beneficiary trust or from any other trust that has received such property, either directly or indirectly, also are subject to these reporting requirements when making a distribution of that property. This reporting obligation imposed on trustees continues to apply for each subsequent transfer or distribution until the property is distributed to a beneficiary not in trust. However, no trustee of a beneficiary trust or of a subsequent recipient trust is subject to the reporting requirements described in paragraph (h)(2) of this section for a disposition of property in a transaction that is a recognition event for income tax purposes (whether or not resulting in a gain or loss) that results in the entire property having a basis that no longer is related, in whole or in part, to the property's final value or, if applicable, reported value (within the meaning of § 1.1014-10(b)(1) or (2), respectively).

(2) Required reporting. On or before January 31 of the calendar year immediately following the year during which occurs a distribution of property subject to reporting under this paragraph (h), the trustee making the distribution must file an Information Return in accordance with the instructions for that form and must furnish a Statement to each recipient of the distribution. For purposes of this section, each recipient is a beneficiary.

(3) Example. The following example illustrates the application of this paragraph (h). Decedent D was a U.S. citizen and D's executor E was required under section 6018 to file an estate tax return. Pursuant to the will of D, E distributed 100 shares of publicly traded stock in Company X to a trust (Children's Trust) for the benefit of D's two children A and B and their respective issue. E provided a Statement to the trustee of Children's Trust in accordance with the requirements of paragraph (c)(2) of this section. Shortly thereafter, pursuant to the terms of Children's Trust, Children's Trust terminates with the 100 shares of Company X stock being distributed in equal shares between Trust A, for the benefit of A and A's issue, and Trust B, for the benefit of B and B's issue. Pursuant to paragraph (h)(2) of this section, the trustee of Children's Trust files an Information Return with the IRS and furnishes a Statement to the trustees of Trust A and Trust B. Several years later, the trustee of Trust A distributes its 50 shares of Company X stock to C, the only child of A. Pursuant to this paragraph (h), the trustee of Trust A files an Information Return with the IRS and furnishes a Statement to C. Shortly thereafter, C gives the 50 shares of Company X stock, outright, to C's nephew N. C has no obligation to file an Information Return with the IRS or furnish a Statement to N to report the distribution of the 50 shares of Company X stock to N.

(i) Penalties. For the penalties applicable to the filing of Information Returns and the furnishing of Statements required by this section, including waivers for reasonable cause, see sections 6721 through 6724 and the regulations in part 301 under sections 6721 through 6724.

(j) Applicability date. This section applies to executors of the estate of a decedent who are required to file a Federal estate tax return under section 6018 if that return is filed after September 17, 2024, and to trustees receiving certain property included in the gross estate of such a decedent.

[T.D. 9991, 89 FR 76380, Sept. 17, 2024]

§ 1.6035-2 Transitional relief.

(a) Statements due before June 30, 2016. Executors and other persons required to file or furnish a statement under section 6035(a)(1) or (2) after July 31, 2015 and before June 30, 2016, need not have done so until June 30, 2016.

(b) Applicability Date. This section is applicable to executors and other persons who file a return required by section 6018(a) or (b) after July 31, 2015.

[T.D. 9797, 81 FR 86955, Dec. 2, 2016]

§ 1.6036-1 Notice of qualification as executor or receiver.

For provisions relating to the notice required of fiduciaries, see the regulations under section 6036 contained in part 301 of this chapter (Regulations on Procedure and Administration).

§ 1.6037-1 Return of electing small business corporation.

(a) In general. Every small business corporation (as defined in section 1371(a)) which has made an election under section 1372(a) not to be subject to the tax imposed by chapter 1 of the Code shall file, with respect to each taxable year for which the election is in effect, a return of income on Form 1120-S. The return shall set forth the items of gross income and the deductions allowable in computing taxable income as required by the return form or in the instructions issued with respect thereto and shall be signed in accordance with section 6062 by the person authorized to sign a return. The return shall also set forth the following information concerning the electing small business corporation:

(1) The names and addresses of all persons owning stock in the corporation at any time during the taxable year;

(2) The number of shares of stock owned by each shareholder at all times during the taxable year;

(3) The amount of money and other property distributed by the corporation during the taxable year to each shareholder;

(4) The date of each distribution of money and other property; and

(5) Such other information as is required by the form or by the instructions issued with respect to such form.

(b) Time and place for filing return. The return shall be filed on or before the 15th day of the third month following the close of the taxable year with the internal revenue officer designated in the instructions applicable to Form 1120-S. (See section 6072.)

(c) Other provisions. The return on Form 1120-S will be treated as a return filed by the corporation under section 6012, relating to persons required to make returns of income, for purposes of the provisions of chapter 66 of the Code, relating to limitations. Thus, for example, the period of limitation on assessment and collection of any corporate tax found to be due upon a subsequent determination that the corporation was not entitled to the benefits of subchapter S, chapter 1 of the Code, will run from the date of filing the return under section 6037, or from the date prescribed for filing such return, whichever is the later. For the rules requiring the disclosure of certain transactions, see § 1.6011-4T.

(d) Penalties. For criminal penalties for failure to file a return, supply information, or pay tax, and for filing a false or fraudulent return, statement, or other document, see sections 7203, 7206, and 7207.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 7012, 34 FR 7690, May 15, 1969; T.D. 9000, 67 FR 41328, June 18, 2002]

§ 1.6037-2 Required use of electronic form for income tax returns of electing small business corporations.

(a) In general. The return of an electing small business corporation that is required to be filed electronically under § 301.6037-2 of this chapter must be filed in accordance with IRS revenue procedures, publications, forms, or instructions, including those posted electronically.

(b) Applicability date. The rules of this section apply to returns required to be filed for taxable years ending on or after December 31, 2023.

[T.D. 9972, 88 FR 11764, Feb. 23, 2023]

§ 1.6038-1 Information returns required of domestic corporations with respect to annual accounting periods of certain foreign corporations beginning before January 1, 1963.

(a) Requirement of return. For taxable years beginning after December 31, 1960, every domestic corporation shall make a separate annual information return on Form 2952, in duplicate, with respect to each foreign corporation which it controls, as defined in paragraph (b) of this section, and with respect to each foreign subsidiary, as defined in paragraph (c) of this section, for each annual accounting period (described in paragraph (d) of this section) of each such controlled foreign corporation or foreign subsidiary beginning after December 31, 1960, and before January 1, 1963. Such information shall not be required to be furnished, however, with respect to a corporation defined in section 1504(d) of the Code which makes a consolidated return for the taxable year. For annual accounting periods beginning after December 31, 1962, see § 1.6038-2.

(b) Control. A domestic corporation shall be deemed to be in control of a foreign corporation if at any time during its taxable year it owns more than 50 percent of the voting stock of such foreign corporation.

(c) Foreign subsidiary. A foreign corporation more than 50 percent of the voting stock of which is owned by a controlled foreign corporation at any time during the annual accounting period of such controlled foreign corporation shall be considered a foreign subsidiary.

(d) Period covered by return—(1) Controlled foreign corporation. The information with respect to a controlled foreign corporation shall be furnished for its annual accounting period ending with or within the domestic corporation's taxable year.

(2) Foreign subsidiary. The information with respect to a foreign subsidiary shall be furnished for such subsidiary's annual accounting period ending with or within the controlled foreign corporation's annual accounting period.

(3) Annual accounting period defined. For purposes of this section, the annual accounting period of a controlled foreign corporation or of a foreign subsidiary is the annual period on the basis of which the controlled foreign corporation or foreign subsidiary regularly computes its income in keeping its books. The term “annual accounting period” may refer to a period of less than 1 year, where for example the foreign income, war profits, and excess profits taxes are determined on the basis of an accounting period of less than 1 year as described in section 902(c)(2).

(e) Contents of return. The return on Form 2952 shall contain the following information with respect to each controlled corporation and each foreign subsidiary:

(1) The name and address of the corporation;

(2) The principal place of business of the corporation;

(3) The date of incorporation and the country under whose laws incorporated;

(4) The nature of the corporation's business;

(5) As regards the outstanding stock of the corporation:

(i) A description of each class of the corporation's stock, and

(ii) The number of shares of each class outstanding at the beginning and the end of the annual accounting period;

(6) A list showing the name and address of, and the number of shares of each class of the corporation's stock held by, each citizen or resident of the United States, and each domestic corporation, who is a shareholder of record owning at any time during the annual accounting period 5 percent or more in value of any class of the corporation's outstanding stock;

(7) The amount of the corporation's gross receipts, net profits before taxes and provision for foreign income taxes, for the annual accounting period, as reflected on the financial statements required under paragraph (f) of this section to be filed with the return; and

(8) A summary showing the total amount of each of the following types of transactions of the corporation, which took place during the annual accounting period, with the domestic corporation or any shareholder of the domestic corporation owning at the time of the transaction 10 percent or more of the value of any class of stock outstanding of the domestic corporation:

(i) Sales and purchases of stock in trade;

(ii) Purchases of property of a character which is subject to the allowance for depreciation;

(iii) Compensation paid and compensation received for the rendition of technical, managerial, engineering, construction, scientific, or like services;

(iv) Commissions paid and commissions received;

(v) Rents and royalties paid and rents and royalties received;

(vi) Amounts loaned and amounts borrowed (other than open accounts which arise and are collected in the ordinary course of business);

(vii) Dividends paid and dividends received;

(viii) Interest paid and interest received; and

(ix) Premiums received for insurance or reinsurance.

If the domestic corporation is a bank, as defined in section 581, or is controlled within the meaning of section 368(c) by a bank, the term “transactions” shall not, as to a corporation with respect to which a return is filed, include banking transactions entered into on behalf of customers; in any event, however, deposits in accounts between a controlled foreign corporation or a foreign subsidiary and the domestic corporation or a 10-percent shareholder described in this subparagraph and withdrawals from such accounts shall be summarized by reporting end-of-month balances.

(f) Financial statements. The following information with respect to each controlled foreign corporation and each foreign subsidiary shall be attached to and filed as part of the return required by this section:

(1) A statement of the corporation's profit and loss for the annual accounting period;

(2) A balance sheet as of the end of the annual accounting period of the corporation showing:

(i) The corporation's assets,

(ii) The corporation's liabilities, and

(iii) The corporation's net worth; and

(3) An analysis of changes in the corporation's surplus accounts during the annual accounting period including both opening and closing balances.

The statements listed in subparagraphs (1), (2), and (3) of this paragraph shall be prepared in conformity with generally accepted accounting principles, and in such form and detail as is customary for the corporation's accounting records.

(g) Method of reporting. All amounts furnished under paragraphs (e) and (f) of this section shall be expressed in United States currency with a statement of the exchange rates used.

(h) Time and place for filing return. Returns on Form 2952 required under paragraph (a) of this section shall be filed with the domestic corporation's income tax return on or before the fifteenth day of the third month following the close of such corporation's taxable year.

(i) Extensions of time for filing. District directors are authorized to grant reasonable extensions of time for filing returns on Form 2952 in accordance with the applicable provisions of § 1.6081-1. An application by a domestic corporation for an extension of time for filing a return of income shall also be considered as an application for an extension of time for filing returns on Form 2952.

(j) Failure to furnish information—(1) Effect on foreign tax credit. (i) Failure by a domestic corporation to furnish, in accordance with the provisions of this section, any return or any information in any return, required to be filed for a taxable year under authority of section 6038 on or before the date prescribed in paragraph (h) of this section (determined with regard to any extension of time for such filing) shall affect the application of section 902 as provided in subparagraph (2) of this paragraph. Such failure shall affect the application of section 902 to such domestic corporation or to any person who acquires from any person any portion (but only to the extent of such portion) of the interest of such domestic corporation in any controlled foreign corporation or foreign subsidiary.

(ii) Where the domestic corporation, having filed the return required by this section except for an omission of, or error with respect to, some of the information referred to in paragraphs (e) and (f) of this section, establishes to the satisfaction of the Commissioner that such omission or error was inadvertent or for reasonable cause and that such domestic corporation has substantially complied with this section, such omission or error shall not constitute a failure under this section.

(2) Reduction of foreign taxes. In the application of section 902 to the domestic corporation or person referred to in subparagraph (1)(i) of this paragraph for any taxable year, the amount of taxes paid or deemed paid by each controlled foreign corporation and each foreign subsidiary for the accounting period or periods for which the domestic corporation was required for the taxable year of the failure to furnish information under this section shall be reduced by 10 percent. The 10 percent reduction is not limited to the taxes paid or deemed paid by the controlled foreign corporation or foreign subsidiary with respect to which there is a failure to file information but shall apply to the taxes paid or deemed paid by all controlled foreign corporations and foreign subsidiaries.

(3) Reduction for continued failure. (i) If the failure, referred to in subparagraph (1)(i) of this paragraph, continues for 90 days or more after date of written notice by the district director to the domestic corporation, then the amount of the reduction referred to in subparagraph (2) of this paragraph shall be 10 percent plus an additional 5 percent for each 3-month period, or fraction thereof, during which such failure continues after the expiration of such 90-day period.

(ii) Taxes paid by a foreign subsidiary when once reduced for a failure shall not be reduced again for the same failure in their status as taxes deemed paid by a controlled foreign corporation. Where a failure continues, each additional periodic 5 percent reduction, referred to in subdivision (i) of this subparagraph, shall be considered as part of the one reduction.

(4) Reasonable cause. (i) For purposes of subsection (b) of section 6038 and this section the time prescribed for furnishing information under this paragraph, and the beginning of the 90-day period after notice by the district director, shall be treated as being not earlier than the last day on which (as shown to the satisfaction of the district director) reasonable cause existed for failure to furnish such information.

(ii) A domestic corporation, which wishes to avoid a reduction in foreign tax credit as provided in subparagraphs (2) and (3) of this paragraph for failure to furnish information in accordance with this section, must make an affirmative showing of all facts alleged as a reasonable cause for such failure in the form of a written statement containing a declaration that it is made under the penalties of perjury.

(5) Penalties. The information required by section 6038 of the Code must be furnished even though there are no foreign taxes which would be reduced under the provisions of subparagraph (2) of this paragraph. For criminal penalties for failure to file a return and filing a false or fraudulent return, see sections 7203, 7206, and 7207 of the Code.

[T.D. 6506, 25 FR 12241, Nov. 30, 1960, as amended by T.D. 6621, 27 FR 11878, Dec. 1, 1962]

§ 1.6038-2 Information returns required of United States persons with respect to annual accounting periods of certain foreign corporations.

(a) Requirement of return. Every U.S. person shall make a separate annual information return with respect to each annual accounting period (described in paragraph (e) of this section) of each foreign corporation which that person controls (as defined in paragraph (b) of this section) at any time during such annual accounting period.

(1) Form 2952, “Information Return with Respect to Controlled Foreign Corporations,” if such taxable year ends before December 31, 1982;

(2) Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations,” if such taxable year ends on or after December 31, 1983; or

(3) Either Form 5471 or Form 2952 if such taxable year ends on or after December 31, 1982 and before December 31, 1963.

(b) Control. A person shall be deemed to be in control of a foreign corporation if at any time during that person's taxable year it owns stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or more than 50 percent of the total value of shares of all classes of stock of the foreign corporation. A person in control of a corporation which, in turn, owns more than 50 percent of the combined voting power, or of the value, of all classes of stock of another corporation is also treated as being in control of such other corporation. The provisions of this paragraph may be illustrated by the following example:

Example.Corporation A owns 51 percent of the voting stock in Corporation B. Corporation B owns 51 percent of the voting stock in Corporation C. Corporation C in turn owns 51 percent of the voting stock in Corporation D. Corporation D is controlled by Corporation A.

(c) Attribution rules. For the purpose of determining control of domestic or foreign corporations the constructive ownership rules of section 318(a) shall apply except that:

(1) Stock owned by or for a partner or a beneficiary of an estate or trust shall not be considered owned by the partnership, estate, or trust when the effect is to consider a United States person as owning stock owned by a person who is not a United States person;

(2) A corporation will not be considered as owning stock owned by or for a 50 percent or more shareholder when the effect is to consider a United States person as owning stock owned by a person who is not a United States person; and

(3) If 10 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, section 318(a)(2)(C) shall apply.

The constructive ownership rules of section 318(a) apply only for purposes of determining control as defined in paragraph (b) of this section.

(d) U.S. person—(1) In general. For purposes of section 6038 and this section, the term United States person has the meaning assigned to it by section 7701(a)(30), except as provided in paragraphs (d)(2) and (3) of this section.

(2) Special rule for individuals residing in certain possessions. (i) With respect to an individual who is a bona fide resident of Puerto Rico, the term United States person has the meaning assigned to it by § 1.957-3 except that the rules of § 1.937-2(g)(1) will apply.

(ii) With respect to an individual who is a bona fide resident of any section 931 possession, as defined in § 1.931-1(c)(1), the term United States person has the meaning assigned to it by § 1.957-3.

(3) Special rule for certain nonresident aliens. An individual for whom an election under section 6013(g) or (h) is in effect will, subject to the exceptions contained in paragraph (d)(2) of this section, be considered a United States person for purposes of section 6038 and this section.

(e) Period covered by return. The information required under paragraphs (f) and (g) of this section with respect to a foreign corporation shall be furnished for the annual accounting period of the foreign corporation ending with or within the United States person's taxable year. For purposes of this section, the annual accounting period of a foreign corporation is the annual period on the basis of which that corporation regularly computes its income in keeping its books. In the case of a specified foreign corporation (as defined in section 898), the taxable year of such corporation shall be treated as its annual accounting period. The term annual accounting period may refer to a period of less than one year, where, for example, the foreign income, war profits, and excess profits taxes are determined on the basis of an accounting period of less than one year as described in section 902(c)(5). If more than one annual accounting period ends with or within the United States person's taxable year, separate annual information returns shall be submitted for each annual accounting period.

(f) Contents of return. The return on Form 5471 shall contain so much of the following information, and in such form or manner, as the form shall prescribe with respect to each foreign corporation:

(1) The name, address, and employer identification number, if any, of the corporation;

(2) The principal place of business of the corporation;

(3) The date of incorporation and the country under whose laws incorporated;

(4) The name and address of the foreign corporation's statutory or resident agent in the country of incorporation;

(5) The name, address, and identifying number of any branch office or agent of the foreign corporation located in the United States;

(6) The name and address of the person (or persons) having custody of the books of account and records of the foreign corporation, and the location of such books and records if different from such address;

(7) The nature of the corporation's business and the principal places where conducted;

(8) As regards the outstanding stock of the corporation—

(i) A description of each class of the corporation's stock, and

(ii) The number of shares of each class outstanding at the beginning and end of the annual accounting period;

(9) A list showing the name, address, and identifying number of, and the number of shares of each class of the corporation's stock held by, each United States person who is a shareholder owning at any time during the annual accounting period 5 percent or more in value of any class of the corporation's outstanding stock;

(10) For the annual accounting period, the amount of the corporation's:

(i) Current earnings and profits;

(ii) Foreign income, war profits, and excess profits taxes paid or accrued;

(iii) Distributions out of current earnings and profits for the period;

(iv) Distributions other than those described in paragraph (f)(10)(iii) of this section and the source thereof; and

(v) For Forms 5471 filed for taxable years ending after December 15, 1990, such earnings and profits information as the form shall prescribe, including post-1986 undistributed earnings described in section 902(c)(1), pre-1987 amounts, total earnings and profits, and previously taxed earnings and profits described in section 959(c); and

(11) Transactions with certain related parties. (i) A summary showing the total amount of each of the following types of transactions of the corporation, which took place during the annual accounting period, with the person required to file this return, any other corporation or partnership controlled by that person, or any United States person owning at the time of the transaction 10 percent or more in value of any class of stock outstanding of the foreign corporation, or of any corporation controlling that foreign corporation—

(A) Sales and purchases of stock in trade;

(B) Sales and purchases of tangible property other than stock in trade;

(C) Sales and purchases of patents, inventions, models, or designs (whether or not patented), copyrights, trademarks, secret formulas or processes, or any other similar property rights;

(D) Compensation paid and compensation received for the rendition of technical, managerial, engineering, construction, scientific, or like services;

(E) Commissions paid and commissions received;

(F) Rents and royalties paid and rents and royalties received;

(G) Amounts loaned and amounts borrowed (except open accounts resulting from sales and purchases reported under other items listed in this paragraph (f)(11) that arise and are collected in full in the ordinary course of business);

(H) Dividends paid and dividends received;

(I) Interest paid and interest received; and

(J) Premiums paid and premiums received for insurance or reinsurance.

(ii) Special rule for banks. For purposes of this paragraph (f)(11), if the United States person is a bank, as defined in section 581, or is controlled within the meaning of section 368(c) by a bank, the term transactions shall not, as to a corporation with respect to which a return is filed, include banking transactions entered into on behalf of customers; in any event, however, deposits in accounts between a foreign corporation, controlled (within the meaning of paragraph (b) of this section) by a United States person, and a person described in this paragraph (f)(11) and withdrawals from such accounts shall be summarized by reporting end-of-month balances.

(12) Accrued payments and receipts. For purposes of the required summary under paragraph (f)(11) of this section, a corporation that uses an accrual method of accounting shall use accrued payments and accrued receipts for purposes of computing the total amount of each of the types of transactions listed.

(13) Amounts involving hybrid transactions or hybrid entities under section 267A. If for the annual accounting period, the corporation pays or accrues interest or royalties for which a deduction is disallowed under section 267A and the regulations in this part under section 267A of the Internal Revenue Code, then Form 5471 (or successor form) must contain such information about the disallowance in the form and manner and to the extent prescribed by the form, instruction, publication, or other guidance.

(14) Hybrid dividends under section 245A(e). If for the annual accounting period, the corporation pays or receives a hybrid dividend or a tiered hybrid dividend under section 245A(e) and the regulations in this part under section 245A(e) of the Internal Revenue Code, then Form 5471 (or successor form) must contain such information about the hybrid dividend or tiered hybrid dividend in the form and manner and to the extent prescribed by the form, instruction, publication, or other guidance. Form 5471 (or successor form) must also contain any other information relating to the rules of section 245A(e) and the regulations in this part under section 245A(e) of the Internal Revenue Code (including information related to a specified owner's hybrid deduction account), as prescribed by the form, instruction, publication, or other guidance.

(15) Information reporting under section 250. If the person required to file Form 5471 (or any successor form) claims a deduction under section 250(a) that is determined, in whole or part, by reference to its foreign-derived intangible income, and any amount required to be reported under paragraph (f)(11) of this section is included in its computation of foreign-derived deduction eligible income, such person will provide on Form 5471 (or any successor form) such information that is prescribed by the form, instructions to the form, publication, or other guidance published in the Internal Revenue Bulletin.

(16) Amounts related to extraordinary dispositions and extraordinary reductions. The corporation must report the information in the form and manner and to the extent prescribed by the form, instructions to the form, publication, or other guidance published in the Internal Revenue Bulletin if any of the following conditions are met during the corporation's annual accounting period—

(i) The corporation distributes or receives a dividend that gives rise to an ineligible amount (as defined in § 1.245A-5(i)(12)), a tiered extraordinary disposition amount (as defined in § 1.245A-5(i)(25)), or a tiered extraordinary reduction amount (as defined in § 1.245A-5(i)(26));

(ii) A section 245A shareholder with respect to the corporation has an extraordinary disposition account (as defined in § 1.245A-5(i)(6)); or

(iii) The corporation would have been deemed to have undertaken an extraordinary disposition (as defined in § 1.245A-5(i)(5)) but for the application of § 1.245A-5(c)(3)(ii)(C)(2).

(17) Reporting of disqualified basis and disqualified payments. If for the annual accounting period of a corporation it holds an item of property having disqualified basis within the meaning of § 1.951A-3(h)(2)(ii) or § 1.951A-2(c)(5), or incurs an item of deduction or loss related to a disqualified payment (within the meaning of § 1.951A-2(c)(6)(ii)(A)), then Form 5471 (or successor form) must contain such information about the disqualified basis, or such information relating to the disqualified payment, in the form and manner and to the extent prescribed by the form, instructions to the form, publication, or other guidance published in the Internal Revenue Bulletin.

(18) Adjustments to extraordinary disposition accounts and disqualified basis. If for the annual accounting period a section 245A shareholder of the corporation reduces its extraordinary disposition account pursuant to § 1.245A-7(c) or § 1.245A-8(c), as applicable, or the corporation reduces the disqualified basis in an item of specified property pursuant to § 1.245A-7(b) or § 1.245A-8(b), as applicable, then Form 5471 (or a successor form) must contain such information about the reduction to the extraordinary disposition account or disqualified basis, as applicable, in the form and manner and to the extent prescribed by the form, instructions to the form, publication, or other guidance published in the Internal Revenue Bulletin.

(g) Financial statements. The following information with respect to the foreign corporation shall be attached to and filed as part of the return required by this section. Forms 5471 filed after September 30, 1991, shall contain this information in such form or manner as the form shall prescribe with respect to each foreign corporation:

(1) A statement of the corporation's profit and loss for the annual accounting period;

(2) A balance sheet as of the end of the annual accounting period of the corporation showing—

(i) The corporation's asset;

(ii) The corporation's liabilities; and

(iii) The corporation's net worth; and

(3) An analysis of changes in the corporation's surplus accounts during the annual accounting period including both opening and closing balances.

The information listed in this paragraph (g) shall be prepared in conformity with generally accepted accounting principles, and in such detail as is customary for the corporation's accounting records.

(h) Method of reporting. Except as provided in this paragraph (h), all amounts furnished under paragraphs (f) and (g) of this section shall be expressed in United States dollars with a statement of the exchange rates used. The following rules shall apply for taxable years ending after December 31, 1994, with respect to returns filed after December 31, 1995. All amounts furnished under paragraph (g) of this section shall be expressed in United States dollars computed and translated in conformity with United States generally accepted accounting principles. Amounts furnished under paragraph (g)(1) of this section shall also be furnished in the foreign corporation's functional currency as required on the form. Earnings and profits amounts furnished under paragraphs (f)(10) (i), (iii), (iv), and (v) of this section shall be expressed in the foreign corporation's functional currency except to the extent the form requires specific items to be translated into United States dollars. Tax amounts furnished under paragraph (f)(10)(ii) of this section shall be furnished in the foreign currency in which the taxes are payable and in United States dollars translated in accordance with section 986(a). All amounts furnished under paragraph (f)(11) of this section shall be expressed in U.S. dollars translated from functional currency at the weighted average exchange rate for the year as defined in § 1.989(b)-1. The foreign corporation's functional currency is determined under section 985. All statements submitted on or with the return required under this section shall be rendered in the English language.

(i) Time and place for filing return. Returns on Form 5471 required under paragraph (a) of this section shall be filed with the United States person's income tax return on or before the date required by law for the filing of that person's income tax return. Directors of Field Operations and Field Directors are authorized to grant reasonable extensions of time for filing returns on Form 5471 in accordance with the applicable provisions of § 1.6081-1 of this chapter. An application for an extension of time for filing a return of income shall also be considered as an application for an extension of time for filing returns on Form 5471.

(j) Two or more persons required to submit the same information—(1) Return jointly made. If two or more persons are required to furnish information with respect to the same foreign corporation for the same period, such persons may, in lieu of making separate returns, jointly make one return. Such joint return shall be filed with the income tax return of any one of the persons making such joint return.

(2) Persons excepted from furnishing information—(i) Conditions. Any person required to furnish information under this section with respect to a foreign corporation need not furnish that information provided all of the following conditions are met:

(A) Such person does not directly own an interest in the foreign corporation;

(B) Such person is required to furnish the information solely by reason of attribution of stock ownership from a United States person under paragraph (c) of this section; and

(C) The person from whom the stock ownership is attributed furnishes all of the information required under this section of the person to whom the stock ownership is attributed. (For a rule regarding attribution from a nonresident alien, see paragraph (l) of this section).

(ii) If an individual who is a United States person required to furnish information with respect to a foreign corporation under section 6038 is entitled under a treaty to be treated as a nonresident of the United States, and if the individual claims this treaty benefit, and if there are no other United States persons that are required to furnish information under section 6038 with respect to the foreign corporation, then the individual may satisfy the requirements of paragraphs (f)(10), (f)(11), (g), and (h) of this section by filing the audited foreign financial statements of the foreign corporation with the individual's return required under section 6038.

(iii) Illustrations. The rule of this paragraph (j)(2) is illustrated by the following examples:

Example 1.A, a U.S. person owns 100 percent of the stock of M, a domestic corporation. A also owns 100 percent of the stock of N, a foreign corporation organized under the laws of foreign country Y. A, in filing the information return required by this section with respect to N Corporation, in fact furnishes all of the information required of M Corporation with respect to N Corporation. M Corporation need not file the information.

Example 2.X, a domestic corporation owns 100 percent of the stock of Y, a domestic corporation, Y Corporation owns 100 percent of the stock of Z, a foreign corporation. X Corporation is not excused by this paragraph (j)(2) from filing information with respect to Z Corporation because X Corporation is deemed to control Z Corporation under the provisions of paragraph (b) of this section without recourse to the attribution rules in paragraph (c) of this section.

(3) Statement required. Any United States person required to furnish information under this section with his return who does not do so by reason of the provisions of paragraph (j)(1) of this section shall file a statement with his income tax return indicating that such requirement has been (or will be) satisfied and identifying the return with which the information was or will be filed and the place of filing.

(k) Failure to furnish information—(1) Dollar amount penalty—(i) In general. If any person required to file Form 5471 under section 6038 and this section fails to furnish any information described in paragraphs (f) and (g) of this section within the time prescribed by paragraph (i) of this section, such person shall pay a penalty of $10,000 for each annual accounting period of each foreign corporation with respect to which such failure occurs.

(ii) Increase in penalty for continued failure after notification. If a failure described in paragraph (k)(1)(i) of this section continues for more than 90 days after the date on which the Director of Field Operations, Area Director, or Director of Compliance Campus Operations mails notice of such failure to the person required to file Form 5471, such person shall pay a penalty of $10,000, in addition to the penalty imposed by section 6038(b)(1) and paragraph (k)(1)(i) of this section, for each 30-day period (or a fraction of) during which such failure continues after such 90-day period has expired. The additional penalty imposed by section 6038(b)(2) and this paragraph (k)(1)(ii) shall be limited to a maximum of $50,000 for each failure.

(2) Penalty of reducing foreign tax credit—(i) Effect on foreign tax credit. Failure of a United States person to furnish, in accordance with the provisions of this section, any return or any information in any return, required to be filed for a taxable year under authority of section 6038 on or before the date prescribed in paragraph (i) of this section may affect the application of section 901 as provided in paragraph (k)(2)(ii) of this section and may affect the application of sections 902 and 960 as provided in paragraph (k)(2)(iii) of this section. Such failure may affect the application of sections 902 and 960 to any such United States person which is a corporation or to any person who acquires from any other person any portion (but only to the extent of such portion) of the interest of such other person in any such foreign corporation.

(ii) Application of section 901. In the application of section 901 to a United States person referred to in paragraph (k)(2)(i) of this section, the amount of taxes paid or deemed paid by such person for any taxable year, with or within which the annual accounting period of a foreign corporation for which such person failed to furnish information required under this section ended, may be reduced by 10 percent. However, no tax reduced under paragraph (k)(2)(iii) of this section or deemed paid under section 904(c) shall be reduced under the provisions of this paragraph (k)(2)(ii).

(iii) Application of sections 902 and 960. In the application of sections 902 and 960 to a United States person referred to in paragraph (k)(2)(i) of this section for any taxable year, the amount of taxes paid or deemed paid by each foreign corporation for the accounting period or periods for which such person was required for the taxable year of the failure to furnish information under this section may be reduced by 10 percent. The 10-percent reduction is not limited to the taxes paid or deemed paid by the foreign corporation with respect to which there is a failure to file information but may apply to the taxes paid or deemed paid by all foreign corporations controlled by that person. In applying subsections (a) and (b) of section 902, and in applying subsection (a) of section 960, the reduction provided by this paragraph (k)(2) shall not apply for purposes of determining the amount of accumulated profits in excess of income, war profits, and excess profits taxes.

(iv) Reduction for continued failure after notice. (A) If the failure referred to in paragraph (k)(2)(i) of this section continues for more than 90 days after the date on which the Director of Field Operations mails notice of such failure to such United States person, then the amount of the reduction referred to in paragraphs (k)(2) (ii) and (iii) of this section may be 10 percent plus an additional 5 percent for each 3-month period, or fraction thereof, during which such failure continues after the expiration of such 90-day period.

(B) No taxes shall be reduced under this paragraph (k)(2) more than once for the same failure. Taxes paid by a foreign corporation when once reduced for a failure shall not be reduced again for the same failure in their status as taxes deemed paid by a corporate shareholder. Where a failure continues, each additional periodic 5-percent reduction, referred to in paragraph (k)(2)(iv)(A) of this section, shall be considered as part of the one reduction.

(v) Limitation on reduction of foreign tax credit. The amount of the reduction under this paragraph (k)(2) for each failure to furnish information with respect to a foreign corporation as required under this section shall not exceed the greater of:

(A) $10,000, or

(B) The income of the foreign corporation for its annual accounting period with respect to which the failure occurs. For purposes of this section if a person is required to furnish information with respect to more than one foreign corporation, controlled (within the meaning of paragraph (b) of this section) by that person, each failure to submit information for each such corporation constitutes a separate failure.

(vi) Offset for dollar amount penalty imposed. The total amount of the reduction or reductions which, but for this paragraph (k)(2)(vi), may be made under this paragraph (k)(2) with respect to any separate failure, shall not exceed the maximum amount of such reductions which may be imposed, reduced (but not below zero) by the amount of the dollar amount penalty imposed by paragraph (k)(1) of this section with respect to such separate failure.

(3) Reasonable cause. (i) For purposes of section 6038 (b) and (c) and this section, the time prescribed for furnishing information under paragraph (i) of this section, and the beginning of the 90-day period after mailing of notice by the Director of Field Operations under paragraphs (k)(1)(ii) and (2)(iv)(A) of this section, shall be treated as being not earlier than the last day on which reasonable cause existed for failure to furnish the information.

(ii) To show that reasonable cause existed for failure to furnish information as required by section 6038 and this section, the person required to report such information must make an affirmative showing of all facts alleged as reasonable cause for such failure in a written statement containing a declaration that it is made under the penalties of prejury. The statement must be filed with the district director for the district or the director of the service center where the return is required to be filed. The district director or the director of the service center shall determine whether the failure to furnish information was due to reasonable cause, and if so, the period of time for which such reasonable cause existed. In the case of a return that has been filed as required by this section except for an omission of, or error with respect to, some of the information required, if the person who filed the return establishes to the satisfaction of the district director or the director of the service center that the person has substantially complied with this section, then the omission or error shall not constitute a failure under this section.

(4) Other penalties. The information required by section 6038 and this section must be furnished even though there are no foreign taxes which would be reduced under the provisions of this section, and even though the information required may not affect the amount of any tax due under the Internal Revenue Code. For criminal penalties for failure to file a return and filing a false or fraudulent return, see sections 7203, 7206, and 7207 of the Code.

(5) Illustrations. The provisions of this paragraph may be illustrated by the following examples.

Example 1. M, a domestic corporation owns 100 percent of the stock of N, a foreign corporation. Both M and N use the calendar year as a taxable year and annual accounting period, and all of the following events occur in or with respect to the 1980 taxable year. The dividend from N is the only dividend from a foreign corporation received by M during the taxable year, and the foreign taxes listed are the only foreign taxes paid or deemed paid by M and N for the taxable year. On March 15, 1981, M filed its income tax return and paid its income tax, but M did not file Form 2952 with respect to N's 1980 annual accounting period. On June 1, 1961, the district director mailed notice to M of M's failure to file Form 2952 with respect to N. On November 30, 1981, M filed a complete Form 2952 with respect to N's 1980 annual accounting period.

(a) Gains, profits, and income of N | $100,000

(b) Foreign tax paid by N with respect to such gains, profits, and income | 40,000

(c) Reduction of foreign tax paid by N (for purposes of M's section 902 deemed paid credit) resulting from M's failure to file information with respect to N as required under section 6038(a) and this section: failure to file within the time prescribed in paragraph (i) of this section, 10-percent reduction; continued failure for one additional 3-month period after 90-day period after notice mailed, 5-percent reduction; total reduction, 15 percent ($40,000 times 15 percent) | 6,000

(d) Foreign tax paid by N after section 6038(c)(1)(B) reduction | 34,000

(e) Dividend paid by N to M | 45,000

(f) Accumulated profits of N as defined in section 902(c)(1) (determined without regard to the section 6038(c)(1)(B) reduction) | 100,000

(g) Accumulated profits of N as described in section 902(a) (determined without regard to the section 6038(c)(1)(B) reduction) | 60,000

(h) For purposes of the section 902 credit, M is deemed to have paid the same proportion of foreign taxes paid (reduced as provided under section 6038(c)) with respect to the accumulated profits described in section 902(a) (determined without regard to the reduction provided under section 6038(c)) as the amount of the dividend (determined without regard to section 78) bears to such amount of accumulated profits | 25,500

(45,000 ÷ 60,000) × 34,000 = 25,500

M must include $25,500 in gross income as a dividend under the provisions of section 78 of the Code. This example illustrates that the reductions in foreign taxes paid by the foreign corporation provided under section 8038(c) are taken into account in determining the amount included in gross income of the domestic corporation under section 78 of the Code as foreign taxes deemed paid, but such reductions are not taken into account in computing accumulated profits for purposes of determining the portion of foreign taxes deemed paid with respect to a particular dividend. The dollar amount penalty imposed by section 8038 (b) and paragraph (k)(1) of this section does not apply with respect to information for annual accounting periods ending before September 4, 1982, and therefore does not apply to M with respect to M's failure to file Form 2952 in this example.

Example 2.The facts are the same as in example (1) except that all of the events occur in or with respect to the 1982 taxable year. On March 15, 1983. M filed its income tax return and paid its income tax, but M did not file Form 2952 or Form 5471 with respect to N's 1982 annual accounting period. On June 1, 1983, the district director mailed notice to M of M's failure to file Form 2952 or Form 5471 with respect to N. On November 30, 1983, M filed a complete Form 5471 with respect to N's 1982 annual accounting period. Under paragraph (k)(1)(i) of this section, M is subject to a penalty of $1,000. Under paragraph (k)(1)(ii) of this section, that penalty is increased by $4,000 because the failure continued for 92 days (three full 30-day periods and a fraction of a fourth 30-day period) after the end of the 90-day period following mailing of the notice by the district director, bringing M's dollar amount penalty under paragraph (k)(1) of this section to $5,000. For purpose of determining the foreign tax credit available to M, there may be imposed a reduction of foreign tax paid by N of $6,000, which would be the total of reductions under paragraph (k)(2) of this section with respect to M's failure to file under section 6038 for N's 1982 annual accounting period, before application of paragraph (k)(2)(vi) of this section. Under said paragraph (k)(2)(vi), the amount of the foreign tax reduction imposed is reduced by the amount of the dollar amount penalty, leaving a foreign tax reduction penalty of $1,000 which may be imposed in addition to the $5,000 dollar amount penalty. If imposed, the $1,000 tax reduction would then be applied in the calculation of taxes deemed paid by M under section 902 as in example (1), items (c), (d), and (h).

Example 3.A, a U.S. person, owns 100 percent of the stock of FC. On April 15, 2008, A timely filed its 2007 income tax return but did not file Form 5471 with respect to FC's 2007 annual accounting period. On June 1, 2008, the Director of Field Operations mailed a notice to A of A's failure to file Form 5471 for 2007 with respect to FC. On August 1, 2008, A submits a written statement asserting facts for reasonable cause for failure to file the 2007 Form 5471 for FC. Based on A's statement and discussions with A, the Director of Field Operations agrees that A had reasonable cause for failure to file FC's 2007 Form 5471 and determined that it is reasonable for A to file FC's 2007 Form 5471 by September 15, 2008. The time prescribed for furnishing information under paragraph (i) of this section is September 15, 2008, and the 90-day period described under paragraphs (k)(1)(ii) and (k)(2)(iv)(A) of this section begins on that same date. Thus, if A files a completed Form 5471 by September 15, 2008, A is not subject to the penalties under paragraphs (k)(1) and (k)(2) of this section. If A does not file a completed Form 5471 by December 14, 2008, in addition to the penalties under paragraphs (k)(1) and (k)(2) of this section, A will also be subject to the penalties for continued failure under paragraphs (k)(1)(ii) and (k)(2)(iv)(A) of this section.

Example 4.The facts are the same as in Example 3 except A submits the written statement to the Director before a notice of failure to furnish information is mailed to A. The notice is mailed to A on September 7, 2008. Under these facts, the time prescribed for furnishing information under paragraph (i) of this section is September 15, 2008, and the 90-day period after mailing of notice of failure under paragraphs (k)(1)(ii) and (k)(2)(iv)(A) of this section begins on that same date.

(l) Other persons excepted from filing. For tax years of foreign corporations ending on or after December 29, 1999, any person required to furnish information under this section with respect to a foreign corporation does not have to furnish that information if the following conditions are met—

(1) Such person does not own a direct or indirect interest in the foreign corporation; and

(2) Such person is required to furnish information solely by reason of attribution of stock ownership from a nonresident alien(s) under paragraph (c) of this section.

(m) Applicability dates—(1) In general. This section applies to taxable years of foreign corporations beginning on or after October 3, 2018. See 26 CFR 1.6038-2 (revised as of April 1, 2018) for rules applicable to taxable years of foreign corporations beginning before such date.

(2) Special rule for paragraph (f)(16) of this section. Paragraph (f)(16) of this section applies with respect to information for annual accounting periods to which § 1.245A-5 applies.

(3) Rules relating to certain hybrid arrangements. Paragraphs (f)(13) and (14) of this section apply with respect to information for annual accounting periods beginning on or after December 20, 2018.

(4) Paragraph (f)(15) of this section applies with respect to information for annual accounting periods beginning on or after March 4, 2019.

(5) Special rule for paragraphs (f)(17) and (18) of this section. Paragraphs (f)(17) and (18) of this section apply with respect to information for annual accounting periods beginning after December 1, 2020. In addition, as provided in § 1.245A-11(b), paragraph (f)(18) of this section applies with respect to information for an annual accounting period that includes a taxable year for which a taxpayer has chosen to apply §§ 1.245A-6 through 1.245A-11 pursuant to § 1.245A-11(b).

[T.D. 8040, 50 FR 30163, July 24, 1985, as amended by T.D. 8573, 59 FR 64302, Dec. 14, 1994; T.D. 8733, 62 FR 53385, Oct. 14, 1997; T.D. 8850, 64 FR 72550, Dec. 28, 1999; T.D. 9194, 70 FR 18946, Apr. 11, 2005; T.D. 9268, 71 FR 35525, June 21, 2006; T.D. 9338, 72 FR 38475, July 13, 2007; T.D. 9391, 73 FR 19376, Apr. 9, 2008; T.D. 9650, 78 FR 79611, Dec. 31, 2013; T.D. 9806, 81 FR 95470, Dec. 28, 2016; T.D. 9866, 84 FR 29369, June 21, 2019; T.D. 9896, 85 FR 19856, Apr. 8, 2020; T.D. 9909, 85 FR 53097, Aug. 27, 2020; T.D. 9901, 85 FR 43116, July 15, 2020; T.D. 9934, 85 FR 76975, Dec. 1, 2020]

§ 1.6038-3 Information returns required of certain United States persons with respect to controlled foreign partnerships (CFPs).

(a) Persons required to make return—(1) Controlling fifty-percent partners. The term controlling fifty-percent partner means a United States person that controlled (as defined in paragraph (b)(1) of this section) the foreign partnership at any time during the partnership's tax year (as defined in paragraph (b)(8) of this section). Except as provided in paragraph (c), (d), or (e) of this section, for each tax year of a foreign partnership during which the partnership has one or more controlling fifty-percent partners, each controlling fifty-percent partner must complete and file Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships,” containing the information described in paragraph (g) of this section.

(2) Controlling ten-percent partners. If at any point during a foreign partnership's tax year (as defined in paragraph (b)(8) of this section) a United States person owned a ten-percent or greater interest in the partnership while the partnership was controlled by United States persons owning ten-percent or greater interests, such United States person is a controlling ten-percent partner. See paragraph (b)(1) of this section for the definition of control. However, a United States person is not a controlling ten-percent partner with respect to a particular foreign partnership for a particular tax year of the foreign partnership if at any point during that year the partnership had a controlling fifty-percent partner, as defined in paragraph (a)(1) of this section. Except as provided in paragraph (c), (d), or (e) of this section, for each tax year of a partnership during which the partnership has controlling ten-percent partners, each controlling ten-percent partner must complete and file Form 8865 containing the information described in paragraph (g)(1) of this section.

(3) Separate returns for each partnership. A United States person required to report under this paragraph (a) must file a separate Form 8865 for each foreign partnership with respect to which the person is a controlling fifty-percent partner or a controlling ten-percent partner.

(b) Ownership determinations and definitions—(1) Control. Control of a foreign partnership is ownership of more than a fifty-percent interest in the partnership.

(2) Fifty-percent interest. A fifty-percent interest in a partnership is an interest equal to fifty percent of the capital interest in such partnership, an interest equal to fifty percent of the profits interest in such partnership, or an interest to which fifty percent of the deductions or losses of such partnership are allocated.

(3) Ten-percent interest. A ten-percent interest in a partnership is an interest equal to ten percent of the capital interest in such partnership, an interest equal to ten percent of the profits interest in such partnership, or an interest to which ten percent of the deductions or losses of such partnership are allocated.

(4) Constructive ownership rules. For purposes of determining an interest in a partnership, the constructive ownership rules of section 267(c) (other than section 267(c)(3)) apply, taking into account that such rules refer to corporations and not to partnerships. However, an interest will be attributed from a nonresident alien under the family attribution rules of section 267(c)(2) and (4) only if the person to whom the interest is attributed owns a direct or indirect (under the rules of 267(c)(1) or (5)) interest in the foreign partnership.

(5) Determination of amount of interest. Whether a person owns a fifty-percent interest, or a ten-percent interest, as described in paragraphs (b)(2) and (3) of this section, is determined for each tax year of the foreign partnership by reference to the agreement of the partners relating to such interests during that tax year.

(6) Definition of United States person. The term United States person is defined in section 7701(a)(30).

(7) Definition of a foreign partnership. A foreign partnership is a partnership described in section 7701(a)(5).

(8) Tax year of a foreign partnership. The tax year of a foreign partnership is determined under section 706.

(9) Examples. The rules of paragraph (a) of this section and this paragraph (b) are illustrated by the following examples:

Example 1.Sole U.S. partner does not own more than a fifty-percent interest. No United States person owns any interest (directly or constructively) in FPS, a foreign partnership whose tax year under section 706 is the calendar year. On January 1, 2001, US, a United States person with the calendar year as its tax year, contributes property to FPS in exchange for a 40% interest in a section 721 transaction. No United States persons acquire directly or constructively any other interests in FPS during FPS's 2001 tax year. US is not a controlling fifty-percent partner during FPS's 2001 tax year. US did not own during that tax year, either directly or constructively, more than a 50% interest in the partnership under paragraphs (b)(2) and (4) of this section. Also, US is not a controlling ten-percent partner; although US owned a 10% or greater interest, US persons owning at least 10% interests did not control FPS. Therefore, US does not have to file with its 2001 income tax return a Form 8865 with respect to FPS under section 6038. (But see section 6038B for the reporting obligations of US with respect to its transfer of property to FPS and section 6046A for the reporting obligation of US with respect to its acquisition of an interest in FPS. See also § 1.6046A-1(f)(1) regarding the overlap between sections 6038B and 6046A.

Example 2.Controlling ten-percent partners. Assume the same facts as in Example 1. In addition, on January 1, 2002, US1, a United States person unrelated to US and a calendar year taxpayer, purchases a 15% interest in FPS from a foreign partner of FPS. Neither US nor US1 is a controlling fifty-percent partner during FPS's 2002 tax year because neither one owns more than a 50% percent interest in FPS during that year. However, US and US1 are controlling ten-percent partners for that year because each owns at least a 10% interest (US owns a 40% interest and US1 owns a 15% interest) and together they control FPS because collectively they own more than a 50% interest in FPS. As controlling ten-percent partners, under section 6038, each is required to file a Form 8865 with its 2002 income tax return. (US1 must also report its acquisition of the 15% interest in FPS under section 6046A on its Form 8865 filed with its 2002 income tax return.)

Example 3.Constructive ownership rules. Assume the same facts as in Example 2. In addition, on January 1, 2003, US2, a United States person and the brother of US, purchases 50% of the stock of FC, a foreign corporation. FC owns a 20% interest in FPS. Thus, under sections 6038(e)(3) and 267(c)(1), US2 indirectly owns a 10% interest in FPS (10% is US2's proportionate share of FC's 20% interest in FPS), and under sections 6038(e)(3) and 267(c)(2), US2 is attributed US's 40% interest. Additionally, US directly owns a 40% interest in FPS and is attributed US2's 10% interest pursuant to section 6038(e)(3) and section 267(c)(2). Therefore, US2 is considered to own a 50% interest (10% indirectly and 40% from US) in FPS, and US is considered to own a 50% interest in FPS (40% directly and 10% from US2). FPS has no controlling fifty-percent partners, because neither US, US1, nor US2, owns a greater than 50% interest. However, US, US1, and US2 are each controlling ten-percent partners and each must file Form 8865 pursuant to section 6038 for FPS's 2003 tax year ending December 31, 2003. Each must attach Form 8865 to its tax return for its 2003 tax year.

Example 4.Controlling fifty-percent partners. Assume the same facts as in Example 3. In addition, on June 1, 2004, US acquires an additional 1% direct interest in FPS. US is now a controlling fifty-percent partner of FPS, because US owns a 41% interest directly and a 10% interest constructively from US2. US2 is also a controlling fifty-percent partner, because US2 owns 10% indirectly and 41% constructively from US. Both US and US2 are required to file Form 8865 containing all the information required to be submitted by controlling fifty-percent partners. (But see paragraph (c)(1) of this section, which contains filing exceptions when there are multiple controlling fifty-percent partners). US1 is no longer a controlling ten-percent partner because FPS now has at least one controlling fifty-percent partner, and US1 does not qualify as a controlling fifty-percent partner. Therefore, US1 is not required to file Form 8865 under section 6038.

Example 5.Constructive ownership from a nonresident alien. US, a United States person, does not own directly or constructively an interest in FPS, a foreign partnership. The tax year of FPS is the calendar year. NRA, a nonresident alien, is the mother of US. In 2002, NRA acquires a 55% interest in FPS. Because US owns neither a direct nor a constructive interest in FPS under sections 6038(e)(3) and 267(c)(1) or (5), NRA's interest is not attributed to US under sections 6038(e)(3) and 267(c)(2). If in 2003 NRA becomes a United States person, NRA's interest will be attributed to US. However, US is excused from filing Form 8865 if US satisfies the requirements of the constructive owners exception in paragraph (c)(2) of this section. In 2003, NRA is a controlling fifty-percent partner and must file a Form 8865 under section 6038 for FPS's 2003 tax year.

(c) Exceptions when more than one United States person is required to file Form 8865 pursuant to section 6038—(1) Multiple controlling fifty-percent partners—(i) In general. If, with respect to the same foreign partnership for the same tax year, more than one United States person is a controlling fifty-percent partner, then in lieu of each controlling fifty-percent partner filing a separate Form 8865, only one Form 8865 from one of the controlling fifty-percent partners is required, provided all of the requirements of paragraph (c)(1)(ii) of this section are satisfied. A person that is a controlling fifty-percent partner solely because of an interest to which deductions or losses are allocated may file the single return only if there is no United States person that is a controlling fifty-percent partner by reason of an interest in capital or profits.

(ii) Requirements—(A) The person undertaking the filing obligation must file Form 8865 with that person's income tax return in the manner provided by Form 8865 and the accompanying instructions. The return must contain all of the information that would have been required to be reported by this section if each controlling fifty-percent partner had filed its own Form 8865.

(B) Any controlling fifty-percent partner not filing Form 8865 must file with its income tax return a statement titled “Controlled Foreign Partnership Reporting” containing the following information—

(1) A statement that the person qualified as a controlling fifty-percent partner, but is not submitting Form 8865 pursuant to the multiple controlling fifty-percent partners exception;

(2) The name, address, and taxpayer identification number (if any) of the foreign partnership of which the person qualified as a controlling fifty-percent partner;

(3) A representation that the filing requirement has been or will be satisfied;

(4) The name and address of the person filing the single return;

(5) The Internal Revenue Service Center where the single return is required to be filed; and

(6) Any additional information that Form 8865 and the accompanying instructions require.

(iii) Penalties. If the requirements listed in paragraph (c)(1)(ii) of this section are not satisfied, a United States person that did not file a Form 8865 pursuant to this paragraph will be subject to the penalties in paragraph (k) of this section, unless the reasonable cause provision in paragraph (k)(4) of this section is satisfied.

(2) Certain constructive owners excepted from furnishing information—(i) In general. A United States person that does not own a direct interest in the foreign partnership and that is required to file Form 8865 under this section solely by reason of constructive ownership from a United States person(s) pursuant to paragraph (b)(4) of this section (an indirect partner) is not required to file Form 8865 if all of the requirements listed in paragraph (c)(2)(ii) of this section are met.

(ii) Requirements—(A) The United States person(s) whose interest the indirect partner constructively owns reports all the information such person(s) is required to submit under this section, unless such person also is required to file solely by reason of constructive ownership from a United States person(s) pursuant to paragraph (b)(4) of this section, or another person reports the information pursuant to paragraph (c)(1) of this section.

(B) The indirect partner files with its income tax return a statement titled “Controlled Foreign Partnership Reporting” containing the following information—

(1) A representation that the indirect partner was required to file Form 8865, but is not doing so pursuant to the constructive owners exception;

(2) The names and addresses of the United States persons whose interests the indirect partner constructively owns;

(3) The name and address of the foreign partnership with respect to which the indirect partner would have had to have filed Form 8865 but for this exception; and

(4) Any additional information that Form 8865 and the accompanying instructions require.

(iii) Penalties. A United States person that pursuant to this paragraph (c)(2) does not file a return will be subject to the penalties in paragraph (k) of this section if the requirements listed in paragraph (c)(2)(ii) of this section are not satisfied, unless such failure is due to reasonable cause, as defined in paragraph (k)(4) of this section.

(iv) Overlap with multiple controlling fifty-percent partners exception—(A) If a United States person qualifies for both the exception in paragraph (c)(1) of this section and the exception in this paragraph (c)(2), such person may only utilize the multiple controlling fifty-percent partners exception in paragraph (c)(1) of this section to avoid filing Form 8865.

(B) Example. The following example illustrates the operation of this paragraph (c)(2)(iv):

Example.US is a U.S. citizen. US owns 100% of the stock of DC, a domestic corporation. DC owns a 60% direct interest in FPS, a foreign partnership. DC and US are the only U.S. persons that own interests directly or constructively in FPS. DC owns directly a greater than 50% interest in FPS. US constructively owns DC's interest pursuant to sections 6038(e)(3) and 267(c)(1). Therefore, both DC and US are controlling fifty-percent partners. US qualifies for both the exception in paragraph (c)(1) of this section (multiple controlling fifty-percent partners) and the exception in paragraph (c)(2) of this section (constructive owner exception). US may only utilize the paragraph (c)(1) exception to avoid its filing obligation. Accordingly, DC may file a single Form 8865 on behalf of US and itself. However, that form must contain all the information that would have been submitted had DC and US each submitted a separate Form 8865.

(3) Members of an affiliated group of corporations filing a consolidated return. If one or more members of an affiliated group of corporations filing a consolidated return are required under section 6038 to file a Form 8865 for a particular foreign partnership, the common parent corporation may file one Form 8865 on behalf of all of the members of the group required to report under section 6038. Except with respect to group members who also qualify under the exception in paragraph (c)(2) of this section, the Form 8865 must contain all the information that would have been required to be submitted if each group member were required to file its own Form 8865.

(d) Exception for certain trusts. Trusts relating to state and local government employee retirement plans are not required to report under this section, unless the instructions to Form 8865 provide otherwise.

(e) Reporting under this section not required with respect to partnerships excluded from the application of subchapter K. The reporting requirements of this section will not apply to any United States person in respect of an eligible partnership as described in § 1.761-2(a) if such partnership has validly elected to be excluded from all of the provisions of subchapter K of chapter 1 of the Internal Revenue Code in the manner specified in § 1.761-2(b)(2)(i), or such partnership is deemed to have elected to be excluded from all of the provisions of subchapter K of chapter 1 of the Internal Revenue Code in accordance with the provisions of § 1.761-2(b)(2)(ii).

(f) Period covered by return. The information required under this section must be furnished for the tax year of the foreign partnership ending with or within the United States person's tax year. See section 706 for rules regarding tax years of partnerships.

(g) Contents of return—(1) Information required to be submitted by controlling fifty-percent partners and controlling ten-percent partners. All controlling fifty-percent partners and all controlling ten-percent partners must submit the following information on Form 8865 in the form and manner and to the extent prescribed by Form 8865 and its instructions—

(i) The name, address, and taxpayer identification number (if any) of the foreign partnership of which the person qualified as a controlling fifty-percent partner or a controlling ten-percent partner;

(ii) A statement of the income, gain, losses, deductions and credits allocated to the direct interest in the partnership of the person reporting under section 6038;

(iii) A list of all partnerships (foreign or domestic) in which the foreign partnership owned a direct interest, or owned a constructive interest of ten percent of more under the rules of section 267(c)(1) or (5), during the partnership's tax year for which the Form 8865 is being filed;

(iv) Information about all foreign entities that were disregarded as entities separate from their owner under §§ 301.7701-2 and 301.7701-3 that were owned by the foreign partnership during the partnership's tax year for which the Form 8865 is being filed;

(v) A summary of the transactions that took place during the partnership's tax year between the partnership and the person filing the return, between the partnership and any other partnership of which the person filing the return is a controlling fifty-percent partner, and between the partnership and any corporation controlled (under section 6038(e)(2) and the regulations thereunder) by the person filing the return; and

(vi) Any other information that Form 8865 or its accompanying instructions require to be submitted.

(2) Additional information required to be submitted by controlling fifty-percent partners. In addition to the information required pursuant to paragraph (g)(1) of this section, controlling fifty-percent partners must also submit the following information in the form and manner and to the extent required by Form 8865 and its instructions—

(i) A list of the names, addresses and tax identification numbers (if any) of each United States person that owned a direct interest of ten percent or more in the partnership during the partnership's tax year, and of each United States and foreign person whose interests in the partnership the controlling fifty-percent partner constructively owned under paragraph (b)(4) of this section during the partnership's tax year;

(ii) A list of transactions between the partnership and any United States person owning at the time of the transaction at least a 10-percent direct interest (as defined in paragraph (b)(3) of this section) in the foreign partnership;

(iii) A statement of the aggregate of the partners' distributive shares of items of income, gain, losses, deductions and credits;

(iv) A statement of income, gain, losses, deductions and credits allocated to each United States person holding a direct interest in the foreign partnership of ten percent or more; and

(v) Any other information Form 8865 or its accompanying instructions require controlling fifty-percent partners to submit.

(3) Amounts involving hybrid transactions or hybrid entities under section 267A. In addition to the information required pursuant to paragraphs (g)(1) and (2) of this section, if, during the partnership's taxable year for which the Form 8865 is being filed, the partnership paid or accrued interest or royalties for which a deduction is disallowed under section 267A and the regulations in this part under section 267A, the controlling fifty-percent partners must provide information about the disallowance in the form and manner and to the extent prescribed by Form 8865 (or successor form), instruction, publication, or other guidance.

(4) Additional information required to be submitted by a controlling ten-percent or a controlling fifty-percent partner that has a deduction under section 250 by reason of FDII. In addition to the information required pursuant to paragraphs (g)(1), (2), and (3) of this section, if, with respect to the partnership's tax year for which the Form 8865 is being filed, a controlling ten-percent partner or a controlling fifty-percent partner has a deduction under section 250 (by reason of having foreign-derived intangible income), determined, in whole or in part, by reference to the income, assets, or activities of the partnership, or transactions between the controlling-ten percent partner or controlling fifty-percent partner and the partnership, the controlling ten-percent partner or controlling fifty-percent partner must provide its share of the partnership's gross DEI, gross FDDEI, deductions that are properly allocable to the partnership's gross DEI and gross FDDEI, and partnership QBAI (as those terms are defined in the section 250 regulations) in the form and manner and to the extent prescribed by Form 8865 (or any successor form), instructions to the form, publication, or other guidance published in the Internal Revenue Bulletin. To the extent that the partnership amounts described in the previous sentence cannot be determined, the controlling ten-percent partner or controlling fifty-percent partner must provide its share of the partnership's attributes that the partner uses to determine the partner's gross DEI, gross FDDEI, deductions that are properly allocable to the partner's gross DEI and gross FDDEI, and the partner's adjusted bases in partnership specified tangible property.

(h) Method of reporting. Except as otherwise provided on Form 8865 or the accompanying instructions, all amounts required to be furnished on Form 8865 must be expressed in United States dollars. All statements required on or with Form 8865 pursuant to this section must be in English.

(i) Time and place for filing return—(1) In general. Form 8865 must be filed with the United States person's income tax return on or before the due date (including extensions) of that return. If the United States person is not required to file an income tax return for its tax year with which or within which the foreign partnership's tax year ends, but is required to file an information return for that year (for example, Form 1065, “U.S. Partnership Return of Income,” or Form 990, “Return of Organization Exempt from Income Tax”), the Form 8865 must be filed with the United States person's information return filed on or before the due date (including extensions) of that return.

(2) Duplicate return. If required by the instructions to Form 8865, a duplicate Form 8865 (including attachments and schedules) must also be filed.

(j) Overlap with section 6031. A partner may be required to file Form 8865 under this section and the foreign partnership in which it is a partner may also be required to file a Form 1065 or Form 1065-B under section 6031(e) for the same partnership tax year. For cases where a United States person is a controlling fifty-percent partner or a controlling ten-percent partner with respect to a foreign partnership, and that foreign partnership completes and files Form 1065 or Form 1065-B, the instructions for Form 8865 will specify the filing requirements that address this overlap in reporting obligations.

(k) Failure to comply with reporting requirement—(1) In general. Any United States person required to file Form 8865 under Section 6038 and this section that fails to comply (as defined in paragraph (k)(2) of this section) with the reporting requirements of this section, will be subject to the penalties described in paragraph (k)(3) of this section.

(2) Failure to comply. A failure to comply is separately determined for each foreign partnership for which a United States person has a section 6038 reporting obligation. A failure to comply with the requirements of section 6038 includes the following—

(i) The failure to report at the proper time and in the proper manner any information required to be reported under the rules of this section; or

(ii) The provision of false or inaccurate information in purported compliance with the requirements of this section.

(3) Penalties. A United States person that fails to comply (as defined in paragraph (k)(2) of this section) with the reporting requirements of this section must pay the following penalties, subject to the reasonable cause exception in paragraph (k)(4) of this section:

(i) Dollar amount penalty—(A) $10,000 penalty. A penalty of $10,000 shall be imposed for each tax year of each foreign partnership with respect to which a failure to comply occurs.

(B) Increase in penalty. If a failure to comply with the applicable reporting requirements of section 6038 and this section continues for more than 90 days after the date on which the Commissioner or the Commissioner's delegate mails notice of the failure to the United States person required to file Form 8865, the person must pay an additional penalty of $10,000 for each 30-day period (or fraction thereof) during which the failure continues after the 90-day period has expired.

(C) Limitation. The additional penalty imposed on any United States person by section 6038(b)(2) and paragraph (k)(3)(i)(B) of this section is limited to a maximum of $50,000 for each partnership for each tax year with respect to which the failure occurs.

(ii) Penalty of reducing foreign tax credit—(A) Effect on foreign tax credit. Failure to comply with the reporting requirements of section 6038 and this section may cause a reduction of foreign tax credits under section 901 (taxes of foreign countries and of possessions of the United States). In applying section 901 to a United States person for any tax year with or within which its foreign partnership's tax year ended, the amount of taxes paid (and deemed paid under sections 902 and 960) by the United States person will be reduced by 10 percent if the person fails to comply. However, no tax deemed paid under section 904(c) will be reduced under the provisions of this paragraph (k)(3)(ii).

(B) Reduction for continued failure. If a failure to comply with the reporting requirements of section 6038 and this section continues for more than 90 days after the date on which the Commissioner or the Commissioner's delegate mails notice of the failure to the person required to file Form 8865, then the amount of the reduction in paragraph (k)(3)(ii)(A) of this section will be 10 percent, plus an additional 5 percent for each 3-month period (or fraction thereof) during which the failure continues after the 90-day period has expired.

(C) Limitation on reduction. The amount of the reduction under paragraphs (k)(3)(ii)(A) and (B) of this section for each failure to furnish information required under this section will not exceed the greater of $10,000, or the gross income of the foreign partnership for its tax year with respect to which the failure occurred.

(D) Offset for dollar amount penalty imposed. The total amount of the reduction which, but for this paragraph (k)(3)(ii)(D), may be made under this paragraph (k)(3)(ii) with respect to any separate failure, may not exceed the maximum amount of the reductions that may be imposed, reduced (but not below zero) by the dollar amount penalty imposed by paragraph (k)(3)(i) of this section with respect to the failure.

(4) Reasonable cause limitation. The time prescribed for filing a complete Form 8865, and the beginning of the 90-day period after the Commissioner or the Commissioner's delegate mails notice under paragraphs (k)(3)(i)(B) and (ii)(B) of this section, will be treated as being not earlier than the last day on which reasonable cause existed for failure to furnish the information. The United States person may show reasonable cause by providing a written statement to the Commissioner's delegate having jurisdiction over the person's return to which the Form 8865 should have been attached, setting forth the reasons for the failure to comply. Whether a failure to comply was due to reasonable cause will be determined by the Commissioner, or the Commissioner's delegate, under all the facts and circumstances.

(5) Statute of limitations. For exceptions to the limitations on assessment in the event of a failure to provide information under section 6038, see section 6501(c)(8).

(l) Applicability dates. Except as otherwise provided, this section shall apply for tax years of a foreign partnership ending on or after December 31, 2000. For tax years of a foreign partnership ending before December 23, 2002, see § 1.6038-3(j) in effect prior to the amendments made by T.D. 9033 (see 26 CFR part 1 revised April 1, 2002). Paragraph (g)(3) of this section applies for taxable years of a foreign partnership beginning on or after December 20, 2018. Paragraph (g)(4) of this section applies for tax years of a foreign partnership beginning on or after March 4, 2019.

[T.D. 8850, 64 FR 72550, Dec. 28, 1999, as amended by T.D. 9033, 67 FR 78175, Dec. 23, 2002; T.D. 9065, 68 FR 39012, July 1, 2003; T.D. 9896, 85 FR 19857, Apr. 8, 2020; T.D. 9901, 85 FR 43116, July 15, 2020]

§ 1.6038-4 Information returns required of certain United States persons with respect to such person's U.S. multinational enterprise group.

(a) Requirement of return. Except as provided in paragraph (h) of this section, every ultimate parent entity of a U.S. multinational enterprise (MNE) group must make an annual return on Form 8975, Country-by-Country Report, setting forth the information described in paragraph (d) of this section, and any other information required by Form 8975, with respect to the reporting period described in paragraph (c) of this section.

(b) Definitions—(1) Ultimate parent entity of a U.S. MNE group. An ultimate parent entity of a U.S. MNE group is a U.S. business entity that:

(i) Owns directly or indirectly a sufficient interest in one or more other business entities, at least one of which is organized or tax resident in a tax jurisdiction other than the United States, such that the U.S. business entity is required to consolidate the accounts of the other business entities with its own accounts under U.S. generally accepted accounting principles, or would be so required if equity interests in the U.S. business entity were publicly traded on a U.S. securities exchange; and

(ii) Is not owned directly or indirectly by another business entity that consolidates the accounts of such U.S. business entity with its own accounts under generally accepted accounting principles in the other business entity's tax jurisdiction of residence, or would be so required if equity interests in the other business entity were traded on a public securities exchange in its tax jurisdiction of residence.

(2) Business entity. For purposes of this section, a business entity generally is any entity recognized for federal tax purposes that is not properly classified as a trust under § 301.7701-4 of this chapter. However, any grantor trust within the meaning of section 671, all or a portion of which is owned by a person other an individual, is a business entity for purposes of this section. Additionally, the term business entity includes any entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3 of this chapter and a permanent establishment, as defined in paragraph (b)(3) of this section, that prepares financial statements separate from those of its owner for financial reporting, regulatory, tax reporting, or internal management control purposes. A business entity does not include a decedent's estate or a bankruptcy estate described in section 1398.

(3) Permanent establishment. For purposes of this section, the term permanent establishment includes:

(i) A branch or business establishment of a constituent entity in a tax jurisdiction that is treated as a permanent establishment under an income tax convention to which that tax jurisdiction is a party;

(ii) A branch or business establishment of a constituent entity that is liable to tax in the tax jurisdiction in which it is located pursuant to the domestic law of such tax jurisdiction; or

(iii) A branch or business establishment of a constituent entity that is treated in the same manner for tax purposes as an entity separate from its owner by the owner's tax jurisdiction of residence.

(4) U.S. business entity. A U.S. business entity is a business entity that is organized or has its tax jurisdiction of residence in the United States. For purposes of this section, foreign insurance companies that elect to be treated as domestic corporations under section 953(d) are U.S. business entities that have their tax jurisdiction of residence in the United States.

(5) U.S. MNE group. A U.S. MNE group comprises the ultimate parent entity of a U.S. MNE group as defined in paragraph (b)(1) of this section and all of the business entities required to consolidate their accounts with the ultimate parent entity's accounts under U.S. generally accepted accounting principles, or that would be so required if equity interests in the ultimate parent entity were publicly traded on a U.S. securities exchange, regardless of whether any such business entities could be excluded from consolidation solely on size or materiality grounds.

(6) Constituent entity. With respect to a U.S. MNE group, a constituent entity is any separate business entity of such U.S. MNE group, except that the term constituent entity does not include a foreign corporation or foreign partnership for which the ultimate parent entity is not required to furnish information under section 6038(a) (determined without regard to §§ 1.6038-2(j) and 1.6038-3(c)) or any permanent establishment of such foreign corporation or foreign partnership.

(7) Tax jurisdiction. For purposes of this section, a tax jurisdiction is a country or a jurisdiction that is not a country but that has fiscal autonomy. For purposes of this section, a U.S. territory or possession of the United States is considered to have fiscal autonomy.

(8) Tax jurisdiction of residence. A business entity is considered a resident in a tax jurisdiction if, under the laws of that tax jurisdiction, the business entity is liable to tax therein based on place of management, place of organization, or another similar criterion. A business entity will not be considered a resident in a tax jurisdiction if the business entity is liable to tax in such tax jurisdiction only by reason of a tax imposed by reference to gross amounts of income without any reduction for expenses, provided such tax applies only with respect to income from sources in such tax jurisdiction or capital situated in such tax jurisdiction. If a business entity is resident in more than one tax jurisdiction, then the applicable income tax convention rules, if any, should be applied to determine the business entity's tax jurisdiction of residence. If a business entity is resident in more than one tax jurisdiction and no applicable income tax convention exists between those tax jurisdictions, or if the applicable income tax convention provides that the determination of residence is based on a determination by the competent authorities of the relevant tax jurisdictions and no such determination has been made, the business entity's tax jurisdiction of residence is the tax jurisdiction of the business entity's place of effective management determined in accordance with Article 4 of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital 2014, or as provided by Form 8975. A corporation that is organized or managed in a tax jurisdiction that does not impose an income tax on corporations will be treated as resident in that tax jurisdiction, unless such corporation is treated as resident in another tax jurisdiction under another provision of this section. The tax jurisdiction of residence of a permanent establishment is the jurisdiction in which the permanent establishment is located. If a business entity does not have a tax jurisdiction of residence, then solely for purposes of paragraph (b)(1) of this section, the tax jurisdiction of residence is the business entity's country of organization.

(9) Applicable financial statements. An applicable financial statement is a certified audited financial statement that is accompanied by a report of an independent certified public accountant or similarly qualified independent professional that is used for purposes of reporting to shareholders, partners, or similar persons; for purposes of reporting to creditors in connection with securing or maintaining financing; or for any other substantial non-tax purpose.

(10) U.S. territory or possession of the United States. The term U.S. territory or possession of the United States means American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands.

(11) U.S. territory ultimate parent entity. A U.S. territory ultimate parent entity is a business entity organized in a U.S. territory or possession of the United States that controls (as defined in section 6038(e)) a U.S. business entity and that is not owned directly or indirectly by another business entity that consolidates the accounts of the U.S. territory ultimate parent entity with its accounts under generally accepted accounting principles in the other business entity's tax jurisdiction of residence, or would be so required if equity interests in the other business entity were traded on a public securities exchange in its tax jurisdiction of residence.

(c) Reporting period. The reporting period covered by Form 8975 is the period of the ultimate parent entity's applicable financial statement prepared for the 12-month period (or a 52-53 week period described in section 441(f)) that ends with or within the ultimate parent entity's taxable year. If the ultimate parent entity does not prepare an annual applicable financial statement, then the reporting period covered by Form 8975 is the 12-month period (or a 52-53 week period described in section 441(f)) that ends on the last day of the ultimate parent entity's taxable year.

(d) Contents of return—(1) Constituent entity information. The return on Form 8975 must contain so much of the following information with respect to each constituent entity of the U.S. MNE group, and in such form or manner, as Form 8975 prescribes:

(i) The complete legal name of the constituent entity;

(ii) The tax jurisdiction, if any, in which the constituent entity is resident for tax purposes;

(iii) The tax jurisdiction in which the constituent entity is organized or incorporated (if different from the tax jurisdiction of residence);

(iv) The tax identification number, if any, used for the constituent entity by the tax administration of the constituent entity's tax jurisdiction of residence; and

(v) The main business activity or activities of the constituent entity.

(2) Tax jurisdiction of residence information. The return on Form 8975 must contain so much of the following information with respect to each tax jurisdiction in which one or more constituent entities of a U.S. MNE group is resident, presented as an aggregate of the information for the constituent entities resident in each tax jurisdiction, and in such form or manner, as Form 8975 prescribes:

(i) Revenues generated from transactions with other constituent entities;

(ii) Revenues not generated from transactions with other constituent entities;

(iii) Profit or loss before income tax;

(iv) Total income tax paid on a cash basis to all tax jurisdictions, and any taxes withheld on payments received by the constituent entities;

(v) Total accrued tax expense recorded on taxable profits or losses, reflecting only operations in the relevant annual period and excluding deferred taxes or provisions for uncertain tax liabilities;

(vi) Stated capital, except that the stated capital of a permanent establishment must be reported in the tax jurisdiction of residence of the legal entity of which it is a permanent establishment unless there is a defined capital requirement in the permanent establishment tax jurisdiction for regulatory purposes;

(vii) Total accumulated earnings, except that accumulated earnings of a permanent establishment must be reported by the legal entity of which it is a permanent establishment;

(viii) Total number of employees on a full-time equivalent basis; and

(ix) Net book value of tangible assets, which, for purposes of this section, does not include cash or cash equivalents, intangibles, or financial assets.

(3) Special rules—(i) Constituent entity with no tax jurisdiction of residence. The information listed in paragraph (d)(2) of this section also must be provided, in the aggregate, for any constituent entity or entities that have no tax jurisdiction of residence. In addition, if a constituent entity is an owner of a constituent entity that does not have a jurisdiction of tax residence, then the owner's share of such entity's revenues and profits will be aggregated with the information for the owner's tax jurisdiction of residence.

(ii) Definition of revenue. For purposes of this section, the term revenue includes all amounts of revenue, including revenue from sales of inventory and property, services, royalties, interest, and premiums. The term revenue does not include payments received from other constituent entities that are treated as dividends in the payor's tax jurisdiction of residence. Distributions and remittances from partnerships and other fiscally transparent entities and permanent establishments that are constituent entities are not considered revenue of the recipient-owner. The term revenue also does not include imputed earnings or deemed dividends received from other constituent entities that are taken into account solely for tax purposes and that otherwise would be included as revenue by a constituent entity. With respect to a constituent entity that is an organization exempt from taxation under section 501(a) because it is an organization described in section 501(c), 501(d), or 401(a), a state college or university described in section 511(a)(2)(B), a plan described in section 403(b) or 457(b), an individual retirement plan or annuity as defined in section 7701(a)(37), a qualified tuition program described in section 529, a qualified ABLE program described in section 529A, or a Coverdell education savings account described in section 530, the term revenue includes only revenue that is reflected in unrelated business taxable income as defined in section 512.

(iii) Number of employees. For purposes of this section, the number of employees on a full-time equivalent basis may be reported as of the end of the accounting period, on the basis of average employment levels for the annual accounting period, or on any other reasonable basis consistently applied across tax jurisdictions and from year to year. Independent contractors participating in the ordinary operating activities of a constituent entity may be reported as employees of such constituent entity. Reasonable rounding or approximation of the number of employees is permissible, provided that such rounding or approximation does not materially distort the relative distribution of employees across the various tax jurisdictions. Consistent approaches should be applied from year to year and across entities.

(iv) Income tax paid and accrued tax expense of permanent establishment. In the case of a constituent entity that is a permanent establishment, the amount of income tax paid and the amount of accrued tax expense referred to in paragraphs (d)(2)(iv) and (v) of this section should not include the income tax paid or tax expense accrued by the business entity of which the permanent establishment would be a part, but for the third sentence of paragraph (b)(2) of this section, in that business entity's tax jurisdiction of residence on the income derived by the permanent establishment.

(v) Certain transportation income. If a constituent entity of a U.S. MNE group derives income from international transportation or transportation in inland waterways that is covered by income tax convention provisions that are specific to such income and under which the taxing rights on such income are allocated exclusively to one tax jurisdiction, then the U.S. MNE group should report the information required under paragraph (d)(2) of this section with respect to such income for the tax jurisdiction to which the relevant income tax convention provisions allocate these taxing rights.

(e) Reporting of financial amounts—(1) Reporting in U.S. dollars required. All amounts furnished under paragraph (d)(2) of this section, other than paragraph (d)(2)(viii) of this section, must be expressed in U.S. dollars. If an exchange rate is used other than in accordance with U.S. generally accepted accounting principles for conversion to U.S. dollars, the exchange rate must be indicated.

(2) Sources of financial amounts. All amounts furnished under paragraph (d)(2) of this section, other than paragraph (d)(2)(viii) of this section, should be based on applicable financial statements, books and records maintained with respect to the constituent entity, regulatory financial statements, or records used for tax reporting or internal management control purposes for an annual period of each constituent entity ending with or within the period described in paragraph (c) of this section.

(f) Time and manner for filing. Returns on Form 8975 required under paragraph (a) of this section for a reporting period must be filed with the ultimate parent entity's income tax return for the taxable year, in or with which the reporting period ends, on or before the due date (including extensions) for filing that person's income tax return or as otherwise prescribed by Form 8975.

(g) Maintenance of records. The U.S. person filing Form 8975 as an ultimate parent entity of a U.S. MNE group must maintain records to support the information provided on Form 8975. However, the U.S. person is not required to create and maintain records that reconcile the amounts provided on Form 8975 with the tax returns of any tax jurisdiction or applicable financial statements.

(h) Exceptions to furnishing information. An ultimate parent entity of a U.S. MNE group is not required to report information under this section for the reporting period described in paragraph (c) of this section if the annual revenue of the U.S. MNE group for the immediately preceding reporting period was less than $850,000,000.

(i) [Reserved]

(j) U.S. territories and possessions of the United States. A U.S. territory ultimate parent entity may designate a U.S. business entity that it controls (as defined in section 6038(e)) to file Form 8975 on the U.S. territory ultimate parent entity's behalf with respect to such U.S. territory ultimate parent entity and the business entities that would be required to consolidate their accounts with such U.S. territory ultimate parent entity under U.S. generally accepted accounting principles, or would be so required if equity interests in the U.S. territory ultimate parent entity were publicly traded on a U.S. securities exchange.

(k) Applicability dates. The rules of this section apply to reporting periods of ultimate parent entities of U.S. MNE groups that begin on or after the first day of a taxable year of the ultimate parent entity that begins on or after June 30, 2016.

[T.D. 9773, 81 FR 42489, June 30, 2016; 81 FR 64061, Sept. 19, 2016]

§ 1.6038-5 Information returns required of certain United States persons to report amounts determined with respect to certain foreign corporations for global intangible low-taxed income (GILTI) purposes.

(a) Requirement of return. Except as provided in paragraph (d) of this section, each United States person who is a United States shareholder (as defined in section 951(b)) of any controlled foreign corporation (as defined in section 957) must make an annual return on Form 8992, “U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI),” (or successor form) for each U.S. shareholder inclusion year (as defined in § 1.951A-1(f)(7)) setting forth the information with respect to each such controlled foreign corporation, in such form and manner, as Form 8992 (or successor form) prescribes.

(b) Time and manner for filing. Returns on Form 8992 (or successor form) required under paragraph (a) of this section for a taxable year must be filed with the United States person's income tax return on or before the due date (taking into account extensions) for filing that person's income tax return.

(c) Failure to furnish information—(1) Penalties. If any person required to file Form 8992 (or successor form) under section 6038 and this section fails to furnish the information prescribed on Form 8992 within the time prescribed by paragraph (b) of this section, the penalties imposed by section 6038(b) and (c) apply.

(2) Increase in penalty. If a failure described in paragraph (c)(1) of this section continues for more than 90 days after the date on which the Director of Field Operations, Area Director, or Director of Compliance Campus Operations mails notice of such failure to the person required to file Form 8992, such person shall pay a penalty of $10,000, in addition to the penalty imposed by section 6038(b)(1), for each 30-day period (or a fraction of) during which such failure continues after such 90-day period has expired. The additional penalty imposed by section 6038(b)(2) and this paragraph (c)(2) shall be limited to a maximum of $50,000 for each failure.

(3) Reasonable cause—(i) For purposes of section 6038(b) and (c) and this section, the time prescribed for furnishing information under paragraph (b) of this section, and the beginning of the 90-day period after mailing of notice by the director under paragraph (c)(2) of this section, shall be treated as being not earlier than the last day on which reasonable cause existed for failure to furnish the information.

(ii) To show that reasonable cause existed for failure to furnish information as required by section 6038 and this section, the person required to report such information must make an affirmative showing of all facts alleged as reasonable cause for such failure in a written statement containing a declaration that it is made under the penalties of perjury. The statement must be filed with the director where the return is required to be filed. The director shall determine whether the failure to furnish information was due to reasonable cause, and if so, the period of time for which such reasonable cause existed. In the case of a return that has been filed as required by this section except for an omission of, or error with respect to, some of the information required, if the person who filed the return establishes to the satisfaction of the director that the person has substantially complied with this section, then the omission or error shall not constitute a failure under this section.

(d) Exception from filing requirement. Any United States person that does not own, within the meaning of section 958(a), stock of a controlled foreign corporation in which the United States person is a United States shareholder for a taxable year is not required to file Form 8992. For this purpose, whether a U.S. person owns, within the meaning of section 958(a), stock of a controlled foreign corporation is determined under § 1.951A-1(e).

(e) Applicability date. This section applies to taxable years of controlled foreign corporations beginning on or after October 3, 2018.

[T.D. 9866, 84 FR 29369, June 21, 2019]

§ 1.6038A-0 Table of contents.

This section lists the captions that appear in the regulations under section 6038A.

§ 1.6038A-1 General requirements and definitions.

(a) Purpose and scope.

(b) In general.

(1) In general.

(2) 25-percent foreign-owned.

(3) 25-percent foreign shareholder.

(i) In general.

(ii) Total voting power and value.

(iii) Direct 25-percent foreign shareholder.

(iv) Indirect 25-percent foreign shareholder.

(4) Application to prior open years.

(5) Exceptions.

(i) Treaty country residents having no permanent establishment.

(ii) Qualified exempt shipping income.

(iii) Status as a foreign related party.

(d) Related party.

(e) Attribution rules.

(1) Attribution under section 318.

(2) Attribution of transactions with related parties engaged in by a partnership.

(f) Foreign person.

(g) Foreign related party.

(h) Small corporation exception.

(i) Safe harbor for reporting corporations with related party transactions of de minimis value.

(1) In general.

(2) Aggregate value of gross payments made or received.

(j) Related reporting corporations.

(k) Consolidated return groups.

(1) Required information.

(2) Maintenance of records and authorization of agent.

(3) Monetary penalties.

(l) District Director.

(m) Examples.

(n) Effective dates.

(1) Section 1.6038A-1.

(2) Section 1.6038A-2.

(3) Section 1.6038A-3.

(4) Section 1.6038A-4.

(5) Section 1.6038A-5.

(6) Section 1.6038A-6.

(7) Section 1.6038A-7.

§ 1.6038A-2 Requirement of return.

(a) Form 5472 required.

(1) In general.

(2) Reportable transaction.

(b) Contents of return.

(1) Reporting corporation.

(2) Related party.

(3) Foreign related party transactions for which only monetary consideration is paid or received by the reporting corporation.

(4) Foreign related party transactions involving nonmonetary consideration or less than full consideration.

(5) Additional information.

(6) Reasonable estimate.

(i) Estimate within 25 percent of actual amount.

(ii) Other estimates.

(7) Small amounts.

(8) Accrued payments and receipts.

(9) Examples.

(d) Time and place for filing returns.

(e) Untimely filed return.

(f) Exceptions.

(1) No reportable transactions.

(2) Transactions solely with a domestic reporting corporation.

(3) Transactions with a corporation subject to reporting under section 6038.

(4) Transactions with a foreign sales corporation.

(g) Filing Form 5472 when transactions with related parties engaged in by a partnership are attributed to a reporting corporation.

(h) Effective dates for certain reporting corporations.

§ 1.6038A-3 Record maintenance.

(a) General maintenance requirements.

(1) Section 6001 and section 6038A.

(2) Safe harbor.

(3) Examples.

(b) Other maintenance requirements.

(1) Indirectly related records.

(2) Foreign related party or third-party maintenance.

(3) Translation of records.

(4) Exception for foreign governments.

(1) In general.

(2) Descriptions of categories of documents to be maintained.

(i) Original entry books and transaction records.

(ii) Profit and loss statements.

(iii) Pricing documents.

(iv) Foreign country and third party filings.

(v) Ownership and capital structure records.

(vi) Records of loans, services, and other non-sales transactions.

(3) Material profit and loss statements.

(4) Existing records test.

(5) Significant industry segment test.

(i) In general.

(ii) Form of the statements.

(iii) Special rule for component sales.

(iv) Level of specificity required.

(v) Examples.

(6) High profit test.

(i) In general.

(ii) Return on assets test.

(iii) Additional rules.

(7) Definitions.

(i) U.S.-connected products or services.

(ii) Industry segment.

(iii) Gross revenue of an industry segment.

(iv) Identifiable assets of an industry segment.

(v) Operating profit of an industry segment.

(vi) Product.

(vii) Related products or services.

(viii) Model.

(ix) Product line.

(8) Example.

(i) Facts.

(ii) Existing records test.

(iii) Significant industry segments.

(iv) High profit test.

(v) Material profit and loss statements.

(d) Liability for certain partnership record maintenance.

(e) Agreements with the District Director or the Assistant Commissioner (International).

(1) In general.

(2) Content of agreement.

(i) In general.

(ii) Significant industry segment test.

(iii) Example.

(3) Circumstances of agreement.

(4) Agreement as part of APA process.

(f) U.S. maintenance.

(1) General rule.

(2) Non-U.S. maintenance requirements.

(3) Prior taxable years.

(4) Scheduled production for high volume or other reasons.

(5) Required U.S. maintenance.

(g) Period of retention.

(h) Application of record maintenance rules to banks and other financial institutions. [Reserved]

(i) Effective dates.

§ 1.6038A-4 Monetary penalty.

(a) Imposition of monetary penalty.

(1) In general.

(2) Liability for certain partnership transactions.

(3) Calculation of monetary penalty.

(b) Reasonable cause.

(1) In general.

(2) Affirmative showing required.

(i) In general.

(ii) Small corporations.

(iii) Facts and circumstances taken into account.

(d) Increase in penalty where failure continues after notification.

(1) In general.

(2) Additional penalty for another failure.

(3) Cessation of accrual.

(4) Continued failures.

(e) Other penalties.

(f) Examples.

Example (1)—Failure to file Form 5472.

Example (2)—Failure to maintain records.

(g) Effective dates.

§ 1.6038A-5 Authorization of agent.

(a) Failure to authorize.

(b) Authorization by related party.

(1) In general.

(2) Authorization for prior years.

(1) In general.

(2) Application of noncompliance penalty adjustment.

(d) Legal effect of authorization of agent.

(1) Agent for purposes of commencing judicial proceedings.

(2) Foreign related party found where reporting corporation found.

(e) Successors in interest.

(f) Deemed compliance.

(1) In general.

(2) Reason to know.

(3) Effect of deemed compliance.

(g) Effective dates.

§ 1.6038A-6 Failure to furnish information.

(a) In general.

(b) Coordination with treaties.

(d) De minimis failure.

(e) Suspension of statute of limitations.

(f) Effective dates.

§ 1.6038A-7 Noncompliance.

(a) In general.

(b) Determination of the amount.

(d) Effective dates.

[T.D. 8353, 56 FR 28060, June 19, 1991, as amended by T.D. 9796, 81 FR 89850, Dec. 13, 2016]

§ 1.6038A-1 General requirements and definitions.

(a) Purpose and scope. This section and §§ 1.6038A-2 through 1.6038A-7 provide rules for certain foreign-owned U.S. corporations and foreign corporations engaged in trade or business within the United States (reporting corporations) relating to information that must be furnished, records that must be maintained, and the authorization of the reporting corporation to act as agent for related foreign persons for purposes of sections 7602, 7603, and 7604 that must be executed. Section 6038A(a) and this section require that a reporting corporation furnish certain information annually and maintain certain records relating to transactions between the reporting corporation and certain related parties. This section also provides definitions of terms used in section 6038A. Section 1.6038A-2 provides guidance concerning the information to be submitted and the filing of the required return. Section 1.6038A-3 provides guidance concerning the maintenance of records. Section 1.6038A-4 provides guidance concerning the application of the monetary penalty for the failure either to furnish information or to maintain records. Section 1.6038A-5 provides guidance concerning the authorization of an agent for purposes of sections 7602, 7603, and 7604. Section 1.6038A-6 provides guidance concerning the failure to furnish information requested by a summons. Finally, § 1.6038A-7 provides guidance concerning the application of the noncompliance penalty for failure by the related party to authorize an agent or by the reporting corporation to substantially comply with a summons.

(b) In general. A reporting corporation must furnish the information described in § 1.6038A-2 by filing an annual information return (Form 5472 or any successor), and must maintain records as described in § 1.6038A-3.

(c) Reporting corporation—(1) In general. For purposes of section 6038A, a reporting corporation is either a domestic corporation that is 25-percent foreign-owned as defined in paragraph (c)(2) of this section, or a foreign corporation that is 25-percent foreign-owned and engaged in trade or business within the United States. After November 4, 1990, a foreign corporation engaged in a trade or business within the United States at any time during a taxable year is a reporting corporation. See section 6038C. A domestic business entity that is wholly owned by one foreign person and that is otherwise classified under § 301.7701-3(b)(1)(ii) of this chapter as disregarded as an entity separate from its owner is treated as an entity separate from its owner and classified as a domestic corporation for purposes of section 6038A. See § 301.7701-2(c)(2)(vi) of this chapter.

(2) 25-percent foreign-owned. A corporation is 25-percent foreign-owned if it has at least one direct or indirect 25-percent foreign shareholder at any time during the taxable year.

(3) 25-percent foreign shareholder—(i) In general. A foreign person is a 25-percent foreign shareholder of a corporation if the person owns at least 25 percent of—

(A) The total voting power of all classes of stock of the corporation entitled to vote, or

(B) The total value of all classes of stock of the corporation.

(ii) Total voting power and value. In determining whether one foreign person owns 25 percent of the total voting power of all classes of stock of a corporation entitled to vote or 25 percent of the total value of all classes of stock of a corporation, consideration will be given to all the facts and circumstances of each case, under principles similar to § 1.957-1(b)(2) (consideration of arrangements to shift formal voting power away from a foreign person).

(iii) Direct 25-percent foreign shareholder. A foreign person is a direct 25-percent foreign shareholder if it owns directly at least 25 percent of the stock of the reporting corporation, either by vote or by value.

(iv) Indirect 25-percent foreign shareholder. A foreign person is an indirect 25-percent foreign shareholder if it owns indirectly (or under the attribution rules of section 318 is considered to own indirectly) at least 25 percent of the stock of the reporting corporation, either by vote or by value.

(4) Application to prior open years. For taxable years beginning before July 11, 1989, the definition of a reporting corporation under this paragraph applies in determining whether a foreign-owned corporation is a reporting corporation. An examination may be reopened if the statute of limitations period for that taxable year has not expired. A taxable year may not be reopened under section 6038A for examination purposes if the taxable year is open under section 6511 only for purposes of the carryback of net operating losses or net capital losses.

(5) Exceptions—(i) Treaty country residents having no permanent establishment. A foreign corporation that has no permanent establishment in the United States under an applicable income tax convention is not a reporting corporation for purposes of section 6038A and this section. Accordingly, such a foreign corporation is not subject to §§ 1.6038A-2, 1.6038A-3, and 1.6038A-5. It must timely and fully provide the required notice to the Commissioner under section 6114. See section 6114 and the regulations thereunder for the notice that such a corporation must file and the applicable penalties for failure to file such notice.

(ii) Qualified exempt shipping income. A foreign corporation whose gross income is exempt from U.S. taxation under section 883 is not a reporting corporation provided that it timely and fully complies with the reporting requirements required to claim such exemption. In the event that such a corporation does not timely and fully comply with the reporting requirements under sections 887 and 883, it will be a reporting corporation subject to section 6038A, including the application of the monetary penalty for failure to file required information.

(iii) Status as foreign related party. Nothing in this paragraph affects the determination of whether a person is a foreign related party as defined in paragraph (g) of this section.

(d) Related party. The term “related party” means—

(1) Any direct or indirect 25-percent foreign shareholder of the reporting corporation,

(2) Any person who is related within the meaning of sections 267(b) or 707(b)(1) to the reporting corporation or to a 25-percent foreign shareholder of the reporting corporation, or

(3) Any other person who is related to the reporting corporation within the meaning of section 482 and the regulations thereunder. However, the term “related party” does not include any corporation filing a consolidated federal income tax return with the reporting corporation.

(e) Attribution rules—(1) Attribution under section 318. For purposes of determining whether a corporation is 25-percent foreign-owned and whether a person is a related party under section 6038A, the constructive ownership rules of section 318 shall apply, and the attribution rules of section 267(c) also shall apply to the extent they attribute ownership to persons to whom section 318 does not attribute ownership. However, “10 percent” shall be substituted for “50 percent” in section 318(a)(2)(C), and section 318(a)(3) (A), (B), and (C) shall not be applied so as to consider a U.S. person as owning stock that is owned by a person who is not a U.S. person. Additionally, section 318(a)(3)(C) and § 1.318-1(b) shall not be applied so as to consider a U.S. corporation as being a reporting corporation if, but for the application of such sections, the U.S. corporation would not be 25-percent foreign owned.

(2) Attribution of transactions with related parties engaged in by a partnership. The transactions in which a domestic or foreign partnership engages shall be attributed to any reporting corporation whose interest in the capital or profits of the partnership, either directly or indirectly, combined with the interests of all related parties of the reporting corporation partner, equals 25 percent or more of the total partnership interests. Attribution of such transactions shall be made only to the extent of the partnership interest held by that reporting corporation partner. See sections 875 and 702(a) and the regulations thereunder. (Attribution shall not be made however, of transactions directly between the partnership and a reporting corporation.) Accordingly, a reporting corporation partner that is deemed to engage in transactions with related parties under this rule is subject to the information reporting requirements of § 1.6038A-2, to the record maintenance requirements of § 1.6038A-3, to the monetary penalty under § 1.6038A-4, to the requirement of authorization of agent under § 1.6038A-5, to the rules of § 1.6038A-6 relating to the requirement to produce records, and to the noncompliance penalty adjustment under § 1.6038A-7.

(f) Foreign person. For purposes of section 6038A, a foreign person is—

(1) Any individual who is not a citizen or resident of the United States, but not including any individual for whom an election under section 6013 (g) or (h) (relating to an election to file a joint return) is in effect;

(2) Any individual who is a citizen of any possession of the United States and who is not otherwise a citizen or resident of the United States;

(3) Any partnership, association, company, or corporation that is not created or organized in the United States or under the law of the United States or any State thereof;

(4) Any foreign trust or foreign estate, as defined in section 7701(a)(31); or

(5) Any foreign government (or agency or instrumentality thereof). To the extent that a foreign government is engaged in the conduct of commercial activity as defined under section 892 and the regulations thereunder, it will be treated as a foreign person under section 6038A and this section only for purposes of the information reporting requirements of § 1.6038A-2. A foreign government will not be treated as a foreign related party for purposes of §§ 1.6038A-3 and 1.6038A-5.

For purposes of section 6038A, a possession of the United States shall be considered to be a foreign country.

(g) Foreign related party. A foreign related party is a foreign person as defined under paragraph (f) of this section that is also a related party as defined under paragraph (d) of this section.

(h) Small corporation exception. A reporting corporation (other than an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter) that has less than $10,000,000 in U.S. gross receipts for a taxable year is not subject to §§ 1.6038A-3 and 1.6038A-5 for that taxable year. Such a corporation, however, remains subject to the information reporting requirements of § 1.6038A-2 and the general record maintenance requirements of section 6001. For purposes of this paragraph, U.S. gross receipts includes all amounts received or accrued to the extent that such amounts are taken into account for the determination and computation of the gross income of the corporation. For purposes of this test, the U.S. gross receipts of all related reporting corporations shall be aggregated.

(i) Safe harbor for reporting corporations with related party transactions of de minimis value—(1) In general. A reporting corporation (other than an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter) is not subject to §§ 1.6038A-3 and 1.6038A-5 for any taxable year in which the aggregate value of all gross payments it makes to and receives from foreign related parties with respect to related party transactions (including monetary consideration, nonmonetary consideration, and the value of transactions involving less than full consideration) is not more than $5,000,000 and is less than 10 percent of its U.S. gross income. Such a corporation, however, remains subject to the information reporting requirements of § 1.6038A-2 and the general record maintenance requirements of section 6001. For purposes of this paragraph, U.S. gross income means the gross income reportable by the reporting corporation (or the aggregate gross income reportable by all related reporting corporations) for U.S. income tax purposes. Gross payments made to or received from foreign related parties cannot be netted; rather, the gross payments made to and received from foreign related parties are to be aggregated. Thus, for example, if a reporting corporation receives $4,700,000 of gross payments from a related party and makes $500,000 of gross payments to the same related party, it has aggregate gross payments of $5,200,000, and, therefore, does not qualify for the safe harbor under this paragraph.

(2) Aggregate value of gross payments made or received. The aggregate value of gross payments made to (or received from) a foreign related party with respect to foreign related party transactions is determined by totaling the dollar amounts of foreign related party transactions as described in § 1.6038A-2(b) (3) and (4) on all Forms 5472 filed by the reporting corporation or related reporting corporations.

(j) Related reporting corporations. A reporting corporation is related to another reporting corporation if it is related to that other reporting corporation under the principles described in paragraphs (d) and (e) of this section.

(k) Consolidated return groups—(1) Required information. If a reporting corporation is a member of an affiliated group for which a U.S. consolidated income tax return is filed, the return requirement of § 1.6038A-2 may be satisfied by filing a consolidated Form 5472. The common parent, as identified on Form 851, must attach a schedule to the consolidated Form 5472 stating which members of the U.S. affiliated group are reporting corporations under section 6038A, and which of those are joining in the consolidated Form 5472. The schedule must provide the name, address, and taxpayer identification number of each member whose transactions are included on the consolidated Form 5472. A member is not required to join in filing a consolidated Form 5472 merely because other members of the group choose to file one or more Forms 5472 on a consolidated basis.

(2) Maintenance of records and authorization of agent. Either the common parent or the principal operating company of an affiliated group filing a consolidated income tax return may be authorized under § 1.6038A-5 to act as the agent for foreign related persons engaged in transactions with members of the group solely for purposes of section 7602, 7603, and 7604 under section 6038A(e)(1) and § 1.6038A-5. Each member of the group, however, must maintain the records required under section 6038A (a) and § 1.6038A-3 relating to its related party transactions.

(3) Monetary penalties. The common parent (or principal operating company) and all reporting corporations that join in the filing of a consolidated Form 5472 are liable jointly and severally for penalties for failure to file Form 5472 and for failure to mantain records under section 6038A(d) and § 1.6038A-4(e). See § 1.1502-77(a) regarding the scope of agency of the common parent corporation.

(l) District Director. For purposes of the regulations under section 6038A, the term “District Director” means any District Director, or the Assistant Commissioner (International) when performing duties similar to those of a District Director with respect to any person over which the Assistant Commissioner (International) has appropriate jurisdiction.

(m) Examples. The following examples illustrate the rules of this section.

Example 1.P, a U.S. partnership that is engaged in a U.S. trade or business, is 75 percent owned by FC1, a foreign corporation that, in turn, is wholly owned by another foreign corporation, FC2. The remaining 25 percent of P is owned by Corp, a domestic corporation, that is wholly owned by FC3. P engages in transactions solely with FC2 and FC3. These transactions are attributed to FC1 and Corp. Under section 875, FC1 is considered as being engaged in a U.S. trade or business. For purposes of section 6038A and this section, FC1 and Corp are reporting corporations and must report their pro rata shares of the value of the transactions with FC2 and FC3. Thus, Corp must report 25 percent of P's transactions with FC3 and FC1 must report 75 percent of P's transactions with FC2.

Example 2.FC2 and FC3 are both foreign corporations that are wholly owned by FC1, also a foreign corporation. FC2 engages in a trade or business in the United States through a branch. The branch engages in related party transactions with FC1. FC2 is a reporting corporation. FC3 is a foreign related party. FC1 is a direct 25-percent foreign shareholder of both FC2 and FC3. Neither FC1 nor FC3 is a reporting corporation.

Example 3.FC1 owns 25 percent of total voting power in each of FC2 and FC3. FC2 and FC3 each own 20 percent of the total voting power of Corp, a domestic corporation. The remaining stock of Corp is owned by an unrelated domestic corporation. Neither FC2 nor FC3 is engaged in a U.S. trade or business. Under section 318(a)(2)(C) and paragraph (e) of this section, FC1 constructively owns its proportionate share of the stock of Corp owned directly by FC2 and FC3. Thus, FCl is treated as constructively owning five percent of Corp through each of FC2 and FC3 or a total of 10 percent of the Corp stock. Consequently, Corp is not a reporting corporation because no 25 percent shareholder exists.

Example 4.FP owns 100 percent of FCl which, in turn, owns 100 percent of FC2. FC2 owns 100 percent of FC3 which owns 100 percent of RC. FP, FC1, and FC2 are indirect 25-percent foreign shareholders of RC, and FC3 is a direct 25-percent foreign shareholder.

Example 5.FP owns 100 percent of USS, a U.S. corporation, and 25 percent of FS, a foreign corporation. The remaining 75 percent of FS is publicly owned by numerous small shareholders. Sales transactions occur between USS and FS. Applying the rules of this section, USS is a reporting corporation. It is determined that USS and FS are each controlled by FP under section 482 and the regulations thereunder. Therefore, FS is related to USS within the meaning of section 482 and is a related party to USS. Accordingly, the sales transactions between USS and FS are subject to section 6038A.

Example 6.The facts are the same as in Example 5, except that the remaining 75 percent of FS is owned by one shareholder that is unrelated to the FP group and it is determined that FS is not controlled by FP for purposes of section 482. Under these facts, FS is not a related party of either FP or USS. Accordingly, section 6038A does not apply to the sales transactions between FS and USS.

Example 7.P, a U.S. multinational, is a holding company that wholly owns X, a U.S. operating company, which in turn wholly owns FS, a controlled foreign corporation. Applying the rule of section 318(a)(3)(C), FS is deemed to own the stock of X that is actually held by P. However, under the rules of paragraph (e) of this section, X will not be a reporting corporation by reason of section 318.

(n) Effective dates—(1) Section 1.6038A-1. Paragraphs (c) (relating to the definition of a reporting corporation), (d) (relating to the definition of a related party), (e)(1) (relating to the application of section 318), and (f) (relating to the definition of a foreign person) of this section are effective for taxable Years beginning after July 10, 1989. The remaining paragraphs of this section are effective December 10, 1990, without regard to when the taxable year began. However, § 1.6038A-1 as it applies to entities that are reporting corporations as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter applies to taxable years of such reporting corporations beginning after December 31, 2016, and ending on or after December 13, 2017.

(2)(Section 1.6038A-2—(i) In general. Section 1.6038A-2 (relating to the requirement to file Form 5472) generally applies for taxable years beginning after July 10, 1989. However, § 1.6038A-2 as it applies to reporting corporations whose sole trade or business in the United States is a banking, financing, or similar business as defined in § 1.864-4(c)(5)(i) applies for taxable years beginning after December 10, 1990. Section 1.6038A-2(d) applies for taxable years ending on or after June 10, 2011. For taxable years ending on or after June 10, 2011, but before December 24, 2014, see § 1.6038A-2(e) as contained in 26 CFR part 1 revised as of April 1, 2014. For taxable years ending before June 10, 2011, see § 1.6038A-2(d) and (e) as contained in 26 CFR part 1 revised as of April 1, 2011. Section 1.6038A-2 as it applies to entities that are reporting corporations as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter applies to taxable years of such reporting corporations beginning after December 31, 2016, and ending on or after December 13, 2017. Section 1.6038A-2(a)(3), (b)(6), and (b)(7) apply to taxable years ending on or after December 17, 2018. However, taxpayers may apply these final regulations in their entirety for taxable years ending before December 17, 2018.

(ii) Transition rule. No penalty under sections 6038A(d) or 6038C(c) will apply to a failure solely under § 1.6038A-2(a)(3), (b)(6), or (b)(7) that is corrected by March 6, 2020.

(3) Section 1.6038A-4. Section 1.6038A-4 (relating to the monetary penalty) is generally effective for taxable years beginning after July 10, 1989, for the failure to file Form 5472. For the failure to maintain records or the failure to produce documents under § 1.6038A-4(f)(2), the section is effective December 10, 1990, without regard to when the taxable year to which the records relate began. For taxable years ending on or before December 31, 2017, see § 1.6038A-4 as contained in 26 CFR part 1 revised as of April 1, 2018.

(4) Section 1.6038A-5. Section 1.6038A-5 (relating to the authorization of agent requirement) is effective December 10, 1990, without regard to when the taxable year to which the records relate began.

(5) Section 1.6038A-6. Section 1.6038A-6 (relating to the failure to furnish information under a summons) is effective November 6, 1990, without regard to when the taxable year to which the summons relates began.

(6) Section 1.6038A-7. Section 1.6038A-7 (relating to the noncompliance penalty adjustment) is effective December 10, 1990, without regard to when the taxable year began.

[T.D. 8353, 56 FR 28061, June 19, 1991; T.D. 8353, 56 FR 41792, Aug. 23, 1991, as amended by T.D. 9161, 69 FR 55500, Sept. 15, 2004; T.D. 9456, 74 FR 38875, Aug. 4, 2009; T.D. 9529, 76 FR 33999, June 10, 2011; T.D. 9667, 78 FR 32644, June 6, 2014; T.D. 9707, 79 FR 77388, Dec. 24, 2014; T.D. 9796, 81 FR 89850, Dec. 13, 2016; T.D. 9885, 84 FR 67044, Dec. 6, 2019]

§ 1.6038A-2 Requirement of return.

(a) Forms required—(1) Form 5472. Each reporting corporation as defined in § 1.6038A-1(c) (or members of an affiliated group filing together as described in § 1.6038A-1(k)) shall make a separate annual information return on Form 5472 with respect to each related party as defined in § 1.6038A-1(d) with which the reporting corporation (or any group member joining in a consolidated Form 5472) has had any reportable transaction during the taxable year. The information required by section 6038A and this section must be furnished even though it may not affect the amount of any tax due under the Code.

(2) Reportable transaction. A reportable transaction is any transaction of the types listed in paragraphs (b)(3) and (4) of this section, and, in the case of a reporting corporation that is an applicable taxpayer, as defined under § 1.59A-2(b), any other arrangement that, to prevent avoidance of the purposes of section 59A, is identified on Form 5472 as a reportable transaction. However, except as the Secretary may prescribe otherwise for an applicable taxpayer, the transaction is not a reportable transaction if neither party to the transaction is a United States person as defined in section 7701(a)(30) (which, for purposes of section 6038A, includes an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter) and the transaction—

(i) Will not generate in any taxable year gross income from sources within the United States or income effectively connected, or treated as effectively connected, with the conduct of a trade or business within the United States, and

(ii) Will not generate in any taxable year any expense, loss, or other deduction that is allocable or apportionable to such income.

(3) Form 8991. Each reporting corporation that is an applicable taxpayer, as defined under § 1.59A-2(b), must make an annual information return on Form 8991. The obligation of an applicable taxpayer to report on Form 8991 does not depend on applicability of tax under section 59A or obligation to file Form 5472.

(b) Contents of return—(1) Reporting corporation. Form 5472 must provide the following information in the manner the form prescribes with respect to each reporting corporation:

(i) Its name, address (including mailing code), and U.S. taxpayer identification number; each country in which the reporting corporation files an income tax return as a resident under the tax laws of that country; its country or countries of organization, and incorporation; its total assets for U.S. reporting corporation; the places where it conducts its business; and its principal business activity.

(ii) The name, address, and U.S. taxpayer identification number, if applicable, of all its direct and indirect foreign shareholders (for an indirect 25-percent foreign shareholder, explain the attribution of ownership); whether any 25-percent foreign shareholder is a surrogate foreign corporation under section 7874(a)(2)(B) or a member of an expanded affiliated group as defined in section 7874(c)(1); each country in which each 25-percent foreign shareholder files an income tax return as a resident under the tax laws of that country; the places where each 25-percent shareholder conducts its business; and the country or countries of organization, citizenship, and incorporation of each 25-percent foreign shareholder.

(iii) The number of Forms 5472 filed for the taxable year and the aggregate value in U.S. dollars of gross payments as defined in § 1.6038A-1(h)(2) made with respect to all foreign related party transactions reported on all Forms 5472.

(2) Related party. The reporting corporation must provide information on Form 5472, set forth in the manner the form prescribes, about each related party, whether foreign or domestic, with which the reporting corporation had a transaction of the types described in paragraphs (b) (3) and (4) of this section during its taxable year, including the following information:

(i) The name, U.S. taxpayer identification number, if applicable, and address of the related party.

(ii) The nature of the reated party's business and the principal place or places where it conducts its business.

(iii) Each country in which the related party files an income tax return as a resident under the tax laws of that country.

(iv) The relationship of the reporting corporation to the related party (including, to the extent the form may prescribe, any intermediate relationships).

(3) Foreign related party transactions for which only monetary consideration is paid or received by the reporting corporation. If the related party is a foreign person, the reporting corporation must set forth on Form 5472 the dollar amounts of all reportable transactions for which monetary consideration (including U.S. and foreign currency) was the sole consideration paid or received during the taxable year of the reporting corporation. The total amount of such transactions, as well as the separate amounts for each type of transaction described below, and, to the extent the form may prescribe, any further description, categorization, or listing of transactions within these types, must be reported on Form 5472, in the manner the form or its instructions may prescribe. Where actual amounts are not determinable, a reasonable estimate (as described in paragraph (b)(6) of this section) is permitted. The types of transactions described in this paragraph are:

(i) Sales and purchases of stock in trade (inventory);

(ii) Sales and purchases of tangible property other than stock in trade;

(iii) Rents and royalties paid and received (other than amounts reported under paragraph (b)(3)(iv) of this section);

(iv) Sales, purchases, and amounts paid and received as consideration for the use of all intangible property, including (but not limited to) copyrights, designs, formulas, inventions, models, patents, processes, trademarks, and other similar intangible property rights;

(v) Consideration paid and received for technical, managerial, engineering, construction, scientific, or other services;

(vi) Commissions paid and received;

(vii) Amounts loaned and borrowed (except open accounts resulting from sales and purchases reported under other items listed in this paragraph (b)(3) that arise and are collected in full in the ordinary course of business), to be reported as monthly averages or outstanding balances at the beginning and end of the taxable year, as the form shall prescribe;

(viii) Interest paid and received;

(ix) Premiums paid and received for insurance and reinsurance;

(x) Other amounts paid or received not specifically identified in this paragraph (b)(3) to the extent that such amounts are taken into account for the determination and computation of the taxable income of the reporting corporation; and

(xi) With respect to an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter, any other transaction as defined by § 1.482-1(i)(7), such as amounts paid or received in connection with the formation, dissolution, acquisition and disposition of the entity, including contributions to and distributions from the entity.

(4) Foreign related party transactions involving nonmonetary consideration or less than full consideration. If the related party is a foreign person, the reporting corporation must provide on Form 5472 a description of any reportable transaction, or group of reportable transactions, listed in paragraph (b)(3) of this section, for which any part of the consideration paid or received was not monetary consideration, or for which less than full consideration was paid or received. A description required under paragraph (b)(4) of this section shall include sufficient information from which to determine the nature and approximate monetary value of the transaction or group of transactions, and shall include:

(i) A description of all property (including monetary consideration), rights, or obligations transferred from the reporting corporation to the foreign related party and from the foreign related party to the reporting corporation;

(ii) A description of all services performed by the reporting corporation for the foreign related party and by the foreign related party for the reporting corporation; and

(iii) A reasonable estimate of the fair market value of all properties and services exchanged, if possible, or some other reasonable indicator of value.

If, for any transaction, the entire consideration received includes both tangible and intangible property and the consideration paid is solely monetary consideration, the transaction should be reported under paragraph (b)(3) of this section if the intangible property was related and incidental to the transfer of the tangible property (for example, a right to warranty services.)

(5) Additional information. In addition to the information required under paragraphs (b) (3) and (4) of this section, a reporting corporation must provide on Form 5472, in the manner the form prescribes, the following information:

(i) If the reporting corporation imports goods from a foreign related party, whether the costs taken into account in computing the basis or inventory cost of such goods are greater than the costs taken into account in computing the valuation of the goods for customs purposes, adjusted pursuant to section 1059A and the regulations thereunder, and if so, the reasons for the difference.

(ii) If the costs taken into account in computing the basis or inventory cost of such goods are greater than the costs taken into account in computing the valuation of the goods for customs purposes, whether the documents supporting the reporting corporation's treatment of the items set forth in paragraph (b)(5)(i) of this section are in existence and available in the United States at the time Form 5472 is filed.

(iii) If, for the taxable year, a reporting corporation pays or accrues interest or royalties for which a deduction is disallowed under section 267A and the regulations in this part under section 267A, then the reporting corporation must provide such information about the disallowance in the form and manner and to the extent prescribed by Form 5472 (or successor form), instruction, publication, or other guidance.

(iv) If, for the taxable year, the reporting corporation has a deduction under section 250 (by reason of having foreign-derived intangible income) with respect to any amount required to be reported under paragraph (b)(3) or (4) of this section, the reporting corporation will provide on Form 5472 (or any successor form) such information about the deduction in the form and manner and to the extent prescribed by Form 5472 (or any successor form), instructions to the form, publication, or other guidance published in the Internal Revenue Bulletin.

(6) Compilation of reportable transactions across multiple related parties. A reporting corporation must, to the extent and in the manner Form 5472 or its instructions may prescribe, include a schedule tabulating information with respect to related parties for which the reporting corporation is required to file Forms 5472. The schedule will not require information (beyond totaling) that is not required for the individual Forms 5472. The schedule may include the following:

(i) The identity and status of the related parties;

(ii) The reporting corporation's relationship to the related parties;

(iii) The reporting corporation's reportable transactions with the related parties; and

(iv) Other items required to be reported on Form 5472.

(7) Information on Form 5472 and Form 8991 regarding base erosion payments. If any reporting corporation is an applicable taxpayer, as defined under § 1.59A-2(b), it must report the information required by Form 8991 and by any Form 5472 it is required to file (including the information required by their accompanying instructions), regarding:

(i) Determination of whether a taxpayer is an applicable taxpayer;

(ii) Computation of base erosion minimum tax amount, including computation of regular tax liability as adjusted for purposes of computing base erosion minimum tax amount;

(iii) Computation of modified taxable income;

(iv) Base erosion tax benefits;

(v) Base erosion percentage calculation;

(vi) Base erosion payments;

(vii) Amounts with respect to services as described in § 1.59A-3(b)(3)(i), including a breakdown of the amount of the total services cost and any mark-up component;

(viii) Arrangements or transactions described in § 1.59A-9;

(ix) Any qualified derivative payment, including:

(A) The aggregate amount of qualified derivative payments for the taxable year; and

(B) A representation that all payments satisfy the requirements of § 1.59A-6(b)(2); and

(x) Any other information necessary to carry out section 59A.

(8) Reasonable estimate—(i) Estimate within 25 percent of actual amount. Any amount reported under this section is considered to be a reasonable estimate if it is at least 75 percent and not more than 125 percent of the actual amount.

(ii) Other estimates. If any amount reported under this paragraph (b) of this section fails to meet the reasonable estimate test of paragraph (b)(6)(i) of this section, the reporting corporation nevertheless may show that such amount is a reasonable estimate by making an affirmative showing of relevant facts and circumstances in a written statement containing a declaration that it is made under the penalties of perjury. The District Director shall determine whether the amount reported was a reasonable estimate.

(9) Small amounts. If any actual amount required under this section does not exceed $50,000, the amount may be reported as “$50,000 or less.”

(10) Accrued payments and receipts. For purposes of this section, a reporting corporation that uses an accrual method of accounting shall use accrued payments and accrued receipts for purposes of computing the total amount of each of the types of transactions listed in this section.

(11) Examples. The following examples illustrate the application of paragraph (b)(3) of this section:

Example 1. (i) In year 1, W, a foreign corporation, forms and contributes assets to X, a domestic limited liability company that does not elect to be treated as a corporation under § 301.7701-3(c) of this chapter. In year 2, W contributes funds to X. In year 3, X makes a payment to W. In year 4, X, in liquidation, distributes its assets to W.

(ii) In accordance with § 301.7701-3(b)(1)(ii) of this chapter, X is disregarded as an entity separate from W. In accordance with § 301.7701-2(c)(2)(vi) of this chapter, X is treated as an entity separate from W and classified as a domestic corporation for purposes of section 6038A. In accordance with paragraphs (a)(2) and (b)(3) of this section, each of the transactions in years 1 through 4 is a reportable transaction with respect to X. Therefore, X has a section 6038A reporting and record maintenance requirement for each of those years.

Example 2. (i) The facts are the same as in Example 1 of this paragraph (b)(9) except that, in year 1, W also forms and contributes assets to Y, another domestic limited liability company that does not elect to be treated as a corporation under § 301.7701-3(c) of this chapter. In year 1, X and Y form and contribute assets to Z, another domestic limited liability company that does not elect to be treated as a corporation under § 301.7701-3(c) of this chapter. In year 2, X transfers funds to Z. In year 3, Z makes a payment to Y. In year 4, Z distributes its assets to X and Y in liquidation.

(ii) In accordance with § 301.7701-3(b)(1)(ii) of this chapter, Y and Z are disregarded as entities separate from each other, W, and X. In accordance with § 301.7701-2(c)(2)(vi) of this chapter, Y, Z and X are treated as entities separate from each other and W, and are classified as domestic corporations for purposes of section 6038A. In accordance with paragraph (b)(3) of this section, each of the transactions in years 1 through 4 involving Z is a reportable transaction with respect to Z. Similarly, W's contribution to Y and Y's contribution to Z in year 1, the payment to Y in year 3, and the distribution to Y in year 4 are reportable transactions with respect to Y. Moreover, X's contribution to Z in Year 1, X's funds transfer to Z in year 2, and the distribution to X in year 4 are reportable transactions with respect to X. Therefore, Z has a section 6038A reporting and record maintenance requirement for years 1 through 4; Y has a section 6038A reporting and record maintenance requirement for years 1, 3, and 4; and X has a section 6038A reporting and record maintenance requirement in years 1, 2, and 4 in addition to its section 6038A reporting and record maintenance described in Example 1 of this paragraph (b)(9).

(c) Method of reporting. All statements required on or with the Form 5472 or Form 8991 under this section and § 1.6038A-5 must be in the English language. All amounts required to be reported under paragraph (b) of this section must be expressed in United States currency, with a statement of the exchange rates used, and, to the extent the forms may require, must indicate the method by which the amount of a reportable transaction or item was determined.

(d) Time for filing returns. A Form 5472 and Form 8991 required under this section must be filed with the reporting corporation's income tax return for the taxable year by the due date (including extensions) of that return. In the case of an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter, Form 5472 must be filed at such time and in such manner as the Commissioner may prescribe in forms or instructions.

(e) Exceptions—(1) No reportable transactions. A reporting corporation is not required to file Form 5472 if it has no transactions of the types listed in paragraphs (b) (3) and (4) of this section during the taxable year with any related party.

(2) Transactions solely with a domestic reporting corporation. If all of a foreign reporting corporation's reportable transactions are with one or more related domestic reporting corporations that are not members of the same affiliated group, the foreign reporting corporation shall furnish on Form 5472 only the information required under paragraphs (b) (1) and (2) of this section, if the domestic reporting corporations provide the information required under paragraphs (b) (3) through (5) of this section. Such a foreign reporting corporation nonetheless is subject to the record maintenance requirements of § 1.6038A-3 and the requirements of §§ 1.6038A-5 and 1.6038A-6. The name, address, and taxpayer identification number of each domestic reporting corporation that provided such information must be indicated on Form 5472 in the space provided for the information under paragraphs (b) (1) and (2) of this section.

(3) Transactions with a corporation subject to reporting under section 6038. A reporting corporation (other than an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter) is not required to make a return of information on Form 5472 with respect to a related foreign corporation for a taxable year for which a U.S. person that controls the foreign related corporation makes a return of information on Form 5471 that is required under section 6038 and this section, if that return contains information required under § 1.6038-2(f)(11) with respect to the reportable transactions between the reporting corporation and the related corporation for that taxable year. Such a reporting corporation also is not subject to §§ 1.6038A-3 and 1.6038A-5. It remains subject to the general record maintenance requirements of section 6001.

(4) Transactions with a foreign sales corporation. A reporting corporation (other than an entity that is a reporting corporation as a result of being treated as a corporation under § 301.7701-2(c)(2)(vi) of this chapter) is not required to make a return of information on Form 5472 with respect to a related corporation that qualifies as a foreign sales corporation for a taxable year for which the foreign sales corporation files Form 1120-FSC.

(f) Filing Form 5472 when transactions with related parties engaged in by a partnership are attributed to a reporting corporation. If transactions engaged in by a partnership are attributed under § 1.6038A-1(e)(2) to a reporting corporation, the reporting corporation need report on Form 5472 only the percentage of the value of the transaction or transactions equal to the percentage of its partnership interest. Thus, for example, if a partnership buys $1000 of widgets from the foreign parent of a reporting corporation whose partnership interest in the partnership equals 50 percent of the partnership interests (and the remaining 50 percent is held by unrelated parties), the reporting corporation must report $500 of purchases from a foreign related party on Form 5472.

(g) Effective/applicability date. Except as otherwise provided, for applicability dates for this section for certain reporting corporations, see § 1.6038A-1(n). Paragraph (b)(10) of this section applies with respect to information for annual accounting periods beginning on or after June 21, 2006. Paragraph (b)(7)(ix) of this section applies to payments made in taxable years beginning on or after January 1, 2027. Before these final regulations are applicable, a taxpayer will be treated as satisfying the reporting requirement described in § 1.59A-6(b)(2) only to the extent that it reports the aggregate amount of qualified derivative payments on Form 8991. See § 1.59A-6(b)(2)(iv) (transition period for qualified derivative payment reporting). Paragraph (b)(5)(iii) of this section applies with respect to information for annual accounting periods beginning on or after December 20, 2018. Paragraph (b)(5)(iv) of this section applies with respect to information for annual accounting periods beginning on or after March 4, 2019.

[T.D. 8353, 56 FR 28063, June 19, 1991, as amended by T.D. 9113, 69 FR 5932, Feb. 9, 2004; T.D. 9161, 69 FR 55500, Sept. 15, 2004; T.D. 9268, 71 FR 35526, June 21, 2006; T.D. 9338, 72 FR 38476, July 13, 2007; T.D. 9529, 76 FR 33999, June 10, 2011; T.D. 9667, 78 FR 32645, June 6, 2014; T.D. 9707, 79 FR 77389, Dec. 24, 2014; T.D. 9796, 81 FR 89851, Dec. 13, 2016; T.D. 9885, 84 FR 67044, Dec. 6, 2019; T.D. 9885, 85 FR 9370, Feb. 19, 2020; T.D. 9896, 85 FR 19857, Apr. 8, 2020; T.D. 9901, 85 FR 43117, July 15, 2020; T.D. 10041, 90 FR 59051, Dec. 18, 2025]

§ 1.6038A-3 Record maintenance.

(a) General maintenance requirements—(1) Section 6001 and section 6038A. A reporting corporation must keep the permanent books of account or records as required by section 6001 that are sufficient to establish the correctness of the federal income tax return of the corporation, including information, documents, or records (“records”) to the extent they may be relevant to determine the correct U.S. tax treatment of transactions with related parties. Under section 6001, the District Director may require any person to make such returns, render such statements, or keep such specific records as will enable the District Director to determine whether or not that person is liable for any of the taxes to which the regulations under part I have application. See section 6001 and the regulations thereunder. Such records must be permanent, accurate, and complete, and must clearly establish income, deductions, and credits. Additionally, in appropriate cases, such records include sufficient relevant cost data from which a profit and loss statement may be prepared for products or services transferred between a reporting corporation and its foreign related parties. This requirement includes records of the reporting corporation itself, as well as to records of any foreign related party that may be relevant to determine the correct U.S. tax treatment of transactions between the reporting corporation and foreign related parties. The relevance of such records with respect to related party transactions shall be determined upon the basis of all the facts and circumstances. Section 6038A and this section provide detailed guidance regarding the required maintenance of records with respect to such transactions and specify penalties for noncompliance. Banks and other financial institutions shall follow the specific record maintenance rules described in paragraph (h) of this section.

(2) Safe harbor. A safe harbor for record maintenance is provided under paragraph (c) of this section, which sets forth detailed guidance concerning the types of records to be maintained with respect to related party transactions. The safe harbor consists of an all-inclusive list of record types that could be relevant to different taxpayers under a variety of facts and circumstances. It does not constitute a checklist of records that every reporting corporation must maintain or that generally should be requested by the Service. A specific reporting corporation is required to maintain, and the Service will request, only those records enumerated in the safe harbor (including material profit and loss statements) that may be relevant to its business or industry and to the correct U.S. tax treatment of its transactions with its foreign related parties. Accordingly, not every item listed in the safe harbor must be maintained by every reporting corporation. A corporation that maintains or causes another person to maintain the records listed in paragraph (c)(2) of this section that may be relevant to its foreign related party transactions and to its business or industry will be deemed to have met the record maintenance requirements of section 6038A.

(3) Examples. The following examples illustrate the rules of this paragraph.

Example 1.RC, a U.S. reporting corporation, is owned by two shareholders, F and P. F is a foreign corporation that owns 30 percent of the stock of RC. P is a domestic corporation that owns the remaining 70 percent. RC purchases tangible property from F; however, the only potential audit issue with respect to these transactions is their treatment under section 482. It is determined that F does not in fact control RC and the two corporations do not constitute a group of “controlled taxpayers” for purposes of section 482 and the regulations thereunder. There are no other reportable transactions between RC and F. Under § 1.6038A-1(g), F is a foreign related party with respect to RC. Accordingly, RC is required to report its purchases of property from F under the reporting requirements of § 1.6038A-2. Nevertheless, because section 482 is not applicable to the transactions between RC and F, the records created by F with respect to its sales to RC are not relevant for purposes of determining the correct tax treatment of these transactions. RC is required to maintain its own records of these transactions under the requirements of section 6001, but the transactions are not subject to the record maintenance requirements of this section. If, however, on audit it is determined that F does control RC, all records relevant to determining the arm's length consideration for the tangible property under section 482 will be subject to these requirements.

Example 2.FP, a foreign person, owns 30 percent of the stock of RC, a reporting corporation. The remaining 70 percent of RC stock is held by persons that are not 25-percent foreign shareholders. It is determined that FP is related to RC within the meaning of section 482 and the regulations thereunder. The only transactions between FP and RC are FP's capital contributions, dividends paid from RC to FP, and loans from FP to RC. Under section 6001, RC is required to maintain all documentation necessary to establish the U.S. tax treatment of the capital contributions, dividends, and loans. RC is not required to maintain records in other categories listed in paragraph (c)(3) of this section because they are not relevant to the transactions between FP and RC. Records of FP not related to these transactions are not subject to the record maintenance requirements under section 6038A(a) and this section.

Example 3.G, a foreign multinational group, creates Sub, a wholly-owned U.S. subsidiary, in order to purchase tangible property from unrelated parties in the United States and resell such property to G. The property purchased by Sub is either used in G's business or resold to other unrelated parties by G. Sub's sole function is to act as a buyer for G and these purchases are the only transactions that G has with any U.S. affiliates. Under all the facts and circumstances of this case, it is determined that an analysis of the group's worldwide profit attributable to the property it purchases from Sub is not relevant for purposes of determining the tax treatment of the sales from Sub to G. Therefore, the records with respect to the profitability of G are not subject to the record maintenance requirements of this section. However, all records related to the appropriate method under section 482 for determining an arm's-length consideration for the property sold by Sub to G are subject to the record maintenance requirements of this section.

Example 4.S, a U.S. reporting corporation, provides computer consulting services for its foreign parent, X. Based on the application of section 482 and the regulations, it is determined that the cost of services plus method, as described in § 1.482-9(e), will provide the most reliable measure of an arm's length result, based on the facts and circumstances of the controlled transaction between S and X. S is required to maintain records to permit verification upon audit of the comparable transactional costs (as described in § 1.482-9(e)(2)(iii)) used to calculate the arm's length price. Based on the facts and circumstances, if it is determined that X's records are relevant to determine the correct U.S. tax treatment of the controlled transaction between S and X, the record maintenance requirements under section 6038A(a) and this section will be applicable to the records of X.

(b) Other maintenance requirements—(1) Indirectly related records. This section applies to records that are directly or indirectly related to transactions between the reporting corporation and any foreign related parties. An example of records that are indirectly related to such transactions is records possessed by a foreign subsidiary of a foreign related party that document the raw material or component costs of a product that is manufactured or assembled by the subsdiary and sold as a finished product by the foreign related party to the reporting corporation.

(2) Foreign related party or third-party maintenance. If records that are required to be maintained under this section are in the control of a foreign related party, the records may be obtained or compiled (if not already in the possession of the foreign related party or already compiled) under the direction of the reporting corporation and then maintained by the reporting corporation, the foreign related party, or a third party. Thus, for example, a foreign related party may either itself maintain such records outside the United States or permit a third party to maintain such records outside the United States, provided that the conditions described in paragraph (f) of this section are met. Upon a request for such records by the Service, a foreign related party or third party may make arrangements with the District Director to furnish the records directly, rather than through the reporting corporation.

(3) Translation of records. When records are provided to the Service under a request for production, any portion of such records must be translated into the English language within 30 days of a request for translation of that portion by the District Director. To the extent that any requested documents are identical to documents that have already been translated, an explanation of how such documents are identical instead may be provided. An extension of this time period may be requested under paragraph (f)(4) of this section. Appropriate extensions will be liberally granted for translation requests where circumstances warrant. If a good faith effort is made to translate accurately the requested documents within the specified time period, the reporting corporation will not be subject to the penalties in §§ 1.6038A-4 and 1.6038A-7.

(4) Exception for foreign governments. A foreign government is not subject to the obligation to maintain records under this section.

(5) Records relating to conduit financing arrangements. See § 1.881-4 relating to conduit financing arrangements.

(c) Specific records to be maintained for safe harbor—(1) In general. A reporting corporation that maintains or causes another person to maintain the records specified in this paragraph (c) that are relevant to its business or industry and to the correct U.S. tax treatment of its transactions with its foreign related parties will deemed to have met the record maintenance requirements of this section. This paragraph provides general descriptions of the categories of records to be maintained; the particular title or label applied by a reporting corporation or related party does not control. Functional equivalents of the specified documents are acceptable. Record maintenance in accordance with this safe harbor, however, requires only the maintenance of types of documents described in paragraph (c)(2) of this section that are directly or indirectly related to transactions between the reporting corporation and any foreign related party. Additionally, to the extent the reporting corporation establishes that records in a particular category are not applicable to the industry or business of the reporting corporation and any foreign related party, maintenance of such records is not required under this paragraph. Record maintenance in accordance with this paragraph (c) generally does not require the original creation of records that are ordinarily not created by the reporting corporation or its related parties. (If, however, a document that is actually created is described in this paragraph (c), it is to be maintained even if the document is not of the type ordinarily created by the reporting corporation or its related parties.) There are two exceptions to the rule. First, basic accounting records that are sufficient to document the U.S. tax effects of transactions between related parties must be created and retained, if they do not otherwise exist. Second, records sufficient to produce material profit and loss statements as described in paragraphs (c)(2)(ii) and (3) of this section that are relevant for determining the U.S. tax treatment of transactions between the reporting corporation and foreign related parties must be created if such records are not ordinarily maintained. All internal records storage and retrieval systems used for each taxable year must be retained.

(2) Descriptions of categories of documents to be maintained. The following records must be maintained in order to satisfy this paragraph (c) to the extent they may be relevant to determine the correct U.S. tax treatment of transactions between the reporting corporation and any foreign related party.

(i) Original entry books and transaction records. This category includes books and records of original entry or their functional equivalents, however designated or labelled, that are relevant to transactions between any foreign related party and the reporting corporation. Examples include, but are not limited to, general ledgers, sales journals, purchase order books, cash receipts books, cash disbursement books, canceled checks and bank statements, workpapers, sales contracts, and purchase invoices. Descriptive material to explicate entries in the foregoing types of records, such as a chart of accounts or an accounting policy manual, is included in this category.

(ii) Profit and loss statements. This category includes records from which the reporting corporation can compile and supply, within a reasonable time, material profit and loss statements of the reporting corporation and all related parties as defined in § 1.6038A-1 (d) (the “related party group”) that reflect profit or loss of the related party group attributable to U.S.-connected products or services as defined in paragraph (c)(7)(i) of this section. The determination of whether a profit and loss statement is material is made under the rules provided in paragraph (c)(3) of this section. The material profit and loss statements described in this paragraph (c)(2)(ii) must reflect the consolidated revenue and expenses of all members of the related party group. Thus, records in this category include the documentation of the cost of raw materials used by a related party to manufacture finished goods that are then sold by another related party to the reporting corporation. The records should be kept under U.S. generally accepted accounting principles if they are ordinarily maintained in such manner; if not, an explanation of the material differences between the accounting principles used and U.S. generally accepted accounting principles must be made available. The statements need not reflect tracing of the actual costs borne by the group with respect to its U.S.-connected products or services; rather, any reasonable method may be used to allocate the group's worldwide costs to the revenues generated by the sales of those products or services. An explanation of the methods used to allocate specific items to a particular profit and loss statement must be made available. The explanation of material differences between accounting principles and the explanation of allocation methods must be sufficient to permit a comparison of the profitability of the group to that of the reporting corporation attributable to the provision of U.S.-connected products or services.

(iii) Pricing documents. This category includes all documents relevant to establishing the appropriate price or rate for transactions between the reporting corporation and any foreign related party. Examples include, but are not limited to, documents related to transactions involving the same or similar products or services entered into by the reporting corporation or a foreign related party with related and unrelated parties; shipping and export documents; commission agreements; documents relating to production or assembly facilities; third-party and intercompany purchase invoices; manuals, specifications, and similar documents relating to or describing the performance of functions conducted at particular locations; intercompany correspondence discussing any instructions or assistance relating to such transactions provided to the reporting corporations by the related foreign person (or vice versa); intercompany and intracompany correspondence concerning the price or the negotiation of the price used in such transactions; documents related to the value and ownership of intangibles used or developed by the reporting corporation or the foreign related party; documents related to cost of goods sold and other expenses; and documents related to direct and indirect selling, and general and administrative expenses (for example, relating to advertising, sales promotions, or warranties).

(iv) Foreign country and third party filings. This category includes financial and other documents relevant to transactions between a reporting corporation and any foreign related party filed with or prepared for any foreign government entity, any independent commission, or any financial institution.

(v) Ownership and capital structure records. This category includes records or charts showing the relationship between the reporting corporation and the foreign related party; the location, ownership, and status (for example, joint venture, partnership, branch, or division) of all entities and offices directly or indirectly involved in the transactions between the reporting corporation and any foreign related party; a worldwide organization chart; records showing the management structure of all foreign affiliates; and loan documents, agreements, and other documents relating to any transfer of the stock of the reporting corporation that results in the change of the status of a foreign person as a foreign related party.

(vi) Records of loans, services, and other non-sales transactions. This category includes relevant documents relating to loans (including all deposits by one foreign related party or reporting corporation with an unrelated party and a subsequent loan by that unrelated party to a foreign related party or reporting corporation that is in substance a direct loan between a reporting corporation and a foreign related party); guarantees of a foreign related party of debts of the reporting corporation, and vice versa; hedging arrangements or other risk shifting or currency risk shifting arrangements involving the reporting corporation and any foreign related party; security agreements between the reporting corporation and any foreign related party; research and development expense allocations between any foreign related party and the reporting corporation; service transactions between any foreign related party and the reporting corporation, including, for example, a description of the allocation of charges for management services, time or travel records, or allocation studies; import and export transactions between a reporting corporation and any foreign related party; the registration of patents and copyrights with respect to transactions between the reporting corporation and any foreign related party: and documents regarding lawsuits in foreign countries that relate to such transactions between a reporting corporation and any foreign related party (for example, product liability suits for U.S. products).

(vii) Records relating to conduit financing arrangements. See § 1.881-4 relating to conduit financing arrangements.

(3) Material profit and loss statements. For purposes of paragraph (c)(2)(ii) of this section, the determination of whether a profit and loss statement is material will be made according to the following rules. An agreement between the reporting corporation and the District Director as described in paragraph (e) of this section may identify material profit and loss statements of the related party group and describe the items to be included in any profit and loss statements for which records are to be maintained to satisfy the requirements of paragraph (c)(2)(ii) of this section. In the absence of such an agreement, a profit and loss statement will be material if it meets any of the following tests: the existing records test described in paragraph (c)(4) of this section, the significant industry segment test described in paragraph (c)(5) of this section, or the high profit test described in paragraph (c)(6) of this section.

(4) Existing records test. A profit and loss statement is material under the existing records test described in this paragraph (c)(4) if any member of the related party group creates or compiles such statement in the course of its business operations and the statement reflects the profit or loss of the related party group attributable to the provision of U.S.-connected products or services (regardless of whether the profit and loss attributable to U.S.-connected products or services is shown separately or included within the calculation of aggregate figures on the statement). For example, a profit and loss statement is described in this paragraph if it was produced for internal accounting or management purposes, or for disclosure to shareholders, financial institutions, government agencies, or any other persons. Such existing statements and the records from which they were complied (to the extent such records relate to profit and loss attributable to U.S.-connected products or services) are subject to the record maintenance requirements described in paragraph (c)(2)(ii) of this section.

(5) Significant industry segment test—(i) In general. A profit and loss statement is material under the significant industry segment test described in this paragraph (c)(5) if—

(A) The statement reflects the profit or loss of the related party group attributable to the group's provision of U.S.-connected products or services within a single industry segment (as defined in paragraph (c)(7)(ii) of this section);

(B) The worldwide gross revenue attributable to such industry segment is 10 percent or more of the worldwide gross revenue attributable to the group's combined industry segments; and

(C) The amount of gross revenue earned by the group from the provision of U.S.-connected products or services within such industry segment is $25 million or more in the taxable year.

(ii) Form of the statements. Profit and loss statements compiled for the group's provision of U.S.-connected products or services in each significant industry segment must reflect revenues and expenses attributable to the operations in such segment by all members of the related party group. Statements may show each related party's revenues and expenses separately, or may be prepared in a consolidated format. Any reasonable method may be used to allocate the group's worldwide costs within the industry segment to the U.S.-connected products or services within that segment. An explanation of the methods used to prepare consolidated statements and to allocate specific items to a particular profit and loss statement must be made available, and the records from which the consolidations and allocations were prepared must be maintained.

(iii) Special rule for component sales. Where the U.S.-connected products or services consist of components that are incorporated into other products or services before sale to customers, the portion of the total gross revenue derived from sales of the finished products or services attributable to the components may be determined on the basis of relative costs of production. Thus, where relevant for determining whether the $25 million threshold in paragraph (c)(5)(i)(C) of this section has been met, the amount of gross revenue derived by the related party group from the provision of the finished products or services may be reduced by multiplying it by a fraction, the numerator of which is the costs of production of the related party group attributable to the component products or services that constitute U.S.-connected products or services and the denominator of which is the costs of production of the related party group attributable to the finished products in which such components are incorporated.

(iv) Level of specificity required. In applying the significant industry segment test of this paragraph (c)(5), groups of related products and services must be chosen to provide a reasonable level of specificity that results in the greatest number of separate significant industry segments in comparison to other possible classifications. This determination must be made on the basis of the particular facts presented by the operations of the related party group. The following rules, however, provide general guidelines for making such classifications. First, the related party group's operations that involve the provision of U.S.-connected products should be grouped into product lines. The rules of this paragraph (c)(5) should then be applied to determine if any such product line would, standing alone, constitute a significant industry segment when compared to the related party group's operations as a whole. Any significant industry segments determined at the level of product lines should be further segregated, and tested for significant industry segments, at the level of separate products. Finally, any significant industry segments determined at the level of separate products should be segregated, and tested for significant industry segments, at the level of separate models. Similar principles should be applied in classifying and testing types of services. A profit and loss statement reflecting the related party group's provision of any product or service (or group of products or services as classified under these rules) that constitutes a significant industry segment will be considered material for purposes of this paragraph (c)(5). For definitions of the terms “product”, “related products or services”, “model”, and ”product line”, see paragraph (c)(7) of this section.

(v) Examples. The rules for determining reasonable levels of specificity for significant industry segments may be illustrated by the following examples.

Example 1.A related party group is engaged in the manufacture and worldwide sales of automobiles and aftermarket parts. The group's operations within the categories of “automobiles” and “aftermarket parts”. are each sufficient to constitute significant industry segments for the group under the rules of this paragraph (c)(5). No narrower classification of aftermarket parts results in any significant industry segments. Automobiles produced by the group are generally classified for marketing purposes by trade names; aggregating groups of automobiles by these trade names results in three significant industry segments, those for trade names A, B, and C. Finally, two car models sold under the trade name A (“A1” and “A2”) and one car model sold under the trade name B (“B3”), produce sufficient revenue to constitute significant industry segments. Such classifications into trade names and car models are generally used in the related party group's industry; moreover, different types of classifications would produce fewer significant industry segments. Accordingly, a reasonable level of specificity for this related party group's industry segments would be eight categories of products consisting of “automobiles”, “aftermarket parts”, “A”, “B”, “C”, “A1”, “A2”, and “B3”.

Example 2.A related party group is engaged in manufacturing electronic goods that are distributed at retail in the United States by the reporting corporation. The group sells three types of products in the United States: televisions, radios, and video cassette recorders (VCRs). Each of these three broad product areas constitutes a significant industry segment for the group as a whole. VCRs can be further segregated by price into high-end and low-end models, and the provision of each constitutes a significant industry segment for the group. Revenues from only one VCR model, model number VCRX-10, are sufficiently large to make the provision of that model a significant industry segment. With respect to televisions, the group normally accounts for these products by size. Using this classification, portable televisions, medium-sized televisions, and consoles each constitute significant industry segments. Narrower classifications by television model numbers result in no additional significant industry segments. Finally, a single radio product line, those sold under the trade name R, produces sufficient revenue to constitute a significant industry segment, but no other radio models or product groups are large enough to constitute a significant industry segment. In each case, these classifications conform to normal business practices in the industry and result in the greatest possible number of significant industry segments for this related party group. Accordingly, a reasonable level of specificity for this related party group's industry segments would include the ten categories consisting of “VCRs”, “high-end VCRs”, “low-end VCRs”, “model number VCRX-10”, “televisions”, “portable televisions”, “medium-sized televisions”, “console televisions”, “radios”, and “radio trade name R”.

(6) High profit test—(i) In general. A profit and loss statement is material under the high profit test described in this paragraph (c)(6) if—

(B) The amount of gross revenue earned by the group from the provision of U.S.-connected products or services within such industry segment is $100 million or more in the taxable year; and

(C) The return on assets test described in paragraph (c)(6)(ii) of this section is satisfied with respect to the products and services attributable to such segment.

Accordingly, a significant industry segment (as determined under paragraph (c)(5) of this section) must be divided into any narrower industry segments that meet the high profit test of this paragraph (c)(6), even if such narrower segments would not, standing alone, meet the significant industry segment test of paragraph (c)(5) of this section.

(ii) Return on assets test. An industry segment meets the return on assets test if the rate of return on assets earned by the related party group on its worldwide operations within this industry segment exceeds 15 percent, and is at least 200 percent of the return on assets earned by the group in all industry segments combined. For purposes of this paragraph, the rate of return on assets earned by an industry segment is determined by dividing that segment's operating profit (as defined in paragraph (c)(7)(v) of this section) by its identifiable assets (as defined in paragraph (c)(7)(iv) of this section).

(iii) Additional rules. The rules in paragraphs (c)(5)(ii) through (iv) of this section describing the application of the significant industry segment test shall apply in a similar manner for purposes of the high profit test.

(7) Definitions. The following definitions apply for purposes of paragraphs (c)(2)(ii), (c)(5), and (c)(6) of this section.

(i) U.S.-connected products or services. The term U.S.-connected products or services means products or services that are imported to or exported from the United States by transfers between the reporting corporation and any of its foreign related parties.

(ii) Industry segment. An industry segment is a segment of the related party group's combined operations that is engaged in providing a product or service or a group of related products or services (as defined in paragraph (c)(7)(vii) of this section) primarily to customers that are not members of the related party group.

(iii) Gross revenue of an industry segment. Gross revenue of an industry segment includes receipts (prior to reduction for cost of goods sold) both from sales to customers outside of the related party group and from sales or transfers to other industry segments within the related party group (but does not include sales or transfers between members of the related party group within the same industry segment). Interest from sources outside the related party group and interest earned on trade receivables between industry segments is included in gross revenue if the asset on which the interest is earned is included among the industry segment's identifiable assets, but interest earned on advances or loans to other industry segments is not included.

(iv) Identifiable assets of an industry segment. The identifiable assets of an industry segment are those tangible and intangible assets of the related party group that are used by the industry segment, including assets that are used exclusively by that industry segment and an allocated portion of assets used jointly by two or more industry segments. The value of an identifiable asset may be determined using any reasonable method (such as book value or fair market value) applied consistently. Any allocation of assets among industry segments must be made on a reasonable basis, and a description of such basis must be provided. Assets of an industry segment that transfers products or services to another industry segment shall not be allocated to the receiving segment. Assets that represent part of the related party group's investment in an industry segment, such as goodwill, shall be included in the industry segment's identifiable assets. Assets maintained for general corporate purposes (that is, those not used in the operations of any industry segment) shall not be allocated to industry segments.

(v) Operating profit of an industry segment. The operating profit of an industry segment is its gross revenue (as defined in paragraph (c)(7)(iii) of this section) minus all operating expenses. None of the following shall be added or deducted in computing the operating profit of an industry segment: revenue earned at the corporate level and not derived from the operations of any industry segment; general corporate expenses; interest expense; domestic and foreign income taxes; and other extraordinary items not reflecting the ongoing business operations of the industry segment.

(vi) Product. The term product means an item of property (or combination of component parts) that is the result of a production process, is primarily sold to unrelated parties (or incorporated by the related party group into other products sold to unrelated parties), and performs a specific function.

(vii) Related products or services. The term related products or services means groupings of products and types of services that reflect reasonable accounting, marketing, or other business practices within the industries in which the related party group operates.

(viii) Model. The term model means a classification of products that incorporate particular components, options, styles, and any other unique features resulting in product differentiation. Examples of models are electronic products that are sold or accounted for under a single model number and automobiles sold under a single model name.

(ix) Product line. The term product line means a group of products that are aggregated into a single classification for accounting, marketing, or other business purposes. Examples of product lines are groups of products that perform similar functions; products that are marketed under the same trade names, brand names, or trademarks; and products that are related economically (that is, having similar rates of profitability, similar degrees of risk, and similar opportunities for growth).

(8) Example. The application of the rules for determining material profit and loss statements under paragraphs (c)(4) through (7) of this section is illustrated by the following example.

Example. (i) Facts. A multinational enterprise manufactures 50 different agricultural and chemical products that are sold through Subl, its wholly owned U.S. subsidiary, and other subsidiaries located in foreign countries. The parent company of the enterprise, P, is a foreign corporation. The corporations participating in the enterprise form a related party group, and Subl is a reporting corporation for purposes of section 6038A. Under the facts and circumstances of this case, an analysis of the group's worldwide profit attributable to its products sold in the U.S. is relevant for determining an arm's length consideration under section 482 for the transfers of goods between Subl and its foreign affiliates.

(ii) Existing records test. For management purposes, the group prepares profit and loss statements that are segmented by sales in different geographic markets. One of these statements shows the combined worldwide profitability of the group. Another statement shows the profitability of the group attributable to its North American sales. Both of these profit and loss statements reflect aggregate figures that include sales to unrelated parties of products that have been transferred from P and other group members to Subl (that is, the group's “U.S.-connected products”). The two statements meet the existing records test described in paragraph (c)(4) of this section.

(iii) Significant industry segments. The group's worldwide gross revenue in all industry segments is $2 billion. An analysis of the group's 50 products demonstrates that they are reasonably grouped into eight industry segments (each of which earns roughly $250 million in worldwide gross revenue). Segments 1 through 6 relate to agricultural products and Segments 7 and 8 relate to other chemical products. More specific categories would result in groupings that generate less than 10 percent of the group's worldwide gross revenue (that is, less than $200 million each); these narrower categories would thus fail the gross revenue percentage test of paragraph (c)(5)(i)(B) of this section. The gross revenue in each of the eight segments from the sale to unrelated parties of U.S.-connected products is as follows: $180 million for Segment 1; $30 million for Segment 2; and less than $25 million for each of Segments 3 through 8. Under the $25 million threshold test of paragraph (c)(5)(i)(C) of this section, the group's significant industry segments are thus limited to Segments 1 and 2. In addition, the combined operations of the group related to agricultural products (encompassing Segments 1 through 6 on an aggregated basis), constitute a single significant industry segment.

(iv) High profit test. One highly profitable product line within Segment 1, HPPL, accounts for $120 million gross revenue from Sub1's domestic sales of U.S.-connected products (and thus exceeds the $100 million gross revenue threshold in paragraph (c)(6)(i)(B) of this section). The return on the identifiable assets attributable to the HPPL product line is 85 percent, which is more than 15 percent and more than twice the return on assets earned by the group from its worldwide operations in its combined industry segments. The group's industry segment for HPPL thus meets the high profit test described in paragraph (c)(6) of this section.

(v) Material Profit and Loss Statements. The group's material profit and loss statements consist of statements for combined worldwide sales and North American sales (under the existing records test); Segment 1, Segment 2, and aggregated Segments 1-6 (under the significant industry segment test); and HPPL (under the high profit test). Under paragraph (c) of this section, Subl is required to retain the combined worldwide sales and North American sales profit and loss statements and to maintain sufficient records so that it can compile and supply upon request statements of the group's profitability from sales of its U.S.-connected products within Segment l, Segment 2, aggregated Segments 1-6, and HPPL. These records need not be in the possession of Subl and may be kept under the control of and produced by P or any third party. The statements for Segment l, Segment 2, aggregated Segments 1-6, and HPPL do not require tracing of actual costs to the U.S.-connected products; rather, these statements may be prepared by using any reasonable method to allocate a portion of the industry segment's overall operating costs to the sales of U.S.-connected products within that segment.

(d) Liability for certain partnership record maintenance. A reporting corporation to which transactions engaged in by a partnership are attributed under § 1.6038A-1 (e)(2) is subject to the record maintenance requirements of this section to the extent of the transactions so attributed.

(e) Agreements with the District Director—(1) In general. The District Director who has audit jurisdiction over the reporting corporation may negotiate and enter into an agreement with a reporting corporation that establishes the records the reporting corporation must maintain or cause another to maintain, how the records must be maintained, the period of retention for the records, and by whom the records must be maintained in order to satisfy the reporting corporation's obligations under this section.

(2) Content of agreement—(i) In general. The agreement may include provisions relating to the authorization of agent requirement, the record maintenance requirement, and the production and translation time periods that vary the rules contained in these regulations under section 6038A. The District Director will generally require a reporting corporation to maintain only those records specified under the safe harbor provisions of paragraph (c) of this section that permit an adequate audit of the income tax return of the reporting corporation and to provide such authorizations of agent that permit adequate access to such records. In most instances, required record maintenance for a particular reporting corporation under a negotiated agreement will be less than the broad range of records described under the safe harbor provisions. Additionally, a provision specifying the effective date and the expiration date of the agreement that may vary the effective date of the regulations may be included.

(ii) Significant industry segment test. A District Director may determine which industry segment profit and loss statements are material for purposes of requiring the maintenance of records (under either paragraph (a)(1) of this section or the safe harbor described in paragraph (a)(2) of this section). The industry segments that the District Director determines are material need not be the industry segments that meet the significant industry segment test under paragraph (c)(5) of this section or the high profit test under paragraph (c)(6) of this section. For this purpose, a reporting corporation will be required to maintain only those records from which profit and loss statements for the related party group may be constructed with respect to industry segments identified by the District Director. To the extent that existing profit and loss statements are similar in scope and level of detail to statements for industry segments that would otherwise be described under the tests of paragraphs (c)(5) and (6) of this section, the District Director shall accept the existing statements instead of the statements that would otherwise be required under paragraphs (c)(5) and (6) of this section.

(iii) Example. The following example illustrates the rules of paragraph (e)(2)(ii) of this section.

Example.The District Director determines that RC, a reporting corporation that is a manufacturer of related chemical products, has two industry segments, Segment 1 and Segment 2. While both industry segments meet the significant industry segment test of paragraph (c)(5) of this section, Segment 1 has a relatively low volume of sales to foreign related parties. Additionally, Segment 1 consists of products that produce only a small profit margin because the product is generic and other companies also sell the product. The District Director enters into an agreement with RC that requires only records from which a profit and loss statement for the related party group can be constructed for Segment 2. Therefore, RC is not required to maintain records for Segment 1 from which a profit and loss statement for the related party group can be constructed. The other record maintenance requirements under this section apply, however.

(3) Circumstances of agreement. The District Director generally will enter into an agreement under this paragraph (e) upon request by the reporting corporation when the District Director believes that the District has or can obtain sufficient knowledge of the business or industry of the reporting corporation to limit the record maintenance requirement to particular documents.

(4) Agreement as part of APA process. An agreement with a reporting corporation under this paragraph (e) may be entered into as a part of the Advance Pricing Agreement (APA) process at any time during the APA process, insofar as the agreement relates to the subject matter of the APA.

(f) U.S. maintenance—(1) General rule. Records that must be maintained under this section must be maintained within the United States, unless the conditions described in paragraph (f)(2) of this section are met.

(2) Non-U.S. maintenance requirements. A reporting corporation may maintain outside the United States records not ordinarily maintained in the United States but required to be maintained in the United States under this section. However, the reporting corporation must either:

(i) Deliver to the Service the original documents (or duplicates) requested within 60 days of the request by the Service for such records and provide translations of such documents within 30 days of a request for translations of specific documents; or

(ii) Move the original documents (or duplicates) requested to the United States within 60 days of the request of the Service for such records; provide the Service with an index to the requested records, the name and address of a custodian located within the United States having control over the records, and the address where the records are located within 60 days of the Service's request for the records; and continue to maintain the records within the United States throughout the period of retention described in paragraph (g) of this section. For summons procedures with respect to records that have been moved to the United States, see sections 6038A(e), 7602, 7603, and 7604.

With respect to any material profit and loss statements required to be created (either under paragraph (c) of this section or under an agreement with the District Director), unless otherwise specified, “120 days” shall be substituted for “60 days” in this paragraph (f)(2), and labels and text with respect to such statements must be in the English language.

(3) Prior taxable years. The non-U.S. maintenance requirements described in paragraph (f)(2) of this section apply to records located outside the United States that were in existence on or after March 20, 1990, without regard to the taxable year to which such records relate.

(4) Scheduled production for high volume or other reasons. Upon a written request, for good cause shown, the District Director may grant an extension of the time for the production or translation of the requested documents. Such requests should be made within 30 days of the request for records by the Service. If an extension is needed because of the volume of records requested or the amount of translation requested, the District Director may allow production or translation to be scheduled over a period of time so that not all records need be produced or translated at the same time.

(5) Required U.S. maintenance. The District Director (with the concurrence of the Assistant Commissioner (International)), may require, for cause, the maintenance within the United States of any records specified in paragraph (f)(1) of this section. Such a requirement will be imposed only if there exists a clear pattern of failure to maintain or timely produce the required records. The assessment of a monetary penalty under section 6038A(d) and § 1.6038A-4 for failure to maintain records is not necessarily sufficient to require the maintenance of records within the United States.

(g) Period of retention. Records required to be maintained by section 6038A(a) and this section shall be kept as long as they may be relevant or material to determining the correct tax treatment of any transaction between the reporting corporation and a related party, but in no case less than the applicable statute of limitations on assessment and collection with respect to the taxable year in which the transaction or item to which the records relate affects the U.S. tax liability of the reporting corporation. See section 6001 and the regulations thereunder.

(h) Application of record maintenance rules to banks and other financial institutions. [Reserved]

(i) Effective/applicability date—(1) In general. This section is generally applicable on December 10, 1990. However, records described in this section in existence on or after March 20, 1990, must be maintained, without regard to when the taxable year to which the records relate began. Paragraph (a)(3) Example 4 of this section is generally applicable for taxable years beginning after July 31, 2009.

(2) Election to apply regulation to earlier taxable years. A person may elect to apply the provisions of paragraph (a)(3) Example 4 of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9(n)(2).

[T.D. 8353, 56 FR 28065, June 19, 1991; T.D. 8353, 56 FR 41792, Aug. 23, 1991, as amended by T.D. 8611, 60 FR 41015, Aug. 11, 1995; T.D. 9278, 71 FR 44518, Aug. 4, 2006; T.D. 9456, 74 FR 38875, Aug. 4, 2009]

§ 1.6038A-4 Monetary penalty.

(a) Imposition of monetary penalty—(1) In general. If a reporting corporation fails to furnish the information described in § 1.6038A-2 within the time and manner prescribed in § 1.6038A-2(d), fails to maintain or cause another to maintain records as required by § 1.6038A-3, or (in the case of records maintained outside the United States) fails to meet the non-U.S. record maintenance requirements within the applicable time prescribed in § 1.6038A-3(f), a penalty of $25,000 shall be assessed for each taxable year with respect to which such failure occurs. The filing of a substantially incomplete Form 5472 constitutes a failure to file Form 5472. Where, however, the information described in § 1.6038A-2(b)(3) through (5) is not required to be reported, a Form 5472 filed without such information is not a substantially incomplete Form 5472.

(2) Liability for certain partnership transactions. A reporting corporation to which transactions engaged in by a partnership are attributed under § 1.6038A-1(e)(2) is subject to the rules of this section to the extent failures occur with respect to the partnership transactions so attributed.

(3) Calculation of monetary penalty. If a reporting corporation fails to maintain records as required by § 1.6038A-3 of transactions with multiple related parties, the monetary penalty may be assessed for each failure to maintain records with respect to each related party. The monetary penalty, however, shall be imposed on a reporting corporation only once for a taxable year with respect to each related party for a failure to furnish the information required on Form 5472, for a failure to maintain or cause another to maintain records, or for a failure to comply with the non-U.S. maintenance requirements described in § 1.6038A-3(f). An additional penalty for another failure may be imposed, however, under the rules of paragraph (d)(2) of this section. Thus, unless such failures continue after notification as described in paragraph (d) of this section, the maximum penalty under this paragraph with respect to each related party for all such failures in a taxable year is$25,000. The members of a group of corporations filing a consolidated return are jointly and severally liable for any monetary penalty that may be imposed under this section.

(b) Reasonable cause—(1) In general. Certain failures may be excused for reasonable cause, including not timely filing Form 5472, not maintaining or causing another to maintain records as required by § 1.6038A-3, and not complying with the non-U.S. maintenance requirements described in § 1.6038A-3(f). If an affirmative showing is made that the taxpayer acted in good faith and there is reasonable cause for a failure that results in the assessment of the monetary penalty, the period during which reasonable cause exists shall be treated as beginning on the day reasonable cause is established and ending not earlier than the last day on which reasonable cause existed for any such failure. Additionally, the beginning of the 90-day period after mailing of a notice by the District Director or the Director of an Internal Revenue Service Center of a failure described in paragraph (d) of this section shall be treated as not earlier than the last day on which reasonable cause existed.

(2) Affirmative showing required—(i) In general. To show that reasonable cause exists for purposes of paragraph (b)(1) of this section, the reporting corporation must make an affirmative showing of all the facts alleged as reasonable cause for the failure in a written statement containing a declaration that it is made under penalties of perjury. The statement must be filed with the District Director (in the case of failure to maintain or furnish requested information permitted to be maintained outside the United States within the time required under § 1.6038A-3(f) or a failure to file Form 5472) or the Director of the Internal Revenue Service Center where the Form 5472 is required to be filed (in the case of failure to file Form 5472). The District Director or the Director of the Internal Revenue Service Center where the Form 5472 is required to be filed, as appropriate, shall determine whether the failure was due to reasonable cause, and if so, the period of time for which reasonable cause existed. If a return has been filed as required by § 1.6038A-2 or records have been maintained as required by § 1.6038A-3, except for an omission of, or error with respect to, some of the information required or a record to be maintained, the omission or error shall not constitute a failure for purposes of section 6038A(d) if the reporting corporation that filed the return establishes to the satisfaction of the District Director or the Director of the Internal Revenue Service Center that it has substantially complied with the filing of Form 5472 or the requirement to maintain records.

(ii) Small corporations. The District Director shall apply the reasonable cause exception liberally in the case of a small corporation that had no knowledge of the requirements imposed by section 6038A; has limited presence in and contact with the United States; and promptly and fully complies with all requests by the District Director to file Form 5472, and to furnish books, records, or other materials relevant to the reportable transaction. A small corporation is a corporation whose gross receipts for a taxable year are $20,000,000 or less.

(iii) Facts and circumstances taken into account. The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of the experience and knowledge of the taxpayer. Isolated computational or transcriptional errors generally are not inconsistent with reasonable cause and good faith. Reliance upon an information return or on the advice of a professional (such as an attorney or accountant) does not necessarily demonstrate reasonable cause and good faith. Similarly, reasonable cause and good faith is not necessarily indicated by reliance on facts that, unknown to the taxpayer, are incorrect. Reliance on an information return, professional advice or other facts, however, constitutes reasonable cause and good faith if, under all the circumstances, the reliance was reasonable. A taxpayer, for example, may have reasonable cause for not filing a Form 5472 or for not maintaining records under section 6038A if the taxpayer has a reasonable belief that it is not owned by a 25-percent foreign shareholder. A reasonable belief means that the taxpayer does not know or has no reason to know that it is owned by a 25-percent foreign shareholder. For example, a reporting corporation would not know or have reason to know that it is owned by a 25-percent foreign shareholder if its belief that it is not so owned is consistent with other information reported or otherwise furnished to or known by the reporting corporation. A taxpayer may have reasonable cause for not treating a foreign corporation as a related party for purposes of section 6038A where the foreign corporation is a related party solely by reason of § 1.6038A-1(d)(3) (under the principles of section 482), and the taxpayer had a reasonable belief that its relationship with the foreign corporation did not meet the standards for related parties under section 482.

(c) Failure to maintain records or to cause another to maintain records. A failure to maintain records or to cause another to maintain records is determined by the District Director upon the basis of the reporting corporation's overall compliance (including compliance with the non-U.S. maintenance requirements under § 1.6038A-3(f)(2)) with the record maintenance requirements. It is not an item-by-item determination. Thus, for example, a failure to maintain a single or small number of items may not constitute a failure for purposes of section 6038A(d), unless the item or items are essential to the correct determination of transactions between the reporting corporation and any foreign related parties. The District Director shall notify the reporting corporation in writing of any determination that it has failed to comply with the record maintenance requirement.

(d) Increase in penalty where failure continues after notification—(1) In general. If any failure described in this section continues for more than 90 days after the day on which the District Director or the Director of the Internal Revenue Service Center where the Form 5472 is required to be filed mails notice of the failure to the reporting corporation, the reporting corporation shall pay a penalty (in addition to the penalty described in paragraph (a) of this section) of $25,000 with respect to each related party for which a failure occurs for each 30-day period during which the failure continues after the expiration of the 90-day period. Any uncompleted fraction of a 30-day period shall count as a 30-day period for purposes of this paragraph (d).

(2) Additional penalty for another failure. An additional penalty for a taxable year may be imposed, however, if at a time subsequent to the time of the imposition of the monetary penalty described in paragraph (a) of this section, a second failure is determined and the second failure continues after notification under paragraph (d)(1) of this section. Thus, if a taxpayer fails to file Form 5472 and is assessed a monetary penalty and later, upon audit, is determined to have failed to maintain records, an additional penalty for the failure to maintain records may be assessed under the rules of this paragraph if the failure to maintain records continues after notification under this paragraph.

(3) Cessation of accrual. The monetary penalty will cease to accrue if the reporting corporation either files Form 5472 (in the case of a failure to file Form 5472), furnishes information to substantially complete Form 5472, or demonstrates compliance with respect to the maintenance of records (in the case of a failure to maintain records) for the taxable year in which the examination occurs and subsequent years to the satisfaction of the District Director. The monetary penalty also will cease to accrue if requested information, documents, or records, kept outside the United States under the requirements of § 1.6038A-3(f) and not produced within the time specified are produced or moved to the United States under the rules of paragraph (f)(2)(ii) of this section.

(4) Continued failures. If a failure under this section relating to a taxable year beginning before July 11, 1989 occurs, and if the failure continues following 90 days after the notice of failure under this paragraph is sent, the amount of the additional penalty to be assessed under this paragraph is $25,000 for each 30-day period beginning after November 5, 1990, during which the failure continues. There is no limitation on the amount of the monetary penalty that may be assessed after November 5, 1990.

(e) Other penalties. For criminal penalties for failure to file a return and filing a false or fraudulent return, see sections 7203 and 7206 of the Code. For the penalty relating to an underpayment of tax, see section 6662.

(f) Examples. The following examples illustrate the rules of this section.

(1) Failure to file Form 5472. Corp X, a U.S. reporting corporation, engages in related party transactions with FC. Corp X does not timely file a Form 5472 or maintain records relating to the transactions with FC for Year 1 or subsequent years. The Service Center with which Corp X files its income tax return imposes a $25,000 penalty for each of Years 1, 2, and 3 under section 6038A (d) and this section for failure to provide information as required on Form 5472 and mails a notice of failure to provide inrormation. Corp X does not file Form 5472. Ninety days following the mailing of the notice of failure to Corp X an additional penaly of $25,000 is imposed. On the 135th day following the mailing of the notice of failure, Corp X files Form 5472 for Years 1, 2, and 3. The total penalty owed by Corp X for Year 1 is $75,000. ($25,000 for not timely filing Form 5472, $25,000 for the first 30-day period following the expiration of the 90-day period, and $25,000 for the fraction of the second 30-day period). The penalty for Years 2 and 3 for the failure to file Form 5472 is also $75,000 for each year, calculated in the same manner as for Year 1. The total penalty for failure to file Form 5472 for Years 1, 2, and 3 is $225,000.

(2) Failure to maintain records.

Assume the same facts as in Example 1. In Year 5, Corp X is audited for Years 1 through 3. Corp X has not been maintaining records relating to the transactions with FC. The District Director issues a notice of failure to maintain records. Corp X has already been subject to the monetary penalty of $25,000 for each of Years 1, 2, and 3 for failure to file Form 5472 and, therefore, a monetary penalty under paragraph (a) of this section for failure to maintain records is not assessed. However, an additional penalty is assessed after the 90th day following the mailing of the notice of failure to maintain records. Corp X develops a record maintenance system as required by section 6038A and § 1.6038A-3. On the 180th day following the mailing of the notice of failure to maintain records, Corp X demonstrates to the satisfaction of the District Director that the newly developed record maintenance system will comply with the requirements of § 1.6038A-3 and the increase in the monetary penalty after notification ceases to accrue. The additional penalty for failure to maintain records is $75,000. An additional penalty of $75,000 per year is assessed for each of years 2 and 3 for the failure to maintain records for a total of $225,000.

(g) Effective dates. For effective dates for this section, see § 1.6038A-1(n).

[T.D. 8353, 56 FR 28072, June 19, 1991, as amended by T.D. 9707, 79 FR 77389, Dec. 24, 2014; T.D. 9885, 84 FR 67045, Dec. 6, 2019]

§ 1.6038A-5 Authorization of agent.

(a) Failure to authorize. The rules of § 1.6038A-7 shall apply to any transaction between a foreign related party and a reporting corporation (including any transaction engaged in by a partnership that is attributed to the reporting corporation under § 1.6038A-1(e)(2)), unless the foreign related party authorizes (in the manner described in paragraph (b) of this section) the reporting corporation to act as its limited agent solely for purposes of sections 7602, 7603, and 7604 with respect to any request by the Service to examine records or produce testimony that may be relevant to the tax treatment of such a transaction or with respect to any summons by the Service for such records or testimony. The fact that a reporting corporation is authorized to act as an agent for a foreign related party is to be disregarded for purposes of determining whether the foreign related party either has a trade or business in the United States for purposes of the Code or a permanent establishment or fixed base in the United States for purposes of an income tax treaty.

(b) Authorization by related party—(1) In general. Upon request by the Service, a foreign related party shall authorize as its agent (solely for purposes of sections 7602, 7603, and 7604) the reporting corporation with which it engages in transactions. The authorization must be signed by the foreign related party or an officer of the foreign related party possessing the authority to authorize an agent for purposes of Rule 4 of the Federal Rules of Civil Procedure. The reporting corporation will accept this appointment by providing a statement to that effect, signed by an officer of the reporting corporation possessing the authority to accept such an appointment. The agency shall be effective at all times. For taxable years beginning after July 10, 1989, the authorization and acceptance must be provided to the Service within 30 days of a request by the Service to the reporting corporation for such an authorization. The authorization must contain a heading and statement as set forth below. A foreign government is not subject to the authorization of agent requirement.

AUTHORIZATION OF AGENT

“[Name of foreign related party] hereby expressly authorizes [name of reporting corporation] to act as its agent solely for purposes of sections 7602, 7603, and 7604 of the Internal Revenue Code with respect to any request to examine records or produce testimony that may be relevant to the U.S. income tax treatment of any transaction between [name of the above-named foreign related party] and [name of reporting corporation] or with respect to any summons for such records or testimony.

Signature of or for [name of foreign related party] (Title) (Date)

(If signed by a corporate officer, partner, or fiduciary on behalf of a foreign related party: I certify that I have the authority to execute this authorization of agent to act on behalf of [name of foreign related party]).

Type or print your name below if signing for a foreign related party that is not an individual.

[Name of reporting corporation] accepts this appointment to act as agent for [name of foreign related party] for the above purpose.

Signature for (Name of Reporting Corporation] (Title) (Date)

I certify that I have the authority to accept this appointment to act as agent on behalf of (name of foreign related party] and agree to accept service of process for the above purposes.

Type or print your name below.

(2) Authorization for prior years. A foreign related party shall authorize a reporting corporation to act as its agent with respect to taxable years for which a Form 5472 is required to be filed prior to the date on which the final regulations under section 6038A are published by providing the above executed authorization of agent within 30 days of a request by the Service for such an authorization.

(c) Foreign affiliated groups—(1) In general. A foreign corporation that has effective legal authority to make the authorization of agent under paragraph (b) of this section on behalf of any group of foreign related parties may execute such an authorization for any members of the group. A single authorization may be made on a consolidated basis. In such a case, the common parent must attach a schedule to the authorization of agent stating which members of the group would otherwise be required to separately authorize the reporting corporation as agent. The schedule must provide the name, address, relationship to the reporting corporation, and U.S. taxpayer identification number, if applicable, of each member.

(2) Application of noncompliance penalty adjustment. In circumstances where a consolidated authorization of agent has been executed, if the agency authorization for any member of the group is not legally effective for purposes of sections 7602, 7603, and 7604, the noncompliance penalty adjustment under section 6038A(e) and § 1.6038A-7 shall apply.

(d) Legal effect of authorization of agent. The legal consequences of a foreign related party authorizing a reporting corporation to act as its agent for purposes of sections 7602, 7603, and 7604 of the Code are as follows.

(1) Agent for purposes of commencing judicial proceedings. A reporting corporation that is authorized by a foreign related party to act as its agent for purposes of sections 7602, 7603, and 7604 (including service of process) is also the agent of the foreign related party for purposes of—

(i) The filing of a petition to quash under section 6038A(e)(4)(A) or a petition to review an Internal Revenue Service determination of noncompliance under section 6038A(e)(4)(B), and

(ii) The commencement of a judicial proceeding to enforce a summons under section 7604, whether commenced in conjunction with a petition to quash under section 6038A(e)(4)(A) or commenced as a separate proceeding in the federal district court for the district in which the person to whom the summons is issued resides or is found.

(2) Foreign related party found where reporting corporation found. For any purposes relating to sections 7602, 7603, or 7604 (including service of process), a foreign related party that authorizes a reporting corporation to act on its behalf under section 6038A(e)(1) and this section may be found anywhere where the reporting corporation has residence or is found.

(e) Successors in interest. A successor in interest to a related party must execute the authorization of agent as described in paragraph (b) of this section.

(f) Deemed compliance—(1) In general. In exceptional circumstances, the District Director may treat a reporting corporation as authorized to act as agent for a related party for purposes of sections 7602, 7603, and 7604 in the absence of an actual agency appointment by the foreign related party, in circumstances where the actual absence of an appointment is reasonable. Factors to be considered include—

(i) If neither the reporting corporation nor the other party to the transaction knew or had reason to know that the two parties were related at the time of the transaction, and

(ii) The extent to which the taxpayer establishes to the satisfaction of the District Director that all transactions between the reporting corporation and the related party were on arm's length terms and did not involve the participation of any known related party.

(2) Reason to know. Whether the reporting corporation or other party had reason to know that the two parties were related at the time of the transaction will be determined by all the facts and circumstances.

(3) Effect of deemed compliance. If a reporting corporation is deemed under this paragraph (f) to have been authorized to act as an agent for a foreign related party for purposes of sections 7602, 7603, and 7604, such deemed compliance is applicable only for that particular transaction and other reportable transactions entered into prior to the time when the reporting corporation knew or had reason to know that the related party, in fact, was related. The noncompliance rule of § 1.6038A-7 shall apply to any transaction subsequent to that time with the same related party, unless the related party actually authorizes the reporting corporation to act as its agent under paragraph (a) of this section. In addition, the record maintenance requirements of § 1.6038A-3 will apply to all subsequent transactions and, with respect to prior transactions, will apply to relevant records in existence at the time the relationship was discovered.

(g) Effective dates. For effective dates for this section, see § 1.6038A-1(n).

[T.D. 8353, 56 FR 28073, June 19, 1991; T.D. 8353, 56 FR 41792, Aug. 23, 1991]

§ 1.6038A-6 Failure to furnish information.

(a) In general. The rules of § 1.6038A-7 may be applied with respect to a transaction between a foreign related party and the reporting corporation (including any transaction engaged in by a partnership that is attributed to the reporting corporation under § 1.6038A-1(e)(2)) if a summons is issued to the reporting corporation to produce any records or testimony, either directly or as agent for such related party, to determine the correct treatment under title 1 of the Code of such a transaction between the reporting corporation and the related party; and if—

(1)(i) The summons is not quashed in a proceeding, if any, begun under section 6038A(e)(4) and is not determined to be invalid in a proceeding, if any, begun under section 7604 to enforce such summons; and

(ii) The reporting corporation does not substantially and timely comply with the summons, and the District Director has sent by certified or registered mail a notice under section 6038A(e)(2)(C) to the reporting corporation that it has not so complied; or

(2) The reporting corporation fails to maintain or to cause another to maintain records as required by § 1.6038A-3, and by reason of that failure, the summons is quashed in a proceeding under section 6038A(e)(4) or in a proceeding begun under section 7604 to enforce the summons, or the reporting corporation is not able to provide the records requested in the summons.

(b) Coordination with treaties. Where records of a related party are obtainable on a timely and efficient basis under information exchange procedures provided under a tax treaty or tax information exchange agreement (TIEA), the Service generally will make use of such procedures before issuing a summons. The absence or pendency of a treaty or TIEA request may not be asserted as grounds for refusing to comply with a summons or as a defense against the assertion of the noncompliance penalty adjustment under § 1.6038A-7. For purposes of this paragraph, information is available on a timely and efficient basis if it can be obtained within 180 days of the request.

(c) Enforcement proceeding not required. The District Director is not required to begin an enforcement proceeding to enforce the summons in order to apply the rules of § 1.6038A-7.

(d) De minimis failure. Where a reporting corporation's failure to comply with the requirement to furnish information under this section is de minimis, the District Director, in the exercise of discretion, may choose not to apply the noncompliance penalty. Thus, for example, in cases where a particular document or group of documents is not furnished upon request or summons, the District Director (in the District Director's sole discretion), may choose not to apply the noncompliance penalty if the District Director deems the document or documents not to have significant or sufficient value in the determination of the correctness of the tax treatment of the related party transaction.

(e) Suspension of statute of limitations. If the reporting corporation brings an action under section 6038A(e)(4)(A) (proceeding to quash) or (e)(4)(B) (review of secretarial determination of noncompliance), the running of any period of limitation under section 6501 (relating to assessment and collection of tax) or under section 6531 (relating to criminal prosecutions) for the taxable year or years to which the summons that is the subject of such proceeding relates shall be suspended for the period during which such proceeding, and appeals therein, are pending. In no event shall any such period expire before the 90th day after the day on which there is a final determination in such proceeding.

(f) Effective dates. For effective dates for this section, see § 1.6038A-1(n).

[T.D. 8353, 56 FR 28075, June 19, 1991]

§ 1.6038A-7 Noncompliance.

(a) In general. In the case of any failure described in § 1.6038A-5 or § 1.6038A-6, the rules of this § 1.6038A-7 apply to the reporting corporation. In such a case—

(1) The amount of the deduction allowed under subtitle A for any amount paid or incurred by the reporting corporation to the related party in connection with such transaction, and

(2) The cost to the reporting corporation of any property acquired in such transaction from the related party or transferred by such corporation in such transaction to the related party, may be determined by the District Director.

(b) Determination of the amount. The amount of the deduction or the cost to the reporting corporation shall be the amount determined by the District Director (in the District Director's sole discretion) from the District Director's own knowledge or from such information as the District Director may choose to obtain through testimony or otherwise. The District Director shall consider any information or materials that have been submitted by the reporting corporation or a foreign related party. The District Director, however, may disregard any information, documents, or records submitted by the reporting corporation or the related party if (in the District Director's sole discretion) the District Director deems that they are insufficiently probative of the relevant facts.

(c) Separate application. If the noncompliance penalty of this section applies with respect to transactions with a related party of the reporting corporation, it will not be applied with respect to any other related parties of the reporting corporation solely upon the basis of that failure. Thus, for example, if a reporting corporation engages in transactions with related party A and related party B, and the reporting corporation does not respond to a summons for records related to the transactions between the reporting corporation and related party A, the noncompliance penalty imposed as a result of such failure will not apply to the transactions between the reporting corporation and related party B. If a separate summons is issued for records relating to the transactions between the reporting corporation and related party B and the reporting corporation does not produce such records, the noncompliance penalty may be applied to those transactions.

(d) Effective dates. For effective dates for this section, see § 1.6038A-1(n).

[T.D. 8353, 56 FR 28075, June 19, 1991]

§ 1.6038B-1 Reporting of certain transfers to foreign corporations.

(a) Purpose and scope. This section sets forth information reporting requirements under section 6038B concerning certain transfers of property to foreign corporations. Paragraph (b) of this section provides general rules explaining when and how to carry out the reporting required under section 6038B with respect to the transfers to foreign corporations. Paragraph (c) of this section and § 1.6038B-1T(d) specify the information that is required to be reported with respect to certain transfers of property that are described in section 6038B(a)(1)(A) and 367(d), respectively. Section 1.6038B-1(e) describes the filing requirements for property transfers described in section 367(e). Paragraph (f) of this section sets forth the consequences of a failure to comply with the requirements of section 6038B and this section. For effective dates, see paragraph (g) of this section. For rules regarding transfers to foreign partnerships, see section 6038B(a)(1)(B) and any regulations thereunder.

(b) Time and manner of reporting—(1) In general—(i) Reporting procedure. Except for stock or securities qualifying under the special reporting rule of § 1.6038B-1(b)(2), and certain exchanges described in section 354 or 356 (listed below), any U.S. person that makes a transfer described in section 6038B(a)(1)(A), 367(d) or (e), is required to report pursuant to section 6038B and the rules of § 1.6038B-1 and must attach the required information to Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation.” In addition, if the U.S. person files a statement under § 1.367(a)-3(d)(2)(vi)(C), a gain recognition agreement under § 1.367(a)-8, or a liquidation document under § 1.367(e)-2(b), such person must comply in all material respects with the requirements of such section pursuant to the terms of the statement, gain recognition agreement, or liquidation document, as applicable, in order to satisfy a reporting obligation under section 6038B. For special rules regarding cash transfers made in tax years beginning after February 5, 1999, see paragraphs (b)(3) and (g) of this section. For purposes of determining a U.S. transferor that is subject to section 6038B, the rules of §§ 1.367(a)-1(c) and 1.367(a)-3(d) shall apply with respect to a transfer described in section 367(a), and the rules of § 1.367(a)-1(c) shall apply with respect to a transfer described in section 367(d). Additionally, if in an exchange described in section 354 or 356, a U.S. person exchanges stock or securities of a foreign corporation in a reorganization described in section 368(a)(1)(E), or a U.S. person exchanges stock or securities of a domestic or foreign corporation pursuant to an asset reorganization described in section 368(a)(1) (involving a transfer of assets under section 361) that is not treated as an indirect stock transfer under § 1.367(a)-3(d), then the U.S. person exchanging stock or securities is not required to report under section 6038B. Notwithstanding any statement to the contrary on Form 926, the form and attachments must be attached to, and filed by the due date (including extensions) of the transferor's income tax return for the taxable year that includes the date of the transfer (as defined in § 1.6038B-1T(b)(4)). For taxable years beginning before January 1, 2003, any attachment to Form 926 required under the rules of this section is filed subject to the transferor's declaration under penalties of perjury on Form 926 that the information submitted is true, correct and complete to the best of the transferor's knowledge and belief. For taxable years beginning after December 31, 2002, Form 926 and any attachments shall be verified by signing the income tax return with which the form and attachments are filed.

(ii) Reporting by corporate transferor. For transfers by corporations in taxable years beginning before January 1, 2003, Form 926 must be signed by an authorized officer of the corporation if the transferor is not a member of an affiliated group under section 1504(a)(1) that files a consolidated Federal income tax return and by an authorized officer of the common parent corporation if the transferor is a member of such an affiliated group. For transfers by corporations in taxable years beginning after December 31, 2002, Form 926 shall be verified by signing the income tax return to which the form is attached.

(iii) Transfers of jointly-owned property. If two or more persons transfer jointly-owned property to a foreign corporation in a transfer with respect to which a notice is required under this section, then each person must report with respect to the particular interest transferred, specifying the nature and extent of the interest. However, a husband and wife who jointly file a single Federal income tax return may file a single Form 926 with their tax return.

(2) Exceptions and special rules for transfers of stock or securities under section 367(a)—(i) Transfers on or after July 20, 1998. A U.S. person that transfers stock or securities on or after July 20, 1998 in a transaction described in section 6038B(a)(1)(A) will be considered to have satisfied the reporting requirement under section 6038B and paragraph (b)(1) of this section if either—

(A) The U.S. transferor owned less than 5 percent of both the total voting power and the total value of the transferee foreign corporation immediately after the transfer (taking into account the attribution rules of section 318 as modified by section 958(b)), and either:

(1) The U.S. transferor qualified for nonrecognition treatment with respect to the transfer (i.e., the transfer was not taxable under §§ 1.367(a)-3(b) or (c)); or

(2) The U.S. transferor is a tax-exempt entity and the income was not unrelated business income; or

(3) The transfer was taxable to the U.S. transferor under § 1.367(a)-3(c), and such person properly reported the income from the transfer on its timely-filed (including extensions) Federal income tax return for the taxable year that includes the date of the transfer; or

(4) The transfer is considered to be to a foreign corporation solely by reason of § 1.83-6(d)(1) and the fair market value of the property transferred did not exceed $100,000; or

(B) The U.S. transferor owned 5 percent or more of the total voting power or the total value of the transferee foreign corporation immediately after the transfer (taking into account the attribution rules of section 318 as modified by section 958(b)) and either:

(1) Except as provided in paragraph (b)(2)(iii) of this section, the U.S. transferor (or one or more successors) filed an initial gain recognition agreement under § 1.367(a)-8, and filed Form 926 in accordance with paragraph (b)(2)(iv) of this section; or

(2) The transferor is a tax-exempt entity and the income was not unrelated business income; or

(3) The transferor properly reported the income from the transfer on its timely-filed (including extensions) Federal income tax return for the taxable year that includes the date of the transfer; or

(4) The transfer is considered to be to a foreign corporation solely by reason of § 1.83-6(d)(1) and the fair market value of the property transferred did not exceed $100,000.

(ii) Transfers before July 20, 1998. With respect to transfers occurring after December 16, 1987, and prior to July 20, 1998, a U.S. transferor that transferred U.S. or foreign stock or securities in a transfer described in section 367(a) is not subject to section 6038B if such person is described in paragraph (b)(2)(i)(A) of this section.

(iii) Timely filed initial gain recognition agreement. Paragraph (b)(2)(i)(B)(1) of this section will not apply unless the initial gain recognition agreement is timely filed as determined under § 1.367(a)-8(d)(1), but for purposes of this section, determined without regard to § 1.367(a)-8(p). However, see paragraph (f)(3) of this section for certain relief that may be available.

(iv) Satisfaction of section 6038B reporting if a gain recognition agreement is timely filed. If the U.S. transferor is described in paragraph (b)(2)(i)(B)(1) of this section and is not otherwise required to file a Form 926 with respect to a transfer of assets other than the stock or securities to the transferee foreign corporation, the requirements of this section are satisfied with respect to the transfer of the stock or securities by completing Part I and Part II of Form 926, noting on the Form 926 that a gain recognition agreement is being filed pursuant to § 1.367(a)-8; reporting on the Form 926 the fair market value, adjusted tax basis, and gain recognized with respect to the transferred stock or securities; submitting on the Form 926 any other information that Form 926, its accompanying instructions, or other applicable guidance require to be submitted with respect to the transfer of the stock or securities; and attaching a signed copy of the Form 926 to its timely filed U.S. income tax return (including extensions) for the year of the transfer. If the U.S. transferor is required to file Form 926 with respect to a transfer of assets in addition to the stock or securities, the requirements of this section are satisfied with respect to the transfer of the stock or securities by noting on the Form 926 that a gain recognition agreement is being filed pursuant to § 1.367(a)-8; reporting on the Form 926 the fair market value, adjusted tax basis, and gain recognized with respect to the transferred stock or securities; and submitting on the Form 926 any other information that Form 926, its accompanying instructions, or other applicable guidance require to be submitted with respect to the transfer of the stock or securities.

(3) Special rule for transfers of cash. A U.S. person that transfers cash to a foreign corporation in a transfer described in section 6038B(a)(1)(A) must report the transfer if—

(i) Immediately after the transfer such person holds directly, indirectly, or by attribution (determined under the rules of section 318(a), as modified by section 6038(e)(2)) at least 10 percent of the total voting power or the total value of the foreign corporation; or

(ii) The amount of cash transferred by such person or any related person (determined under section 267(b)(1) through (3) and (10) through (12)) to such foreign corporation during the 12-month period ending on the date of the transfer exceeds $100,000.

(4) [Reserved]. For further guidance, see § 1.6038B-1T(b)(4).

(c) Information required with respect to transfers described in section 6038B(a)(1)(A). A United States person that transfers property to a foreign corporation in an exchange described in section 6038B(a)(1)(A) (including cash transferred in taxable years beginning after February 5, 1999, and other unappreciated property) must provide the following information, in paragraphs labeled to correspond with the number or letter set forth in this paragraph (c) and § 1.6038B-1T(c)(1) through (5). If a particular item is not applicable to the subject transfer, the taxpayer must list its heading and state that it is not applicable. For special rules applicable to transfers of stock or securities, see paragraph (b)(2)(ii) of this section.

(1) through (4) introductory text [Reserved]. For further guidance, see § 1.6038B-1T(c)(1) through (4) introductory text.

(i) Active business property. Describe any transferred property that qualifies under § 1.367(a)-2(a)(2). Provide here a general description of the business conducted (or to be conducted) by the transferee, including the location of the business, the number of its employees, the nature of the business, and copies of the most recently prepared balance sheet and profit and loss statement. Property listed within this category may be identified by general type. For example, upon the transfer of the assets of a manufacturing operation, a reasonable description of the property to be used in the business might include the categories of office equipment and supplies, computers and related equipment, motor vehicles, and several major categories of manufacturing equipment. However, any property that is includible in both paragraphs (c)(4)(i) and (iii) of this section (property subject to depreciation recapture under § 1.367(a)-4(a)) must be identified in the manner required in paragraph (c)(4)(iii) of this section. If property is considered to be transferred for use in the active conduct of a trade or business under a special rule in paragraph (e), (f), or (g) of § 1.367(a)-2, specify the applicable rule and provide information supporting the application of the rule.

(ii) Stock or securities. Describe any transferred stock or securities, including the class or type, amount, and characteristics of the transferred stock or securities, as well as the name, address, place of incorporation, and general description of the corporation issuing the stock or securities.

(iii) Depreciated property. Describe any property that is subject to depreciation recapture under § 1.367(a)-4(a). Property within this category must be separately identified to the same extent as was required for purposes of the previously claimed depreciation deduction. Specify with respect to each such asset the relevant recapture provision, the number of months that such property was in use within the United States, the total number of months the property was in use, the fair market value of the property, a schedule of the depreciation deduction taken with respect to the property, and a calculation of the amount of depreciation required to be recaptured.

(iv) Property not transferred for use in the active conduct of a trade or business. Describe any property that is eligible property, as defined in § 1.367(a)-2(b) taking into account the application of § 1.367(a)-2(c), that was transferred to the foreign corporation but not for use in the active conduct of a trade or business outside the United States (and was therefore not listed under paragraph (c)(4)(i) of this section).

(v) Property transferred under compulsion. If property qualifies for the exception of § 1.367(a)-2(a)(2) under the rules of paragraph (h) of that section, provide information supporting the claimed application of such exception.

(vi) Certain ineligible property. Describe any property that is described in § 1.367(a)-2(c) and that therefore cannot qualify under § 1.367(a)-2(a)(2) regardless of its use in the active conduct of a trade or business outside of the United States. The description must be divided into the relevant categories, as follows:

(A) Inventory, etc. Property described in § 1.367(a)-2(c)(1);

(B) Installment obligations, etc. Property described in § 1.367(a)-2(c)(2);

(D) Leased property. Property described in § 1.367(a)-2(c)(4).

(vii) Other property that is ineligible property. Describe any property, other than property described in § 1.367(a)-2(c), that cannot qualify under § 1.367(a)-2(a)(2) regardless of its use in the active conduct of a trade or business outside of the United States and that is not subject to the rules of section 367(d) under § 1.367(a)-1(b)(5) (treatment of certain property as subject to section 367(d)). Each item of property must be separately identified.

(viii) [Reserved]. For further guidance, see § 1.6038B-1T(c)(4)(viii).

(5) Transfer of foreign branch with previously deducted losses. If the property transferred is property of a foreign branch with previously deducted losses subject to §§ 1.367(a)-6 and -6T, provide the following information:

(i) through (iv) [Reserved]. For further information, see § 1.6038B-1T(c)(5)(i) through (iv).

(6) Transfers subject to section 367(a)(5)—(i) In general. This paragraph (c)(6) applies to a domestic corporation (U.S. transferor) that transfers section 367(a) property (as defined in § 1.367(a)-7(f)(10)) to a foreign corporation in a section 361 exchange (as defined in § 1.367(a)-7(f)(8)) and to which the provisions of § 1.367(a)-7(c) apply. Paragraph (c)(6)(ii) of this section establishes the time and manner for the U.S. transferor to elect to apply the provisions of § 1.367(a)-7(c). Paragraph (c)(6)(iii) of this section establishes the manner for the U.S. transferor to satisfy the requirement of § 1.367(a)-7(c)(4).

(ii) Election. The U.S. transferor elects to apply the provisions of § 1.367(a)-7(c) by including a statement entitled, “ELECTION TO APPLY EXCEPTION UNDER § 1.367(a)-7(c),” with its timely filed return (within the meaning of § 1.367(a)-7(f)(12)) for the taxable year during which the reorganization occurs and that includes the information described in paragraphs (c)(6)(ii)(A), (c)(6)(ii)(B), (c)(6)(ii)(C), (c)(6)(ii)(D), (c)(6)(ii)(E), (c)(6)(ii)(F), (c)(6)(ii)(G), and (c)(6)(ii)(H) of this section. See § 1.367(a)-7(c)(5)(ii) for the statement required to be filed by a control group member (as defined in § 1.367(a)-7(f)(1)) or final distributee (as defined in § 1.367(a)-7(d)).

(A) The name and taxpayer identification number (if any) of each control group member and final distributee (if any), the foreign acquiring corporation, and in the case of a triangular reorganization (within the meaning of § 1.358-6(b)(2)) the corporation that controls the foreign acquiring corporation, and the ownership interest percentage (as defined in § 1.367(a)-7(f)(7)) in the U.S. transferor of each control group member.

(B) A calculation of the gain recognized (if any) by the U.S. transferor under § 1.367(a)-7(c)(2)(i) and (c)(2)(ii), and the basis adjustments (if any) required to be made by each control group member under § 1.367(a)-7(c)(3).

(C) The date on which the U.S. transferor and each control group member or final distributee entered into the written agreement described in § 1.367(a)-7(c)(5)(iv).

(D) The amount of any deductible liability (as defined by § 1.367(a)-7(f)(2)).

(E) The fair market value (as defined by § 1.367(a)-7(f)(3)) of property transferred to the foreign acquiring corporation in the section 361 exchange.

(F) The inside basis (as defined by § 1.367(a)-7(f)(4)).

(G) The inside gain (as defined by § 1.367(a)-7(f)(5)).

(H) The section 367(a) percentage (as defined by § 1.367(a)-7(f)(9)).

(iii) Agreement to amend U.S. transferor's tax return. The U.S. transferor complies with the requirement of § 1.367(a)-7(c)(4)(i) by attaching a statement to its timely filed return (within the meaning of § 1.367(a)-7(f)(12)) for the taxable year in which the reorganization occurs, entitled “STATEMENT UNDER § 1.367(a)-7(c)(4) FOR TRANSFERS OF ASSETS TO A FOREIGN CORPORATION IN A SECTION 361 EXCHANGE.” The statement must certify that if a significant amount of the section 367(a) property received by the foreign acquiring corporation from the U.S. transferor in the section 361 exchange is disposed of, directly or indirectly, in one or more related transactions described in paragraph (c)(6)(iii)(B) of this section occurring within the sixty (60) month period that begins on the date of distribution or transfer (within the meaning of § 1.381(b)-1(b)), then the exception provided in § 1.367(a)-7(c) will not apply to the section 361 exchange. Accordingly, the U.S. transferor will recognize the gain realized but not recognized in the section 361 exchange, computed as if the exception provided in § 1.367(a)-7(c) had never applied. A U.S. income tax return (or amended U.S. income tax return, as the case may be) for the year in which the reorganization occurred reporting the gain must be filed. If the section 361 exchange occurs in connection with a triangular reorganization (within the meaning of § 1.358-6(b)(2)) and the corporation that controls the foreign acquiring corporation is foreign, an indirect disposition of the section 367(a) property includes the disposition by such controlling foreign corporation of the stock of the foreign acquiring corporation.

(A) Disposition of a significant amount—(1) General rule. Except as provided in paragraphs (c)(6)(iii)(A)(2) and (c)(6)(iii)(A)(3) of this section, for purposes of this paragraph (c)(6)(iii), a disposition of a significant amount occurs if, in one or more related transactions, the foreign acquiring corporation disposes of an amount of the section 367(a) property received from the U.S. transferor in the section 361 exchange that is greater than 40 percent of the fair market value of all of the section 367(a) property transferred in the section 361 exchange.

(2) Exception for certain nonrecognition exchanges. Section 367(a) property that is subsequently transferred (retransferred property) pursuant to a nonrecognition provision is not treated as disposed of for purposes of paragraph (c)(6)(iii)(A)(1) of this section, provided such transfer satisfies, and is treated in a manner consistent with the principles underlying § 1.367(a)-8(k). Thus, for example, if section 367(a) property is subsequently transferred to a foreign corporation in exchange solely for stock in a transaction described in section 351, such retransferred property is not treated as disposed of for purposes of paragraph (c)(6)(iii)(A)(1) of this section; in such a case, however, a subsequent disposition of either the retransferred property by the transferee foreign corporation, or of the stock of the transferee foreign corporation received in exchange for the retransferred property, is subject to the provisions of paragraph (c)(6)(iii)(A)(1) of this section.

(3) Exception for dispositions occurring in the ordinary course of business. Dispositions of section 367(a) property described in section 1221(a)(2) occurring in the ordinary course of business of the foreign acquiring corporation are not treated as disposed of for purposes of paragraph (c)(6)(iii)(A)(1) of this section.

(B) Gain recognition transaction—(1) General rule. A transaction is described in this paragraph (c)(6)(iii)(B) if the transaction is entered into with a principal purpose of avoiding the U.S. tax that would have been imposed on the U.S. transferor on the disposition of the property transferred to the foreign acquiring corporation in the section 361 exchange. A disposition may have a principal purpose of tax avoidance even if the tax avoidance purpose is outweighed by other purposes when taken together.

(2) Presumptive tax avoidance. For purposes of this paragraph (c)(6)(iii)(B), the principal purpose of the foreign acquiring corporation's disposition of a significant amount of the section 367(a) property within the two-year period that begins on the date of distribution or transfer (within the meaning of § 1.381(b)-1(b)) (whether in a recognition or nonrecognition transaction) will be presumed to be the avoidance of the U.S. tax that would have been imposed on the U.S. transferor on the disposition of the property transferred to the foreign acquiring corporation in the section 361 exchange. However, this presumption will not apply if it is demonstrated to the satisfaction of the Director of Field Operations, Large Business & International (or any successor to the roles and responsibilities of such person (Director) that the avoidance of U.S. tax was not a principal purpose of the disposition.

(3) Interest. If additional tax is required to be paid as a result of a transaction described in paragraph (c)(6)(iii)(B) of this section, then interest must be paid on that amount at rates determined under section 6621 with respect to the period between the date prescribed for filing the U.S. transferor's income tax return for the year in which the reorganization occurs and the date on which the additional tax for that year is paid.

(d) Transfers subject to section 367(d)—(1) Initial transfer. For further guidance, see § 1.6038B-1T(d)(1) introductory text through (d)(1)(iii).

(i) through (iii) [Reserved]

(iv) Intangible property transferred. Provide a description of the intangible property transferred, including its adjusted basis. Generally, each item of intangible property must be separately identified, including intangible property described in § 1.367(d)-1(g)(2)(i). Identify all property that is subject to the rules of section 367(d) under § 1.367(a)-1(b)(5) (treatment of certain property as subject to section 367(d)). Describe any property for which the income required to be taken into account under section 367(d) and the regulations thereunder will be recognized over a 20-year period pursuant to § 1.367(d)-1(c)(3)(ii). Estimate the anticipated income or cost reductions attributable to the intangible property's use beyond the 20-year period.

(v)-(vi) [Reserved]. For further guidance, see § 1.6038B-1T(d)(1)(v) through (1)(vi).

(vii) Coordination with loss rules. List any intangible property subject to section 367(d) the transfer of which also gives rise to the recognition of gain under section 904(f)(3) or §§ 1.367(a)-6 or -6T. Provide a calculation of the gain required to be recognized with respect to such property, in accordance with the provisions of § 1.367(d)-1(g)(3).

(viii) Other intangibles. For further guidance, see § 1.6038B-1T(d)(1)(viii).

(2) Subsequent transfers. For additional, see § 1.6038B-1T(d)(2) introductory text through (d)(2)(ii).

(i) through (ii) [Reserved]

(iii) Subsequent transfer. Except for a subsequent transfer described in paragraph (d)(2)(iv) of this section, provide the following information concerning the subsequent transfer:

(A) For further guidance, see § 1.6038B-1T(d)(2)(iii)(A) through (C).

(B) through (C) [Reserved]

(iv) Subsequent transfer of intangible property to a qualified domestic person. Provide the following information concerning a subsequent transfer of intangible property described in § 1.367(d)-1(f)(4)(i):

(A) A statement providing that § 1.367(d)-1(f)(4)(i)(B) applies to the subsequent transfer;

(B) A general description of the subsequent transfer and any wider transaction of which it forms a part, including the U.S. transferor's former adjusted basis in the intangible property and the transferee foreign corporation's adjusted basis in the intangible property (as determined immediately before the subsequent transfer), the amount and computation of any gain recognized by the U.S. transferor under § 1.367(d)-1(f)(4)(i)(A), and a description of whether the intangible property was, or is expected to be, subsequently transferred to one or more other persons (as described in § 1.367(d)-1(f)(4)(v));

(D) A copy of the Form 926 with respect to the original transfer of the intangible property and any attachments identifying the intangible property as within the scope of section 367(d);

(E) The name, address, and taxpayer identification number of the qualified domestic person that receives the intangible property, including a statement describing the relationship between the U.S. transferor and the qualified domestic person, and, if applicable, such information regarding any other persons described in § 1.367(d)-1(f)(4)(v); and

(F) Any other information as may be prescribed by the Commissioner in publications, forms, instructions, or other guidance.

(e) Transfers subject to section 367(e)—(1) In general. If a domestic corporation (distributing corporation) makes a distribution described in section 367(e)(1) or section 367(e)(2), the distributing corporation must comply with the reporting requirements of this paragraph (e). Unless otherwise provided in this section, a distributing corporation making a distribution described in sections 367(e)(1) or 367(e)(2) must file a Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation (under section 367),” as amended and modified by this section.

(2) Reporting requirements for section 367(e)(1) distributions of domestic controlled corporations. A domestic distributing corporation making a distribution of the stock or securities of a domestic corporation under section 355 is not required to file a Form 926, as described in paragraph (e)(1) of this section, and shall have no other reporting requirements under section 6038B.

(3) Reporting requirements for section 367(e)(1) distributions of foreign controlled corporations. If the distributing corporation makes a section 355 distribution of the stock or securities of a foreign controlled corporation to distributee shareholders who are not qualified U.S. persons, as defined in § 1.367(e)-1(b)(1), then the distributing corporation shall complete Part 1 of the Form 926 and attach a signed copy of such form to its U.S. income tax return for the year of the distribution. The distributing corporation shall also attach to its U.S. income tax return for the year of distribution a statement signed under the penalties of perjury entitled, “Addendum to Form 926.” The addendum shall contain a brief description of the transaction, state the number of shares distributed to distributees who are not qualified U.S. persons (applying the rules contained in § 1.367(e)-1(d)), and state the basis and fair market value of the distributed stock or securities (including a list stating the amounts that were distributed to distributees who were not qualified U.S. persons and distributees who were qualified U.S. persons).

(4) Reporting rules for section 367(e)(2) distributions by domestic liquidating corporations—(i) General rule. Except as provided in paragraph (e)(4)(ii) of this section, if the distributing corporation makes a distribution of property in complete liquidation under section 332 to a foreign distributee corporation that meets the stock ownership requirements of section 332(b) with respect to the stock of the distributing corporation, then the distributing corporation must complete a Form 926 and attach a signed copy of such form to its timely filed U.S. income tax return (including extensions) for the taxable years that include one or more liquidating distributions. The property description contained in Part III of the Form 926 must contain a description, including the adjusted tax basis and fair market value, of all property distributed by the distributing corporation (regardless of whether the distribution of the property qualifies for nonrecognition treatment). The description must also identify the items of property for which nonrecognition treatment is claimed under § 1.367(e)-2(b)(2)(ii) or (iii), as applicable.

(ii) Special rule. Except as provided in paragraph (e)(4)(iii) of this section, if the distributing corporation distributes items of property that will be used by the foreign distributee corporation in the conduct of a trade or business in the United States and the distributing corporation does not recognize gain or loss on such distribution under § 1.367(e)-2(b)(2)(i) with respect to such property, then the distributing corporation may satisfy the requirements of this section by completing Part I and Part II of Form 926, noting in Part III that the information required by Form 926 is contained in a statement required by § 1.367(e)-2(b)(2)(i)(C)(2), and attaching a signed copy of Form 926 to its timely filed U.S. income tax return (including extensions) for each taxable year that includes one or more distributions in liquidation. In addition, if the distributing corporation distributes stock of a domestic subsidiary corporation and does not recognize gain or loss on such distribution under § 1.367(e)-2(b)(2)(iii) with respect to such stock, then the distributing corporation may satisfy the requirements of this section by completing Part I and Part II of Form 926, noting in Part III that the information required by Form 926 is contained in a statement required by § 1.367(e)-2(b)(2)(iii)(D), and attaching a signed copy of Form 926 to its timely filed U.S. income tax return (including extensions) for the taxable years that include one or more distributions of domestic subsidiary stock.

(iii) Properly filed statement. Paragraph (e)(4)(ii) will not apply if there is a failure to file an initial liquidation document as determined under § 1.367(e)-2(e)(3)(i), but for purposes of this section, determined without regard to § 1.367(e)-2(f). However, see paragraph (f)(3) of this section for certain relief that may be available.

(f) Failure to comply with reporting requirements—(1) Consequences of failure. If a U.S. person is required to file a notice (or otherwise comply) under paragraph (b) of this section and fails to comply with the applicable requirements of section 6038B and this section, then with respect to the particular property as to which there was a failure to comply—

(i) The U.S. person shall pay a penalty under section 6038B(b)(1) equal to 10 percent of the fair market value of the transferred property at the time of the exchange, but in no event shall the penalty exceed $100,000 unless the failure with respect to such exchange was due to intentional disregard (described under paragraph (g)(4) of this section); and

(ii) The period of limitations on assessment of tax upon the transfer of that property does not expire before the date which is 3 years after the date on which the Secretary is furnished the information required to be reported under this section. See section 6501(c)(8) and any regulations thereunder.

(2) Failure to comply. A failure to comply with the requirements of section 6038B is—

(i) The failure to report at the proper time and in the proper manner any material information required to be reported under the rules of this section; or

(ii) The provision of false or inaccurate information in purported compliance with the requirements of this section. Thus, a transferor that timely files Form 926 with the attachments required under the rules of this section shall, nevertheless, have failed to comply if, for example, the transferor reports therein that property will be used in the active conduct of a trade or business outside of the United States, but in fact the property continues to be used in a trade or business within the United States.

(iii) With respect to an initial gain recognition agreement filed under § 1.367(a)-8, a failure to comply as determined under § 1.367(a)-8(j)(8), but for purposes of this section, determined without regard to the application of § 1.367(a)-8(p).

(iv) With respect to an initial liquidation document filed under § 1.367(e)-2(b)(2), a failure to comply as determined under § 1.367(e)-2(e)(4)(i), but for purposes of this section, determined without regard to the application of § 1.367(e)-2(f).

(3) Reasonable cause for failure to comply—(i) Request for relief. If the U.S. transferor fails to comply with any requirement of section 6038B and this section, the failure shall be deemed not to have occurred if the U.S. transferor is able to demonstrate that the failure was due to reasonable cause and not willful neglect using the procedure set forth in paragraph (f)(3)(ii) of this section. Whether the failure to timely comply was due to reasonable cause and not willful neglect will be determined by the Director of Field Operations, Cross Border Activities Practice Area of Large Business & International (Director) based on all the facts and circumstances.

(ii) Procedures for establishing that a failure to timely comply was due to reasonable cause and not willful neglect—(A) Time of submission. A U.S. transferor's statement that the failure to timely comply was due to reasonable cause and not willful neglect will be considered only if, promptly after the U.S. transferor becomes aware of the failure, an amended return is filed for the taxable year to which the failure relates that includes the information that should have been included with the original return for such taxable year or that otherwise complies with the rules of this section, and that includes a written statement explaining the reasons for the failure to timely comply.

(B) Notice requirement. In addition to the requirements of paragraph (f)(3)(ii)(A) of this section, the U.S. transferor must comply with the notice requirements of this paragraph (f)(3)(ii)(B). If any taxable year of the U.S. transferor is under examination when the amended return is filed, a copy of the amended return and any information required to be included with such return must be delivered to the Internal Revenue Service personnel conducting the examination. If no taxable year of the U.S. transferor is under examination when the amended return is filed, a copy of the amended return and any information required to be included with such return must be delivered to the Director.

(4) Definition of intentional disregard. If the transferor fails to qualify for the exception under paragraph (f)(3) of this section and if the taxpayer knew of the rule or regulation that was disregarded, the failure will be considered an intentional disregard of section 6038B, and the monetary penalty under paragraph (f)(1)(ii) of this section will not be limited to $100,000. See § 1.6662-3(b)(2).

(g) Effective/applicability dates. (1) This section applies to transfers occurring on or after July 20, 1998, except as provided in paragraphs (g)(2) through (g)(7) of this section, and except for transfers of cash made in tax years beginning on or before February 5, 1999 (which are not required to be reported under section 6038B), and transfers described in paragraph (e) of this section (which applies to transfers that are subject to §§ 1.367(e)-1(f) and 1.367(e)-2(e)). See § 1.6038B-1T for transfers occurring prior to July 20, 1998. See also § 1.6038B-1T(e) in effect prior to August 9, 1999 (as contained in 26 CFR part 1 revised April 1, 1999), for transfers described in section 367(e) that are not subject to §§ 1.367(e)-1(f) and 1.367(e)-2(e).

(2) The rules of paragraph (b)(1)(i) of this section as they apply to section 368(a)(1)(A) reorganizations (including reorganizations described in section 368(a)(2)(D) or (E)) apply to transfers occurring on or after January 23, 2006.

(3) The rules of paragraph (b)(1)(i) of this section that provide an exception from reporting under section 6038B for transfers of stock or securities in a section 354 or 356 exchange, pursuant to a section 368(a)(1)(G) reorganization that is not treated as an indirect stock transfer under § 1.367(a)-3(d), apply to transfers occurring on or after January 23, 2006.

(4) The rules of paragraph (b)(1)(i) of this section that provide an exception from reporting under section 6038B for transfers of stock in a section 354 or 356 exchange, pursuant to a section 368(a)(1)(E) reorganization or an asset reorganization under section 368(a)(1) that is not treated as an indirect stock transfer under § 1.367(a)-3(d), apply to transfers occurring on or after January 23, 2006. The rules of paragraph (b)(1)(i) of this section that provide an exception from reporting under section 6038B for transfers of securities in a section 354 or 356 exchange, pursuant to a section 368(a)(1)(E) reorganization or an asset reorganization under section 368(a)(1) that is not treated as an indirect stock transfer under § 1.367(a)-3(d), apply only to transfers occurring after January 5, 2005 (although taxpayers may apply such provision to transfers of securities occurring on or after July 20, 1998 and on or before January 5, 2005 if done consistently to all transactions). See § 1.6038-1T(b)(i), as contained in 26 CFR part 1 revised as of April 1, 2005, for transfers occurring prior to the effective dates described in paragraphs (g)(2) through (4) of this section.

(5) Paragraphs (c)(6) and (f)(3) of this section apply to transfers occurring on or after April 18, 2013. For guidance with respect to paragraphs (c)(6) and (f)(3) of this section before April 18, 2013, see 26 CFR part 1 revised as of April 1, 2012.

(6) The second sentence of paragraph (b)(1)(i) and paragraphs (b)(2)(i)(B)(1), (b)(2)(iii), (b)(2)(iv), (c), (e)(4), (f)(2)(iii), and (f)(2)(iv) of this section will apply to transfers for which documents are required to be filed on or after November 19, 2014, as well as to transfers that are the subject of requests for relief submitted on or after November 19, 2014. The second sentence of paragraph (b)(1)(i) and paragraphs (b)(2)(i)(B)(1), (b)(2)(iii), (b)(2)(iv), (c), and (f)(2)(iii) of this section will also apply to any transfer that is the subject of a request for relief submitted pursuant to § 1.367(a)-8(r)(3).

(7) Paragraphs (c)(4)(i) through (vii), (c)(5), and (d)(1)(iv) and (vii) of this section apply to transfers occurring on or after September 14, 2015, and to transfers occurring before September 14, 2015, resulting from entity classification elections made under § 301.7701-3 that are filed on or after September 14, 2015. For guidance with respect to paragraphs (c)(4), (c)(5), and (d)(1) of this section before this section is applicable, see §§ 1.6038B-1 and 1.6038B-1T as contained in 26 CFR part 1 revised as of April 1, 2016.

(8) Paragraphs (d)(2)(iii) introductory text and (d)(2)(iv) of this section apply to transfers occurring on or after October 10, 2024.

[T.D. 8770, 63 FR 33568, June 19, 1998]

Editorial Note:For Federal Register citations affecting § 1.6038B-1, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6038B-1T Reporting of certain transactions to foreign corporations (temporary).

(a) through (b)(3) [Reserved]. For further guidance, see § 1.6038B-1(a) through (b)(3).

(4) Date of transfer—(i) In general. For purposes of this section, the date of a transfer described in section 367 is the first date on which title to, possession of, or rights to the use of stock, securities, or other property passes pursuant to the plan for purposes of subtitle A of the Internal Revenue Code. A transfer will not be considered to begin with a decision of a board of directors or similar action unless the transaction otherwise takes effect for purposes of subtitle A of the Internal Revenue Code on that date.

(ii) Termination of section 1504(d) election. A transfer deemed to occur as a result of the termination of an election under section 1504(d) will be considered to occur on the date the contiguous country corporation first fails to continue to qualify for the election under section 1504(d). The rule of this paragraph (b)(3)(ii) is illustrated by the following example.

Example.Domestic corporation W previously made a valid election under section 1504(d) to have its Mexican subsidiary S treated as a domestic corporation. On August 1, 1986, W disposes of its right, title, and interest in 10 percent of the stock of S by selling such stock to an unrelated United States person who is not a director of S. S first fails to continue to qualify for the election under section 1504(d) on August 1, 1986, since on such date it ceases to be directly or indirectly wholly owned or controlled by W. The constructive transfer of assets from “domestic” corporation S to Mexican corporation S is considered to occur on that date.

(iii) Change in classification. A transfer deemed to occur as a result of a change in classification of an entity caused by a change in the governing documents, articles, or agreements of the entity (as described in § 1.367(a)-1T(c)(6)) will be considered to occur on the date that such changes take effect for purposes of subtitle A of the Internal Revenue Code.

(iv) U.S. resident under section 6013 (g) or (h). A transfer made by an alien individual who is considered to be a U.S. resident by reason of a timely election under section 6013 (g) or (h) will be considered to occur, for purposes of this section (but not for purposes of section 367), on the later of—

(A) The date on which the election under section 6013 (g) or (h) is made; or

(B) The date on which the transfer would otherwise be considered to occur under the rules of this paragraph (b)(3).

The rule of this paragraph (b)(3)(iv) is illustrated by the following example.

Example.D is a nonresident alien individual who is married to a United States citizen. On March 1, 1986, D transfers property to a foreign corporation in an exchange described in section 351. On April 15, 1987, D and the spouse timely file with their tax return for the taxable year ended December 31, 1986, an election under section 6013(g) for D to be treated as a United States resident. The election is effective on January 1, 1986. For purposes of section 6038 B, the transfer described in section 367(a) made by D in connection with the section 351 exchange is considered to occur on April 15, 1987, the date on which the timely election was made under section 6013(g).

(1) Transferor. Provide the name, U.S. taxpayer identification number, and address of the U.S. person making the transfer.

(2) Transfer. Provide the following information concerning the transfer:

(i) Name, U.S. taxpayer identification number (if any), address, and country of incorporation of transferee foreign corporation;

(ii) A general description of the transfer, and any wider transaction of which it forms a part, including a chronology of the transfers involved and an identification of the other parties to the transaction to the extent known.

(3) Consideration received. Provide a description of the consideration received by the U.S. person making the transfer, including its estimated fair market value and, in the case of stock or securities, the class or type, amount, and characteristics of the interest received.

(4) Property transferred. Provide a description of the property transferred. The description must be divided into the following categories, and must include the estimated fair market value and adjusted basis of the property, as well as any additional information specified below.

(i) through (c)(5) introductory text [Reserved]

(i) Branch operation. Describe the foreign branch the property of which is transferred, in accordance with the definition of § 1.367(a)-6T(g).

(ii) Branch property. Describe the property of the foreign branch, including its adjusted basis and fair market value. For this purpose property must be identified with reasonable particularity, but may be identified by category rather than listing every asset separately. Substantially similar property may be listed together for this purpose, and property of minor value may be grouped into functional categories. For example, a reasonable description of the property of a business office might include the following categories: Word processing or data processing equipment, other office equipment and furniture, and office supplies.

(iii) Previously deducted losses. Set forth a detailed calculation of the sum of the losses incurred by the foreign branch before the transfer, and a detailed calculation of any reduction of such losses, in accordance with § 1.367(a)-6T (d) and (e).

(iv) Character of gain. Set forth a statement of the character of the gain required to be recognized, in accordance with § 1.367(a)-6T(c)(1).

(6) [Reserved]. For further guidance, see § 1.6038B-1(c)(6).

(d) Transfers subject to section 367(d)—(1) Initial transfer. A U.S. person that transfers inntangible property to a foreign corporation in an exchange described in section 351 or 361 must provide the following information in paragraphs labelled to correspond with the number or letter set forth below. If a particular item is not applicable to the subject transfer, list its heading and state that it is not applicable. The information required by subdivisions (i) through (iii) need only be provided if such information was not otherwise provided under paragraph (c) of this section. (Note that the U.S. transferor may subsequently be required to file another return under paragraph (d)(2) of this section.)

(i) Transferor. Provide the name, U.S. taxpayer identification number, and address of the U.S. person making the transfer.

(ii) Transfer. Provide information concerning the transfer, including:

(A) Name, U.S. taxpayer identification number (if any), address, and country of incorporation of the transferee foreign corporation;

(B) A general description of the transfer, and any wider transaction of which it forms a part, including a chronology of the transfers involved and an identification of the other parties to the transaction to the extent known.

(iii) Consideration received. Provide a description of the consideration received by the U.S. person making the transfer, including its estimated fair market value and, in the case of stock or securities, the class or type, amount, and characteristics of the interest received.

(iv) [Reserved]

(v) Annual payment. Provide and explain the calculation of the annual deemed payment for the use of the intangible property required to be recognized by the transferor under the rules of section 367(d).

(vi) Election to treat as sale. List any intangible with respect to which an election is being made under § 1.367(d)-1T(g)(2) to treat the transfer as a sale. Include the fair market value of the intangible on the date of the transfer and a calculation of the gain required to be recognized in the year of the transfer by reason of the election.

(vii) [Reserved]

(viii) Other intangibles. Describe any intangible property sold or licensed by the transferor to the transferee foreign corporation, and set forth the general terms of each sale or license.

(2) Subsequent transfers. If a U.S. person transfers intangible property to a foreign corporation in an exchange described in section 351 or 361, and at any time thereafter (within the useful life of the intangible property) either that U.S. person disposes of the stock of the transferee foreign corporation or the transferee foreign corporation disposes of the transferred intangible, then the U.S. person must provide the following information in paragraphs labelled to correspond with the number or letter set forth below. The information required by subdivisions (i) and (ii) need only be provided if such information was not otherwise provided in the same return, pursuant to paragraph (c) or (d)(1) of this section. For purposes of determining the date on which a return under this subparagraph (2) is required to be filed, the date of transfer is the date of the subsequent transfer of stock or intangible property.

(i) Transferor. Provide the name, U.S. taxpayer identification number, and address of the U.S. person making the transfer.

(ii) Initial transfer. Provide the following information concerning the initial transfer:

(A) The date of the transfer;

(B) The name, U.S. taxpayer identification number (if any), address, and country of incorporation of the transferee foreign corporation; and

(iii) Subsequent transfer. For further guidance, see § 1.6038B-1T(d)(2)(iii) introductory text:

(A) A general description of the subsequent transfer and any wider transaction of which it forms a part;

(B) A calculation of any gain required to be recognized by the U.S. person under the rules of § 1.367(d)-1T (d) through (f); and

(C) The name, address, and identifying number of each person that under the rules of § 1.367(d)-1T (e) or (f) will be considered to receive contingent annual payments for the use of the intangible property.

(e) [Reserved]. For further guidance, see § 1.6038B-1(e).

(f)(1) through (f)(3) [Reserved] For further guidance, see § 1.6038B-1(f)(1) through (f)(2).

(f)(4) [Reserved] For further guidance, see § 1.6038B-1T(f)(4).

(g) Effective date. This section applies to transfers occurring after December 31, 1984. See § 1.6038B-1T(a) through (b)(2), (c) introductory text, and (f) (26 CFR part 1, revised April 1, 1998) for transfers occurring prior to July 20, 1998. See § 1.6038B-1 for transfers occurring on or after July 20, 1998.

[T.D. 8087, 51 FR 17957, May 16, 1986, as amended by T.D. 8682, 61 FR 42177, Aug. 14, 1996; T.D. 8770, 63 FR 33570, June 19, 1998; T.D. 8834, 64 FR 43083, Aug. 9, 1999; T.D. 9100, 68 FR 70708, Dec. 19, 2003; 69 FR 5017, Feb. 3, 2004; T.D. 9243, 71 FR 4294, Jan. 26, 2006; T.D. 9300, 71 FR 71045, Dec. 8, 2006; T.D. 9615, 78 FR 17064, Mar. 19, 2013; T.D. 9760, 81 FR 15169, Mar. 22, 2016; T.D. 9803, 81 FR 91032, Dec. 16, 2016; T.D. 9994, 89 FR 82170, Oct. 10, 2024]

§ 1.6038B-2 Reporting of certain transfers to foreign partnerships.

(a) Reporting requirements—(1) Requirement to report transfers. A United States person that transfers property to a foreign partnership in a contribution described in section 721 (including section 721(b)) must report that transfer on Form 8865 “Information Return of U.S. Persons With Respect to Certain Foreign Partnerships” pursuant to section 6038B and the rules of this section, if—

(i) Immediately after the transfer, the United States person owns, directly, indirectly, or by attribution, at least a 10-percent interest in the partnership, as defined in section 6038(e)(3)(C) and the regulations thereunder;

(ii) The value of the property transferred, when added to the value of any other property transferred in a section 721 contribution by such person (or any related person) to the partnership during the 12-month period ending on the date of the transfer, exceeds $100,000; or

(iii) The United States person is a U.S. transferor (as defined in § 1.721(c)-1(b)(18)) that makes a gain deferral contribution and is required to report under § 1.721(c)-6(b)(2). The reporting required under this paragraph (a) includes the annual reporting required by § 1.721(c)-6(b)(3). For purposes of applying this paragraph (a)(1)(iii) to partnerships formed on or after January 18, 2017, a domestic partnership is treated as a foreign partnership pursuant to section 7701(a)(4).

(2) Indirect transfer through a domestic partnership—For purposes of this section, if a domestic partnership transfers property to a foreign partnership in a section 721 transaction, the domestic partnership's partners shall be considered to have transferred a proportionate share of the property to the foreign partnership. However, if the domestic partnership properly reports all of the information required under this section with respect to the contribution, no partner of the transferor partnership, whether direct or indirect (through tiers of partnerships), is also required to report under this section. For illustrations of this rule, see Examples 4 and 5 of paragraph (a)(7) of this section.

(3) Indirect transfer through a foreign partnership. Solely for purposes of this section, if a foreign partnership transfers section 721(c) property (as defined in § 1.721(c)-1(b)(15)) to another foreign partnership in a transfer described in § 1.721(c)-3(d) (tiered-partnership rules), then the transferor foreign partnership's partners will be considered to have transferred a proportionate share of the property to the foreign partnership.

(4) Requirement to report dispositions—(i) In general. If a United States person was required to report a transfer to a foreign partnership of appreciated property under paragraph (a)(1) or (2) of this section, and the foreign partnership disposes of the property while such United States person remains a direct or indirect partner, that United States person must report the disposition by filing Form 8865. The form must be attached to, and filed by the due date (including extensions) of, the United States person's income tax return for the year in which the disposition occurred.

(ii) Disposition of contributed property in nonrecognition transaction. If a foreign partnership disposes of contributed appreciated property in a nonrecognition transaction and substituted basis property is received in exchange, and the substituted basis property has built-in gain under § 1.704-3(a)(8), the original transferor is not required to report the disposition. However, the transferor must report the disposition of the substituted basis property in the same manner as provided for the contributed property.

(5) Time for filing Form 8865. The Form 8865 on which a transfer is reported must be attached to the transferor's timely filed (including extensions) income tax return for the tax year that includes the date of the transfer. If the person required to report under this section is not required to file an income tax return for its tax year during which the transfer occurred, but is required to file an information return for that year (for example, Form 1065, “U.S. Partnership Return of Income,” or Form 990, “Return of Organization Exempt from Income Tax”), the person should attach the Form 8865 to its information return.

(6) Returns to be made—(i) Separate returns for each partnership. If a United States person transfers property reportable under this section to more than one foreign partnership in a taxable year, the United States person must submit a separate Form 8865 for each partnership.

(ii) Duplicate form to be filed. If required by the instructions accompanying Form 8865, a duplicate Form 8865 (including attachments and schedules) must also be filed by the due date for submitting the original Form 8865 under paragraph (a)(5)(i) or (ii) of this section, as applicable.

(7) Examples. The application of this paragraph (a) may be illustrated by the following examples:

Example 1.On November 1, 2001, US, a United States person that uses the calendar year as its taxable year, contributes $200,000 to FP, a foreign partnership, in a transaction subject to section 721. After the contribution, US owns a 5% interest in FP. US must report the contribution by filing Form 8865 for its taxable year ending December 31, 2001. On March 1, 2002, US makes a $40,000 section 721 contribution to FP, after which US owns a 6% interest in FP. US must report the $40,000 contribution by filing Form 8865 for its taxable year ending December 31, 2002, because the contribution, when added to the value of the other property contributed by US to FP during the 12-month period ending on the date of the transfer, exceeds $100,000.

Example 2. F,a nonresident alien, is the brother of US, a United States person. F owns a 15% interest in FP, a foreign partnership. US contributes $99,000 to FP, in exchange for a 1-percent partnership interest. Under sections 6038(e)(3)(C) and 267(c)(2), US is considered to own at least a 10-percent interest in FP and, therefore, US must report the $99,000 contribution under this section.

Example 3. US,a United States person, owns 40 percent of FC, a foreign corporation. FC owns a 20-percent interest in FP, a foreign partnership. Under section 267(c)(1), US is considered to own 8 percent of FP due to its ownership of FC. US contributes $50,000 to FP in exchange for a 5-percent partnership interest. Immediately after the contribution, US is considered to own at least a 10-percent interest in FP and, therefore, must report the $50,000 contribution under this section.

Example 4. US,a United States person, owns a 60-percent interest in USP, a domestic partnership. On March 1, 2001, USP contributes $200,000 to FP, a foreign partnership, in exchange for a 5-percent partnership interest. Under paragraph (a)(2) of this section, US is considered as having contributed $120,000 to FP ($200,000 × 60%). However, under paragraph (a)(2), if USP properly reports the contribution to FP, US is not required to report its $120,000 contribution. If US directly contributes $5,000 to FP on June 10, 2001, US must report the $5,000 contribution because US is considered to have contributed more than $100,000 to FP in the 12-month period ending on the date of the $5,000 contribution.

Example 5. US,a United States person, owns an 80-percent interest in USP, a domestic partnership. USP owns an 80-percent interest in USP1, a domestic partnership. On March 1, 2001, USP1 contributes $200,000 to FP, a foreign partnership, in exchange for a 3-percent partnership interest. Under paragraph (a)(2) of this section, USP is considered to have contributed $160,000 ($200,000 × 80%) to FP. US is considered to have contributed $128,000 to FP ($200,000 × 80% × 80%). However, if USP1 reports the transfer of the $200,000 to FP, neither US nor USP are required to report under this section the amounts they are considered to have contributed. Additionally, regardless of whether USP1 reports the $200,000 contribution, if USP reports the $160,000 contribution it is considered to have made, US does not have to report under this section the $128,000 contribution US is considered to have made.

(b) Transfers by trusts relating to state and local government employee retirement plans. Trusts relating to state and local government employee retirement plans are not required to report transfers under this section, unless otherwise specified in the instructions to Form 8865.

(c) Information required with respect to transfers of property. With respect to transfers required to be reported under paragraph (a)(1) or (2) of this section, the return must contain information in such form or manner as Form 8865 (and its accompanying instructions) prescribes with respect to reportable events, including—

(1) The name, address, and U.S. taxpayer identification number of the United States person making the transfer;

(2) The name, U.S. taxpayer identification number (if any), and address of the transferee foreign partnership, and the type of entity and country under whose laws the partnership was created or organized;

(3) A general description of the transfer, and of any wider transaction of which it forms a part, including the date of transfer;

(4) The names and addresses of the other partners in the foreign partnership, unless the transfer is solely of cash and the transferor holds less than a ten-percent interest in the transferee foreign partnership immediately after the transfer. However, for tax years of U.S. persons beginning on or after January 1, 2000, the person reporting pursuant to section 6038B (the transferor) must provide the names and addresses of each United States person that owned a ten-percent or greater direct interest in the foreign partnership during the transferor's tax year in which the transfer occurred, and the names and addresses of any other United States or foreign persons that were direct partners in the foreign partnership during that tax year and that were related to the transferor during that tax year. See paragraph (i)(4) of this section for the definition of a related person;

(5) A description of the partnership interest received by the United States person, including a change in partnership interest;

(6) A separate description of each item of contributed property that is appreciated property subject to the allocation rules of section 704(c) (except to the extent that the property is permitted to be aggregated in making allocations under section 704(c)), or is intangible property, including its estimated fair market value and adjusted basis;

(7) A description of other contributed property, not specified in paragraph (c)(6) of this section, aggregated by the following categories (with, in each case, a brief description of the property)—

(i) Stock in trade of the transferor (inventory);

(ii) Tangible property (other than stock in trade) used in a trade or business of the transferor;

(iii) Cash;

(iv) Stock, notes receivable and payable, and other securities; and

(v) Other property;

(8) With respect to reporting required under § 1.721(c)-6(b)(2) and paragraph (a)(1)(iii) of this section with regard to a gain deferral contribution, the information required by § 1.721(c)-6(b)(2); and

(9) With respect to section 721(c) property for which reporting is required under § 1.721(c)-6(b)(3) and paragraph (a)(1)(iii) of this section, the information required by § 1.721(c)-6(b)(3).

(d) Information required with respect to dispositions of property. In respect of dispositions required to be reported under paragraph (a)(4) of this section, the return must contain information in such form or manner as Form 8865 (and its accompanying instructions) prescribes with respect to reportable events, including—

(1) The date and manner of disposition;

(2) The gain and depreciation recapture amounts, if any, realized by the partnership; and

(3) Any such amounts allocated to the United States person.

(e) Method of reporting. Except as otherwise provided on Form 8865, or the accompanying instructions, all amounts reported as required under this section must be expressed in United States currency, with a statement of the exchange rates used. All statements required on or with Form 8865 pursuant to this section must be in the English language.

(f) Reporting under this section not required of partnerships excluded from the application of subchapter K—(1) Election to be wholly excluded. The reporting requirements of this section will not apply to any United States person in respect of an eligible partnership as described in § 1.761-2(a), if such partnership has validly elected to be excluded from all of the provisions of subchapter K of chapter 1 of the Internal Revenue Code in the manner specified in § 1.761-2(b)(2)(i).

(2) Deemed excluded. The reporting requirements of this section will not apply to any United States person in respect of an eligible partnership as described in § 1.761-2(a), if such partnership is validly deemed to have elected to be excluded from all of the provisions of subchapter K of chapter 1 of the Internal Revenue Code in accordance with the provisions of § 1.761-2(b)(2)(ii).

(g) Deemed contributions. Deemed contributions resulting from IRS-initiated section 482 adjustments are not required to be reported under section 6038B. However, taxpayers must report deemed contributions resulting from taxpayer-initiated adjustments. Such information will be furnished timely if filed by the due date, including extensions, for filing the taxpayer's income tax return for the year in which the adjustment is made.

(h) Failure to comply with reporting requirements—(1) Consequences of a failure. If a United States person is required to file a return under paragraph (a) of this section and fails to comply with the reporting requirements of section 6038B and this section, or § 1.721(c)-6, then that person is subject to the following penalties:

(i) The United States person is subject to a penalty equal to 10 percent of the fair market value of the property at the time of the contribution. Such penalty with respect to a particular transfer is limited to $100,000, unless the failure to comply with respect to such transfer was due to intentional disregard.

(ii) The United States person must recognize gain (reduced by the amount of any gain recognized, with respect to that property, by the transferor after the transfer) as if the contributed property had been sold for fair market value at the time of the contribution. Adjustments to the basis of the partnership's assets and any relevant partner's interest as a result of gain being recognized under this provision will be made as though the gain was recognized in the year in which the failure to report was finally determined.

(2) Failure to comply. A failure to comply with the requirements of section 6038B includes—

(i) The failure to report at the proper time and in the proper manner any information required to be reported under the rules of this section; and

(ii) The provision of false or inaccurate information in purported compliance with the requirements of this section.

(3) Reasonable cause exception. Under section 6038B(c)(2) and this section, the provisions of paragraph (h)(1) of this section will not apply if the United States person shows, in a timely manner, that a failure to comply was due to reasonable cause and not willful neglect. A United States person's statement that the failure to comply was due to reasonable cause and not willful neglect will be considered timely only if, promptly after the United States person becomes aware of the failure, an amended return is filed for the taxable year to which the failure relates that includes the information that should have been included with the original return for such taxable year or that otherwise complies with the rules of this section, and that includes a written statement explaining the reasons for the failure to comply. If any taxable year of the United States person is under examination when the amended return is filed, a copy of the amended return must be delivered to the Internal Revenue Service personnel conducting the examination when the amended return is filed. If no taxable year of the United States person is under examination when the amended return is filed, a copy of the amended return must be delivered to the Director of Field Operations, Cross Border Activities Practice Area of Large Business & International (or any successor to the roles and responsibilities of such position, as appropriate) (Director). Whether a failure to comply was due to reasonable cause and not willful neglect will be determined by the Director under all the facts and circumstances.

(4) Statute of limitations. For exceptions to the limitations on assessment in the event of a failure to provide information under section 6038B, see section 6501(c)(8).

(i) Definitions—(1) Appreciated property. Appreciated property is property that has a fair market value in excess of basis.

(2) Domestic partnership. A domestic partnership is a partnership described in section 7701(a)(4).

(3) Foreign partnership. A foreign partnership is a partnership described in section 7701(a)(5).

(4) Related person. Persons are related persons if they bear a relationship described in section 267(b)(1) through (3) or (10) through (12), after application of section 267(c) (except for (c)(3)), or in section 707(b)(1)(B).

(5) Substituted basis property. Substituted basis property is property described in section 7701(a)(42).

(6) Taxpayer-initiated adjustment. A taxpayer-initiated adjustment is a section 482 adjustment that is made by the taxpayer pursuant to § 1.482-1(a)(3).

(7) United States person. A United States person is a person described in section 7701(a)(30).

(j) Effective dates—(1) In general. Except as otherwise provided in this section, this section applies to transfers made on or after January 1, 1998. However, for a transfer made on or after January 1, 1998, but before January 1, 1999, the filing requirements of this section may be satisfied by—

(i) Filing a Form 8865 with the taxpayer's income tax return (including a partnership return of income) for the first taxable year beginning on or after January 1, 1999; or

(ii) Filing a Form 926 (modified to reflect that the transferee is a partnership, not a corporation) with the taxpayer's income tax return (including a partnership return of income) for the taxable year in which the transfer occurred.

(2) Transfers made between August 5, 1997 and January 1, 1998. A United States person that made a transfer of property between August 5, 1997, and January 1, 1998, that is required to be reported under section 6038B may satisfy its reporting requirement by reporting in accordance with the provisions of this section or in accordance with the provisions of Notice 98-17 (1998-11 IRB 6)(see § 601.601(d)(2) of this chapter).

(3) Special rule for transfers made before January 1, 2000. Even if not reported in accordance with the rules provided in paragraph (a)(5) of this section, or paragraph (j) (1) or (2) of this section, a transfer that occurred before January 1, 2000 will nevertheless be considered timely reported if the transferor reports it on a Form 8865 attached to an amended tax return for the transferor's tax year in which the transfer occurred, provided such amended return is filed no later than September 15, 2000.

(4) Transfers of section 721(c) property. Paragraph (c)(8) of this section applies to transfers occurring on or after August 6, 2015, and to transfers that occurred before August 6, 2015 resulting from an entity classification election made under § 301.7701-3 of this chapter that was effective on or before August 6, 2015 but was filed on or after August 6, 2015. Paragraphs (a)(1)(iii), (a)(3), and (c)(9) of this section apply to transfers occurring on or after January 18, 2017, and to transfers that occurred before January 18, 2017 resulting from entity classification elections made under § 301.7701-3 of this chapter that were effective on or before January 18, 2017 but were filed on or after January 18, 2017.

(5) Reasonable cause exception. Paragraph (h)(3) of this section applies to all requests for relief for transfers of property to partnerships filed on or after January 18, 2017.

[T.D. 8817, 64 FR 5715, Feb. 5, 1999; 64 FR 15686, Apr. 1, 1999; T.D. 8850, 64 FR 72554, Dec. 28, 1999, as amended by T.D. 9814, 82 FR 7610, Jan. 19, 2017; T.D. 9891, 85 FR 3851, Jan. 23, 2020]

§ 1.6038D-0 Outline of regulation provisions.

This section lists the table of contents for §§ 1.6038D-1 through 1.6038D-8.

§ 1.6038D-1 Reporting with respect to specified foreign financial assets, definition of terms.

(a) In general.

(1) Specified person.

(2) Specified individual.

(3) Resident alien.

(4) Bona fide resident of a U.S. possession.

(5) U.S. possession.

(6) Specified foreign financial asset.

(7) Financial account.

(8) Financial institution.

(9) Foreign financial institution.

(10) Foreign entity.

(11) Annual return.

(12) Specified domestic entity.

(13) Model 1 IGA and Model 2 IGA.

(b) Effective/applicability dates.

(1) In general.

(2) Financial accounts.

§ 1.6038D-2 Requirement to report specified foreign financial assets.

(a) Reporting requirement.

(1) In general.

(2) Special rule for married specified individuals filing a joint annual return.

(3) Special rule for certain specified individuals living abroad.

(4) Special rule for married specified individuals filing a joint annual return and living abroad.

(5) Assets with no positive value.

(6) Aggregate value calculation in case of specified foreign financial asset excluded from reporting.

(i) Specified individual.

(ii) Specified domestic entity.

(7) Form 8938 filed with annual return.

(i) General rule.

(ii) Consolidated returns.

(8) Reporting required regardless of tax result.

(9) Reporting period.

(10) Successor forms.

(b) Interest in a specified foreign financial asset.

(1) In general.

(2) Property transferred in connection with the performance of services.

(3) Special rule for parent making an election under section 1(g)(7).

(4) Entities.

(i) In general.

(ii) Specified foreign financial assets held by certain trusts.

(iii) Specified foreign financial assets held by a disregarded entity.

(iv) Interest in a foreign trust or foreign estate.

(1) In general.

(i) Determining aggregate value of assets.

(ii) Reporting maximum value.

(2) Aggregate asset value for married specified individuals filing a joint annual return.

(3) Aggregate asset value for married specified individuals filing a separate annual return.

(i) Both spouses are specified individuals.

(ii) One spouse is not a specified individual.

(d) Annual return filed by a married specified individual.

(1) Joint annual return.

(2) Separate annual return.

(e) Special rules for dual resident taxpayers.

(1) In general.

(2) Dual resident taxpayer filing as a nonresident alien at end of taxable year.

(3) Dual resident taxpayer filing as a resident alien at end of taxable year.

(f) Example.

(1) Facts.

(2) Filing requirement.

(i) Married specified individuals filing separate annual returns.

(ii) Married specified individuals filing a joint annual return.

(g) Effective/applicability dates.

§ 1.6038D-3 Specified foreign financial assets.

(a) Financial accounts.

(1) In general.

(2) Financial account in a U.S. possession.

(3) Excepted financial accounts.

(i) Accounts maintained by U.S. payors.

(ii) Mark-to-market election under section 475.

(b) Other specified foreign financial assets.

(1) In general.

(2) Mark-to-market election under section 475.

(3) Held for investment.

(4) Trade-or-business test.

(5) Direct relationship between holding an asset and a trade or business.

(i) In general.

(ii) Presumption of direct relationship.

(d) Examples.

(e) Effective/applicability dates.

§ 1.6038D-4 Information required to be reported.

(a) Required information.

(b) Effective/applicability dates.

§ 1.6038D-5 Valuation guidelines.

(a) Fair market value.

(b) Valuation of assets.

(1) Maximum value.

(2) U.S. dollars.

(3) Asset with no positive value.

(1) In general.

(2) Other publicly available exchange rate.

(3) Currency exchange rate.

(4) Determination date.

(d) Financial accounts.

(e) Asset held in a financial account.

(f) Other specified foreign financial assets.

(1) General rule.

(2) Interests in trusts that are specified foreign financial assets.

(i) Maximum value.

(ii) Reporting threshold.

(3) Interests in estates, pension plans, and deferred compensation plans.

(i) Maximum value.

(ii) Reporting threshold.

(g) Effective/applicability dates.

§ 1.6038D-6 Specified domestic entities.

(a) Specified domestic entity.

(b) Corporations and partnerships.

(1) Formed or availed of.

(2) Closely held.

(i) Domestic corporation.

(ii) Domestic partnership.

(iii) Constructive ownership.

(3) Determination of passive income and assets.

(i) Definition of passive income.

(ii) Exception from passive income treatment for dealers.

(iii) Related entities.

(4) Examples.

(d) Excepted domestic entities.

(1) Certain persons described in section 1473(3).

(2) Certain domestic trusts.

(3) Domestic trusts owned by one or more specified persons.

(e) Effective/applicability dates.

§ 1.6038D-7 Exceptions from the reporting of certain assets under section 6038D.

(a) Elimination of duplicative reporting of assets.

(1) In general.

(2) Foreign grantor trusts.

(3) Joint Form 5471 or Form 8865 filing.

(b) Owner of certain trusts.

(d) Effective/applicability dates.

§ 1.6038D-8 Penalties for failure to disclose.

(a) In general.

(b) Married specified individuals filing a joint annual return.

(d) Presumption of aggregate value.

(e) Reasonable cause exception.

(1) In general.

(2) Affirmative showing required.

(3) Facts and circumstances taken into account.

(f) Penalties for underpayments attributable to undisclosed foreign financial assets.

(1) Accuracy related penalty.

(2) Criminal penalties.

(g) Effective/applicability dates.

[T.D. 9706, 79 FR 73824, Dec. 12, 2014, as amended by T.D. 9752, 81 FR 8838, Feb. 23, 2016]

§ 1.6038D-1 Reporting with respect to specified foreign financial assets, definition of terms.

(a) In general. The following definitions apply for purposes of section 6038D and the regulations—

(1) Specified person. The term specified person means a specified individual or a specified domestic entity.

(2) Specified individual. The term specified individual means an individual who is a—

(i) U.S. citizen;

(ii) Resident alien of the United States for any portion of the taxable year;

(iii) Nonresident alien for whom an election under section 6013(g) or (h) is in effect; or

(iv) Nonresident alien who is a bona fide resident of Puerto Rico or a section 931 possession (as defined in § 1.931-1(c)(1)).

(3) Resident alien. The term resident alien has the meaning set forth in section 7701(b) and §§ 301.7701(b)-1 through 301.7701(b)-9 of this chapter.

(4) Bona fide resident of a U.S. possession. The term bona fide resident of a U.S. possession means an individual who is a “bona fide resident” under section 937(a) and § 1.937-1.

(5) U.S. possession. The term U.S. possession means American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands.

(6) Specified foreign financial asset. The term specified foreign financial asset has the meaning set forth in § 1.6038D-3.

(7) Financial account. The term financial account has the meaning set forth in § 1.1471-5(b), provided, however, that the exclusions of retirement and pension accounts and non-retirement savings accounts under § 1.1471-5(b)(2)(i) and retirement and pension accounts, non-retirement savings accounts, and accounts satisfying similar conditions in an applicable Model 1 IGA or Model 2 IGA under § 1.1471-5(b)(2)(vi) shall not apply (see the section 6038D coordination rule in § 1.1471-5(b)(2)(i)(D)). See § 1.6038D-3(a)(2) relating to financial accounts maintained by a financial institution that is organized under the laws of a U.S. possession.

(8) Financial institution. The term financial institution has the meaning set forth in section 1471(d)(5) and the regulations thereunder.

(9) Foreign financial institution. The term foreign financial institution has the meaning set forth in § 1.1471-5(d).

(10) Foreign entity. The term foreign entity has the meaning set forth in § 1.1473-1(e).

(11) Annual return. The term annual return means an annual federal income tax return of a specified individual or an annual federal income tax return or information return of a specified domestic entity filed with the Internal Revenue Service under section 876, 6011, 6012, 6013, 6031, or 6037, and the regulations.

(12) Specified domestic entity. The term specified domestic entity has the meaning set forth in § 1.6038D-6.

(13) Model 1 IGA and Model 2 IGA. The terms Model 1 IGA and Model 2 IGA have the meanings set forth in § 1.1471-1(b)(78) and (79), respectively.

(b) Effective/applicability dates—(1) In general. Except as otherwise provided in this paragraph (b), this section applies to taxable years ending after December 19, 2011. Taxpayers may elect to apply the rules of this section to taxable years ending prior to December 19, 2011.

(2) Financial accounts. For purposes of applying the financial account definition in § 1.6038D-1(a)(7), the treatment under § 1.1471-5(b)(2)(vi) of retirement and pension accounts, non-retirement savings accounts, and accounts satisfying similar conditions in an applicable Model 1 IGA or Model 2 IGA (see § 1.1471-1(b)(78) and (79)) as financial accounts for purposes of the reporting required under section 6038D and § 1.6038D-2(a) shall apply to taxable years beginning after December 12, 2014.

[T.D. 9706, 79 FR 73825, Dec. 12, 2014, as amended by T.D. 9752, 81 FR 8838, Feb. 23, 2016]

§ 1.6038D-2 Requirement to report specified foreign financial assets.

(a) Reporting requirement—(1) In general. Except as otherwise provided, a specified person that has any interest in a specified foreign financial asset during the taxable year must attach Form 8938, “Statement of Specified Foreign Financial Assets,” to that specified person's annual return for the taxable year to report the information required by section 6038D and § 1.6038D-4 if the aggregate value of all such assets exceeds—

(i) $50,000 on the last day of the taxable year; or

(ii) $75,000 at any time during the taxable year.

(2) Special rule for married specified individuals filing a joint annual return. Except as provided in paragraph (a)(4) of this section, married specified individuals who file a joint annual return for the taxable year must attach a single Form 8938 to their joint annual return for the taxable year to report the information required by section 6038D and § 1.6038D-4 if the aggregate value of all of the specified foreign financial assets in which either married specified individual has an interest exceeds—

(i) $100,000 on the last day of the taxable year; or

(ii) $150,000 at any time during the taxable year.

(3) Special rule for certain specified individuals living abroad. Except as provided in paragraph (a)(4) of this section, a specified individual who is a qualified individual under section 911(d)(1) for the taxable year must attach a Form 8938 to his or her annual return for the taxable year to report the information required by section 6038D and § 1.6038D-4 if the aggregate value of the specified foreign financial assets in which the specified individual has an interest exceeds—

(i) $200,000 on the last day of the taxable year; or

(ii) $300,000 at any time during the taxable year.

(4) Special rule for married specified individuals filing a joint annual return and living abroad. A specified individual who is a qualified individual under section 911(d)(1) for the taxable year and the qualified individual's spouse who file a joint annual return for the taxable year must attach a single Form 8938 to their return for the taxable year to report the information required by section 6038D and § 1.6038D-4 if the aggregate value of the all of the specified foreign financial assets in which either married individual has an interest exceeds—

(i) $400,000 on the last day of the taxable year; or

(ii) $600,000 at any time during the taxable year.

(5) Assets with no positive value. A specified foreign financial asset is subject to reporting even if the specified foreign financial asset does not have a positive value. See § 1.6038D-5(b)(3) to determine the maximum value of a specified foreign financial asset that does not have a positive value during the taxable year.

(6) Aggregate value calculation in case of specified foreign financial asset excluded from reporting—(i) Specified individual. The value of any specified foreign financial asset in which a specified individual has an interest and that is excluded from reporting on Form 8938 pursuant to § 1.6038D-7(a) (concerning certain assets reported on another form) is included for purposes of determining the aggregate value of specified foreign financial assets. The value of any specified foreign financial asset in which a specified individual has an interest and that is excluded from reporting under § 1.6038D-7(b) (concerning assets held by certain domestic trusts) or § 1.6038D-7(c) (concerning certain assets owned by a bona fide resident of a U.S. possession) is excluded for purposes of determining the aggregate value of specified foreign financial assets.

(ii) Specified domestic entity. The value of any specified foreign financial asset in which a specified domestic entity has an interest and that is excluded from reporting on Form 8938 pursuant to § 1.6038D-7(a) (concerning certain assets reported on another form) is excluded for purposes of determining the aggregate value of specified foreign financial assets. For purposes of determining the aggregate value of specified foreign financial assets, a specified domestic entity that is a corporation or partnership and that has an interest in any specified foreign financial asset is treated as owning all the specified foreign financial assets (excluding specified foreign financial assets excluded from reporting on Form 8938 pursuant to § 1.6038D-7(a)) held by all domestic corporations and domestic partnerships that are closely held by the same specified individual as determined under § 1.6038D-6(b)(2).

(7) Form 8938 filed with annual return—(i) General rule. A specified person, including a specified individual who is a bona fide resident of a U.S. possession, is not required to file Form 8938 with respect to a taxable year if the specified person is not required to file an annual return with the Internal Revenue Service with respect to such taxable year.

(ii) Consolidated returns. If a specified domestic entity is a member of an affiliated group of corporations that files a consolidated income tax return, the Form 8938 of the specified domestic entity must be filed with the affiliated group's annual return.

(8) Reporting required regardless of tax result. The Form 8938 required by section 6038D and this section must be furnished by a specified person even if none of the specified foreign financial assets that must be reported affect the specified person's tax liability under the Internal Revenue Code for the taxable year.

(9) Reporting period. The reporting period covered by Form 8938 is the specified person's taxable year, except the reporting period for a specified person that is a specified individual for less than an entire taxable year is the portion of the taxable year that the specified person is a specified individual.

(10) Successor forms. References to Form 8938 include any successor form.

(b) Interest in a specified foreign financial asset—(1) In general. A specified person has an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds, or distributions attributable to the holding or disposition of the specified foreign financial asset are or would be required to be reported, included, or otherwise reflected by the specified person on an annual return. A specified person has an interest in a specified foreign financial asset even if no income, gains, losses, deductions, credits, gross proceeds, or distributions are attributable to the holding or disposition of the specified foreign financial asset for the taxable year.

(2) Property transferred in connection with the performance of services. A specified person that is transferred property in connection with the performance of personal services is first considered to have an interest in the property for purposes of section 6038D on the first date that the property is substantially vested (within the meaning of § 1.83-3(b)) or, in the case of property with respect to which a specified person makes a valid election under section 83(b), on the date of transfer of the property.

(3) Special rule for parent making election under section 1(g)(7). A parent who makes an election under section 1(g)(7) to include certain unearned income of a child in the parent's gross income has an interest in any specified foreign financial asset held by the child for the purposes of section 6038D and the regulations.

(4) Entities—(i) In general. Except as provided in this paragraph (b)(4), a specified person is not treated as having an interest in any specified foreign financial assets held by a corporation, partnership, trust, or estate solely as a result of the specified person's status as a shareholder, partner, or beneficiary of such entity.

(ii) Specified foreign financial assets held by certain trusts. A specified person that is treated as the owner of a trust or any portion of a trust under sections 671 through 679, other than a domestic liquidating trust under § 301.7701-4(d) of this chapter created pursuant to a court order issued in a bankruptcy under Chapter 7 (11 U.S.C. 701 et seq.) or a confirmed plan under Chapter 11 (11 U.S.C. 1101 et seq.) of the Bankruptcy Code, or a domestic widely held fixed investment trust under § 1.671-5, is treated as having an interest in any specified foreign financial assets held by the trust or the portion of the trust.

(iii) Specified foreign financial assets held by a disregarded entity. A specified person that owns a foreign or domestic entity that is disregarded as an entity separate from its owner as described in § 301.7701-2 of this chapter (a disregarded entity) is treated as having an interest in any specified foreign financial assets held by the disregarded entity.

(iv) Interest in a foreign trust or foreign estate. See § 1.6038D-3(c) to determine whether an interest in a foreign trust or foreign estate is a specified foreign financial asset. See § 1.6038D-5(f) to determine the maximum value of an interest in a foreign trust or foreign estate.

(c) Special rules for joint interests—(1) In general—(i) Determining aggregate value of assets. Except as otherwise provided in this paragraph (c), each specified person that is a joint owner of a specified foreign financial asset (whether with a spouse or other person) must include the entire value of the specified foreign financial asset (and not the value of the specified person's interest) for purposes of determining whether the aggregate value of the specified person's specified foreign financial assets exceeds the reporting thresholds set forth in § 1.6038D-2(a).

(ii) Reporting maximum value. Except as provided in paragraph (d) of this section, a specified person that is a joint owner of a specified foreign financial asset must report the entire value of each jointly owned specified foreign financial asset on Form 8938.

(2) Aggregate asset value for married specified individuals filing a joint annual return. Married specified individuals who file a joint annual return must include the value of each specified foreign financial asset that they jointly own or in which both have an interest under paragraph (b)(1) of this section only once in determining whether the aggregate value of all of the specified foreign financial assets in which either married specified individual has an interest exceeds the reporting thresholds set forth in § 1.6038D-2(a).

(3) Aggregate asset value for married specified individual filing a separate annual return—(i) Both spouses are specified individuals. If a married specified individual files a separate annual return and his or her spouse is a specified individual, the married specified individual must include one-half of the value of a specified foreign financial asset that the married specified individual jointly owns with his or her spouse in determining whether the married specified individual has an interest in specified foreign financial assets the aggregate value of which exceeds the reporting thresholds set forth in § 1.6038D-2(a).

(ii) One spouse is not a specified individual. If a married specified individual files a separate annual return and his or her spouse is not a specified individual, the married specified individual must include the entire value of a specified foreign financial asset that the married specified individual jointly owns with his or her spouse in determining whether the married specified individual has an interest in specified foreign financial assets the aggregate value of which exceeds the reporting thresholds set forth in § 1.6038D-2(a).

(d) Annual return filed by a married specified individual—(1) Joint annual return. Married specified individuals who file a joint annual return must file a single Form 8938 to fulfill their reporting requirements under section 6038D and § 1.6038D-2(a). The single Form 8938 must report all of the specified foreign financial assets in which either married specified individual has an interest. If both married specified individuals jointly own a specified foreign financial asset or if they have an interest in a specified foreign financial asset under paragraph (b)(1) of this section, the asset must be reported only once on the single Form 8938 filed for the taxable year.

(2) Separate annual return. A married specified individual who files a separate annual return for the taxable year must fulfill the reporting requirements under section 6038D and § 1.6038D-2(a) by filing a separate Form 8938 with his or her return that reports all of the specified foreign financial assets in which the married specified individual has an interest, including each of the assets jointly owned with the married specified individual's spouse or with another person. If both of the spouses are specified individuals, each specified individual must report the entire value of each specified foreign financial asset that the spouses jointly own on Form 8938, not the value taken into account under paragraph (c)(3)(i) of this section for purposes of applying the applicable reporting thresholds.

(e) Special rules for dual resident taxpayers—(1) In general. Subject to the provisions of paragraphs (e)(2) and (3) of this section, a specified individual is not required to report specified foreign financial assets on Form 8938 for a taxable year or any portion of a taxable year that the individual is a dual resident taxpayer (within the meaning of § 301.7701(b)-7(a)(1) of this chapter) who is treated as a nonresident alien pursuant to § 301.7701(b)-7 of this chapter for purposes of computing his or her U.S. tax liability with respect to the portion of the taxable year the individual is considered a dual resident taxpayer.

(2) Dual resident taxpayer filing as a nonresident alien at end of taxable year. If a specified individual to whom this paragraph (e) applies computes his or her U.S. income tax liability as a nonresident alien on the last day of the taxable year and complies with the filing requirements of § 301.7701(b)-7(b) and (c) of this chapter and, in particular, such individual timely files with the Internal Revenue Service Form 1040NR, “U.S. Nonresident Alien Income Tax Return,” or Form 1040NR-EZ, “U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents,” as applicable, and attaches thereto Form 8833, “Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b),” such individual will not be required to report specified foreign financial assets on Form 8938 with respect to the portion of the taxable year covered by Form 1040NR (or Form 1040NR-EZ).

(3) Dual resident taxpayer filing as resident alien at end of taxable year. If a specified individual to whom this paragraph (e) applies computes his or her U.S. income tax liability as a resident alien on the last day of the taxable year and complies with the filing requirements of § 1.6012-1(b)(2)(ii)(a) and, in particular, such individual timely files with the Internal Revenue Service Form 1040, “U.S. Individual Income Tax Return,” or Form 1040EZ, “Income Tax Return for Single and Joint Filers With No Dependents,” as applicable, and attaches a properly completed Form 8833 to the schedule required by § 1.6012-1(b)(2)(ii)(a), such individual will not be required to report specified foreign financial assets on Form 8938 with respect to the portion of the individual's taxable year reflected on the schedule to such Form 1040 or Form 1040EZ required by § 1.6012-1(b)(2)(ii)(a).

(f) Example. The following example illustrates the application of paragraph (c) of this section:

Example. (1) Facts. Two married specified individuals, H and W, jointly own a specified foreign financial asset with a value of $90,000 at all times during the taxable year. H separately has an interest in a specified foreign financial asset with a value of $10,000 at all times during the taxable year. W separately has an interest in a specified foreign financial asset with a value of $1,000 at all times during the taxable year.

(2) Filing requirement—(i) Married specified individuals filing separate annual returns. If H and W file separate annual returns, the aggregate value of the specified foreign financial assets in which H has an interest at the end of the taxable year is $55,000, comprising one-half of the value of the jointly owned asset, $45,000, and the value of H's separately owned specified foreign financial asset, $10,000. The aggregate value of the specified foreign financial assets in which W has an interest at the end of the taxable year is $46,000, comprising one-half of the value of the jointly owned asset, $45,000, and the value of W's separately owned specified foreign financial asset, $1,000. H must file Form 8938 with his annual return for the taxable year because the aggregate value of the specified foreign financial assets in which H has an interest exceeds the applicable reporting threshold ($50,000) set forth in § 1.6038D-2(a)(1). H must report the maximum value of the entire jointly owned asset, $90,000, and the maximum value of the separately owned asset, $10,000. See § 1.6038D-5(b) regarding the maximum value of a jointly owned specified foreign financial asset to be reported by a specified person, including a married specified individual, that is a joint owner of an asset. The aggregate value of the specified foreign financial assets in which W has an interest, $46,000, does not exceed the applicable reporting threshold set forth in § 1.6038D-2(a)(1). W is not required to file Form 8938 with her separate annual return.

(ii) Married specified individuals filing a joint annual return. If H and W file a joint annual return, they must file a single Form 8938 with their joint annual return for the taxable year because the aggregate value of all of the specified foreign financial assets in which either H or W have an interest ($90,000 (included only once), $10,000, and $1000, or $101,000) exceeds the applicable reporting threshold ($100,000) set forth in § 1.6038D-2(a)(2). The single Form 8938 must report the maximum value of the jointly owned specified foreign financial asset, $90,000, and the maximum value of the specified foreign financial assets separately owned by H and W, $10,000 and $1,000, respectively.

(g) Effective/applicability dates. This section, with the exception of § 1.6038D-2(a)(6)(ii), applies to taxable years ending after December 19, 2011. Section 1.6038D-2(a)(6)(ii) applies to taxable years beginning after December 31, 2015. Taxpayers may elect to apply the rules of this section, with the exception of § 1.6038D-2(a)(6)(ii), to taxable years ending on or prior to December 19, 2011.

[T.D. 9706, 79 FR 73826, Dec. 12, 2014, as amended by T.D. 9752, 81 FR 8838, Feb. 23, 2016]

§ 1.6038D-3 Specified foreign financial assets.

(a) Financial accounts—(1) In general. Except as otherwise provided in this section, a specified foreign financial asset includes any financial account maintained by a foreign financial institution. An asset held in a financial account maintained by a foreign financial institution is not required to be separately reported on Form 8938, “Statement of Specified Foreign Financial Assets.”

(2) Financial account in a U.S. possession. A specified foreign financial asset includes a financial account maintained by a financial institution that is organized under the laws of a U.S. possession.

(3) Excepted financial accounts—(i) Accounts maintained by U.S. payors. A financial account maintained by a U.S. payor as defined in § 1.6049-5(c)(5)(i) (including assets held in such an account) is not a specified foreign financial asset for purposes of section 6038D and the regulations.

(ii) Mark-to-market election under section 475. A financial account is not a specified foreign financial asset if the rules of section 475(a) apply to all of the holdings in the account or an election under section 475(e) or (f) is made with respect to all of the holdings in the account.

(b) Other specified foreign financial assets—(1) In general. Except as otherwise provided in this section, a specified foreign financial asset includes any of the following assets that are not financial accounts and that are held for investment and not held in an account maintained by a financial institution—

(i) Stock or securities issued by a person other than a United States person (including stock or securities issued by a person organized under the laws of a U.S. possession);

(ii) A financial instrument or contract that has an issuer or counterparty which is other than a United States person (including a financial instrument or contract issued by a person organized under the laws of a U.S. possession); and

(iii) An interest in a foreign entity.

(2) Mark-to-market election under section 475. An asset is not a specified foreign financial asset if the rules of section 475(a) apply to the asset or an election under section 475(e) or (f) is made with respect to the asset.

(3) Held for investment. An asset is held for investment for purposes of section 6038D and the regulations if that asset is not used in, or held for use in, the conduct of a trade or business of a specified person.

(4) Trade-or-business test. For purposes of section 6038D and the regulations, an asset is used in, or held for use in, the conduct of a trade or business and not held for investment if the asset is—

(i) Held for the principal purpose of promoting the present conduct of the trade or business;

(ii) Acquired and held in the ordinary course of the trade or business, as, for example, in the case of an account or note receivable arising from that trade or business; or

(iii) Otherwise held in a direct relationship to the trade or business as determined under paragraph (b)(5) of this section.

(5) Direct relationship between holding an asset and a trade or business—(i) In general. In determining whether an asset is held in a direct relationship to the conduct of a trade or business by a specified person, principal consideration will be given to whether the asset is needed in the trade or business of the specified person. An asset shall be considered needed in the trade or business, for this purpose, only if the asset is held to meet the present needs of that trade or business and not its anticipated future needs. An asset shall be considered as needed in the trade or business if, for example, the asset is held to meet the operating expenses of the trade or business. Conversely, an asset shall be considered as not needed in the trade or business if, for example, the asset is held for the purpose of providing for future diversification into a new trade or business, future plant replacement, or future business contingencies. Stock is never considered used or held for use in a trade or business for purposes of applying this test.

(ii) Presumption of direct relationship. An asset will be treated as held in a direct relationship to the conduct of a trade or business of a specified person if—

(A) The asset was acquired with funds generated by the trade or business of the specified person or the affiliated group of the specified person, if any;

(B) The income from the asset is retained or reinvested in the trade or business; and

(C) Personnel who are actively involved in the conduct of the trade or business exercise significant management and control over the investment of such asset.

(c) Special rule for interests in foreign trusts and foreign estates. An interest in a foreign trust or a foreign estate is not a specified foreign financial asset of a specified person unless the person knows, or has reason to know based on readily accessible information, of the interest. Receipt of a distribution from the foreign trust or foreign estate constitutes actual knowledge for this purpose.

(d) Examples. Examples of assets other than financial accounts that may be considered other specified foreign financial assets include, but are not limited to—

(1) Stock issued by a foreign corporation;

(2) A capital or profits interest in a foreign partnership;

(3) A note, bond, debenture, or other form of indebtedness issued by a foreign person;

(4) An interest in a foreign trust;

(5) An interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty; and

(6) Any option or other derivative instrument with respect to any of the items listed as examples in this paragraph or with respect to any currency or commodity that is entered into with a foreign counterparty or issuer.

(e) Effective/applicability dates. This section applies to taxable years ending after December 19, 2011. Taxpayers may elect to apply the rules of this section to taxable years ending prior to December 19, 2011.

[T.D. 9706, 79 FR 73828, Dec. 12, 2014]

§ 1.6038D-4 Information required to be reported.

(a) Required information. The following information must be reported on Form 8938, “Statement of Specified Foreign Financial Assets,” with respect to each specified foreign financial asset:

(1) In the case of a financial account, the name and address of the foreign financial institution with which the account is maintained and the account number of the financial account;

(2) In the case of stock or securities, the name and address of the issuer, and information that identifies the class or issue of which the stock or security is a part;

(3) In the case of a financial instrument or contract, information that identifies the financial instrument or contract, including the names and addresses of all issuers and counterparties;

(4) In the case of an interest in a foreign entity, information that identifies the interest, including the name and address of the foreign entity in which the interest is held;

(5) The maximum value of the specified foreign financial asset during the portion of the taxable year in which the specified person has an interest in the asset;

(6) In the case of a financial account that is a depository account as defined in § 1.1471-5(b)(3)(i) or a custodial account as defined in § 1.1471-5(b)(3)(ii), whether the account was opened or closed during the taxable year;

(7) The date, if any, on which the specified foreign financial asset, other than a financial account that is a depository account as defined in § 1.1471-5(b)(3)(i) or a custodial account as defined in § 1.1471-5(b)(3)(ii), was either acquired or disposed of (or both) during the taxable year;

(8) The amount of any income, gain, loss, deduction, or credit recognized for the taxable year with respect to the reported specified foreign financial asset, and the schedule, form, or return filed with the Internal Revenue Service on which the income, gain, loss, deduction, or credit, if any, is reported or included by the specified person;

(9) The foreign currency in which the account is maintained or the asset is denominated, the foreign currency exchange rate and, if the source of such rate is other than as described in § 1.6038D-5(c)(1), the source of the rate used to determine the specified foreign financial asset's U.S. dollar value, including maximum value;

(10) For any specified foreign financial asset excepted from reporting on Form 8938 under § 1.6038D-7(a), the specified person must report the number of Forms 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts,” Forms 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner,” Forms 5471, “Information Return of U.S. Persons With Respect To Certain Foreign Corporations,” Forms 8621, “Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund,” Forms 8865, “Return of U.S. Persons With Respect To Certain Foreign Partnerships,” and, solely for taxable years beginning after March 18, 2010, and ending on or before December 31, 2013, Forms 8891, “U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans,” or such other form under Title 26 of the United States Code identified by the Secretary under § 1.6038D-7(a), timely filed with the Internal Revenue Service on which excepted foreign financial assets are reported or reflected for the taxable year; and

(11) Such other information as may be required by Form 8938 or its instructions or other guidance.

(b) Effective/applicability dates. This section applies to taxable years ending after December 19, 2011. Taxpayers may elect to apply the rules of this section to taxable years ending prior to December 19, 2011.

[T.D. 9706, 79 FR 73829, Dec. 12, 2014]

§ 1.6038D-5 Valuation guidelines.

(a) Fair market value. Except as provided in paragraphs (c) and (e) of this section, the value of a specified foreign financial asset for purposes of determining the aggregate value of specified foreign financial assets held by a specified person and the maximum value of a specified foreign financial asset required to be reported on Form 8938, “Statement of Specified Foreign Financial Assets,” is the asset's fair market value.

(b) Valuation of assets—(1) Maximum value. Except as provided in this section, the maximum value of a specified foreign financial asset means a reasonable estimate of the asset's maximum fair market value during the taxable year.

(2) U.S. dollars. For purposes of determining the aggregate value of specified foreign financial assets in which a specified person has an interest and determining the maximum value of a specified foreign financial asset, the value of a specified foreign financial asset denominated in a foreign currency during the taxable year must be determined in the foreign currency and then converted to U.S. dollars.

(3) Asset with no positive value. If the maximum fair market value of a specified foreign financial asset is zero or less than zero, then the asset's value is treated as zero for purposes of determining the aggregate value of specified foreign financial assets in which a specified person has an interest, and the maximum value of the specified foreign financial asset is zero for purposes of reporting under § 1.6038D-4(a)(5).

(c) Foreign currency conversion—(1) In general. Except as provided in paragraphs (c)(2) and (d) of this section, the U.S. Treasury Department's Bureau of the Fiscal Service foreign currency exchange rate is to be used to convert the value of a specified foreign financial asset into U.S. dollars for purposes of determining the aggregate value of specified foreign financial assets in which a specified person has an interest and determining the maximum value of a specified foreign financial asset.

(2) Other publicly available exchange rate. If no U.S. Treasury Department Bureau of the Fiscal Service foreign currency exchange rate is available for a particular currency, another publicly available foreign currency exchange rate may be used to convert the value of a specified foreign financial asset into U.S. dollars. In such case, the source of the foreign currency exchange rate must be disclosed on Form 8938.

(3) Currency exchange rate. In converting the currency of a foreign country, the foreign currency exchange rate applicable for converting the currency into U.S. dollars (that is, to purchase U.S. dollars) must be used.

(4) Determination date. In converting the currency of a foreign country into U.S. dollars for purposes of determining the maximum value of a specified foreign financial asset and determining the aggregate value of specified foreign financial assets in which a specified person has an interest, the applicable foreign currency exchange rate is the rate on the last day of the taxable year of the specified person, even if the specified person sold or otherwise disposed of a specified foreign financial asset prior to the last day of such year.

(d) Financial accounts. A specified person may rely upon periodic account statements that are provided at least annually by or on behalf of a financial institution maintaining an account, including the foreign currency conversion reflected in those statements, to determine the financial account's maximum value unless the specified person has actual knowledge, or reason to know based on readily accessible information, that the statements do not reflect a reasonable estimate of the maximum account value during the taxable year.

(e) Asset held in a financial account. The value of an asset held in a financial account maintained by a foreign financial institution is included in determining the value of that financial account for purposes of § 1.6038D-5(a).

(f) Other specified foreign financial assets—(1) General rule. Except as provided in paragraphs (f)(2) and (3) of this section, for specified foreign financial assets that are not financial accounts and that are held for investment and not held in an account maintained by a financial institution, a specified person may use the value of the asset as of the last day of the taxable year on which the specified person has an interest in the asset as the maximum value of that asset, unless the specified person has actual knowledge, or reason to know based on readily accessible information, that the value does not reflect a reasonable estimate of the maximum value of the asset during the taxable year.

(2) Interests in trusts that are specified foreign financial assets—(i) Maximum value. If a specified person is a beneficiary of a foreign trust, the maximum value of the specified person's interest in the trust is the sum of—

(A) The fair market value, determined as of the last day of the taxable year, of all of the currency or other property distributed from the foreign trust during the taxable year to the specified person as a beneficiary; and

(B) The value, determined as of the last day of the taxable year, of the specified person's right as a beneficiary to receive mandatory distributions from the foreign trust as determined under section 7520.

(ii) Reporting threshold. For purposes of determining the aggregate value of specified foreign financial assets in which a specified person has an interest, if the specified person does not know, or have reason to know based on readily accessible information, the fair market value of the person's interest in a foreign trust during the taxable year, the value to be included in determining the aggregate value of the specified foreign financial assets is the maximum value of the specified person's interest in the foreign trust under paragraph (f)(2)(i) of this section.

(3) Interests in estates, pension plans, and deferred compensation plans—(i) Maximum value. The maximum value of a specified person's interest in a foreign estate, foreign pension plan, or foreign deferred compensation plan is the fair market value, determined as of the last day of the taxable year, of the specified person's beneficial interest in the assets of the foreign estate, foreign pension plan, or foreign deferred compensation plan. If the specified person does not know, or have reason to know based on readily accessible information, such fair market value, the maximum value to be reported is the fair market value, determined as of the last day of the taxable year, of the currency and other property distributed during the taxable year to the specified person as a beneficiary or participant.

(ii) Reporting threshold. For purposes of determining the aggregate value of specified foreign financial assets in which a specified person has an interest, if the specified person does not know, or have reason to know based on readily accessible information, the fair market value of the person's interest in a foreign estate, foreign pension plan, or foreign deferred compensation plan during the taxable year, the value to be included in determining the aggregate value of the specified foreign financial assets is the fair market value, determined as of the last day of the taxable year, of the currency and other property distributed during the taxable year to the specified person as a beneficiary or participant.

(g) Effective/applicability dates. This section applies to taxable years ending after December 19, 2011. Taxpayers may elect to apply the rules of this section to taxable years ending prior to December 19, 2011.

[T.D. 9706, 79 FR 73830, Dec. 12, 2014]

§ 1.6038D-6 Specified domestic entities.

(a) Specified domestic entity. A specified domestic entity is a domestic corporation, a domestic partnership, or a trust described in section 7701(a)(30)(E), if such corporation, partnership, or trust is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets. Whether a domestic corporation, a domestic partnership, or a trust described in section 7701(a)(30)(E) is a specified domestic entity is determined annually.

(b) Corporations and partnerships—(1) Formed or availed of. Except as otherwise provided in paragraph (d) of this section, a domestic corporation or a domestic partnership is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if and only if—

(i) The corporation or partnership is closely held by a specified individual as determined under paragraph (b)(2) of this section; and

(ii) At least 50 percent of the corporation's or partnership's gross income for the taxable year is passive income or at least 50 percent of the assets held by the corporation or partnership for the taxable year are assets that produce or are held for the production of passive income as determined under paragraph (b)(3) of this section (passive assets). For purposes of this paragraph (b)(1)(ii), the percentage of passive assets held by a corporation or partnership for a taxable year is the weighted average percentage of passive assets (weighted by total assets and measured quarterly), and the value of assets of a corporation or partnership is the fair market value of the assets or the book value of the assets that is reflected on the corporation's or partnership's balance sheet (as determined under either a U.S. or an international financial accounting standard).

(2) Closely held—(i) Domestic corporation. A domestic corporation is closely held by a specified individual if at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote, or at least 80 percent of the total value of the stock of the corporation, is owned, directly, indirectly, or constructively, by a specified individual on the last day of the corporation's taxable year.

(ii) Domestic partnership. A partnership is closely held by a specified individual if at least 80 percent of the capital or profits interest in the partnership is held, directly, indirectly, or constructively, by a specified individual on the last day of the partnership's taxable year.

(iii) Constructive ownership. For purposes of this paragraph (b)(2), sections 267(c) and (e)(3) apply for the purpose of determining the constructive ownership of a specified individual in a corporation or partnership, except that section 267(c)(4) is applied as if the family of an individual includes the spouses of the individual's family members.

(3) Determination of passive income and assets—(i) Definition of passive income. Except as provided in paragraph (b)(3)(ii) of this section, for purposes of paragraph (b)(1)(ii) of this section, passive income means the portion of gross income that consists of—

(A) Dividends, including substitute dividends;

(B) Interest;

(D) Rents and royalties, other than rents and royalties derived in the active conduct of a trade or business conducted, at least in part, by employees of the corporation or partnership;

(E) Annuities;

(F) The excess of gains over losses from the sale or exchange of property that gives rise to passive income described in paragraphs (b)(3)(i)(A) through (b)(3)(i)(E) of this section;

(G) The excess of gains over losses from transactions (including futures, forwards, and similar transactions) in any commodity, but not including—

(1) Any commodity hedging transaction described in section 954(c)(5)(A), determined by treating the corporation or partnership as a controlled foreign corporation; or

(2) Active business gains or losses from the sale of commodities, but only if substantially all the corporation or partnership's commodities are property described in paragraph (1), (2), or (8) of section 1221(a);

(H) The excess of foreign currency gains over foreign currency losses (as defined in section 988(b)) attributable to any section 988 transaction; and

(I) Net income from notional principal contracts as defined in § 1.446-3(c)(1).

(ii) Exception from passive income treatment for dealers. Notwithstanding paragraph (b)(3)(i) of this section, in the case of a corporation or partnership that regularly acts as a dealer in property described in paragraph (b)(3)(i)(F) of this section (referring to the sale or exchange of property that gives rise to passive income), forward contracts, option contracts, or similar financial instruments (including notional principal contracts and all instruments referenced to commodities), the term passive income does not include—

(A) Any item of income or gain (other than any dividends or interest) from any transaction (including hedging transactions and transactions involving physical settlement) entered into in the ordinary course of such dealer's trade or business as such a dealer; and

(B) If such dealer is a dealer in securities (within the meaning of section 475(c)(2)), any income from any transaction entered into in the ordinary course of such trade or business as a dealer in securities.

(iii) Related entities. For purposes of applying the passive income and asset thresholds of paragraph (b)(1)(ii) of this section, all domestic corporations and domestic partnerships that are closely held by the same specified individual as determined under paragraph (b)(2) of this section and that are connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as owning the combined assets and receiving the combined income of all members of that group. For purposes of the preceding sentence, assets relating to any contract, equity, or debt existing between members of such a group, as well as any items of gross income arising under or from such contract, equity, or debt, are eliminated. A domestic corporation or a domestic partnership is considered connected through stock or partnership interest ownership with a common parent corporation or partnership if stock representing at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote or of the value of such corporation, or partnership interests representing at least 80 percent of the profits interests or capital interests of such partnership, in each case other than stock of or partnership interests in the common parent, is owned by one or more of the other connected corporations, connected partnerships, or the common parent.

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

Example 1. Closely held and constructive ownership. (i) Facts. DC1 is a domestic corporation the total value of the stock of which is owned 60% by A, a specified individual, 30% by B, a member of A's family for purposes of section 267(c)(2) who is not a specified individual, and 10% by FC1, a foreign corporation. DC1 owns 90% of the total value of the stock of DC2, a domestic corporation. FC2, a foreign corporation, owns 10% of DC2. Neither A nor B owns, directly, indirectly, or constructively, any stock in FC1 or FC2.

(ii) Closely held ownership determination. A is considered to own 90% and 81% of the total value of DC1 and DC2, respectively, by application of the rules of section 267(c) and this section. DC1 and DC2 are closely held by A within the meaning of paragraph (b)(2) of this section because A, a specified individual, is considered to own more than 80% of their total value.

Example 2. Application of aggregation rule and reporting threshold. (i) Facts. L is a specified individual. In Year X, L wholly owns DC1, a domestic corporation, and also owns a 90% capital interest in DP, a domestic partnership. DC1 owns 80% of the sole class of stock of DC2, a domestic corporation. DC1 has no assets other than its interest in DC2. DC2's only assets are assets that produce passive income, with a maximum value in Year X of $40,000 on October 12. DC2's assets are comprised in relevant part of specified foreign financial assets with a maximum value in Year X of $15,000 on October 12. DP's only assets are assets that produce passive income and that are specified foreign financial assets with a maximum value of $90,000 in Year X on October 12.

(ii) Specified domestic entity status—(A) DC1 and DC2. DC1 and DC2 are closely held by a specified individual for purposes of paragraph (b)(2) of this section. DC1 and DC2 are considered related entities that are connected through stock ownership with a common parent corporation under paragraph (b)(3)(iii) of this section, because DC1 and DC2 are closely held by L, and DC2 is connected with DC1 through DC1's ownership of stock of DC2 representing at least 80% of the voting power or value of DC2. As a result, for purposes of applying paragraph (b)(1)(ii) of this section, each of DC1 and DC2 is considered as owning the combined assets, and receiving the combined income, of both DC1 and DC2; however, DC1's equity interest in DC2 is disregarded for this purpose under paragraph (b)(3)(iii) of this section. Therefore, DC1 and DC2 each satisfies the passive asset threshold of paragraph (b)(1)(ii) of this section, because 100 percent of each company's assets is passive. DC1 and DC2 are specified domestic entities for Year X.

(B) DP. DP is closely held by a specified individual for purposes of paragraph (b)(2) of this section. DP is not considered a related entity with DC1 and DC2 under paragraph (b)(3)(iii) of this section, because DC1 and DP are not owned by a common parent corporation or partnership. As a result, whether the passive income or passive asset threshold of paragraph (b)(1)(ii) of this section is met with respect to DP is determined solely by reference to DP's separately earned passive income and separately held passive assets. DP holds only passive assets during Year X and therefore satisfies paragraph (b)(1)(ii) of this section. DP is a specified domestic entity for Year X.

(iii) Reporting requirements—(A) DC1. Under § 1.6038D-2(a)(6)(ii), DC1 is not treated as owning the specified foreign financial assets held by DC2 and DP for purposes of applying the reporting threshold of § 1.6038D-2(a)(1), because DC1 does not have an interest in any specified foreign financial assets. DC1 is not required to file Form 8938 because DC1 does not satisfy the reporting threshold of § 1.6038D-2(a)(1).

(B) DC2 and DP. Under § 1.6038D-3, DC2 and DP each has an interest in specified foreign financial assets. For purposes of applying the reporting threshold of § 1.6038D-2(a)(1), § 1.6038D-2(a)(6)(ii) provides that DC2 is treated as owning in addition to its own assets the assets of DP, and DP is treated as owning in addition to its own assets the assets of DC2. As a result, DC2 and DP each satisfies the reporting threshold of § 1.6038D-2(a)(1), because the value of the specified foreign financial assets each is considered as owning for purposes of § 1.6038D-2(a)(1) is $105,000 on October 12, Year X, which exceeds DC2's and DP's $75,000 reporting threshold. DC2 and DP must each file Form 8938 for Year X to report their respective specified foreign financial assets in which they have an interest and disclose their maximum values as provided in § 1.6038D-4 ($15,000 in the case of DC2 and $90,000 in the case of DP).

Example 3. Application of aggregation rule and entity with an active trade or business. (i) Facts. The facts are the same as in Example 2, except that DC2 also owns an active business. The assets attributable to the business are not passive assets and constitute at least 60% of the value of DC2's assets at all times during Year X. The income from the business is not passive income and constitutes at least 60% of the gross income generated by DC2 in Year X.

(ii) Specified domestic entity status—(A) DC1 and DC2. DC1 and DC2 are considered related entities that are connected through stock ownership with a common parent corporation under paragraph (b)(3)(iii) of this section because DC1 and DC2 are closely held by L, and DC2 is connected with DC1 though DC1's ownership of stock of DC2 representing at least 80% of the voting power or value of DC2. As a result, for purposes of applying paragraph (b)(1)(ii) of this section, each of DC1 and DC2 is treated as owning the combined assets, and receiving the combined income, of both DC1 and DC2; however, DC1's equity interest in DC2 is disregarded for this purpose under paragraph (b)(3)(iii) of this section. As a result, no more than 40 percent of the value of DC1's and DC2's assets at all times during Year X are passive and no more than 40 percent of DC1's and DC2's gross income for Year X is passive. DC1 and DC2 do not satisfy the passive income or passive asset threshold in paragraph (b)(1)(ii) of this section for Year X. DC1 and DC2 are not specified domestic entities for Year X.

(B) DP. For the reasons described in paragraph (ii)(B) of Example 2, DP is a specified domestic entity for Year X.

(iii) Reporting requirements—(A) DC1 and DC2. DC1 and DC2 are not specified domestic entities for Year X, and are not required to file Form 8938.

(B) DP. Under § 1.6038D-3, DP has an interest in specified foreign financial assets. Under § 1.6038D-2(a)(6)(ii), DP is treated as owning in addition to its own assets the assets of DC2. As a result, DP satisfies the reporting threshold of § 1.6038D-2(a)(1) because the value of the specified foreign financial assets it is considered to own for purposes of § 1.6038D-2(a)(1) is $105,000 on October 12, Year X, which exceeds DP's $75,000 reporting threshold. DP must file Form 8938 for Year X to report the specified foreign financial assets in which it has an interest and disclose their maximum values as provided in § 1.6038D-4, which is $90,000.

(c) Domestic trusts. Except as otherwise provided in paragraph (d) of this section, a trust described in section 7701(a)(30)(E) is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if and only if the trust has one or more specified persons as a current beneficiary. The term current beneficiary means, with respect to the taxable year, any person who at any time during such taxable year is entitled to, or at the discretion of any person may receive, a distribution from the principal or income of the trust (determined without regard to any power of appointment to the extent that such power remains unexercised at the end of the taxable year). The term current beneficiary also includes any holder of a general power of appointment, whether or not exercised, that was exercisable at any time during the taxable year, but does not include any holder of a general power of appointment that is exercisable only on the death of the holder.

(d) Excepted domestic entities. An entity is not considered to be a specified domestic entity if the entity is—

(1) Certain persons described in section 1473(3). An entity, except for a trust that is exempt from tax under section 664(c), that is excepted from the definition of the term “specified United States person” under section 1473(3) and the regulations issued under that section;

(2) Certain domestic trusts. A trust described in section 7701(a)(30)(E) provided that the trustee of the trust—

(i) Has supervisory authority over or fiduciary obligations with regard to the specified foreign financial assets held by the trust;

(ii) Timely files (including any applicable extensions) annual returns and information returns on behalf of the trust; and

(iii) Is—

(A) A bank that is examined by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, or the National Credit Union Administration;

(B) A financial institution that is registered with and regulated or examined by the Securities and Exchange Commission; or

(C) A domestic corporation described in section 1473(3)(A) or (B), and the regulations issued with respect to those provisions.

(3) Domestic trusts owned by one or more specified persons. A trust described in section 7701(a)(30)(E) to the extent such trust or any portion thereof is treated as owned by one or more specified persons under sections 671 through 678 and the regulations issued under those sections.

(e) Effective/applicability dates. This section applies to taxable years beginning after December 31, 2015.

[T.D. 9752, 81 FR 8838, Feb. 23, 2016]

§ 1.6038D-7 Exceptions from the reporting of certain assets under section 6038D.

(a) Elimination of duplicative reporting of assets—(1) In general. A specified person is not required to report a specified foreign financial asset on Form 8938, “Statement of Specified Foreign Financial Assets,” if the specified person—

(i) Reports the asset on at least one of the following forms timely filed with the Internal Revenue Service for the taxable year—

(A) Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts” (in the case of a specified person that is the beneficiary of a foreign trust);

(B) Form 5471, “Information Return of U.S. Persons With Respect To Certain Foreign Corporations”;

(D) Form 8865, “Return of U.S. Persons With Respect To Certain Foreign Partnerships”;

(E) For taxable years beginning after March 18, 2010, and ending on or before December 31, 2013, Form 8891, “U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans”; or

(F) Any other form under Title 26 of the United States Code timely filed with the Internal Revenue Service and identified for this purpose by the Secretary in regulations or other guidance; and

(ii) Reports on Form 8938 the filing of the form on which the asset is reported.

(2) Foreign grantor trusts. A specified person that is treated as an owner of a foreign trust or any portion of a foreign trust under sections 671 through 679 is not required to report any specified foreign financial assets held by the foreign trust on Form 8938, provided—

(i) The specified person reports the trust on a Form 3520 timely filed with the Internal Revenue Service for the taxable year;

(ii) The trust timely files Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner,” with the Internal Revenue Service for the taxable year; and

(iii) The Form 8938 filed by the specified person for the taxable year reports the filing of the Form 3520 and Form 3520-A.

(3) Joint Form 5471 or Form 8865 filing. A specified person that is included as part of a joint Form 5471 filing pursuant to § 1.6038-2(j) or a joint Form 8865 filing pursuant to § 1.6038-3(c) and who notifies the Internal Revenue Service as required by § 1.6038-2(i) or § 1.6038D-(3)(c) will be considered to have filed a Form 5471 or Form 8865 for purposes of paragraph (a)(1) of this section.

(b) Owner of certain trusts. A specified person that is treated as an owner of any portion of a domestic trust under sections 671 through 678 is not required to file Form 8938 to report any specified foreign financial asset held by the trust if the trust is—

(1) A widely-held fixed investment trust under § 1.671-5; or

(2) A liquidating trust within the meaning of § 301.7701-4(d) of this chapter that is created pursuant to a court order issued in a bankruptcy under Chapter 7 (11 U.S.C. 701 et seq.) or a confirmed plan under Chapter 11 (11 U.S.C. 1101 et seq.) of the Bankruptcy Code.

(c) Special rules for bona fide residents of a U.S. possession. A specified individual who is a bona fide resident of a U.S. possession is not required to include the following specified foreign financial assets in the determination of the aggregate value of his or her specified foreign financial assets and, if required to file Form 8938 with the Internal Revenue Service, is not required to report the following specified foreign financial assets:

(1) A financial account maintained by a financial institution organized under the laws of the U.S. possession of which the specified individual is a bona fide resident;

(2) A financial account maintained by a branch of a financial institution not organized under the laws of the U.S. possession of which the specified individual is a bona fide resident, if the branch is subject to the same tax and information reporting requirements applicable to a financial institution organized under the laws of the U.S. possession;

(3) Stock or securities issued by an entity organized under the laws of the U.S. possession of which the specified individual is a bona fide resident;

(4) An interest in an entity organized under the laws of the U.S. possession of which the specified individual is a bona fide resident; and

(5) A financial instrument or contract held for investment, provided each issuer or counterparty that is not a United States person is—

(i) An entity organized under the laws of the U.S. possession of which the specified individual is a bona fide resident; or

(ii) A bona fide resident of the U.S. possession of which the specified individual is a bona fide resident.

(d) Effective/applicability dates. This section applies to taxable years ending after December 19, 2011. Taxpayers may elect to apply the rules of this section to taxable years ending prior to December 19, 2011.

[T.D. 9706, 79 FR 73831, Dec. 12, 2014]

§ 1.6038D-8 Penalties for failure to disclose.

(a) In general. If a specified person fails to file a Form 8938, “Statement of Specified Foreign Financial Assets,” that includes the information required by section 6038D(c) and § 1.6038D-4 with respect to any taxable year at the time and in the manner described in section 6038D(a) and § 1.6038D-2, a penalty of $10,000 will apply to that specified person.

(b) Married specified individuals filing a joint annual return. Married specified individuals who file a joint annual return and fail to file a required Form 8938 that includes the information required by section 6038D(c) and § 1.6038D-4 with respect to any taxable year at the time and in the manner described in section 6038D(a) and § 1.6038D-2 are subject to penalties under this section as if the married specified individuals are a single specified individual. The liability of married specified individuals who file a joint annual return with respect to any penalties under this section is joint and several.

(c) Increase in penalty. If any failure to comply with the applicable reporting requirement of section 6038D and the regulations continues for more than 90 days after the day on which the Commissioner or his delegate mails a notice of the failure to the specified person required to file the Form 8938, the specified person is required to pay an additional penalty of $10,000 for each 30-day period (or fraction thereof) during which the failure continues after the 90-day period has expired. The additional penalty imposed by section 6038D(d)(2) and this paragraph (c) is limited to a maximum of $50,000 for each such failure.

(d) Presumption of aggregate value. For the purpose of assessing penalties imposed under section 6038D(d), if the Commissioner or his delegate determines that a specified person has an interest in one or more specified foreign financial assets and the specified person does not provide sufficient information to demonstrate the aggregate value of the assets upon request by the Commissioner or his delegate, then the aggregate value of the assets is treated as being in excess of the applicable reporting threshold set forth in § 1.6038D-2(a).

(e) Reasonable cause exception—(1) In general. If the failure to report the information required in section 6038D(c) and § 1.6038D-4 is shown to be due to reasonable cause and not due to willful neglect, no penalty will be imposed under section 6038D(d) or this section.

(2) Affirmative showing required. In order to show that the failure to report the information required in section 6038D(c) and § 1.6038D-4 is due to reasonable cause and not due to willful neglect for purposes of section 6038D(g) and this section, the specified person must make an affirmative showing of all the facts alleged as reasonable cause for the failure to disclose.

(3) Facts and circumstances taken into account. The determination of whether a failure to disclose a specified foreign financial asset on Form 8938 was due to reasonable cause and not due to willful neglect is made on a case-by-case basis, taking into account all pertinent facts and circumstances. The fact that a foreign jurisdiction would impose a civil or criminal penalty on the specified person (or any other person) for disclosing the required information is not reasonable cause.

(f) Penalties for underpayments attributable to undisclosed foreign financial assets—(1) Accuracy-related penalty. For application of the accuracy-related penalty in the case of any portion of an underpayment attributable to any undisclosed foreign financial asset understatement, see section 6662(j).

(2) Criminal penalties. In addition to other penalties, failure to comply with the reporting requirements of section 6038D and the regulations, or any underpayment related to such failure, may result in criminal penalties under sections 7201, 7203, 7206, et seq., or other provisions of Federal law.

[T.D. 9706, 79 FR 73832, Dec. 12, 2014]

§ 1.6039-1 Returns required in connection with certain options.

(a) Requirement of return with respect to incentive stock options under section 6039(a)(1). (1) Every corporation which in any calendar year transfers to any person a share of stock pursuant to such person's exercise of an incentive stock option shall, for such calendar year, file a return with respect to each transfer made during such year. This return must include the following information—

(i) The name, address, and employer identification number of the corporation transferring the stock;

(ii) If other than the corporation identified in paragraph (a)(1)(i) of this section, the name, address and employer identification number of the corporation whose stock is being transferred;

(iii) The name, address, and identifying number of the person to whom the share or shares of stock were transferred pursuant to the exercise of the option;

(iv) The date the option was granted to the person;

(v) The exercise price per share;

(vi) The date the option was exercised by the person;

(vii) The fair market value of a share of stock on the date the option was exercised by the person; and

(viii) The number of shares of stock transferred to the person pursuant to the exercise of the option.

(2) Each return required by this paragraph (a) shall be made on Form 3921, Exercise of an Incentive Stock Option Under Section 422(b) (or its designated successor) and shall be filed in such manner as provided in the instructions thereto.

(b) Requirement of return with respect to stock purchased under an employee stock purchase plan under section 6039(a)(2). (1) Every corporation which in any calendar year records, or has by its agent recorded, a transfer of the legal title of a share of stock acquired by the transferor (person who acquires the shares pursuant to the exercise of the option) pursuant to the transferor's exercise of an option granted under an employee stock purchase plan as described in section 423(c) and where the exercise price is less than 100 percent of the value of the stock on date of grant or is not fixed or determinable on the date of the grant, shall, for such calendar year, file a return with respect to each transfer made during such year. This return must include the following information—

(i) The name, address, and identifying number of the transferor;

(ii) The name, address and employer identification number of the corporation whose stock is being transferred;

(iii) The date the option was granted to the transferor;

(iv) The fair market value of the stock on the date the option was granted;

(v) The actual exercise price paid per share;

(vi) The exercise price per share determined as if the option were exercised on the date the option was granted to the transferor (to be provided only if the exercise price per share is not fixed or determinable on the date the option was granted);

(vii) The date the option was exercised by the transferor;

(viii) The fair market value of the stock on the date the option was exercised by the transferor;

(ix) The date the legal title of the shares was transferred by the transferor (see paragraph (b)(3) of this section); and

(x) The number of shares to which legal title was transferred by the transferor.

(2) Each return required by this paragraph (b) shall be made on Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c) (or its designated successor) and shall be filed in such manner as provided in the instructions thereto.

(3) A return is required by reason of a transfer described in section 6039(a)(2) only with respect to the first transfer of legal title of the shares by the transferor, including the first transfer of legal title to a recognized broker or financial institution. If a contractual agreement exists or is entered into with a recognized broker or financial institution pursuant to which shares acquired upon exercise of the option will be immediately deposited into a brokerage account established on behalf of the transferor, then the deposit of shares by the transferor into the brokerage account following the exercise of the option is the first transfer of legal title of the shares acquired by the transferor, and the corporation is only required to file a return relating to such transfer of legal title.

(4) Every corporation that transfers any share of stock pursuant to the exercise of an option described in this paragraph shall identify such stock in a manner sufficient to enable the accurate reporting of the transfer of legal title to such shares. Such identification may be accomplished by assigning to the certificates of stock issued pursuant to the exercise of such options a special serial number or color.

(c) Time for filing returns. Each return required by this section for a calendar year must be filed in accordance with the guidelines and procedures set forth in the instructions to Form 3921 and Form 3922.

(d) Penalty. For provisions relating to the penalty applicable to the failure to file a return under this section, see section 6721.

(e) Exception to return requirements of section 6039(a) for certain nonresident aliens—(1) Return requirement under section 6039(a)(1). The return requirement of section 6039(a)(1) is not applicable to the exercise of an incentive stock option by an employee who is a nonresident alien (as defined in section 7701(b)) and to whom the corporation is not required to provide a Form W-2, Wage and Tax Statement (or its designated successor) for any calendar year within the time period beginning with the first day of the calendar year in which the option was granted to the employee and ending on the last day of the calendar year in which the employee exercised the option.

(2) Return requirement under section 6039(a)(2). The return requirement of section 6039(a)(2) is not applicable to the first transfer of legal title of a share of stock by an employee who is a nonresident alien (as defined in section 7701(b)) and to whom the corporation is not required to provide a Form W-2 for any calendar year within the time period beginning with the first day of the calendar year in which the option was granted to the employee and ending on the last day of the calendar year in which the employee first transferred legal title to shares acquired under the option as described in paragraph (b)(3) of this section.

(3) For purposes of this paragraph (e), the term corporation is defined in section 7701(a) and includes, but is not limited to, the corporation issuing the stock, a related corporation of the corporation, any agent of the corporation, any party distributing shares of stock or other payments in connection with the plan (for example, a brokerage firm), and any party in control of the payment of remuneration for employment to the employee.

(f) Effective/applicability date—(1) In general. This section is effective on November 17, 2009. This section will apply as of January 1, 2007.

(2) Transition period. Taxpayers are not required to comply with the return requirements of paragraphs (a) and (b) of this section for stock transfers that occur during the 2007, 2008 and 2009 calendar years.

[T.D. 9470, 74 FR 59090, Nov. 17, 2009]

§ 1.6039-2 Statements to persons with respect to whom information is reported.

(a) Requirement of statement with respect to incentive stock options under section 6039(b). (1) Every corporation filing a return under § 1.6039-1(a) shall furnish to each person whose name is set forth in such return a written statement with respect to the transfer or transfers made to such person during such year. This statement must include the information described in § 1.6039-1(a)(1).

(2) Each statement required by this paragraph (a) to be furnished to any person must be furnished to such person on Form 3921, Exercise of an Incentive Stock Option Under Section 422(b) (or its designated successor) and be delivered at such time and in such manner as provided in the instructions thereto.

(b) Requirement of statement with respect to stock purchased under an employee stock purchase plan under section 6039(b). (1) Every corporation filing a return under § 1.6039-1(b) shall furnish to each person whose name is set forth in such return a written statement with respect to the transfer or transfers made by such person during such year. This statement must include the information described in § 1.6039-1(b)(1).

(2) Each statement required by this paragraph (b) to be furnished to any person must be furnished to such person on Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c) (or its designated successor) and be delivered at such time and in such manner as provided in the instructions thereto.

(3) If the statement required by this paragraph is made by the authorized transfer agent of the corporation, it is deemed to have been made by the corporation. The term transfer agent, as used in this section, means any designee authorized to keep the stock ownership records of a corporation and to record a transfer of title of the stock of such corporation on behalf of such corporation.

(c) Time for furnishing statements—(1) In general. Each statement required by this section to be furnished to any person for a calendar year must be furnished to such person on or before January 31 of the year following the year for which the statement is required. However, for a statement required to be furnished after December 31, 2008, the February 15 due date under section 6045 applies to the statement if the statement is furnished in a consolidated reporting statement under section 6045. See §§ 1.6045-1(k)(3), 1.6045-2(d)(2), 1.6045-3(e)(2), 1.6045-4(m)(3), and 1.6045-5(a)(3)(ii).

(2) Extension of time. An extension of time to furnish statements required by this section may be granted in accordance with the guidelines and procedures set forth in the instructions to Form 3921 and Form 3922.

(d) Penalty. For provisions relating to the penalty applicable to the failure to furnish a statement under this section, see section 6722.

(e) Effective/applicability date—(1) In general. This section is effective on November 17, 2009. This section will apply as of January 1, 2007.

(2) Reliance and transition period. Notwithstanding § 1.6039-1(f), corporations must furnish information statements to employees in accordance with this section for stock transfers that are subject to § 1.6039-1(a) and (b), and occur during the 2007, 2008 and 2009 calendar years. For purposes of furnishing information statements for stock transfers that occur during the 2007 or 2008 calendar years, taxpayers may rely on § 1.6039-1 of the 2004 final regulations (69 FR 46401) or § 1.6039-2 of the 2008 proposed regulations (REG-103146-08) (73 FR 40999). For purposes of furnishing information statements for stock transfers that occur during the 2009 calendar year, taxpayers may rely on § 1.6039-1 of the 2004 final regulations (69 FR 46401), § 1.6039-2 of the 2008 proposed regulations (REG-103146-08) (73 FR 40999), or this section.

[T.D. 9470, 74 FR 59091, Nov. 17, 2009, as amended at 74 FR 67973, Dec. 22, 2009; T.D. 9504, 75 FR 64090, Oct. 18, 2010]

§ 1.6039I-1 Reporting of certain employer-owned life insurance contracts.

(a) Requirement to report. Section 6039I requires every taxpayer that is an applicable policyholder owning one or more employer-owned life insurance contracts issued after August 17, 2006, to file a return showing the following information for each year the contracts are owned—

(1) The number of employees of the applicable policyholder at the end of the year;

(2) The number of such employees insured under such contracts at the end of the year;

(3) The total amount of insurance in force at the end of the year under such contracts;

(4) The name, address, and taxpayer identification number of the applicable policyholder and the type of business in which the policyholder is engaged; and

(5) That the applicable policyholder has a valid consent for each insured employee (or, if all such consents are not obtained, the number of insured employees for whom such consent was not obtained).

(b) Time and manner of reporting. Applicable policyholders owning one or more employer-owned life insurance contracts issued after August 17, 2006, must provide the information required under § 6039I by attaching Form 8925, “Report of Employer-Owned Life Insurance Contracts”, to the policyholder's income tax return by the due date of that return, or by filing such other form at such time and in such manner as the Commissioner may in the future prescribe.

[T.D. 9431, 73 FR 65982, Nov. 6, 2008]

§ 1.6041-1 Return of information as to payments of $600 or more.

(a) General rule—(1) Information returns required—(i) Payments required to be reported. Except as otherwise provided in §§ 1.6041-3 and 1.6041-4, every person engaged in a trade or business shall make an information return for each calendar year with respect to payments it makes during the calendar year in the course of its trade or business to another person of fixed or determinable income described in paragraph (a)(1)(i) (A) or (B) of this section. For purposes of the regulations under this section, the person described in this paragraph (a)(1)(i) is a payor.

(A) Salaries, wages, commissions, fees, and other forms of compensation for services rendered aggregating $600 or more.

(B) Interest (including original issue discount), rents, royalties, annuities, pensions, and other gains, profits, and income aggregating $600 or more.

(ii) Information returns required under other provisions of the Internal Revenue Code. The payments described in paragraphs (a)(1)(i)(A) and (B) of this section shall not include any payments of amounts with respect to which an information return is required by, or may be required under authority of, section 6042(a) (relating to dividends), section 6043(a)(2) (relating to distributions in liquidation), section 6044(a) (relating to patronage dividends), section 6045 (relating to brokers' transactions with customers and certain other transactions), sections 6049(a)(1) and (2) (relating to interest), section 6050N(a) (relating to royalties), or section 6050P(a) or (b) (relating to cancellation of indebtedness). For information returns required under section 6045(f) (relating to payments to attorneys), see special rules in §§ 1.6041-1(a)(1)(iii) and 1.6045-5(c)(4). For payment card transactions (as described in § 1.6050W-1(b)) and third party network transactions (as defined in § 1.6050W-1(c)) required to be reported on information returns required under section 6050W (relating to payment card and third party network transactions), see special rules in § 1.6041-1(a)(1)(iv).

(iii) Information returns required under section 6045(f) on or after January 1, 2007. For payments made on or after January 1, 2007 to which section 6045(f) (relating to payments to attorneys) applies, the following rules apply. Not withstanding the provisions of paragraph (a)(1)(ii) of this section, payments to an attorney that are described in paragraph (a)(1)(i) of this section but which otherwise would be reportable under section 6045(f) are reported under section 6041 and this section and not section 6045(f). This exception applies only if the payments are reportable with respect to the same payee under both sections. Thus, a person who, in the course of a trade or business, pays $600 of taxable damages to a claimant by paying that amount to the claimant's attorney is required to file an information return under section 6041 with respect to the claimant, as well as another information return under section 6045(f) with respect to the claimant's attorney. For provisions relating to information reporting for payments to attorneys, see § 1.6045-5.

(iv) Information returns required under section 6050W for calendar years beginning after December 31, 2010. For payments made by payment card (as defined in § 1.6050W-1(b)(3)) or through a third party payment network (as defined in § 1.6050W-1(c)(3)) after December 31, 2010, that are required to be reported on an information return under section 6050W (relating to payment card and third party network transactions), the following rule applies. Transactions that are described in paragraph (a)(1)(ii) of this section that otherwise would be subject to reporting under both sections 6041 and 6050W are reported under section 6050W and not section 6041. For provisions relating to information reporting for payment card and third party network transactions, see § 1.6050W-1. Solely for purposes of this paragraph, the de minimis threshold for third party network transactions in § 1.6050W-1(c)(4) is disregarded in determining whether the transaction is subject to reporting under section 6050W.

(v) Examples. The provisions of paragraph (a)(1)(iv) of this section are illustrated by the following examples:

Example 1.Restaurant owner A, in the course of business, pays $600 of fixed or determinable income to B, a repairman, by credit card. B is one of a network of unrelated persons that has agreed to accept A's credit card as payment under an agreement that provides standards and mechanisms for settling the transactions between a merchant acquiring bank and the persons who accept the cards. Merchant acquiring bank Y is responsible for making the payment to B. Under paragraph (a)(1)(iv) of this section, A, as payor, is not required to file an information return under section 6041 with respect to the transaction because Y, as the payment settlement entity for the payment card transaction, is required to file an information return under section 6050W.

Example 2.Restaurant owner A, in the course of business, pays $600 of fixed or determinable income to B, a repairman, through a third party payment network. B is one of a substantial number of persons who have established accounts with Y, a third party settlement organization that provides standards and mechanisms for settling the transactions and guarantees payments to those persons for goods or services purchased through the network. Y is responsible for making the payment to B. Under paragraph (a)(1)(iv) of this section, A, as payor, is not required to file an information return under section 6041 with respect to the transaction because the transaction is a third party network transaction that is subject to reporting under section 6050W. Solely for purposes of determining whether A is eligible for relief from reporting under section 6041, the de minimis threshold for third party network transactions in § 1.6050W-1(c)(4) is disregarded.

(2) Prescribed form. The return required by subparagraph (1) of this paragraph shall be made on Forms 1096 and 1099 except that (i) the return with respect to distributions to beneficiaries of a trust or of an estate shall be made on Form 1041, and (ii) the return with respect to certain payments of compensation to an employee by his employer shall be made on Forms W-3 and W-2 under the provisions of § 1.6041-2 (relating to return of information as to payments to employees). Where Form 1099 is required to be filed under this section, a separate Form 1099 shall be furnished for each person to whom payments described in subdivision (i), (ii), or (iii) of subparagraph (1) of this paragraph are made. For time and place for filing Forms 1096 and 1099, see § 1.6041-6. For the requirement to submit the information required by Form 1099 on magnetic media for payments after December 31, 1983, see section 6011(e) and § 301.6011-2 of this chapter (Procedure and Administration Regulations).

(b) Persons engaged in trade or business—(1) In general. The term “all persons engaged in a trade or business”, as used in section 6041(a), includes not only those so engaged for gain or profit, but also organizations the activities of which are not for the purpose of gain or profit. Thus, the term includes the organizations referred to in section 401(a), 501(c), 501(d) and 521 and in paragraph (i) of this section. On the other hand, section 6041(a) applies only to payments in the course of trade or business; hence it does not apply to an amount paid by the proprietor of a business to a physician for medical services rendered by the physician to the proprietor's child.

(2) Special rule for REMICs. For purposes of chapter 1 subtitle F, chapter 61A, part IIIB, the terms “all persons engaged in a trade or business” and “any service-recipient engaged in a trade or business” includes a real estate mortgage investment conduit or REMIC (as defined in section 860D).

(c) Fixed or determinable income. Income is fixed when it is to be paid in amounts definitely predetermined. Income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained. The income need not be paid annually or at regular intervals. The fact that the payments may be increased or decreased in accordance with the happening of an event does not for purposes of this section make the payments any the less determinable. A payment made jointly to two or more payees may be fixed and determinable income to one payee even though the payment is not fixed and determinable income to another payee. For example, property insurance proceeds paid jointly to the owner of damaged property and to a contractor that repairs the property may be fixed and determinable income to the contractor but not fixed and determinable income to the owner, and should be reported to the contractor. A salesman working by the month for a commission on sales which is paid or credited monthly receives determinable income.

(d) Payments specifically included—(1) In general. Amounts paid in respect of life insurance, endowment, or annuity contracts are required to be reported in returns of information under this section—

(i) Unless the payment is made in respect of a life insurance or endowment contract by reason of the death of the insured and is not required to be reported by paragraph (b) of § 1.6041-2,

(ii) Unless the payment is made by reason of the surrender prior to maturity or lapse of a policy, other than a policy which was purchased (a) by a trust described in section 401(a) which is exempt from tax under section 501(a), (b) as part of a plan described in section 403(a), or (c) by an employer described in section 403(b)(1)(A),

(iii) Unless the payment is interest as defined in § 1.6049-2 and is made after December 31, 1962,

(iv) Unless the payment is a payment with respect to which a return is required by § 1.6047-1, relating to employee retirement plans covering owner-employees,

(v) Unless the payment is payment with respect to which a return is required by § 1.6052-1, relating to payment of wages in the form of group-term life insurance.

(2) Professional fees. Fees for professional services paid to attorneys, physicians, and members of other professions are required to be reported in returns of information if paid by persons engaged in a trade or business and paid in the course of such trade or business.

(3) Prizes and awards. Amounts paid as prizes and awards that are required to be included in gross income under section 74 and § 1.74-1 when paid in the course of a trade or business are required to be reported in returns of information under this section.

(4) Disability payments. Amounts paid as disability payments under section 105(d) are required to be reported in returns of information under this section.

(5) Notional principal contracts. Except as provided in paragraphs (b)(5)(i) and (ii) of this section, amounts paid after December 31, 2000, with respect to notional principal contracts referred to in § 1.863-7 or 1.988-2(e) to persons who are not described in § 1.6049-4(c)(1)(ii) are required to be reported in returns of information under this section. The amount required to be reported under this paragraph (d)(5) is limited to the amount of cash paid from the notional principal contract as described in § 1.446-3(d). A non-periodic payment is reportable for the year in which an actual payment is made. Any amount of interest determined under the provisions of § 1.446-3(g)(4) (dealing with interest in the case of a significant non-periodic payment) is reportable under this paragraph (d)(5) and not under section 6049 (see § 1.6049-5(b)(15)). See § 1.6041-4(a)(4) for reporting exceptions regarding payments to foreign persons. See, however, § 1.1461-1(c)(1) for reporting amounts described under this paragraph (d)(5) that are paid to foreign persons. The provisions of § 1.6049-5(d) shall apply for determining whether a payment with respect to a notional principal contract is made to a foreign person. See § 1.6049-4(a) for a definition of payor. For purposes of this paragraph (d)(5), a payor includes a middleman defined in § 1.6049-4(f)(4).

(i) An amount paid with respect to a notional principal contract is not required to be reported if the amount is paid by a non-U.S. payor or a non-U.S. middleman and is paid and received outside the United States (as defined in § 1.6049-4(f)(16)).

(ii) An amount paid with respect to a notional principal contract is not required to be reported if the amount is paid by a payor that has no actual knowledge that the payee is a U.S. person and is paid and received outside the United States (as defined in § 1.6049-4(f)(16)), and the payor is—

(A) A U.S. payor or U.S. middleman that is not a U.S. person (such as a controlled foreign corporation defined in section 957(a) or certain foreign corporations or foreign partnerships engaged in a U.S. trade or business); or

(B) A foreign branch of a U.S. bank. See § 1.6049-5(c)(5) for a definition of a U.S. payor, a U.S. middleman, a non-U.S. payor, and a non-U.S. middleman.

(e) Payment made on behalf of another person—(1) In general. A person that makes a payment in the course of its trade or business on behalf of another person is the payor that must make a return of information under this section with respect to that payment if the payment is described in paragraph (a) of this section and, under all the facts and circumstances, that person—

(i) Performs management or oversight functions in connection with the payment (this would exclude, for example, a person who performs mere administrative or ministerial functions such as writing checks at another's direction); or

(ii) Has a significant economic interest in the payment (i.e., an economic interest that would be compromised if the payment were not made, such as by creation of a mechanic's lien on property to which the payment relates, or a loss of collateral).

(2) Determination of payor obligated to report. If two or more persons meet the requirements for making a return of information with respect to a payment, as set forth in paragraph (e)(1) of this section, the person obligated to report the payment is the person closest in the chain to the payee, unless the parties agree in writing that one of the other parties meeting the requirements set forth in paragraph (e)(1) of this section will report the payment.

(3) Special rule for payment by employee to employer. Notwithstanding the provisions of paragraph (e)(1) of this section, an employee acting in the course of his employment who makes a payment to his employer on behalf of another person is not required to make a return of information with respect to that payment.

(4) Optional method to report. A person that makes a payment on behalf of another person but is not required to make an information return under paragraph (e)(1) of this section may elect to do so pursuant to the procedures established by the Commissioner. See, e.g., Rev. Proc. 84-33 (1984-1 C.B. 502) (optional method for a paying agent to report and deposit amounts withheld for payors under the statutory provisions of backup withholding) (see § 601.601(d)(2) of this chapter).

(5) Examples. The provisions of this paragraph (e) are illustrated by the following examples:

Example 1.Bank B provides financing to C, a real estate developer, for a construction project. B makes disbursements from the account for labor, materials, services, and other expenses related to the construction project. In connection with the payments, B performs the following functions: approves payments to the general contractor or subcontractors; ensures that loan proceeds are properly applied and that all approved bills are properly paid to avoid mechanics' or materialmen's liens; conducts site inspections to determine whether work has been completed (but does not check the quality of the work). B is performing management or oversight functions in connection with the payments and is subject to the information reporting requirements of section 6041 with respect to payments.

Example 2.Mortgage company D holds a mortgage on business property owned by E. When the property is damaged by a storm, E's insurance company issues a check payable to both D and E in settlement of E's claim. Pursuant to the contract between D and E, D holds the insurance proceeds in an escrow account and makes disbursements, according to E's instructions, to contractors and subcontractors performing repairs on the property. D is not performing management or oversight functions, but D has a significant economic interest in the payments because the purpose of the arrangement is to ensure that property on which D holds a mortgage is repaired or replaced. D is subject to the information reporting requirements of section 6041 with respect to the payments to contractors.

Example 3.Settlement agent F provides real estate closing services to real estate brokers and agents. F deposits money received from the buyer or lender in an escrow account and makes payments from the account to real estate agents or brokers, appraisers, land surveyors, building inspectors, or similar service providers according to the provisions of the real estate contract and written instructions from the lender. F may also make disbursements pursuant to oral instructions of the seller or purchaser at closing. F is not performing management or oversight functions and does not have a significant economic interest in the payments, and is not subject to the information reporting requirements of section 6041. For the rules relating to F's obligation to report the gross proceeds of the sale, see section 6045(e) and § 1.6045-4.

Example 4.Assume the same facts as in Example 3. In addition, the seller instructs F to hire a contractor to perform repairs on the property. F selects the contractor, negotiates the cost, monitors the progress of the project, and inspects the work to ensure it complies with the contract. With respect to the payments to the contractor, F is performing management or oversight functions and is subject to the information reporting requirements of section 6041.

Example 5.G is a rental agent who manages certain rental property on behalf of property owner H. G finds tenants, arranges leases, collects rent, responds to tenant inquiries regarding maintenance, and hires and makes payments to repairmen. G subtracts her commission and any maintenance payments from rental payments and remits the remainder to H. With respect to payments to repairmen, G is performing management or oversight functions and is subject to the information reporting requirements of section 6041. With respect to the payment of rent to H, G is subject to the information reporting requirements of section 6041 regardless of whether she performs management or oversight functions or has a significant economic interest in the payment. See § 1.6041-3(d) for rules relating to rental agents. See § 1.6041-1(f) to determine the amount that G should report to H as rent.

Example 6.Literary agent J receives a payment from publisher L of fees earned by J's client, author K. J deposits the payment into a bank account in J's name. From time to time and as directed by K, J makes payments from these funds to attorneys, managers, and other third parties for services rendered to K. After subtracting J's commission, J pays K the net amount. J does not order or direct the provision of services by the third parties to K, and J exercises no discretion in making the payments to the third parties or to K. J is not performing management or oversight functions and does not have a significant economic interest in the payments and is not subject to the information reporting requirements of section 6041 in connection with the payments to K or to the third parties. For the rules relating to L's obligation to report the payment of the fees to K, see paragraphs (a)(1)(i) and (f) of this section. For the rules relating to K's obligation to report the payment of the commission to J and the payments to the third parties for services, see paragraphs (a)(1)(i) and (d)(2) of this section.

Example 7.Attorney P deposits into a client trust fund a settlement payment from R, the defendant in a breach of contract action for lost profits in which P represented plaintiff Q. P makes payments from the client trust fund to service providers such as expert witnesses and private investigators for expenses incurred in the litigation. P decides whom to hire, negotiates the amount of payment, and determines that the services have been satisfactorily performed. In the event of a dispute with a service provider, P withholds payment until the dispute is settled. With respect to payments to the service providers, P is performing management or oversight functions and is subject to the information reporting requirements of section 6041.

Example 8.Assume the same facts as in Example 7. In addition, assume that after paying the service providers and deducting his legal fee, P pays Q the remaining funds that P had received from the settlement with R. With respect to the payment to Q, P is not performing management or oversight functions, does not have a significant economic interest in the payment, and is not subject to the information reporting requirements of section 6041. For the rules relating to R's obligation to report the payment of the settlement proceeds to P, see section 6045(f) and the regulations thereunder. For the rules relating to R's obligation to report the payment of the settlement proceeds to Q, see paragraphs (a)(1)(i) and (f) of this section. For the rules relating to Q's obligation to report the payment of attorney fees to P, see paragraphs (a)(1)(i) and (d)(2) of this section.

Example 9.Medical insurer S operates as the administrator of a health care program under a contract with a state. S makes payments of government funds to health care providers who provide care to eligible patients. S receives and reviews claims submitted by patients or health care providers, determines if the claims meet all the requirements of the program (e.g., that the care is authorized and that the patients are eligible beneficiaries), and determines the amount of payment. S is performing management or oversight functions and is subject to the information reporting requirements of section 6041 with respect to the payments.

Example 10.Race track employee T holds deposits made by horse owner U in a special escrow account in U's name. U enters into a contract with jockey V to ride U's horse in a race at the track. As directed by U, T pays V the fee for riding U's horse from U's escrow account. T is not performing management or oversight functions, does not have a significant economic interest in the payment, and is not subject to the information reporting requirements of section 6041. For the rules relating to U's obligation to report the payment of the fee to V, see paragraph (a)(1)(i) of this section.

Example 11.X is a certified public accountant employed by Firm Y, and is not a partner. Client Z pays X directly for accounting services. X remits the amount received to Y, as required by the terms of his employment. X does not have any reporting obligation with respect to the payment to Y. For the rules relating to Z's obligation to report the payment to Y for services, see paragraphs (a)(1)(i) and (d)(2) of this section.

Example 12.Bank contracts with Title Company with respect to the disbursement of funds on a construction loan. Pursuant to their arrangement, the contractor sends draw requests to Title Company, which inspects the work, verifies the amount requested, and then sends the draw request to Bank with supporting documents. Bank pays Title Company the amount of the draw request, and Title Company insures Bank against any loss if it cannot obtain the necessary lien waivers. Bank has a significant economic interest in the payment as a mortgagee, and Title Company exercises management or oversight over the payment. Since Title Company is closest in the chain to the contractor, Title Company should report the payment, unless the parties agree in writing that Bank will report the payment.

(f) Amount to be reported when fees, expenses or commissions are deducted—(1) In general. The amount to be reported as paid to a payee is the amount includible in the gross income of the payee (which in many cases will be the gross amount of the payment or payments before fees, commissions, expenses, or other amounts owed by the payee to another person have been deducted), whether the payment is made jointly or separately to the payee and another person. The Commissioner may, by guidance published in the Internal Revenue Bulletin, illustrate the circumstances under which the gross amount or less than the gross amount may be reported.

(2) Examples. The provisions of this paragraph (f) are illustrated by the following examples:

Example 1.Attorney P represents client Q in a breach of contract action for lost profits against defendant R. R settles the case for $100,000 damages and $40,000 for attorney fees. Under applicable law, the full $140,000 is includible in Q's gross taxable income. R issues a check payable to P and Q in the amount of $140,000. R is required to make an information return reporting a payment to Q in the amount of $140,000. For the rules with respect to R's obligation to report the payment to P, see section 6045(f) and the regulations thereunder.

Example 2.Assume the same facts as in Example 1, except that R issues a check to Q for $100,000 and a separate check to P for $40,000. R is required to make an information return reporting a payment to Q in the amount of $140,000. For the rules with respect to R's obligation to report the payment to P, see section 6045(f) and the regulations thereunder.

(g) Payment made in medium other than cash. If any payment required to be reported on Form 1099 is made in property other than money, the fair market value of the property at the time of payment is the amount to be included on such form.

(h) When payment deemed made. For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.

(i) Payments made by the United States or a State. Information returns on:

(1) Forms 1096 and 1099 and

(2) Forms W-3 and W-2 (when made under the provisions of § 1.6041-2)

of payments made by the United States or a State, or political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any one or more of the foregoing, shall be made by the officer or employee of the United States, or of such State, or political subdivision, or of the District of Columbia, or of such agency or instrumentality, as the case may be, having control of such payments or by the officer or employee appropriately designated to make such returns.

(j) Effective/applicability date. This section applies to payments made on or after January 6, 2017. (For payments made after June 30, 2014, and before January 6, 2017, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2016. For payments made after December 31, 2010, and before July 1, 2014, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2013.)

[T.D. 6500, 25 FR 12108, Nov. 26, 1960]

Editorial Note:For Federal Register citations affecting § 1.6041-1, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6041-2 Return of information as to payments to employees.

(a)(1) In general. Wages, as defined in section 3401, paid to an employee are required to be reported on Form W-2. See section 6011 and the Employment Tax Regulations thereunder. All other payments of compensation, including the cash value of payments made in any medium other than cash, to an employee by his employer in the course of the trade or business of the employer must also be reported on Form W-2 if the total of such payments and the amount of the employee's wages (as defined in section 3401), if any, required to be reported on Form W-2 aggregates $600 or more in a calendar year. For example, if a payment of $700 was made to an employee and $400 thereof represents wages subject to withholding under section 3402 and the remaining $300 represents compensation not subject to withholding, such wages and compensation must both be reported on Form W-2. A separate Form W-2 shall be furnished for each employee for whom a return must be made. At the election of the employer, components of amounts required to be reported on Form W-2 pursuant to the provisions of this subparagraph may be reported on more than one Form W-2.

(2) Transmittal form. The transmittal form for a return on Form W-2 made pursuant to the provisions of subparagraph (1) of this paragraph shall be Form W-3. In a case where an employer must file a Form W-3 under this paragraph and also under § 31.6011(a)-4 or § 31.6011(a)-5 of this chapter (Employment Tax Regulations), the Form W-3 filed under such § 31.6011(a)-4 or § 31.6011(a)-5 shall also be used as the transmittal form for a return on Form W-2 made pursuant to the provisions of this paragraph.

(3) Time for filing—(i) General rule. In a case where an employer must file Forms W-3 and W-2 under this paragraph and also under § 31.6011(a)-4 or § 31.6011(a)-5 of this chapter (Employment Tax Regulations), the time for filing such forms under this paragraph shall be the same as the time (including extensions thereof) for filing such forms under § 31.6011(a)-4 or § 31.6011(a)-5.

(ii) Exception. In a case where an employer is not required to file Forms W-3 and W-2 under § 31.6011(a)-4 or § 31.6011(a)-5 of this chapter, returns on Forms W-3 and W-2 required under this paragraph (a) for any calendar year shall be filed on or before January 31 of the following year.

(iii) Cross reference. For extensions of time for filing returns, see section 6081 and the regulations thereunder.

(4) Place for filing. The returns on Forms W-3 and W-2 required under this paragraph shall be filed pursuant to the rules contained in § 31.6091-1 of this chapter (Employment Tax Regulations), relating to the place for filing certain returns.

(5) Statement for employees. An employer required under this paragraph (a) to file Form W-2 with respect to an employee is also required under sections 6041(d) and 6051 to furnish a written statement to the employee. This written statement must be furnished on Form W-2 in accordance with section 6051 and the regulations.

(b) Distributions under employees' trust or plan. (1) Amounts which are:

(i) Distributed or made available to a beneficiary, and to which section 402 (relating to employees' trusts) or section 403 (relating to employee annuity plans) applies, or

(ii) Described in section 72(m)(3)(B), shall be reported on Forms 1096 and 1099 to the extent such amounts are includible in the gross income of such beneficiary if the amounts so includible aggregate $600 or more in any calendar year. In addition, every trust described in section 501(c)(17) which makes one or more payments (including separation and sick and accident benefits) totaling $600 or more in 1 year to an individual must file an annual information return on Form 1096, accompanied by a statement on Form 1099, for each such individual. Payments made by an employer or a person other than the trustee of the trust should not be considered in determining whether the $600 minimum has been paid by the trustee. The provisions of this subparagraph shall not be applicable to payments of supplemental unemployment compensation benefits made after December 31, 1970, which are treated as if they were wages for purposes of section 3401(a). Such amounts are required to be reported on Forms W-3 and W-2. See paragraph (b)(14) of § 31.3401(a)-1 of this chapter (Employment Tax Regulations).

(2) Any amount with respect to which a statement is required by § 1.6047-1, relating to employee retirement plans covering owner-employees, shall not be included in amounts required to be reported under section 6041.

(c) Payments to foreign persons. See § 1.6041-4 for reporting exemptions regarding payments to foreign persons. See § 1.6049-5(d) for determining whether a payment is made to a foreign person.

(d) Applicability date. This section applies to returns filed on or after January 30, 2020. Section 1.6041-2T (as contained in 26 CFR part 1, revised April 2019) applies to returns filed before January 30, 2020.

[T.D. 7284, 38 FR 20827, Aug. 3, 1973, as amended by T.D. 7580, 43 FR 60159, Dec. 26, 1978; T.D. 8734, 62 FR 53472, Oct. 14, 1997; T.D. 8895, 65 FR 50406, Aug. 18, 2000; T.D. 9114, 69 FR 7570, Feb. 18, 2004; T.D. 9821, 82 FR 33445, July 20, 2017; T.D. 9892, 85 FR 5325, Jan. 30, 2020]

§ 1.6041-3 Payments for which no return of information is required under section 6041.

Returns of information are not required under section 6041 and §§ 1.6041-1 and 1.6041-2 for payments described in paragraphs (a) through (q) of this section. See § 1.6041-4 for reporting exemptions regarding payments to foreign persons.

(a) Payments of income required to be reported on Forms 1120-S, 941, W-2, and W-3 (however, see § 1.6041-2(a) with respect to Forms W-2 and W-3).

(b) Payments by a broker to his customer (but for reporting requirements as to certain of such payments, see sections 6042, 6045, and 6049 and the regulations thereunder in this part).

(d) Payments of rent made to rental agents (but the agent is required to report payments of rent to the landlord in accordance with § 1.6041-1(a)(1)(i)(B) and (2)).

(e) Payments representing earned income for services rendered without the United States made to a citizen of the United States, if it is reasonable to believe that such amounts will be excluded from gross income under the provisions of section 911 and the regulations thereunder.

(f) Compensation and profits paid or distributed by a partnership to the individual partners (but for reporting requirements, see § 1.6031-1).

(g) Payments of commissions to general agents by fire insurance companies or other companies insuring property, except when specifically directed by the Commissioner to be filed.

(h)(1) In general. Payments made under reimbursement or other expense allowance arrangements that meet the requirements of section 62(c) of the Code and § 1.62-2, that do not exceed the amount of the expenses substantiated (i.e., amounts which are treated as paid under an accountable plan), and that are received by an employee on or after January 1, 1989, with respect to expenses paid or incurred on or after January 1, 1989.

(2) Transition rule. Payments made under reimbursement or other expense allowance arrangements that are received by an employee on or after January 1, 1989, but prior to July 1, 1990, to the extent that the employee is required to account (within the meaning of the term “account” as set forth in § 1.162-17(b)(4) or 1.274-5T(f)(4), whichever is applicable) and does so account to the payor for such expenses, provided the payor has made a reasonable, good faith effort to comply with the requirements of section 62(c). In general, compliance with the provisions of this section, as in effect for payments made under reimbursement or other expense allowance arrangements that were received by an employee before January 1, 1989, with respect to expenses paid or incurred before January 1, 1989, will constitute such reasonable good faith compliance. In no event, however, will reasonable good faith compliance exist if a payor fails to report payments made under an arrangement (other than a per diem or mileage allowance type arrangement) under which an employee is not required to substantiate expenses paid or incurred or is not required to return amounts in excess of the substantiated expenses.

(i) Payments of interest on obligations of the United States, or a State, Territory, or political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any one or more of the foregoing (but for requirements for reporting certain such payments by the United States or any agency or instrumentality thereof, see §§ 1.1461-1 to 1.1461-3, inclusive).

(j) Payments of interest on corporate bonds (but for reporting requirements as to payments on certain corporate bonds, see § 1.6049-5.

(k) Amounts paid as an allowance or reimbursement for traveling or other bona fide ordinary and necessary expenses, including an allowance for meals and lodging or a per diem allowance in lieu of subsistence, to persons in the service of an international organization (without regard to whether there is a requirement to account for such amounts) if-

(1) The organization is designated as an international organization by the President of the United States in Executive Orders issued pursuant to 22 U.S.C. 288, and

(2) The organization has immunity with respect to the invoilability of its archives pursuant to an international agreement having full force and effect in the United States.

(l) A payment to an informer as an award, fee, or reward for information relating to criminal activity, but only if such payment is made by the United States, a State, Territory, or political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any one or more of the foregoing, or, with respect to payments made after December 31, 1987, by an organization that is described in section 501(c)(3) and that makes such payments in furtherance of a charitable purpose to lessen the burdens of government within the meaning of § 1.501(c)(3)-1(d)(2).

(m) On and after September 9, 1968, payments by a person carrying on the banking business of interest on a deposit evidenced by a negotiable time certificate of deposit (but for reporting requirements as to payments made after December 31, 1962, of interest on certain deposits, see sec. 6049 and the regulations thereunder in this part).

(n) Payments to individuals as scholarships or fellowship grants within the meaning of section 117(b)(1), whether or not “qualified scholarships” as described in section 117(b). This exception does not apply to any amount of a scholarship or fellowship grant that represents payment for services within the meaning of section 117(c). Instead, these amounts are required to be reported as wages on Form W-2. See § 1.1461-1(c) for applicable reporting requirements for amounts paid to foreign persons.

(o) Per diem of certain alien trainees described under section 1441(c)(6).

(p) Payments made to the following persons:

(1) A corporation described in § 1.6049-4(c)(1)(ii)(A), except with respect to payments made to a corporation after December 31, 1997 for attorneys' fees, and except a corporation engaged in providing medical and health care services or engaged in the billing and collecting of payments in respect to the providing of medical and health care services. However, no reporting is required where payment is made to a hospital or extended care facility described in section 501(c)(3) which is exempt from taxation under section 501(a) or to a hospital or extended care facility owned and operated by the United States, a State, the District of Columbia, a possession of the United States, or a political subdivision, agency or instrumentality of any of the foregoing. For reporting requirements as to payments by cooperatives, and to certain other payments, see sections 6042, 6044, and 6049 and the regulations thereunder in this part.

(2) An organization exempt from taxation under section 501(a), as described in § 1.6049-4(c)(1)(ii)(B)(1), or an individual retirement plan, as described in § 1.6049-4(c)(1)(ii)(C).

(3) The United States, as described in § 1.6049-4(c)(1)(ii)(D).

(4) A State, the District of Columbia, a possession of the United States, or any political subdivision of any of the foregoing, as described in § 1.6049-4(c)(1)(ii)(E).

(5) A foreign government or political subdivision of a foreign government, as described in § 1.6049-4(c)(1)(ii)(F).

(6) An international organization, as described in § 1.6049-4(c)(1)(ii)(G).

(7) A foreign central bank of issue, as described in § 1.6049-4(c)(1)(ii)(H) and the Bank for International Settlements.

(8) Any wholly owned agency or instrumentality of any person described in paragraph (p) (2), (3), (4), (5), (6), or (7) of this section.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960]

Editorial Note:For Federal Register citations affecting § 1.6041-3, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.

§ 1.6041-4 Foreign-related items and other exceptions.

(a) Exempted foreign-related items.(1) Returns of information are not required for payments that a payor can, prior to payment, reliably associate with documentation upon which it may rely to treat as made to a foreign beneficial owner in accordance with § 1.1441-1(e)(1)(ii) or as made to a foreign payee in accordance with § 1.6049-5(d)(1) or presumed to be made to a foreign payee under § 1.6049-5(d)(2), (3), (4), or (5). Returns of information are also not required for a payment that a payor or middleman can, prior to payment, reliably associate with documentation upon which it may rely to treat as made to a foreign intermediary or flow-through entity in accordance with § 1.1441-1(b) if it obtains from the intermediary or flow-through entity a withholding statement described in § 1.6049-5(b)(14) that allocates the payment to a chapter 4 withholding rate pool (as defined in § 1.6049-4(f)(5)) or specific payees to which withholding applies under chapter 4. Payments excepted from reporting under this paragraph (a)(1) may be reportable, for purposes of chapter 3 of the Internal Revenue Code (Code), under § 1.1461-1(b) and (c) and, for purposes of chapter 4 of the Code, under § 1.1474-1(d)(2). The provisions in § 1.6049-5(c) regarding documentation of foreign status shall apply for purposes of this paragraph (a)(1). The provisions in § 1.6049-5(c)(5) regarding the definitions of U.S. payor and non-U.S. payor shall also apply for purposes of this paragraph (a)(1). See § 1.1441-1(b)(3)(iii)(B) and (C) for special payee rules regarding scholarships, grants, pensions, annuities, etc. The provisions of § 1.1441-1 shall apply by substituting the term “payor” for the term “withholding agent” and without regard to the fact that the provisions apply only to amounts subject to withholding under chapter 3 of the Code and the regulations under that chapter.

(2) Returns of information are not required for payments of amounts from sources outside the United States (determined under the provisions of part I, subchapter N, chapter 1 of the Code and the regulations under those provisions) paid by a non-U.S. payor or non-U.S. middleman and that are paid and received outside the United States. For a definition of non-U.S. payor and non-U.S. middleman, see § 1.6049-5(c)(5). For circumstances in which an amount is considered to be paid and received outside the United States, see § 1.6049-4(f)(16).

(3) If a foreign intermediary, as described in § 1.1441-1(c)(13), or a U.S. branch that is not treated as a U.S. person receives a payment from a payor, which payment the payor can reliably associate with a valid withholding certificate described in § 1.1441-1(e)(3)(ii) or (iii), or § 1.1441-1(e)(3)(v), respectively, furnished by such intermediary or branch, then the intermediary or branch is not required to report such payment when it, in turn, pays the amount, unless, and to the extent, the intermediary or branch knows that the payment is required to be reported under this section and was not so reported. For example, if a U.S. branch described in § 1.1441-1(b)(2)(iv) fails to provide information regarding U.S. persons that are not exempt from reporting under § 1.6041-3(q) to the person from whom the U.S. branch receives the payment, the U.S. branch must report the payment on an information return. See, however, paragraph (a)(7) of this section for when reporting under section 6041is coordinated with reporting under chapter 4 of the Code or an applicable IGA (as defined in § 1.6049-4(f)(7)). The exception described in this paragraph (a)(3) for amounts paid by a foreign intermediary shall not apply to a qualified intermediary that assumes reporting responsibility under chapter 61 of the Code with respect to amounts reportable under the agreement described in § 1.1441-1(e)(5)(iii).

(4) Returns of information are not required for amounts paid with respect to notional principal contracts referred to in § 1.863-7 or 1.988-2(e) which the payor may treat as effectively connected income of a foreign payee under the provisions of § 1.1441-4(a)(3) or if the payee provides a representation in a master agreement that governs the transactions in notional principal contracts between the parties (for example, an International Swap and Derivatives Association (ISDA) Agreement, including the Schedule thereto) or in the confirmation on the particular notional principal contract transaction that the counterparty is a foreign person. See, however, § 1.1461-1(c)(2)(i) for applicable reporting requirements.

(5) Returns of information are not required for the period that the amounts paid represent assets blocked as described in § 1.1441-2(e)(3). The exemption in this paragraph (a)(5) shall terminate when payment is deemed to occur in accordance with the provisions of § 1.1441-2(e)(3).

(6) For rules concerning direct sellers, see § 1.6041A-1(d)(3)(i)(C).

(7) Returns of information are not required for payments with respect to which a return is not required by applying the rules of § 1.6049-4(c)(4) (by substituting the term “a payment subject to reporting under section 6041” for the term “an interest payment”).

(b) Joint owners. Amounts paid to joint owners for which a certificate or documentation is required as a condition for being exempt from reporting under paragraph (a) of this section are presumed made to U.S. payees who are not exempt recipients if, prior to payment, the payor or middleman cannot reliably associate the payment either with a Form W-9 furnished by one of the joint owners in the manner required in §§ 31.3406(d)-1 through 31.3406(d)-5, or with documentation described in paragraph (a)(1) of this section furnished by each joint owner upon which the payor or middleman can rely to treat each joint owner as a foreign payee or foreign beneficial owner. However, in the case of a withholdable payment (as defined in § 1.6049-4(f)(15)) made to joint payees, if any joint payee does not appear to be an individual, the payment is presumed made to a foreign payee that is a nonparticipating FFI (as defined in § 1.1471-1(b)(82)). See § 1.1471-3(f)(7).

(c) Conversion into United States dollars of amounts paid in foreign currency. For rules concerning foreign currency conversion, see § 1.6049-4(d)(3)(i).

(d) Effective/applicability date. This section applies to payments made on or after January 6, 2017. (For payments made after June 30, 2014, and before January 6, 2017, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2016. For payments made after December 31, 2002, and before July 1, 2014, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2013.)

[T.D. 8734, 62 FR 53473, Oct. 14, 1997, as amended by T.D. 8804, 63 FR 72188, Dec. 31, 1998; T.D. 8856, 64 FR 73412, Dec. 30, 1999; T.D. 8881, 65 FR 32205, May 22, 2000; T.D. 9658, 79 FR 12793, Mar. 6, 2014; T.D. 9808, 82 FR 2106, Jan. 6, 2017]

§ 1.6041-5 Information as to actual owner.

When a person receiving a payment described in section 6041 is not the actual owner of the income received, the name and address of the actual owner shall be furnished upon demand of the person paying the income, and in default of compliance with such demand the payee becomes liable for the penalties provided. See section 7203.

§ 1.6041-6 Returns made on Forms 1096 and 1099 under section 6041; contents and time and place for filing.

(a) In general. Except as provided in paragraph (b) of this section, returns made under section 6041 on Forms 1096 and 1099 for any calendar year shall be filed on or before February 28 (March 31 if filed electronically) of the following year with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for such forms. The name and address of the person making the payment and the name and address of the recipient of the payment shall be stated on Form 1099. If the present address of the recipient is not available, the last known post office address must be given. See section 6109 and the regulations in part 301 of this title under section 6109 for rules requiring the inclusion of identifying numbers in Form 1099.

(b) Exception. Returns made on Form 1099 reporting nonemployee compensation shall be filed on or before January 31 of the year following the calendar year to which such returns relate.

(c) Applicability date. This section applies to returns filed on or after January 30, 2020. Section 1.6041-6T (as contained in 26 CFR part 1, revised April 2019) applies to returns filed before January 30, 2020.

[T.D. 9892, 85 FR 5325, Jan. 30, 2020]

§ 1.6041-7 Magnetic media requirement.

(a) General. For rules relating to permission to submit the information required by Form 1099 or W-2 on magnetic tape or other media, see § 1.9101-1. See also paragraph (b)(2) of § 31.6011(a)-7 of this chapter (Employment Tax Regulations) for additional rules relating to Form W-2. High-volume filers of information returns must file their returns on magnetic media. See section 6011(e) and § 301.6011-2 of this chapter (Procedure and Administration Regulations) for the requirements for filing on magnetic media.

(b) Returns on magnetic tape by departments of health care carriers. (1) For calendar years beginning on or after January 1, 1971, a health care carrier, or an agent thereof, making payment of fees or other compensation to providers of medical and health care services, may make a separate return on magnetic tape for each separate department within a specific line of such carrier's business, so long as all of such returns taken together contain all of the information required by section 6041 with respect to each provider of medical and health care services to whom such health care carrier makes payments aggregating $600 or more during the calendar year. Examples of separate departments within a specific line of such carrier's business (such as health and accident insurance) include, but are not limited to, separate departments to process claims of individual and group policyholders; and separate departments established along geographic lines.

(2) For purposes of this paragraph, the term “health care carrier” means any person making health care payments: (i) In exchange for the payment of a premium, (ii) in accordance with an employee benefit program, or (iii) in connection with a government-sponsored health care program.

[T.D. 7106, 36 FR 6422, Apr. 3, 1971, as amended by T.D. 8734, 62 FR 53473, Oct. 14, 1997]

§ 1.6041-8 Cross-reference to penalties.

For provisions relating to the penalty provided for failure to file timely a correct information return required under section 6041(a) or (b), see § 301.6721-1 of this chapter (Procedure and Administration Regulations). For provisions relating to the penalty provided for failure to furnish timely a correct payee statement required under section 6041(d), see § 301.6722-1 of this chapter. See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

[T.D. 8734, 62 FR 53474, Oct. 14, 1997]

§ 1.6041-9 Coordination with reporting rules for widely held fixed investment trusts under § 1.671-5.

See § 1.671-5 for the reporting rules for widely held fixed investment trusts (WHFIT) (as defined under that section). For purposes of section 6041, middlemen and trustees of WHFITs are deemed to have management and oversight functions in connection with payments made by the WHFIT.

[T.D. 9241, 71 FR 4024, Jan. 24, 2006]

§ 1.6041-10 Return of information as to payments of winnings from bingo, keno, and slot machine play.

(a) In general. Every person engaged in a trade or business (as defined in § 1.6041-1(b)) and who, in the course of such trade or business, makes a payment of reportable gambling winnings (defined in paragraph (b)(1) of this section) must make an information return with respect to such payment. Unless the provisions of paragraph (g) of this section (regarding aggregate reporting) apply, a separate information return is required with respect to each payment of reportable gambling winnings.

(b) Definitions—(1) Reportable gambling winnings. (i) For purposes of this section, the term reportable gambling winnings is defined as follows:

(A) For bingo, the term “reportable gambling winnings” means winnings of $1,200 or more from one bingo game, without reduction for the amount wagered. All winnings received from all wagers made during one bingo game are combined (for example, all winnings from all cards played during one bingo game are combined).

(B) For keno, the term “reportable gambling winnings” means winnings of $1,500 or more from one keno game reduced by the amount wagered on the same keno game. All winnings received from all wagers made during one keno game are combined (for example, all winnings from all “ways” on a multi-way keno ticket are combined).

(C) For slot machine play, the term “reportable gambling winnings” means winnings of $1,200 or more from one slot machine play, without reduction for the amount wagered.

(ii) Winnings and wagers from different types of games are not combined to determine if the reporting threshold is satisfied. Bingo, keno, and slot machine play are different types of games.

(iii) Winnings include the fair market value of a payment in any medium other than cash.

(iv) The amount wagered in the case of a free play is zero.

(2) Information reporting period—(i) In general. For purposes of paragraph (g) of this section, the “information reporting period” begins when a patron places the first wager on a particular type of game at a gaming establishment, as defined in paragraph (b)(2)(iv) of this section, and ends when the patron places his or her last wager on the same type of game at the same gaming establishment before the end of the “information reporting period.” An information reporting period is a 24-hour period. A payor may select a calendar day (as defined in paragraph (b)(2)(ii) of this section) or a gaming day (as defined in paragraph (b)(2)(iii) of this section) as the information reporting period for purposes of the aggregate reporting method in paragraph (g) of this section. For purposes of this paragraph (b)(2), time is determined by the time zone of the location where the patron places the wager. A payor must use the same information reporting period (a calendar day or gaming day) to report all “reportable gambling winnings” paid during the calendar year. Once selected, a payor may not change its information reporting period during a calendar year. Any changes to a payor's information reporting period from one calendar year to another must be implemented on January 1.

(ii) Calendar day. A calendar day is determined with reference to a period beginning at 12 a.m. and ending no later than 11:59 p.m. of the same calendar day.

(iii) Gaming day—(A) In general. A gaming day is a 24-hour period other than a calendar day (as defined in paragraph (b)(2)(ii) of this section) selected by the payor, subject to the special rules for December 31 and January 1 in paragraphs (b)(2)(iii)(B) and (C) of this section.

(B) Special rule for December 31. For purposes of paragraph (b)(2)(iii) of this section, the gaming day that begins on December 31 of any calendar year ends at 11:59 p.m. on December 31, regardless of the time on December 31 on which that gaming day began.

(C) Special rule for January 1. For purposes of paragraph (b)(2)(iii) of this section, the gaming day of January 1 begins at 12:00 a.m. on January 1, regardless of the time and calendar day on which that gaming day ends, and may extend beyond 24 hours.

(iv) Gaming establishment. For purposes of this section, a gaming establishment is a business entity of a payor of reportable gambling winnings with respect to bingo, keno, or slot machine play, and includes all gaming establishments owned by such payor using the same employer identification number (EIN) issued to such payor in accordance with section 6109.

(v) Examples. The following examples illustrate the provisions of paragraph (b)(2) of this section.

Example 1.Casino R uses the aggregate reporting method under paragraph (g) of this section to report certain reportable gambling winnings. For other regulatory purposes, Casino R uses a gaming day that begins at 3 a.m. and ends at 2:59 a.m. the following calendar day. Casino R chooses to use its gaming day as its information reporting period for purposes of paragraph (b)(2) of this section during Year 1. Accordingly, the information reporting period for purposes of paragraph (g) of this section for each day during Year 1 begins at 3 a.m. and ends at 2:59 a.m. the following day. The information reporting period for December 31 of Year 1 begins at 3 a.m. on December 31 of Year 1 and ends at 11:59 p.m. on December 31 of Year 1. The information reporting period for January 1 of Year 2 begins at 12 a.m. on January 1 of Year 2 and ends at 2:59 a.m. on January 2 of Year 2.

Example 2.The facts are the same as Example 1, except Casino R uses a calendar day as its information reporting period for purposes of paragraph (b)(2) of this section during Year 1. Accordingly, the information reporting period for purpose of paragraph (g) of this section for each day during Year 1 begins at 12 a.m. and ends at 11:59 p.m. on the same day.

Example 3.Casino R uses the aggregate reporting method under paragraph (g) of this section to report certain reportable gambling winnings. For other regulatory purposes, Casino R uses a gaming day that begins at 9:00 p.m. and ends at 8:59 p.m. the following calendar day. Casino R chooses to use its gaming day as its information reporting period for purposes of paragraph (b)(2) of this section during Year 1. Accordingly, the information reporting period for purposes of paragraph (g) of this section for each day during Year 1 begins at 9:00 p.m. and ends at 8:59 p.m. the following day. The information reporting period for December 31 of Year 1 begins at 9:00 p.m. on December 30 and ends at 8:59 p.m. on December 31. A second information reporting period for December 31 then begins at 9:00 p.m. on December 31 and ends at 11:59 p.m. on December 31. The information reporting period for January 1 of Year 2 begins at 12:00 a.m. on January 1 and ends at 8:59 p.m. on January 1 of Year 2.

Example 4.Casino R uses the aggregate reporting method under paragraph (g) of this section to report certain reportable gambling winnings. In Year 1, Casino R chooses to use a “gaming day” that begins at 3 a.m. and ends at 2:59 a.m. the following day as its information reporting period. During the course of Year 1, Casino R decides that it would like to change its information reporting period to instead begin at 5 a.m. and end at 4:59 a.m. the following day. Casino R must wait until January 1 of Year 2 to implement such a change. On January 1 of Year 2, Casino R's information reporting period will begin at 12 a.m. and end at 4:59 a.m. on January 2. On December 31 of Year 2, Casino R's information reporting period will begin at 5 a.m. and end at 11:59 p.m.

(3) Slot machine. The term “slot machine” means a device that, by application of the element of chance, may deliver, or entitle the person playing or operating the device to receive cash, premiums, merchandise, or tokens whether or not the device is operated by insertion of a coin, token, or similar object.

(c) Prescribed form; time and place for filing the return. The return described in paragraph (a) of this section is a Form W-2G, “Certain Gambling Winnings.” The Form W-2G must be filed with the appropriate Internal Revenue Service location designated in the instructions to the form on or before February 28 (March 31, if filed electronically) of the year following the calendar year in which the reportable gambling winnings were paid. See section 6011 and § 1.6011-2 for requirements to file electronically.

(d) Information included on the return—(1) In general. Each return required by paragraph (a) of this section must contain:

(i) The name, address, and taxpayer identification number of the payor;

(ii) The name, address, and taxpayer identification number of the payee;

(iii) A general description of the two types of identification (as described in paragraph (e) of this section), one of which must have the payee's photograph on it (except in the case of tribal member identification cards in certain circumstances as described in paragraph (d)(2) of this section) that the payor relied on to verify the payee's name, address, and taxpayer identification number;

(iv) The date and amount of payment;

(v) The type of wagering transaction (bingo, keno, or slot machine play);

(vi) In the case of a bingo or keno game, any number, color, or other designation assigned to the game for which the payment is made;

(vii) In the case of slot machine play, the identification number of the slot machine(s) (for example, location and asset number);

(viii) Any other information required by the forms, instructions, revenue procedures, or other applicable guidance published in the Internal Revenue Bulletin.

(2) Special rule for tribal member identification cards. A tribal member identification card need not contain the payee's photograph to meet the identification requirement described in paragraph (d)(1)(iii) of this section if:

(i) The payee is a member of a federally recognized Indian tribe;

(ii) The payee presents the payor with a tribal member identification card issued by a federally recognized Indian tribe stating that the payee is a member of such tribe; and

(iii) The payor is a gaming establishment (as described in paragraph (b)(2)(iv) of this section) owned or licensed (in accordance with 25 U.S.C. 2710) by the tribal government that issued the tribal member identification card referred to in (d)(2)(ii).

(3) Special rule for optional aggregate reporting method. In the case of aggregate reporting under paragraph (g) of this section, the amount of the payment in paragraph (d)(1)(iv) of this section is the aggregate amount of payments of reportable gambling winnings from the same type of game (bingo, keno, or slot machine play) made to the same payee during the same information reporting period (as defined in paragraph (b)(2) of this section). Unless otherwise provided in forms, instructions, or other guidance, in the case of aggregate reporting under paragraph (g) of this section, the information required by paragraphs (d)(1)(v) through (viii) of this section must be maintained by the payor as described in paragraph (g)(3) of this section.

(e) Identification. The following items are treated as identification for purposes of paragraph (d)(1)(iii) of this section—

(1) Government-issued identification (for example, a driver's license, passport, social security card, military identification card, tribal member identification card issued by a federally recognized Indian tribe, or voter registration card) in the name of the payee; and

(2) A Form W-9, “Request for Taxpayer Identification Number and Certification,” signed by the payee, that includes the payee's name, address, taxpayer identification number, and other information required by the form. A Form W-9 is not acceptable for this purpose if the payee has modified the form (other than pursuant to instructions to the form) or if the payee has deleted the jurat or other similar provisions by which the payee certifies or affirms the correctness of the statements contained on the form.

(f) Furnishing a statement to the payee. Every payor required to make a return under paragraph (a) of this section must also make and furnish to each payee, with respect to each payment of reportable gambling winnings, a written statement that contains the information that is required to be included on the return under paragraph (d) of this section. The payor must furnish the statement to the payee on or before January 31st of the year following the calendar year in which payment of the reportable gambling winnings is made. The statement will be considered furnished to the payee if it is provided to the payee at the time of payment or if it is mailed to the payee on or before January 31st of the year following the calendar year in which payment was made.

(g) Aggregate reporting of bingo, keno, and slot machine winnings—(1) In general. In lieu of filing a separate information return for each payment of reportable gambling winnings as required by paragraph (a) of this section, a payor may use the aggregate reporting method (defined in paragraph (g)(2) of this section) to report reportable gambling winnings from bingo, keno, or slot machine play. A payor using the aggregate reporting method to file information returns under paragraph (a) of this section must also furnish statements to the payee under paragraph (f) of this section using the aggregate reporting method.

(2) Aggregate reporting method defined. (i) The aggregate reporting method is a method of reporting more than one payment of reportable gambling winnings from the same type of game (bingo, keno, or slot machine play) made to the same payee during the same information reporting period (as defined in this paragraph (b)(2) of this section) on one information return or statement.

(ii) A payor may use the aggregate reporting method for payments to some payees and not others, at its own discretion. In addition, with respect to a single payee, the payor may use the aggregate reporting method to report winnings from one type of game, but not for winnings from another type of game.

(iii) Failure to report some reportable gambling winnings from a particular type of game during one information reporting period to a particular payee under the aggregate reporting method (for whatever reason, including because the winnings are not permitted to be reported using the aggregate reporting method under paragraph (g)(4) of this section) will not disqualify the payor from using the aggregate reporting method to report other reportable gambling winnings from that type of game during that information reporting period to that payee. The payor may stop using the aggregate reporting method for a particular payee or for all payees before the end of the payor's information reporting period for any reason.

(3) Recordkeeping under the aggregate reporting method. A payor using the aggregate reporting method must maintain a record of every payment of reportable gambling winnings from the same type of game made to the same payee during the information reporting period that will be reported using the aggregate reporting method. Every individual that the payor has determined is responsible for an entry in the record must confirm the information in the entry by signing the record in a manner that will enable the signature to be associated with the relevant entry. Each payment of a reportable gambling winning made to the same payee and reported under the aggregate reporting method must have its own entry in the record, however, the information required by paragraphs (d)(1)(i) through (iii) of this section is not required to be recorded more than one time per information reporting period. A payor that uses the aggregate reporting method must retain a copy of the record in its files. The record (which may be electronic provided the requirements set forth in forms, instructions, or guidance published in the Internal Revenue Bulletin are met) must include the following information about each payment:

(i) The payee's signature confirming the information in the record;

(ii) The information required under paragraph (d) of this section;

(iii) The time of the win resulting in the reportable gambling winnings;

(iv) The total amount of reportable gambling winnings with respect to all payments to the payee during the information reporting period;

(v) The amount of reportable gambling winnings with respect to each particular payment;

(vi) The method of payment to the payee (for example, cash, check, voucher, credit, token, or chips); and

(vii) The name and unique identification number of the individual who the payor has determined is responsible for ensuring that the entry with respect to the reportable gambling winnings (including the general description of two types of identification used to verify the payee's name, address, and taxpayer identification number) is complete and accurate and who is authorized to perform that function by the applicable gaming regulatory control authority. Such individual may or may not be the same individual who prepared the entry.

(4) When the aggregate reporting method may not be used. A payor cannot use the aggregate reporting method if—

(i) The payment is to a foreign person, as described in section 1.6041-10(h);

(ii) The payor knows or has reason to know that the person making the wager is not the person entitled to the winnings or is not the only person entitled to the winnings (regardless of whether the person making the wager furnishes a Form 5754, “Statement by Person(s) Receiving Gambling Winnings”); or

(iii) Backup withholding under section 3406(a) applies to the payment.

(5) Examples. The following examples illustrate the provisions of this section. For each example, assume that for purposes of the aggregate reporting method in paragraph (g) of this section, Casino R's “information reporting period” for all calendar years is a gaming day that begins at 3 a.m. and ends at 2:59 a.m. the following day (except for January 1 and December 31) and that individuals C, D, and E are U.S. persons.

Example 1. On Day 1, between 7 a.m. and 4 p.m., C places five wagers at casino R on five different slot machines. The first two wagers result in no win. The third wager results in a $1,500 win. The fourth wager results in a $2,500 win. The fifth wager results in an $800 win:

(i) Under paragraph (b)(1)(i)(C) of this section, there are reportable gambling winnings from the slot machine play of $4,000 ($1,500 + $2,500). The $800 win is not a reportable gambling winning from slot machine play because it does not equal or exceed the $1,200 threshold.

(ii) Because all of the amounts were won on the same type of game (even though each of the winnings occurred on different machines) during the same information reporting period, R is permitted to use the aggregate reporting method under this paragraph (g). If R decides not to use the aggregate reporting method, a separate Form W-2G would have to be filed and furnished for the payment of reportable gambling winnings of $1,500 and for the payment of reportable gambling winnings of $2,500. However, if R decides to use the aggregate reporting method, R may report total reportable gambling winnings from slot machine play of $4,000 ($1,500 + $2,500) on one Form W-2G.

Example 2.Assume the same facts as Example 1, except that in addition to the winnings described in Example 1, at 5 a.m. on Day 2, C wins $3,250 from one slot machine play at casino R. Even though C played the same type of game (slot machine play) on Day 1 and Day 2, under paragraph (b)(2) of this section, the win at 5 a.m. on Day 2 is a win during a separate information reporting period. Under paragraph (g)(2)(i) of this section, the $3,250 of reportable gambling winnings on Day 2 cannot be aggregated with the reportable gambling winnings of $4,000 from Day 1 on a single Form W-2G. Accordingly, if R uses the aggregate reporting method, R must file two Forms W-2G with respect to C's reportable gambling winnings on Day 1 and Day 2. R must report $4,000 of reportable gambling winnings from slot machine play paid to C on Day 1 on the first Form W-2G, and $3,250 of reportable gambling winnings from slot machine play paid to C on Day 2 on the second Form W-2G.

Example 3.On December 31 of Year 1 at 4:00 p.m., C wins $10,000 from one slot machine play at casino R. At 12:30 a.m. on January 1 of Year 2, C wins $4,000 from one slot machine play at casino R. Under paragraphs (b)(2)(iii)(B) and (C) of this section, the win at 4 p.m. on December 31 of Year 1 and the win at 12:30 a.m. on January 1 of Year 2 are wins during different information reporting periods. Under paragraph (g)(2)(i) of this section, the $4,000 of reportable gambling winnings on January 1 cannot be aggregated with the reportable gambling winnings of $10,000 from December 31 on a single Form W-2G. Accordingly, if R uses the aggregate reporting method, R must file two Forms W-2G with respect to C's reportable gambling winnings on Day 1 and Day 2. R must report $10,000 of reportable gambling winnings from slot machine play paid to C on December 31 on the first Form W-2G and $4,000 of reportable gambling winnings from slot machine play paid to C on January 1 on the second Form W-2G.

Example 4.Assume the same facts as example 3, except that C also wins $5,000 from one slot machine play at 3:30 p.m. on January 1 and $7,000 from one slot machine play at 1:30 a.m. on January 2. Under the special rule of paragraph (b)(2)(iii) of this section, the “information reporting period” begins at 12:00 a.m. on January 1 and extends until the start of the next information reporting period, in this case 2:59 a.m. on January 2. Under paragraph (b)(1)(C) of this section, Casino R will pay C a total of $26,000 ($10,000 + $4,000 + $5,000 + $7,000) in reportable gambling winnings; however, $10,000 must be reported in Year 1, and $16,000 must be reported in Year 2. Because all of the amounts won in Year 2 were won on the same type of game and during the same information reporting period, R is permitted to use the aggregate reporting method under this paragraph (g). If R decides to use the aggregate reporting method, R may report $10,000 of reportable gambling winnings from slot machine play paid to C on December 31 on the first Form W-2G and $16,000 of total reportable gambling winnings from slot machine play paid to C on January 1 on the second Form W-2G.

Example 5. At 2 p.m. on Day 1, D won $2,000 (after reducing the amount of the win by the amount wagered) playing one keno game at casino R. D provides R with his driver's license. The driver's license has D's photograph on it, as well as D's name and address. The driver's license does not include D's social security number. D cannot remember his social security number and has no other identification at the time with his social security number on it. D does not provide R with his social security number before R pays the winnings to D. Because D cannot remember his social security number, D cannot complete and sign a Form W-9. R deducts and withholds $560 (28 percent of $2,000) under the backup withholding provisions of section 3406(a) and pays the remaining $1,440 in winnings to D. D returns to casino R and at 6 p.m. on Day 1 wins $1,500 (after reducing the amount of the win by the amount wagered) in one keno game. D provides R with his driver's license as well as D's social security card. R generally uses the aggregate reporting method and in all cases where it is used, R complies with the requirements of this paragraph (g). At 8 p.m. and 10 p.m. on Day 1, D wins an additional $1,800 and $1,700 (after reducing the amount of the win by the amount wagered), respectively, from two different keno games. For each of these two wins, an employee of R obtains the information from D required by this paragraph (g):

(i) Under paragraph (b)(1)(i)(B) of this section, each of D's wins from the four games of keno on Day 1 ($2,000, $1,500, $1,800, and $1,700) are reportable gambling winnings. Because D's first win on Day 1 was at 2 p.m. and D's last win on Day 1 was at 10 p.m., all of D's reportable gambling winnings from keno are won during the same information reporting period. Because R satisfies the requirements of paragraph (g)(2)(i), R may use the aggregate reporting method to report D's reportable gambling winnings from keno. However, pursuant to paragraph (g)(4)(iii) of this section, the $2,000 payment made to D at 2 p.m. cannot be reported under the aggregate reporting method because that payment was subject to backup withholding. Accordingly, if R uses the aggregate reporting method under this paragraph (g), R will have to file two Forms W-2G with respect to D's reportable gambling winnings from keno on Day 1. On the first Form W-2G, R will report $2,000 of reportable gambling winnings and $560 of backup withholding with respect to the 2 p.m. win from keno, and, on the second Form W-2G, R will report $5,000 of reportable gambling winnings from keno (representing the three payments of $1,500, $1,800, and $1,700 that D won between 6 p.m. and 10 p.m. on Day 1).

Example 6.In one information reporting period on Day 1, E won five reportable gambling winnings from five different bingo games at a casino R. R generally uses the aggregate reporting method and in all cases where it is used, R complies with the requirements of this paragraph (g). Although E signed the entry in the record R maintains for payment of the first four reportable gambling winnings, E refuses to sign the entry in the record for the fifth payment of reportable gambling winnings. R may use the aggregate reporting method for the first four payments of reportable gambling winnings to E. However, because the entry in the record for the fifth payment of reportable gambling winnings does not include E's signature, as required by paragraph (g)(3)(i) of this section, that payment may not be reported under the aggregate reporting method. Accordingly, if R uses the aggregate reporting method under paragraph (g) of this section, R must prepare two Forms W-2G as follows: On the first Form W-2G, R must report the first four payments of reportable gambling winnings from bingo made to E on Day 1. On the second Form W-2G, R must report the fifth payment of reportable gambling winnings from bingo made to E on Day 1.

(h) Payments to foreign persons. See § 1.6041-4 regarding payments to foreign persons. See § 1.6049-5(d) for determining whether the payee is a foreign person.

(i) Effective/applicability date. Section 1.6041-10(b)(2), concerning payor-selected “information reporting periods,” applies to payments of reportable gambling winnings from bingo, keno, or slot machine play made on or after January 1 of the year following the date these regulations are published in the Federal Register. All other sections contained herein apply to payments of reportable gambling winnings from bingo, keno, or slot machine play made on or after December 30, 2016.

(j) Cross-references for certain gambling winnings. For provisions relating to backup withholding for winnings from bingo, keno, and slot machine play and other reportable gambling winnings, see § 31.3406(g)-2(d). For provisions relating to withholding and reporting for gambling winnings from lotteries, sweepstakes, wagering pools, and other wagering transactions, including a wagering transaction in a parimutuel pool with respect to horse races, dog races, or jai alai, see § 31.3402(q)-1.

[T.D. 9807, 81 FR 96377, Dec. 30, 2016]

§ 1.6041A-1 Returns regarding payments of remuneration for services and certain direct sales.

(a) through (c) [Reserved]

(d) Exceptions to return requirement. [Reserved]

(1) and (2) [Reserved]

(3) Foreign transactions—(i) In general. No return shall be required under section 6041A with respect to payments described in this paragraph (d)(3).

(A) Returns of information are not required for payments that a payor can, prior to payment, associate with documentation upon which it may rely to treat as made to a foreign beneficial owner in accordance with § 1.1441-1(e)(1)(ii) or as made to a foreign payee in accordance with § 1.6049-5(d)(1) or presumed to be made to a foreign payee under § 1.6049-5(d)(2), (3), (4), or (5). However, such payments may be reportable under § 1.1461-1(b) and (c). For purposes of this paragraph (d)(3)(i)(A), the provisions in § 1.6049-5(c) (regarding rules applicable to documentation of foreign status and definition of U.S. payor and non-U.S. payor) shall apply. The provisions of § 1.1441-1 shall apply by substituting the term payor for the term withholding agent.

(B) Returns of information are not required for payments of remuneration for services from sources outside the United States (determined under the provisions of part I, subchapter N, chapter 1 of the Internal Revenue Code and the regulations under those provisions) if payments are made outside the United States by a non-U.S. payor or non U.S. middleman. For a definition of non U.S. payor or non-U.S. middleman, see § 1.6049-5(c)(5). For circumstances in which a payment is considered to be made outside the United States, see § 1.6049-5(e).

(C) Returns of information are not required under sections 6041 or 6041A for amounts paid outside of the United States (within the meaning of § 1.6049-5(e)) as remuneration for services as a direct seller (within the meaning of section 3508) performed outside of the United States or for sales described in section 6041A(b) made outside of the United States of consumer products for resale outside of the United States.

(ii) Payor. The term payor has the same meaning as described in § 1.6049-4(a)(2).

(iii) Joint owners. Amounts paid to joint owners for which a certificate or documentation is required as a condition for being exempt from reporting under paragraph (d)(3)(i) of this section are presumed made to U.S. payees who are not exempt recipients if, prior to payment, the payor or middleman cannot reliably associate the payment either with a Form W-9 furnished by one of the joint owners in the manner required in §§ 31.3406(d)-1 through 31.3406(d)-5 of this chapter, or with documentation described in paragraph (d)(3)(i)(A) of this section furnished by each joint owner upon which it can rely to treat each joint owner as a foreign payee or foreign beneficial owner.

(iv) Conversion into United States dollars of amounts paid in foreign currency. For rules concerning foreign currency conversion, see § 1.6049-4(d)(3)(i).

(v) Effective date. The provisions of this paragraph (d)(3) apply to payments made after December 31, 2000.

(4) Information returns required under section 6050W for calendar years beginning after December 31, 2010. (i) For payments made by payment card (as defined in § 1.6050W-1(b)(3)) or through a third party payment network (as defined in § 1.6050W-1(c)(3)) after December 31, 2010, that are required to be reported on an information return under section 6050W (relating to payment card and third party network transactions), the following rule applies. Transactions that otherwise would be reportable under both sections 6041A(a) and 6050W are reported under section 6050W and not section 6041A(a). For provisions relating to information reporting for payment card transactions and third party network transactions, see § 1.6050W-1. Solely for purposes of this paragraph, the de minimis threshold for third party network transactions in § 1.6050W-1(c)(4) is disregarded in determining whether the transaction is subject to reporting under section 6050W.

(ii) Examples. The provisions of paragraph (d)(4) of this section are illustrated by the following examples:

Example 1.Service-recipient A, in the course of its business, pays remuneration of $600 to service provider B by credit card for services performed by B. B is one of a network of unrelated persons that has agreed to accept A's credit card as payment under an agreement that provides standards and mechanisms for settling the transactions between a merchant acquiring bank and the persons who accept the cards. Merchant acquiring bank Y is responsible for making the payment to B. Under paragraph (d)(4)(i) of this section, A is not required to file an information return under section 6041A(a) with respect to the transaction because Y, as the payment settlement entity for the payment card transaction, is required to file an information return under section 6050W.

Example 2.Service-recipient A, in the course of business, pays $600 of fixed or determinable income to B, a repairman, through a third party payment network. B is one of a substantial number of persons who have established accounts with Y, a third party settlement organization that provides standards and mechanisms for settling the transactions and guarantees payments to those persons for goods or services purchased through the network. Y is responsible for making the payment to B. Under paragraph (d)(4)(i) of this section, A is not required to file an information return under section 6041A(a) with respect to the transaction because the transaction is a third party network transaction that is subject to reporting under section 6050W. Solely for purposes of determining whether the transaction is subject to reporting under section 6050W, the de minimis threshold for third party network transactions in § 1.6050W-1(c)(4) is disregarded.

(iii) Effective/applicability date. Paragraph (d)(4) of this section applies to payments made by payment card or through a third party payment network after December 31, 2010.

(e) [Reserved]

(f) Statements to be furnished to persons with respect to whom information is required to be furnished—(1) [Reserved]

(2) Time for furnishing statement. [Reserved]

(3) Contents of statement. [Reserved]

(g) [Reserved]

(h) Cross-reference to penalties. For provisions relating to the penalty provided for failure to file timely a correct information return required under section 6041A(a) or (b), see § 301.6721-1 of this chapter (Procedure and Administration Regulations). For provisions relating to the penalty provided for failure to furnish timely a correct payee statement required under section 6041A(e), see § 301.6722-1 of this chapter. See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

[T.D. 8734, 62 FR 53474, Oct. 14, 1997, as amended by T.D. 8804, 63 FR 72188, Dec. 31, 1998; T.D. 8856, 64 FR 73412, Dec. 30, 1999; T.D. 8881, 65 FR 32205, May 22, 2000; T.D. 9496, 75 FR 49828, Aug. 16, 2010]

§ 1.6042-1 Return of information as to dividends paid in calendar years before 1963.

(a) Requirement of return—(1) In general. Except as provided in subparagraphs (2) and (3) of this paragraph, every domestic corporation, or foreign corporation engaged in business within the United States or having an office or place of business or a fiscal or paying agent in the United States, making payments during any calendar year before 1963 of $10 or more of dividends and distributions (other than distributions in liquidation) to any shareholder who is an individual (citizen or resident of the United States), a resident fiduciary, or a resident partnership any member of which is a citizen or resident shall file for the calendar year a return setting forth the amount of such payments for such calendar year. A separate return on Form 1099, showing the name and address of the payer and the shareholder, and the amount paid, shall be prepared with respect to each shareholder. These returns shall be accompanied by transmittal Form 1096.

(2) Federal land bank associations and certain other corporations. A corporation described in section 501(c) (12), (15), or (16), or section 521(b)(1), or a Federal land bank association or a production credit association, making a payment of a dividend, or a distribution, to any shareholder in any calendar year before 1963 shall file an information return with respect to such payments when they total $100 or more during the calendar year.

(3) Savings and loan associations, etc. A savings and loan association, a cooperative bank, a homestead association, a credit union, or a building and loan association is required to file an information return with respect to distributions made to a shareholder during any calendar year before 1963 only if the amount thereof paid to the shareholder during the calendar year, or such amount when aggregated with other payments made to the shareholder during such year of interest, rents, royalties, annuities, pensions, and other gains, profits, and income, as described in paragraph (a)(2)(ii) of § 1.6041-1, totals $600 or more. For this purpose, the term “distributions to a shareholder” includes periodical distributions of earnings on running installment shares of stock paid or credited by a building and loan association to its holders of that class of stock, and the sum received upon withdrawal from a building and loan association in excess of the amounts paid in on account of membership fees and stock subscriptions, consisting of accumulated profits.

(b) Nontaxable or partly nontaxable distributions. In the case of a distribution which is made from a depletion or depreciation reserve, or which for any other reason is deemed by the corporation to be nontaxable or partly nontaxable to its shareholders, the corporation shall fill in the information on both sides of Form 1096.

(c) Information as to actual owner—(1) In general. When the person receiving a payment with respect to which an information return is required under authority of the Code is not the actual owner of the income received, the name and address of the actual owner or payee shall be furnished upon demand of the person paying the income, and in default of a compliance with such demand the payee becomes liable for the penalties provided. See section 7203. Dividends on stock are prima facie the income of the record owner of the stock. If a record owner of stock who is not the actual owner thereof receives dividends on such stock in any calendar year before 1963, he shall file a Form 1087 disclosing the name and address of the actual owner or payee, the name of the issuing corporation, the number of shares of such stock, and the amount of dividends received with respect to such stock during the calendar year. (For the reporting by a nominee of dividends received by him on behalf of another person in any calendar year after 1962, see § 1.6042-2.) Unless such a disclosure is made the record owner will be held liable for any tax based upon such dividends. A separate Form 1087 shall be filed by the record owner for each of the stockholdings of each actual owner for whom he acts as nominee. However, where the record owner is a banking institution, trust company, or brokerage firm, it may, provided it maintains such records as will permit a prompt substantiation of each payment of dividends made to the actual owner, file one Form 1087 for each actual owner for whom it acts as nominee and report thereon the total amount of the dividends paid to such actual owner (without itemization as to the issuing company, class of stock, etc.).

(2) Exceptions. The filing of Form 1087 is not required if:

(i) The record owner is required to file a fiduciary return on Form 1041, or a withholding return on Form 1042, disclosing the name and address of the actual owner or payee;

(ii) The actual owner or payee is a nonresident alien individual, foreign partnership, or foreign corporation and the tax has been withheld at the source before receipt of the dividends by the record owner;

(iii) The record owner is a banking institution, a trust company, or a brokerage firm which prepares the individual income tax return of the actual owner, provided the verification on the return with respect to the preparation thereof is executed by such record owner;

(iv) The record owner is a nominee of a banking institution or trust company exercising trust powers, and such banking institution or trust company is required to file a fiduciary return on Form 1041 which reflects the name and address of the actual owner or payee;

(v) The actual owner is an organization exempt from taxation under section 501(a) and is exempt from the requirement of filing a return under section 6033 and paragraph (g) of § 1.6033-1; or

(vi) The record owner is a banking institution or trust company exercising trust powers, or a nominee thereof, and the actual owner is an organization exempt from taxation under section 501(a) for which such banking institution or trust company files an annual return.

See § 1.1441-1, relating to withholding of tax on nonresident alien individuals, and § 1.1442-1, relating to withholding of tax on nonresident foreign corporations.

(d) Time and place for filing. Returns made under this section on Forms 1096 and 1099 and Form 1087 for any calendar year shall be filed on or before February 28 of the following year with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for such forms.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6628, 27 FR 12795, Dec. 28, 1962]

§ 1.6042-2 Returns of information as to dividends paid.

(a) Requirement of reporting—(1) In general. An information return on Form 1099 shall be made under section 6042(a) by—

(i) Every person who makes a payment of dividends (as defined in § 1.6042-3) to any other person during a calendar year. The information return shall show the aggregate amount of the dividends, the name, address, and taxpayer identifying number of the person to whom paid, the amount of tax deducted and withheld under section 3406 from the dividends, if any, and such other information as required by the forms. An information return is generally not required if the amount of dividends paid to the other person during the calendar year aggregates less than $10 or if the payment is made to a person who is an exempt recipient described in § 1.6049-4(c)(1)(ii) unless the payor backup withholds under section 3406 on such payment (because, for example, the payee has failed to furnish a Form W-9), in which case the payor must make a return under this section, unless the payor refunds the amount withheld pursuant to § 31.6413(a)-3 of this chapter. Further, a return of information is not required under this section for—

(A) Payments with respect to which a return is not required by applying the rules of § 1.6049-4(c)(4) (by substituting the term “dividend” for the term “interest”); or

(B) Payments made by a paying agent on behalf of a corporation described in section 1297(a) with respect to a shareholder of the corporation if—

(1) The paying agent obtains from the corporation a written certification signed by a person authorized to sign on behalf of the corporation, that states that the corporation is described in section 1297(a) for each calendar year during which the paying agent relies on the provisions of paragraph (a)(1)(i)(B) of this section, and the paying agent has no reason to know the written certification is unreliable or incorrect;

(2) The paying agent identifies, prior to payment, the corporation as a participating FFI (including a reporting Model 2 FFI) (as defined in § 1.6049-4(f)(10) or (14), respectively), or reporting Model 1 FFI (as defined in § 1.6049-4(f)(13)), in accordance with the requirements of § 1.1471-3(d)(4) (substituting the terms “paying agent” and “corporation” for the terms “withholding agent” and “payee,” respectively) and validates that status annually;

(3) The paying agent obtains a written certification representing that the corporation shall report the payment as part of its reporting obligations under chapter 4 of the Code or an applicable IGA (as defined in § 1.6049-4(f)(7)) with respect to its U.S. accounts and provided the paying agent does not know that the corporation is not reporting the payment as required. The paying agent may rely on the written certification until there is a change in circumstances or the paying agent knows or has reason to know that the statement is unreliable or incorrect. A paying agent that knows that the corporation is not reporting the payment as required under chapter 4 of the Code or an applicable IGA (as defined in § 1.6049-4(f)(7)) must report all payments reportable under this section that it makes during the year in which it obtains such knowledge; and

(4) The paying agent is not also acting in its capacity as a custodian, nominee, or other agent of the payee with respect to the payments.

(ii) Every person, except to the extent that he acts as a nominee described in paragraph (a)(1)(iii) of this section, who receives payments of dividends as a nominee on behalf of another person shall make a return of information under this section for the calendar year of the payment . The information return shall show the aggregate amount of the dividends, the name, address, and taxpayer identification number of the person on whose behalf the dividends are received, the amount of tax deducted and withheld under section 3406 from the dividends, if any, and such other information as required by the forms. An information return is generally not required if the amount of the dividends received on behalf of the other person during the calendar year aggregates less than $10. However, a return of information is not required under this section if—

(A) The record owner is, pursuant to section 6012(a) (3) or (4) and § 1.6012-3, required to file a fiduciary return on Form 1041 that is filed for the estate or trust disclosing the name, address, and identifying number of both the record owner and actual owner and furnishes Form K-1 to each actual owner containing the information required to be shown on the form, including amounts withheld under section 3406;

(B) The record owner is a nominee of a banking institution or trust company exercising trust powers, and such banking institution or trust company is, pursuant to section 6012(a) (3) or (4) and § 1.6012-3, required to file a fiduciary return on Form 1041 that is filed for the estate or trust disclosing the name, address, and identifying number of both the record owner and the actual owner and furnishes Form K-1 to each actual owner containing the information required to be shown on the form, including amounts withheld under section 3406; or

(C) The record owner is a banking institution or trust company exercising trust powers, or a nominee thereof, and the actual owner is an organization exempt from taxation under section 501(a) for which such banking institution or trust company files an annual return but only if the name, address, and identifying number of the record owner are included on or with the annual return filed for the tax exempt organization).

(iii) Every person who is a nominee acting as a custodian of a unit investment trust described in section 851(f)(1) and paragraph (d) of § 1.851-7 who, during a calendar year after 1968, receives payments of dividends in such capacity, shall make an information return on Forms 1096 and 1099, for such calendar year showing the information required by such forms and instructions thereto and the name, address, and identifying number of the nominee identified as such. This subdivision shall not apply if the regulated investment company agrees with the nominee to satisfy the requirements of section 6042 and the regulations thereunder with respect to each holder of an interest in the unit investment trust whose shares are being held by the nominee as custodian and within the time limit for furnishing statements prescribed by § 1.6042-4, files with the Internal Revenue Service office where such company's return is to be filed for the taxable year, a statement that the holders of the unit investment trust with whom the agreement was made have been directly notified by the regulated investment company. Such statement shall include the name, sponsor, and custodian of each unit investment trust whose holders have been directly notified. The nominee's requirements under this subdivision shall be deemed met if the regulated investment company transmits a copy of such statement to the nominee within such period; provided, however, if the regulated investment company fails or is unable to satisfy the requirements of section 6042 with respect to the holders of interest in the unit investment trust, it shall so notify the Internal Revenue Service within 45 days following the close of its taxable year. The custodian shall, upon notice by the Internal Revenue Service that the regulated investment company has failed to comply with the agreement, satisfy the requirements of this subdivision within 30 days of such notice.

(2) Definitions. The term “person” when used in this section does not include the United States, a State, the District of Columbia, a foreign government, a political subdivision of a State or of a foreign government, or an international organization. Therefore, dividends paid by or to one of these entities need not be reported. For purposes of this section, a person who receives a dividend shall be considered to have received it as a nominee if he is not the actual owner of such dividend and if he was required under § 1.6109-1 to furnish his identifying number to the payer of the dividend (or would have been so required if the total of such dividends for the year had been $10 or more), and such number was (or would have been) required to be included on an information return filed by the payer with respect to the dividend. However, a person shall not be considered to be a nominee as to any portion of a dividend which is actually owned by another person whose name is also shown on the information return filed by the payer or nominee with respect to such dividend. Thus, in the case of stock jointly owned by a husband and wife, the husband will not be considered as receiving any portion of a dividend on that stock as a nominee for his wife if his wife's name is included on the information return filed by the payer with respect to the dividend.

(3) Determination of person to whom a dividend is paid or for whom it is received. For purposes of applying the provisions of this section, the person whose identifying number is required to be included by the payer of a dividend on an information return with respect to such dividend shall be considered the person to whom the dividend is paid. In the case of a dividend received by a nominee on behalf of another person, the person whose identifying number is required to be included on an information return made by the nominee with respect to such dividend shall be considered the person on whose behalf such dividend is received by the nominee. Thus, in the case of a dividend made payable to a person other than the record owner of the stock with respect to which the dividend is paid, the record owner of the stock shall be considered the person to whom the dividend is paid for purposes of applying the reporting requirements in this section, since his identifying number is required to be included on the information return filed under this section by the payer of the dividend. Similarly, if a stockbroker receives a dividend on stock held in street name for the joint account of a husband and wife, the dividend is considered as received on behalf of the husband since his identifying number should be shown on the information return filed by the nominee under this section. Thus, if the wife has a separate account with the same stockbroker, any dividends received by the stockbroker for her separate account should not be aggregated with the dividends received for the joint account for purposes of information reporting. For regulations relating to the use of identifying numbers, see § 1.6109-1.

(4) Inclusion of other payments. The Form 1099 filed by any person with respect to payments of dividends to another person during a calendar year may, at the election of the maker, include other payments made by him to such other person during such year which are required to be reported on Form 1099. Similarly, the Form 1099 filed by a nominee with respect to payments of dividends received by him on behalf of any other person during a calendar year may include payments of interest received by him on behalf of such person during such year which are required to be reported on Form 1099.

(b) When payment deemed made. For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.

(c) Time and place for filing. The returns required under this section for any calendar year shall be filed after September 30 of such year, but not before the payer's final payment for the year, and on or before February 28 (March 31 if filed electronically) of the following year with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for Form 1096. For extensions of time for filing returns under this section, see § 1.6081-1.

(d) Cross-reference to penalty. For provisions relating to the penalty provided for failure to file timely a correct information return required under section 6042(a), see § 301.6721-1 of this chapter (Procedure and Administration Regulations). See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

(e) Magnetic media requirement. For rules relating to permission to submit the information required by Form 1087 or 1099 on magnetic tape or other media, see § 1.9101-1. For the requirement to submit the information required by Form 1099 on magnetic media for payments after December 31, 1983, see section 6011(e) and § 301.6011-2 of this chapter (Procedure and Administration Regulations).

(f) Effective/applicability date. This section applies to payments made on or after January 6, 2017. (For payments made after June 30, 2014, and before January 6, 2017, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2016. For payments made after December 31, 2000, and before July 1, 2014, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2013.)

[T.D. 6628, 27 FR 12796, Dec. 29, 1962, as amended by T.D. 6677, 28 FR 10147, Sept. 17, 1963; T.D. 6879, 31 FR 3493, Mar. 8, 1966; T.D. 6883, 31 FR 6589, May 3, 1966; T.D. 7000, 34 FR 996, Jan. 23, 1969; T.D. 7187, 37 FR 13258, July 6, 1972; T.D. 8734, 62 FR 53474, Oct. 14, 1997; T.D. 8804, 64 FR 11378, Mar. 9, 1999; T.D. 8895, 65 FR 50406, Aug. 18, 2000; T.D. 9658, 79 FR 12794, Mar. 6, 2014; T.D. 9808, 82 FR 2106, Jan. 6, 2017]

§ 1.6042-3 Dividends subject to reporting.

(a) In general. Except as provided in paragraph (b) of this section, the term dividend for purposes of this section and §§ 1.6042-2 and 1.6042-4 means the amounts described in the following paragraphs (a) (1) through (3) of this section—

(1) Any distribution made by a corporation to its shareholders which is a dividend as defined in section 316; and

(2) Any payment made by a stockbroker to any person as a substitute for a dividend. Such a payment includes any payment made in lieu of a dividend to a person whose stock has been borrowed. See § 1.6045-2(h) for coordination of the reporting requirements under sections 6042 and 6045(d) with respect to such payments; and

(3) A distribution from a regulated investment company (irrespective of the fact that any part of the distribution may not represent ordinary income (i.e., may, for example, represent a capital gain dividend as defined in section 852(b)(3)(C)).

(b) Exceptions—(1) In general. For purposes of §§ 1.6042-2 and 1.6042-4, the amounts described in paragraphs (b)(1)(i) through (vii) of this section are not dividends.

(i) Amounts paid by an insurance company to a policyholder, other than a dividend upon its capital stock.

(ii) Payments (however denominated) by a mutual savings bank, savings and loan association, or similar organization, in respect of deposits, investment certificates, or withdrawable or repurchasable shares. See, however, section 6049 and the regulations under that section for provisions requiring reporting of these payments.

(iii) Distributions or payments that a payor can, prior to payment, reliably associate with documentation upon which it may rely to treat as made to a foreign beneficial owner in accordance with § 1.1441-1(e)(1)(ii) or as made to a foreign payee in accordance with § 1.6049-5(d)(1) or presumed to be made to a foreign payee under § 1.6049-5(d)(2), (3), (4), or (5). Returns of information are also not required for payments that a payor or middleman can, prior to payment, reliably associate with documentation upon which it may rely to treat as made to a foreign intermediary in accordance with § 1.1441-1(b) if it obtains from the intermediary entity a withholding statement (described in § 1.6049-5(b)(14)) that allocates the payment to a chapter 4 withholding rate pool (as defined in § 1.6049-4(f)(5)) or to specific payees to which withholding under chapter 4 applies. Payments excepted from reporting under this paragraph (b)(1)(iii) may be reportable, for purposes of chapter 3 of the Internal Revenue Code (Code), under § 1.1461-1(b) and (c) or, for chapter 4 purposes, under § 1.1474-1(d)(2). The provisions in § 1.6049-5(c) regarding documentation of foreign status shall apply for purposes of this paragraph (b)(1)(iii). The provisions in § 1.6049-5(c) regarding the definitions of U.S. payor and non-U.S. payor shall also apply for purposes of this paragraph (b)(1)(iii). The provisions of § 1.1441-1 shall apply by substituting the term payor for the term withholding agent and without regard to the fact that the provisions apply only to amounts subject to withholding under chapter 3 of the Code.

(iv) Distributions or payments from sources outside the United States (as determined under the provisions of part I, subchapter N, chapter 1 of the Code and the regulations under those provisions) that are paid by a non-U.S. payor or non-U.S. middleman and that are paid and received outside the United States. For a definition of non-U.S. payor and non-U.S. middleman, see § 1.6049-5(c)(5). For circumstances in which an amount is considered to be paid and received outside the United States, see § 1.6049-4(f)(16).

(v) Distributions or payments for the period that the amounts represent assets blocked as described in § 1.1441-2(e)(3). The exemption in this paragraph (b)(1)(v) shall terminate when payment is deemed to occur in accordance with the rules of § 1.1441-2(e)(3).

(vi) If a foreign intermediary, as described in § 1.1441-1(c)(13), or a U.S. branch that is not treated as a U.S. person receives a payment from a payor, which payment the payor can reliably associate with a valid withholding certificate described in § 1.1441-1(e)(3)(ii) or (iii), or § 1.1441-1(e)(3)(v), respectively, furnished by such intermediary or branch, then the intermediary or branch is not required to report such payment when it, in turn, pays the amount, unless, and to the extent, the intermediary or branch knows that the payment is required to be reported under this section and was not so reported. For example, if a U.S. branch described in § 1.1441-1(b)(2)(iv) fails to provide information regarding U.S. persons that are not exempt from reporting under § 1.6049-4(c)(1)(ii) to the person from whom the U.S. branch receives the payment, the amount paid by the U.S. branch to such person is a dividend. See, however, § 1.6042-2(a)(1)(i)(A) for when reporting under section 6042 is coordinated with reporting under chapter 4 of the Code or an applicable IGA (as defined in § 1.6049-4(f)(7)). The exception of this paragraph (b)(1)(vi) for amounts paid by a foreign intermediary shall not apply to a qualified intermediary that assumes reporting responsibility under chapter 61 of the Code with respect to amounts reportable under the agreement described in § 1.1441-1(e)(5)(iii).

(vii) With respect to amounts paid or credited after December 31, 1982, any amount paid or credited to any person described in § 1.6049-4(c)(1)(ii), unless a tax is withheld under section 3406 and is not refunded by the payor in accordance with § 31.6413(a)-3 of this chapter (Employment Tax Regulations).

(2) Payor. The term payor has the same meaning as described in § 1.6049-4(a)(2).

(3) Joint owners. Amounts paid to joint owners for which a certificate or documentation is required as a condition for being exempt from reporting under this paragraph (b) are presumed made to U.S. payees who are not exempt recipients if, prior to payment, the payor or middleman cannot reliably associate the payment either with a Form W-9 furnished by one of the joint owners in the manner required in §§ 31.3406(d)-1 through 31.3406(d)-5 of this chapter, or with documentation described in paragraph (b)(1)(iii) of this section furnished by each joint owner upon which it can rely to treat each joint owner as a foreign payee or foreign beneficial owner. However in the case of a withholdable payment (as defined in § 1.6049-4(f)(15)) made to joint payees, if any such joint payee does not appear to be an individual, the payment is presumed made to a foreign payee that is a nonparticipating FFI (as defined in § 1.1471-1(b)(82)). See § 1.1471-3(f)(7). For purposes of applying this paragraph (b)(3), the grace period described in § 1.6049-5(d)(2)(ii) shall apply only if each payee qualifies for such grace period.

(4) Conversion into United States dollars of amounts paid in foreign currency. For rules concerning foreign currency conversion, see § 1.6049-4(d)(3)(i).

(c) Special rule. If a person makes a payment which may be a dividend, or if a nominee receives a payment which may be a dividend, but such person or nominee is unable to determine the portion of the payment which is a dividend (as defined in paragraphs (a) and (b) of this section) at the time he files his return under § 1.6042-2, he shall, for purposes of such section, treat the entire amount of such payment as a dividend.

(d) Effective/applicability date. This section applies on or after January 6, 2017. (For payments made after June 30, 2014, and before January 6, 2017, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2016. For payments made after December 31, 2000, and before July 1, 2014, see this section as in effect and contained in 26 CFR part 1, as revised April 1, 2013).

[T.D. 6628, 27 FR 12797, Dec. 28, 1962, as amended by T.D. 6908, 31 FR 16774, Dec. 31, 1966; T.D. 7987, 49 FR 42719, Oct. 24, 1984; T.D. 8029, 50 FR 23680, June 5, 1985; T.D. 8734, 62 FR 53475, Oct. 14, 1997; T.D. 8804, 63 FR 72186, Dec. 31, 1998; 64 FR 73411, Dec. 30, 1999; T.D. 8881, 65 FR 32205, May 22, 2000; T.D. 9658, 79 FR 12794, Mar. 6, 2014; T.D. 9808, 82 FR 2107, Jan. 6, 2017]

§ 1.6042-4 Statements to recipients of dividend payments.

(a) Requirement. A person required to make an information return under section 6042(a)(1) and § 1.6042-2 must furnish a statement to each recipient whose identifying number is required to be shown on the related information return for dividend payments.

(b) Form and content of the statement. The statement required by paragraph (a) of this section must be either the official Form 1099 prescribed by the Internal Revenue Service for the respective calendar year or an acceptable substitute statement that contains provisions that are substantially similar to those of the official Form 1099 for the respective calendar year. For further guidance on how to prepare an acceptable substitute statement, see Rev. Proc. 2012-38, 2012-48 IRB 575, also published as Publication 1179, “General Rules and Specifications for Substitute Forms 1096, 1098, 1099, 5498, and Certain Other Information Returns,” or any successor guidance. An IRS truncated taxpayer identifying number (TTIN) may be used as the identifying number of the recipient. For provisions relating to the use of TTINs, see § 301.6109-4 of this chapter (Procedure and Administration Regulations).

(c) Aggregation of payments. A payor may aggregate on one Form 1099 all payments made to a recipient with respect to each separate account during a calendar year.

(d) Manner of providing statements to recipients—(1) In general. The Form 1099, or acceptable substitute statement, must be provided to the recipient either in person or by first-class mail to the recipient's last known address in a statement mailing.

(2) Statement mailing requirement. The mailing required under section 6042(c) of a Form 1099 to a payee-recipient must qualify as a statement mailing. A statement mailing must contain the required Form 1099 or acceptable substitute statement (written statement) and must comply with enclosure and envelope restrictions.

(i) Enclosure restrictions. To qualify as a statement mailing, the mailing cannot contain any enclosures except those listed in this paragraph (d)(2)(i). Moreover, no promotional or advertising material is permitted in the mailing of the written statement. Even a de minimis amount of promotional or advertising material violates the statement mailing requirement. However, a logo on the envelope containing the written statement and on nontax enclosures described in paragraph (d)(2)(i) (A) through (D) of this section does not violate the written statement requirement. The written statement required under section 6042(c) and paragraph (a) of this section may be perforated to a check or to a statement of the recipient-payee's specific account with the payor described in paragraph (d)(2)(i) (A) or (C) of this section. The enclosure to which the written statement is perforated must contain, in a bold and conspicuous type, the legend: “Important Tax Return Document Attached.” The enclosures permitted in a mailing are limited to—

(A) A check with respect to the account reported on the written statement;

(B) A letter explaining why a check with respect to such account is not enclosed with the written statement (for example, because a dividend has not been declared payable);

(C) A statement of the taxpayer-recipient's specific account with the payor if payments on such account are reflected on the written statement;

(D) A letter limited to an explanation of the tax consequences of the information set forth on the enclosed written statement;

(E) Payee statements related to other Forms 1099, Form 1098, and Form 5498 (or the account balance on a Form 5498), Forms W-2 and W-2G; and

(F) Any document concerning the solicitation of the Form W-9, as described in § 31.3406(h)-3(a) of this chapter, or of the Form W-8 as described in § 1.1441-1(e)(1).

(ii) Envelope and delivery restrictions—(A) Envelope restrictions. The outside of the envelope in which the written statement is mailed and each nontax enclosure enclosed in the envelope must contain, in a bold and conspicuous type, the legend: “Important Tax Return Document Enclosed.” For purposes of this paragraph (d)(2)(ii), a nontax enclosure is any item listed in paragraphs (d)(2)(i)(A) through (C) of this section. However, a payor is not required to include the legend on the outside of an envelope containing only the enclosures in paragraph (d)(2)(i)(D) through (F) of this section.

(B) Delivery restrictions. The requirement to provide the written statement in person or by first-class mail may be satisfied by sending the written statement and any enclosures described in paragraph (d)(2)(i) of this section by intra-office mail, provided that intra-office mail is used by the payor in sending account activity, balance information, and other correspondence to the payee. If a payor does not personally deliver the written statement (i.e., the Form 1099 or its acceptable substitute) to the recipient or mail it to the recipient in a statement mailing as described in this paragraph (d), the payor is considered to have failed to mail the statement required under section 6042(c) and will be subject to the penalty under section 6722.

(e) Time for furnishing statements—(1) In general. Each statement required by section 6042(c) and this section to be furnished to any person for a calendar year must be furnished to such person after November 30 of the year and on or before January 31 (February 10 in the case of a nominee filing under § 1.6042-2(a)(1)(iii)) of the following year, but no statement may be furnished before the final dividend for the calendar year has been paid. However, the statement may be furnished at any time after April 30 if it is furnished with the final dividend for the calendar year. For a statement required to be furnished after December 31, 2008, the February 15 due date under section 6045 applies to the statement if the statement is furnished in a consolidated reporting statement under section 6045. See §§ 1.6045-1(k)(3), 1.6045-2(d)(2), 1.6045-3(e)(2), 1.6045-4(m)(3), and 1.6045-5(a)(3)(ii).

(2) Extensions of time. For good cause upon written application of the person required to furnish statements under this section, the Director, Martinsburg Computing Center, may grant an extension of time not exceeding 30 days in which to furnish such statements. The application must be addressed to the Director, Martinsburg Computing Center, and must contain a full recital of the reasons for requesting the extension to aid the Director in determining the period of the extension, if any, that will be granted. Such a request in the form of a letter to the Director, Martinsburg Computing Center, signed by the applicant will suffice as an application. The application must be filed on or before the date prescribed in paragraph (e)(1) of this section.

(3) Last day for furnishing statement. For provisions relating to the time for performance of an act when the last day prescribed for performance falls on Saturday, Sunday, or a legal holiday, see section 7503 and § 301.7503-1 of this chapter (Regulations on Procedure and Administration).

(f) Cross-reference to penalty. For provisions relating to the penalty provided for failure to furnish timely a correct payee statement required under section 6042(c), see § 301.6722-1 of this chapter (Procedure and Administration Regulations). See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

(g) Effective/applicability date. This section is effective for payee statements due after December 31, 1995, without regard to extensions. The amendments to paragraph (b) are effective for payee statements due after December 31, 2014. For payee statements due before January 1, 2015, § 1.6042-4(b) (as contained in 26 CFR part 1, revised April 2013) shall apply.

[T.D. 8637, 60 FR 66110, Dec. 21, 1995, as amended by T.D. 8734, 62 FR 53476, Oct. 14, 1997; T.D. 9504, 75 FR 64090, Oct. 18, 2010; T.D. 9675, 79 FR 41129, July 15, 2014]

§ 1.6042-5 Coordination with reporting rules for widely held fixed investment trusts under § 1.671-5.

See § 1.671-5 for the reporting rules for widely held fixed investment trusts (as defined under that section).

[T.D. 9241, 71 FR 4025, Jan. 24, 2006]

§ 1.6043-1 Return regarding corporate dissolution or liquidation.

(a) Requirement of returns. Within 30 days after the adoption of any resolution or plan for or in respect of the dissolution of a corporation or the liquidation of the whole or any part of its capital stock, the corporation shall file a return on Form 966, containing the information required by paragraph (b) of this section and by such form. Such return shall be filed with the district director for the district in which the income tax return of the corporation is filed. Further, if after the filing of a Form 966 there is an amendment of or supplement to the resolution or plan, an additional Form 966, based on the resolution or plan as amended or supplemented, must be filed within 30 days after the adoption of such amendment or supplement. A return must be filed under section 6043 and this section in respect of a liquidation whether or not any part of the gain or loss to the shareholders upon the liquidation is recognized under the provisions of section 1002.

(b) Contents of return—(1) In general. There shall be attached to and made a part of the return required by section 6043 and paragraph (a) of this section a certified copy of the resolution or plan, together with any amendments thereof or supplements thereto, and such return shall in addition contain the following information:

(i) The name and address of the corporation;

(ii) The place and date of incorporation;

(iii) The date of the adoption of the resolution or plan and the dates of any amendments thereof or supplements thereto; and

(iv) The internal revenue district in which the last income tax return of the corporation was filed and the taxable year covered thereby.

(2) Returns in respect of amendments or supplements. If a return has been filed pursuant to section 6043 and this section, any additional return made necessary by an amendment of or a supplement to the resolution or plan will be deemed sufficient if it gives the date the prior return was filed and contains a duly certified copy of the amendment or supplement and all other information required by this section and by Form 966 which was not given in the prior return.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6949, 33 FR 5531, Apr. 9, 1968; T.D. 7926, 48 FR 55847, Dec. 16, 1983]

§ 1.6043-2 Return of information respecting distributions in liquidation.

(a) Unless the distribution is one in respect of which information is required to be filed pursuant to § 1.332-6(b), § 1.368-3(a), or § 1.1081-11, every corporation making any distribution of $600 or more during a calendar year to any shareholder in liquidation of the whole or any part of its capital stock shall file a return of information on Forms 1096 and 1099, giving all the information required by such form and by the regulations in this part. A separate Form 1099 must be prepared for each shareholder to whom such distribution was made, showing the name and address of such shareholder, the number and class of shares owned by him in liquidation of which such distribution was made, and the total amount distributed to him on each class of stock. If the amount distributed to such shareholder on any class of stock consisted in whole or in part of property other than money, the return on such form shall in addition show the amount of money distributed, if any, and shall list separately each class of property other than money distributed, giving a description of the property in each such class and a statement of its fair market value at the time of the distribution. Such forms, accompanied by transmittal Form 1096 showing the number of Forms 1099 filed therewith, shall be filed on or before February 28 (March 31 if filed electronically) of the year following the calendar year in which such distribution was made with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for Form 1096.

(b) If the distribution is in complete liquidation of a domestic corporation pursuant to a plan of liquidation in accordance with which all the capital stock of the corporation is cancelled or redeemed, and the transfer of all property under the liquidation occurs within some one calendar month pursuant to section 333, and any shareholder claims the benefit of such section, the return on Form 1096 shall show:

(1) The amount of earnings and profits of the corporation accumulated after February 28, 1913, determined as of the close of such calendar month, without diminution by reason of distributions made during such calendar month, but including in such computation all items of income and expense accrued up to the date on which the transfer of all the property under the liquidation is completed;

(2) The ratable share of such earnings and profits of each share of stock canceled or redeemed in the liquidation;

(3) The date and circumstances of the acquisition by the corporation of any or securities distributed to shareholders in the liquidation;

(4) If the liquidation is pursuant to section 333(g), a schedule showing the amount of earnings and profits to which the corporation has succeeded after December 31, 1963, pursuant to any corporate reorganization or pursuant to a liquidation to which section 332 applies, except earnings and profits which on December 31, 1963, constituted earnings and profits of a corporation referred to in section 333(g)(3), and except earnings and profits which were earned after such date by a corporation referred to in section 333(g)(3); and

(5) If the liquidation occurs after December 31, 1966, and is pursuant to section 333(g)(2), the amount of earnings and profits of the corporation accumulated after February 28, 1913, and before January 1, 1967, and the ratable share of such earnings and profits of each share of stock canceled or redeemed in the liquidation.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6949, 33 FR 5531, Apr. 9, 1968; T.D. 8734, 62 FR 53476, Oct. 14, 1997; T.D. 8804, 63 FR 72188, Dec. 31, 1998; T.D. 8895, 65 FR 50406, Aug. 18, 2000; T.D. 9264, 71 FR 30608, May 30, 2006; T.D. 9329, 72 FR 32807, June 14, 2007]

§ 1.6043-3 Return regarding liquidation, dissolution, termination, or substantial contraction of organizations exempt from taxation under section 501(a).

(a) In general—(1) Requirement to provide information. Except as provided in paragraph (b) of this section, for taxable years beginning after December 31, 1969, every organization which for any of its last 5 taxable years preceding any liquidation, dissolution, termination, or substantial contraction of the organization was exempt from taxation under section 501(a) shall provide the information will respect to such liquidation, dissolution, termination, or substantial contraction required by the instructions accompanying the organization's annual return of information. The information required by this section shall be provided with, and at the time prescribed for filing, the organization's annual return of information for the period during which any liquidation, dissolution (or the adopting of a resolution or plan for the dissolution or liquidation in whole or part), termination or substantial contraction occurred with respect to the organization. An organization which is no longer exempt from taxation under section 501(a) shall use the annual return of information it would have been required to file when the organization was exempt.

(2) Transitional rule. In the case of an annual return of information of an organization which was filed before September 11, 1978, if the organization had failed to provide the information with such return in accordance with paragraph (a)(1) of this section, the organization may comply with this section by providing the information with the organization's first annual return of information filed after such date.

(b) Exceptions. The following organizations are not required to provide the information under paragraph (a) of this section:

(1) Churches, their integrated auxiliaries, or conventions or associations of churches;

(2) Any organization which is not a private foundation (as defined in section 509(a)) and the gross receipts of which in each taxable year are normally not more than $5,000;

(3) Any organization which has terminated its private foundation status under section 507(b)(1)(B) with respect to a liquidation, dissolution, termination, or substantial contraction which is in connection with the termination under section 507(b)(1)(B);

(4) Any organization described in section 401(a) if the employer who established such organization files a return which provides the information under paragraph (a) of this section;

(5) Any organization described in section 501(c)(1) and any corporation described in section 501(c)(2) which holds title to property for such 501(c)(1) organizations;

(6) Any organization described in section 501(c)(14)(A) subject to a group exemption letter issued to a state regulatory body; and

(7) Any subordinate unit of a central organization (other than a private foundation) which established its exempt status under the group ruling procedure of regulations § 601.201 (n)(7), if the central or parent organization files an annual information return for the group in accordance with§ 1.6033-2(d); and

(8) Any organization no longer exempt from taxation under section 501(a) and that during the period of its exemption under such section was not an organization described in section 501(c)(3), a corporation described in section 501(c)(2) that held title to property for an organization described in section 501(c)(3), or an organization described in such other section as prescribed by publication, form, or instructions.

(9) The Commissioner may relieve any organization or class or organizations from filing the return required by section 6043(b) of this section, where it is determined that such information is not necessary for the efficient administration of the internal revenue laws.

(c) Penalties. For provisions relating to the penalty provided for failure to furnish any information required by this section, see section 6652(d) and the regulations thereunder.

(d) Definitions. (1) For the definition of the term “normally” as used in paragraph (b)(2) of this section, see § 1.6033-2(g)(3).

(2) For the definition of the term “integrated auxiliaries” as used in paragraph (b)(1) of this section, see § 1.6033-2(h).

(3) For returns filed for taxable years beginning before January 1, 2008, for purposes of this section the definition of the term “substantial contraction” set forth in § 1.6043-3(d)(1) (as contained in 26 CFR part 1 revised April 1, 2008) may be used.

(e) Effective/applicability date—(1) Generally. The provisions of this section shall apply with respect to returns filed for taxable years beginning after December 31, 1969.

(2) Paragraphs (b)(8) and (d) of this section shall apply for taxable years beginning on or after January 1, 2008. For taxable years beginning before January 1, 2008, §§ 1.6043-3(b)(8) and 1.6043-3(d) (as contained in 26 CFR part 1 revised April 1, 2008) shall apply.

[T.D. 7563, 43 FR 40221, Sept. 11, 1978, as amended by T.D. 9423, 73 FR 52555, Sept. 9, 2008; T.D. 9549, 76 FR 55771, Sept. 8, 2011]

§ 1.6043-4 Information returns relating to certain acquisitions of control and changes in capital structure.

(a) Information returns for an acquisition of control or a substantial change in capital structure—(1) General rule. If there is an acquisition of control (as defined in paragraph (c) of this section) or a substantial change in the capital structure (as defined in paragraph (d) of this section) of a domestic corporation (reporting corporation), the reporting corporation must file a completed Form 8806, “Information Return for Acquisition of Control or Substantial Change in Capital Structure,” in accordance with the instructions to that form. The Form 8806 will request information with respect to the following and such other information specified in the instructions:

(i) Reporting corporation. The name, address, and taxpayer identification number (TIN) of the reporting corporation.

(ii) Common parent, if any, of the reporting corporation. If the reporting corporation was a subsidiary member of an affiliated group filing a consolidated return immediately prior to the acquisition of control or the substantial change in capital structure, the name, address, and TIN of the common parent of that affiliated group.

(iii) Acquiring corporation. The name, address and TIN of any corporation that acquired control of the reporting corporation within the meaning of paragraph (c) of this section or combined with or received assets from the reporting corporation pursuant to a substantial change in capital structure within the meaning of paragraph (d) of this section (acquiring corporation) and whether the acquiring corporation was newly formed prior to its involvement in the transaction.

(iv) Information about acquisition of control or substantial change in capital structure. (A) A description of the transaction or transactions that gave rise to the acquisition of control or the substantial change in capital structure of the corporation;

(B) The date or dates of the transaction or transactions that gave rise to the acquisition of control or the substantial change in capital structure; and

(C) A description of and a statement of the fair market value of any stock and other property, if any, provided to the reporting corporation's shareholders in exchange for their stock.

(2) Consent election. Form 8806 will provide the reporting corporation with the ability to elect to permit the Internal Revenue Service (IRS) to publish information that will inform brokers of the transaction and enable brokers to satisfy their reporting obligations under § 1.6045-3. The information to be published, whether on the IRS Web site or in an IRS publication, would be limited to the name and address of the corporation, the date of the transaction, a description of the shares affected by the transaction, and the amount of cash and the fair market value of stock or other property provided to each class of shareholders in exchange for a share.

(3) Time for making return. Form 8806 must be filed on or before the 45th day following the acquisition of control or substantial change in capital structure of the corporation, or, if earlier, on or before January 5th of the year following the calendar year in which the acquisition of control or substantial change in capital structure occurs.

(4) Exception where transaction is reported under section 6043(a). No reporting is required under this paragraph (a) with respect to a transaction for which information is required to be reported pursuant to section 6043(a), provided the transaction is properly reported in accordance with that section.

(5) Exception where shareholders are exempt recipients. No reporting is required under this paragraph (a) if the reporting corporation reasonably determines that all of its shareholders who receive cash, stock, or other property pursuant to the acquisition of control or substantial change in capital structure are exempt recipients under paragraph (b)(5) of this section.

(b) Information returns regarding shareholders—(1) General rule. A corporation that is required to file Form 8806 pursuant to paragraph (a)(1) of this section shall file a return of information on Forms 1096, “Annual Summary and Transmittal of U.S. Information Returns,” and 1099-CAP, “Changes in Corporate Control and Capital Structure,” with respect to each shareholder of record in the corporation (before or after the acquisition of control or the substantial change in capital structure) who receives cash, stock, or other property pursuant to the acquisition of control or the substantial change in capital structure and who is not an exempt recipient as defined in paragraph (b)(5) of this section. A corporation is not required to file a Form 1096 or 1099-CAP with respect to a clearing organization if the corporation makes the election described in paragraph (a)(2) of this section.

(2) Time for making information returns. Forms 1096 and 1099-CAP must be filed on or before February 28 (March 31 if filed electronically) of the year following the calendar year in which the acquisition of control or the substantial change in capital structure occurs.

(3) Contents of return. A separate Form 1099-CAP must be filed with respect to amounts received by each shareholder (who is not an exempt recipient as defined in paragraph (b)(5) of this section). The Form 1099-CAP will request information with respect to the following and such other information as may be specified in the instructions:

(i) The name, address, telephone number and TIN of the reporting corporation;

(ii) The name, address and TIN of the shareholder;

(iii) The number and class of shares in the reporting corporation exchanged by the shareholder; and

(iv) The aggregate amount of cash and the fair market value of any stock or other property provided to the shareholder in exchange for its stock.

(4) Furnishing of forms to shareholders. The Form 1099-CAP filed with respect to each shareholder must be furnished to such shareholder on or before January 31 of the year following the calendar year in which the shareholder receives cash, stock, or other property as part of the acquisition of control or the substantial change in capital structure. The Form 1099-CAP filed with respect to a clearing organization must be furnished to the clearing organization on or before January 5th of the year following the calendar year in which the acquisition of control or substantial change in capital structure occurred. A Form 1099-CAP is not required to be furnished to a clearing organization if the reporting corporation makes the election described in paragraph (a)(2) of this section. An IRS truncated taxpayer identifying number (TTIN) may be used as the identifying number of the shareholder in lieu of the identifying number appearing on the Form 1099-CAP filed with the Internal Revenue Service. For provisions relating to the use of TTINs, see § 301.6109-4 of this chapter (Procedure and Administration Regulations).

(5) Exempt recipients. A corporation is not required to file a Form 1099-CAP pursuant to this paragraph (b) with respect to any of the following shareholders that is not a clearing organization:

(i) Any shareholder who receives stock in an exchange that is not subject to gain recognition under section 367(a) and the regulations.

(ii) Any shareholder if the corporation reasonably determines that the total amount of cash and the fair market value of stock and other property received by the shareholder does not exceed $1,000.

(iii) Any shareholder described in paragraphs (b)(5)(iii)(A) through (M) of this section if the corporation has actual knowledge that the shareholder is described in one of paragraphs (b)(5)(iii)(A) through (M) of this section or if the corporation has a properly completed exemption certificate from the shareholder (as provided in § 31.3406(h)-3 of this chapter). The corporation also may treat a shareholder as described in paragraphs (b)(5)(iii)(A) through (M) of this section based on the applicable indicators described in § 1.6049-4(c)(1)(ii).

(A) A corporation, as described in § 1.6049-4(c)(1)(ii)(A) (except for corporations for which an election under section 1362(a) is in effect).

(B) A tax-exempt organization, as described in § 1.6049-4(c)(1)(ii)(B)(1).

(D) The United States, as described in § 1.6049-4(c)(1)(ii)(D).

(E) A state, as described in § 1.6049-4(c)(1)(ii)(E).

(F) A foreign government, as described in § 1.6049-4(c)(1)(ii)(F).

(G) An international organization, as described in § 1.6049-4(c)(1)(ii)(G).

(H) A foreign central bank of issue, as described in § 1.6049-4(c)(1)(ii)(H).

(I) A securities or commodities dealer, as described in § 1.6049-4(c)(1)(ii)(I).

(J) A real estate investment trust, as described in § 1.6049-4(c)(1)(ii)(J).

(K) An entity registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1), as described in § 1.6049-4(c)(1)(ii)(K).

(L) A common trust fund, as described in § 1.6049-4(c)(1)(ii)(L).

(M) A financial institution such as a bank, mutual savings bank, savings and loan association, building and loan association, cooperative bank, homestead association, credit union, industrial loan association or bank, or other similar organization.

(iv) Any shareholder that the corporation, prior to the transaction, associates with documentation upon which the corporation may rely in order to treat payments to the shareholder as made to a foreign beneficial owner in accordance with § 1.1441-1(e)(1)(ii) or as made to a foreign payee in accordance with § 1.6049-5(d)(1) or presumed to be made to a foreign payee under § 1.6049-5(d)(2) or (3). For purposes of this paragraph (b)(5)(iv), the provisions in § 1.6049-5(c) (regarding rules applicable to documentation of foreign status and definition of U.S. payor and non-U.S. payor) shall apply. The provisions of § 1.1441-1 shall apply by using the terms “corporation” and “shareholder” in place of the terms “withholding agent” and “payee” and without regard to the fact that the provisions apply only to amounts subject to withholding under chapter 3 of the Internal Revenue Code. The provisions of § 1.6049-5(d) shall apply by using the terms “corporation” and “shareholder” in place of the terms “payor” and “payee”. Nothing in this paragraph (b)(5)(iv) shall be construed to relieve a corporation of its withholding obligations under section 1441.

(v) Any shareholder if, on January 31 of the year following the calendar year in which the shareholder receives cash, stock, or other property, the corporation did not know and did not have reason to know that the shareholder received such cash, stock, or other property in a transaction or series of related transactions that would result in an acquisition of control or a substantial change in capital structure within the meaning of this section.

(6) Coordination with other sections. In general, no reporting is required under this paragraph (b) with respect to amounts that are required to be reported under sections 6042 or 6045, unless the corporation knows or has reason to know that such amounts are not properly reported in accordance with those sections. A corporation must satisfy the requirements under this paragraph (b) with respect to any shareholder of record that is a clearing organization.

(c) Acquisition of control of a corporation—(1) In general. For purposes of this section, an acquisition of control of a corporation (first corporation) occurs if, in a transaction or series of related transactions—

(i) Before an acquisition of stock of the first corporation (directly or indirectly) by a second corporation, the second corporation does not have control of the first corporation;

(ii) After the acquisition, the second corporation has control of the first corporation;

(iii) The fair market value of the stock acquired in the transaction and in any related transactions as of the date or dates on which such stock was acquired is $100 million or more;

(iv) The shareholders of the first corporation receive stock or other property pursuant to the acquisition; and

(v) The first corporation or any shareholder of the first corporation is required to recognize gain (if any) under section 367(a) and the regulations, as a result of the transaction.

(2) Control. For purposes of this section, control is determined in accordance with the first sentence of section 304(c)(1). For these purposes the rules of section 318 as modified by the rules of section 958(b) shall apply in determining the ownership of stock.

(d) Substantial change in capital structure of a corporation—(1) In general. A corporation has a substantial change in capital structure if it has a change in capital structure (as defined in paragraph (d)(2) of this section) and the amount of any cash and the fair market value of any property (including stock) provided to the shareholders of such corporation pursuant to the change in capital structure, as of the date or dates on which the cash or other property is provided, is $100 million or more.

(2) Change in capital structure. For purposes of this section, a corporation has a change in capital structure if—

(i) The corporation in a transaction or series of transactions—

(A) Merges, consolidates or otherwise combines with another corporation or transfers all or substantially all of its assets to one or more corporations;

(B) Transfers all or part of its assets to another corporation in a title 11 or similar case and, in pursuance of the plan, distributes stock or securities of that corporation; or

(ii) The corporation or any shareholder is required to recognize gain (if any) under section 367(a) and the regulations, as a result of the transaction.

(e) Reporting by successor entity. If a corporation (transferor) transfers all or substantially all of its assets to another entity (transferee) in a transaction that constitutes a substantial change in the capital structure of transferor, transferor must satisfy the reporting obligations in paragraph (a) and (b) of this section. If transferor does not satisfy one or both of those reporting obligations, then transferee must do so. If neither transferor nor transferee satisfies the reporting obligations in paragraphs (a) and (b) of this section, then transferor and transferee shall be jointly and severally liable for any applicable penalties (see paragraph (g) of this section).

(f) Receipt of property. For purposes of this section, a shareholder is treated as receiving property (or as having property provided to it) pursuant to an acquisition of control or a substantial change in capital structure if a liability of the shareholder is assumed in the transaction and, as a result of the transaction, an amount is realized by the shareholder from the sale or exchange of stock.

(g) Penalties for failure to file. For penalties for failure to file as required under this section, see section 6652(l). The information returns required to be filed under paragraphs (a) and (b) of this section shall be treated as one return for purposes of section 6652(l) and, accordingly, the penalty shall not exceed $500 for each day the failure continues (up to a maximum of $100,000) with respect to any acquisition of control or any substantial change in capital structure. Failure to file as required under this section also includes the failure to satisfy the requirement to file on magnetic media as required by section 6011(e) and § 1.6011-2. In addition, criminal penalties under sections 7203, 7206 and 7207 may apply in appropriate cases.

(h) Examples. The following examples illustrate the application of the rules of this section. For purposes of these examples, assume the transaction is not reported under sections 6042, 6043(a), or 6045, unless otherwise specified, and assume that the fair market value of the consideration provided to the shareholders exceeds $100 million. The examples are as follows:

Example 1.The shareholders of X, a domestic corporation and parent of an affiliated group, exchange their X stock for stock in Y, a foreign corporation, pursuant to sections 351 and 354. After the transaction, Y owns all the outstanding X stock. Assume that, under section 367(a) and the regulations, the X shareholders must recognize gain (if any) on the exchange of their stock. Because the transaction results in an acquisition of control of X, X must comply with the rules in paragraphs (a) and (b) of this section. X must file Form 8806 reporting the transaction. X must also file a Form 1099-CAP with respect to each shareholder who is not an exempt recipient showing the fair market value of the Y stock received by that shareholder, and X must furnish a copy of the Form 1099-CAP to that shareholder. If X elects on the Form 8806 to permit the IRS to publish information regarding the transaction, X is not required to file or furnish Forms 1099-CAP with respect to shareholders that are clearing organizations.

Example 2.The facts are the same as in Example 1, except X hires a transfer agent to effectuate the exchange. The transfer agent is treated as a broker under section 6045 and is required to report the fair market value of the Y stock received by X's shareholders under § 1.6045-3. Under paragraph (b)(6) of this section, X is not required to file information returns under paragraph (b) of this section with respect to a shareholder of record, unless X knows or has reason to know that the transfer agent does not satisfy its information reporting obligation under § 1.6045-3 with respect to that shareholder. Thus, if the transfer agent satisfies its information reporting requirements under § 1.6045-3 with respect to shareholder I, an individual who receives X stock, X is not required to file a Form 1099-CAP with respect to I. Conversely, if the transfer agent does not have an information reporting obligation under § 1.6045-3 with respect to one of X's shareholders of record (for example, a clearing organization that is an exempt recipient under § 1.6045-3(b)(2)), or if X knows or has reason to know that the transfer agent has not satisfied its information reporting requirement with respect to a shareholder, then X must provide a Form 1099-CAP to that shareholder.

(i) Effective/applicability date. This section applies to transactions occurring after December 5, 2005. The amendments to paragraph (b)(4) are effective for any Form 1099-CAP required to be furnished after December 31, 2014. For any Form 1099-CAP required to be furnished before January 1, 2015, § 1.6043-4(b) (as contained in 26 CFR part 1, revised April 2013) shall apply.

[T.D. 9230, 70 FR 72378, Dec. 5, 2005, as amended by T.D. 9675, 79 FR 41129, July 15, 2014]

§ 1.6044-1 Returns of information as to patronage dividends with respect to patronage occurring in taxable years beginning before 1963.

(a) Requirement—(1) In general. Except as provided in subparagraph (2) of this paragraph, any corporation allocating to any patron in respect of patronage occurring in any taxable year of the corporation beginning before January 1, 1963, amounts aggregating $100 or more during a calendar year as patronage dividends, rebates, or refunds (whether in cash, merchandise, capital stock, revolving fund certificates, retain certificates, letters of advice, or in some other manner that discloses to each patron the amount of such dividend, rebate, or refund) shall for each such calendar year file a return of information with respect to such allocation on Forms 1096 and 1099. A separate Form 1099 shall be prepared for each patron showing the name and address of the patron to whom such allocation is made, and the amount of the allocation. The allocation shall be reported for the calendar year during which the allocation is made, regardless of whether the allocation is deemed for the purpose of section 522 to be made at the close of a preceding taxable year of the corporation.

(2) Exception. A return is not required under this section in the case of any corporation (including any cooperative or nonprofit corporation engaged in rural electrification) described in section 501(c) (12) or (15) which is exempt from tax under section 501(a), or in the case of any corporation subject to a tax imposed by subchapter L, chapter 1, of the Code.

(b) Time and place for filing. Returns made under this section on Forms 1096 and 1099 for any calendar year shall be filed on or before February 28 of the following year with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for such forms.

(c) Definitions. The terms “cooperative association”, “patron”, “patronage dividends, rebates, and refunds”, and “allocation” are defined, for the purpose of this section, in paragraph (b) of § 1.522-1.

[T.D. 6500, 25 FR 12108, Nov. 26, 1960, as amended by T.D. 6628, 27 FR 12798, Dec. 28, 1962]

§ 1.6044-2 Returns of information as to payments of patronage dividends.

(a) Requirement of reporting—(1) In general. Except as provided in § 1.6044-4, every organization described in paragraph (b) of this section which makes payments with respect to patronage occurring on or after the first day of the first taxable year of the organization beginning after December 31, 1962, of amounts described in § 1.6044-3 aggregating $10 or more to any person during any calendar year shall make an information return on Forms 1096 and 1099 for the calendar year showing the aggregate amount of such payments, the name and address of the person to whom paid, the total of such payments for all persons, and such other information as is required by the forms. The organization is required to make an information return regardless of the amount of the payment if the tax imposed by section 3406 is required to be withheld. Thus, in the case of any amount subject to backup withholding under section 3406 and not refunded by the payor before the due date of the information return in accordance with the regulations under section 3406, an information return shall be made even if the payment is not generally reportable because it is made to an exempt recipient described in § 1.6049-4(c)(1)(ii) or the amount paid during the calendar year to the recipient aggregates less than $10.

(3) Determination of person to whom a patronage dividend is paid. For purposes of applying the provisions of this section, the person whose identifying number is required to be included by the cooperative on an information return with respect to a patronage dividend shall be considered the person to whom such dividend is paid. For regulations relating to the use of identifying numbers, see § 1.6109-1.

(4) Inclusion of other payments. The Form 1099 filed by an organization with respect to payments of patronage dividends made to any person during a calendar year may, at the election of the organization, include other payments made by it to such person during such year which are required to be reported on Form 1099.

(b) Organizations subject to reporting requirement. The organizations subject to the reporting requirements of paragraph (a) of this section are:

(1) Any organization exempt from tax under section 521 (relating to exemption of farmers' cooperatives from tax), and

(2) Any corporation operating on a cooperative basis other than an organization:

(i) Which is exempt from tax under chapter 1 (other than section 521), or

(ii) Which is subject to the provisions of part II of subchapter H of chapter 1 (relating to mutual savings banks, etc.), or subchapter L of chapter 1 (relating to insurance companies), or

(iii) Which is engaged in furnishing electric energy, or providing telephone service, to persons in rural areas.

(c) When payment deemed made. For purposes of this section, money or other property (except written notices of allocation) is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. A written notice of allocation is considered to have been paid when it is issued by the organization to the distributee. Similarly, a qualified check (as defined in section 1388(d)(4)) is considered to have been paid when it is issued to the distributee.

(d) Time and place for filing. The return required under this section on Forms 1096 and 1099 for any calendar year shall be filed after September 30 of such year, but not before the payer's final payment for the year, and on or before February 28 (March 31 if filed electronically) of the following year, with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for such forms. For extensions of time for filing returns under this section, see § 1.6081-1.

(e) Cross-reference to penalty. For provisions relating to the penalty provided for failure to file timely a correct information return required under section 6044(a), see § 301.6721-1 of this chapter (Procedure and Administration Regulations). See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

(f) Magnetic media requirement. For the requirement to submit the information required by Form 1099 on magnetic media for payments after December 31, 1983, see section 6011(e) and § 301.6011-2 of this chapter (Procedure and Administration Regulations). For rules relating to permission to submit the information required by Form 1099 on magnetic tape or other media, see § 1.9101-1.

[T.D. 6628, 27 FR 12798, Dec. 28, 1962, as amended by T.D. 6677, 28 FR 10147, Sept. 17, 1963; T.D. 6879, 31 FR 3493, Mar. 8, 1966; T.D. 6883, 31 FR 6589, May 3, 1966; T.D. 8734, 62 FR 53476, Oct. 14, 1997; T.D. 8895, 65 FR 50407, Aug. 18, 2000]

§ 1.6044-3 Amounts subject to reporting.

(a) In general. Except as provided in paragraph (c) of this section, the amounts subject to reporting under § 1.6044-2 are:

(1) Payments by all organizations subject to such reporting requirements of:

(i) Patronage dividends (as defined in section 1388(a)) paid in money, qualified written notices of allocation (as defined in section 1388(c)), or other property (except nonqualified written notices of allocation as defined in section 1388(d)); and

(ii) Amounts described in section 1382(b)(2) (relating to redemption of nonqualified written notices of allocation previously paid as patronage dividends) paid in money or property (except written notices of allocation); and

(2) Payments by farmers' cooperatives exempt from tax under section 521 of:

(i) Amounts described in section 1382(c)(2)(A) (relating to distributions with respect to earnings derived from sources other than patronage) paid in money, qualified written notices of allocation, or other property (except nonqualified written notices of allocation); and

(ii) Amounts described in section 1382(c)(2)(B) (relating to redemption of nonqualified written notices of allocation previously paid as distributions with respect to earnings derived from sources other than patronage) paid in money or other property (except written notices of allocation).

(b) Special rules. (1) If an organization makes a distribution consisting in whole or in part of a written notice of allocation and a qualified check and, at the time it files its return under § 1.6044-2, is unable to determine whether such written notice of allocation and such check constitute nonqualified written notices of allocation, such organization shall for purposes of such return treat such written notice of allocation as a qualified written notice of allocation and such qualified check as a payment in money.

(2) An amount described in paragraph (a) of this section is subject to reporting even though the organization paying such amount is allowed no deduction for it because it was not paid within the time prescribed in section 1382. Thus, a patronage dividend of $25 paid by a marketing cooperative must be reported even though it is paid after the end of the payment period (see section 1382(d)) for the organization's taxable year in which the patronage occurred.

(1) Any amount described in § 1.6042-3(b); or

(2) With respect to amounts paid or credited after December 31, 1982, any amount paid or credited to any person described in § 1.6049-4(c)(1)(ii).

(d) Determination of amount paid. For purposes of § 1.6044-2 and this section, in determining the amount of any payment subject to reporting under paragraph (a) of this section:

(1) Property (other than a qualified written notice of allocation) shall be taken into account at its fair market value, and

(2) A qualified written notice of allocation shall be taken into account at its stated dollar amount.

[T.D. 6628, 27 FR 12798, Dec. 28, 1962, as amended by T.D. 8734, 62 FR 53476, Oct. 14, 1997]

§ 1.6044-4 Exemption for certain consumer cooperatives.

(a) In general—(1) Determination of exemption. Exemption from the reporting requirements of § 1.6044-2 shall, upon application therefor, be granted by the district director to any cooperative which he determines is primarily engaged in selling at retail goods or services of a type which is generally for personal, living, or family use. A cooperative is not exempt from the reporting requirements merely because it is an organization of a type to which section 6044(c) and this section relate. In order for the exemption from reporting to apply, it is necessary that the cooperative file an application in accordance with this section and obtain a determination of exemption.

(2) Basis for exemption. For a cooperative to qualify for the exemption from reporting provided by section 6044(c) and this section 85 percent of its gross receipts for the preceding taxable year, or 85 percent of its aggregate gross receipts for the preceding three taxable years, must have been derived from the sale at retail of goods or services of a type which is generally for personal, living, or family use. In determining whether an item is of a type that is generally for personal, living, or family use, an item which may be purchased either for such use or for business use and which when acquired for business purposes is generally purchased at wholesale will, when sold by a cooperative at retail, be treated as goods or services of a type generally for personal, living, or family use.

(3) Period of exemption. A determination of exemption from reporting shall apply beginning with the payments made during the calendar year in which the determination is made and shall automatically cease to be effective beginning with payments made after the close of the first taxable year of the cooperative in which less than 70 percent of its gross receipts is derived from the sale at retail of goods or services of a type which is generally for personal, living, or family use.

(b) Application for exemption. Application for exemption from the reporting requirements of section 6044 shall be made on Form 3491, and shall be filed with the district director for the internal revenue district in which the cooperative has its principal place of business.

[T.D. 6628, 27 FR 12799, Dec. 28, 1962]

§ 1.6044-5 Statements to recipients of patronage dividends.

(a) Requirement. A person required to make an information return under section 6044(a)(1) and § 1.6044-2 must furnish a statement to each recipient whose identifying number is required to be shown on the related information return for patronage dividends paid.

(b) Form, manner, and time for providing statements to recipients. The statement required by paragraph (a) of this section must be either the official Form 1099 prescribed by the Internal Revenue Service for the respective calendar year or an acceptable substitute statement. The rules under § 1.6042-4 (relating to statements with respect to dividends) apply comparably in determining the form of an acceptable substitute statement permitted by this section. Those rules also apply for purposes of determining the manner of and time for providing the Form 1099 or its acceptable substitute to a recipient under this section. However, each Form 1099 or acceptable substitute statement required by this section must be furnished on or before January 31 of the following year, but no statement may be furnished before the final payment has been made for the calendar year. For a statement required to be furnished after December 31, 2008, the February 15 due date under section 6045 applies to the statement if the statement is furnished in a consolidated reporting statement under section 6045. See §§ 1.6045-1(k)(3), 1.6045-2(d)(2), 1.6045-3(e)(2), 1.6045-4(m)(3), and 1.6045-5(a)(3)(ii). An IRS truncated taxpayer identifying number (TTIN) may be used as the identifying number of the recipient in lieu of the identifying number appearing on the corresponding information return filed with the Internal Revenue Service. For provisions relating to the use of TTINs, see § 301.6109-4 of this chapter (Procedure and Administration Regulations).

(c) Cross-reference to penalty. For provisions relating to the penalty provided for failure to furnish timely a correct payee statement required under section 6044(e), see § 301.6722-1 of this chapter (Procedure and Administration Regulations). See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

(d) Effective/applicability date. This section is effective for payee statements due after December 31, 1995, without regard to extensions. The amendments to paragraph (b) are effective for payee statements due after December 31, 2014. For payee statements due before January 1, 2015, § 1.6044-5(b) (as contained in 26 CFR part 1, revised April 2013) shall apply.

[T.D. 8637, 60 FR 66111, Dec. 21, 1995, as amended by T.D. 8734, 62 FR 53476, Oct. 14, 1997; T.D. 9504, 75 FR 64090, Oct. 18, 2010; T.D. 9675, 79 FR 41129, July 15, 2014]

§ 1.6045-0 Table of contents.

In order to facilitate the use of § 1.6045-1, this section lists the paragraphs contained in § 1.6045-1.

§ 1.6045-1 Returns of information of brokers and barter exchanges.

(a) Definitions.

(1) Broker.

(2) Customer.

(i) In general.

(ii) Special rules for payment transactions involving digital assets.

(3) Security.

(4) Barter exchange.

(5) Commodity.

(6) Regulated futures contract.

(7) Forward contract.

(8) Closing transaction.

(9) Sale.

(i) In general.

(ii) Sales with respect to digital assets.

(A) In general.

(B) Dispositions of digital assets for certain property.

(D) Special rule for sales effected by processors of digital asset payments.

(10) Effect.

(i) In general.

(ii) Actions relating to certain options and forward contracts.

(11) Foreign currency.

(12) Cash.

(13) Person.

(14) Specified security.

(15) Covered security.

(i) In general.

(ii) Acquired in an account.

(iii) Corporate actions and other events.

(iv) Exceptions.

(16) Noncovered security.

(17) Debt instrument, bond, debt obligation, and obligation.

(18) Securities futures contract.

(19) Digital asset.

(i) In general.

(ii) No inference.

(20) Digital asset address.

(21) Digital asset middleman.

(i) In general.

(ii) [Reserved]

(iii) Facilitative service.

(A) [Reserved]

(B) Special rule involving sales of digital assets under paragraphs (a)(9)(ii)(B) through (D) of this section.

(22) Processor of digital asset payments.

(23) Stored-value card.

(24) Transaction identification.

(25) Wallet, hosted wallet, unhosted wallet, and held in a wallet or account.

(i) Wallet.

(ii) Hosted wallet.

(iii) Unhosted wallet.

(iv) Held in a wallet or account.

(b) Examples.

(1) Requirement of reporting.

(2) Sales required to be reported.

(3) Exceptions.

(i) Sales effected for exempt recipients.

(A) In general.

(B) Exempt recipient defined.

(1) In general.

(2) Limitation for corporate customers.

(3) Limitation for U.S. digital asset brokers.

(ii) Excepted sales.

(iii) Multiple brokers.

(A) In general.

(B) Special rule for sales of digital assets.

(iv) Cash on delivery transactions.

(v) Fiduciaries and partnerships.

(vi) Money market funds.

(A) In general.

(B) Effective/applicability date.

(vii) Obligor payments on certain obligations.

(viii) Foreign currency.

(ix) Fractional share.

(x) Certain retirements.

(xi) Short sales.

(A) In general.

(B) Short sale closed by delivery of a noncovered security.

(xii) Cross reference.

(xiii) Short-term obligations issued on or after January 1, 2014.

(xiv) Certain redemptions.

(4) Examples.

(5) Form of reporting for regulated futures contracts.

(i) In general.

(ii) Determination of profit or loss from foreign currency contracts.

(iii) Examples.

(6) Reporting periods and filing groups.

(i) Reporting period.

(A) In general.

(B) Election.

(ii) Filing group.

(A) In general.

(B) Election.

(iii) Example.

(7) Exception for certain sales of agricultural commodities and commodity certificates.

(i) Agricultural commodities.

(ii) Commodity Credit Corporation certificates.

(iii) Sales involving designated warehouses.

(iv) Definitions.

(A) Agricultural commodity.

(B) Spot sale.

(D) Designated warehouse.

(8) Special coordination rules for reporting digital assets that are dual classification assets.

(i) General rule for reporting dual classification assets as digital assets.

(ii) Reporting of dual classification assets that constitute contracts covered by section 1256(b) of the Code.

(iii) Reporting of dual classification assets cleared or settled on a limited-access regulated network.

(A) General rule.

(B) Limited-access regulated network.

(iv) Reporting of dual classification assets that are interests in money market funds.

(v) Example: Digital asset securities.

(d) Information required.

(1) In general.

(2) Transactional reporting.

(i) Required information.

(A) General rule for sales described in paragraph (a)(9)(i) of this section.

(B) Required information for digital asset transactions.

(D) Acquisition information for sales of certain digital assets.

(ii) Specific identification of specified securities.

(A) In general.

(B) Identification of digital assets sold, disposed of, or transferred.

(1) No identification of units by customer.

(2) Adequate Identification of units by customer.

(3) Special rule for the identification of certain units withheld from a transaction.

(4) Customer-provided acquisition information for digital assets.

(iii) Penalty relief for reporting information not subject to reporting.

(A) Noncovered securities.

(B) Gross proceeds from digital assets sold before applicability date.

(iv) Information from other parties and other accounts.

(A) Transfer and issuer statements.

(v) Failure to receive a complete transfer statement for securities.

(vi) Reporting by other parties after a sale of securities.

(A) Transfer statements.

(B) Issuer statements.

(vii) Examples.

(3) Sales between interest payment dates.

(4) Sale date.

(i) In general.

(ii) Special rules for digital asset sales.

(5) Gross proceeds.

(i) In general.

(ii) Sales of digital assets.

(A) Determining gross proceeds.

(1) Determining fair market value.

(2) Consideration value not readily ascertainable.

(3) Reasonable valuation method for digital assets.

(B) Digital asset data aggregator.

(iii) Digital asset transactions effected by processors of digital asset payments.

(iv) Definition and allocation of digital asset transaction costs.

(A) Definition.

(B) General allocation rule.

(v) Examples.

(6) Adjusted basis.

(i) In general.

(ii) Initial basis.

(A) Cost basis for specified securities acquired for cash.

(B) Basis of transferred securities.

(1) In general.

(2) Securities acquired by gift.

(1) In general.

(2) Allocation of digital asset transaction costs.

(iii) Adjustments for wash sales.

(A) Securities in the same account or wallet.

(1) In general.

(2) Special rules for covered securities that are also digital assets.

(B) Covered securities in different accounts or wallets.

(D) Reporting at or near the time of sale.

(iv) Certain adjustments not taken into account.

(v) Average basis method adjustments.

(vi) Regulated investment company and real estate investment trust adjustments.

(vii) Treatment of de minimis errors.

(viii) Examples.

(ix) Applicability date.

(x) Examples.

(7) Long-term or short-term gain or loss.

(i) In general.

(ii) Adjustments for wash sales.

(A) Securities in the same account or wallet.

(1) In general.

(2) Special rules for covered securities that are also digital assets.

(B) Covered securities in different accounts or wallets.

(D) Reporting at or near the time of sale.

(iii) Constructive sale and mark-to-market adjustments.

(iv) Regulated investment company and real estate investment trust adjustments.

(v) No adjustments for hedging transactions or offsetting positions.

(8) Conversion into United States dollars of amounts paid or received in foreign currency.

(i) Conversion rules.

(ii) Effect of identification under § 1.988-5(a), (b), or (c) when the taxpayer effects a sale and a hedge through the same broker.

(iii) Example.

(9) Coordination with the reporting rules for widely held fixed investment trusts under § 1.671-5.

(10) Optional reporting methods for qualifying stablecoins and specified nonfungible tokens.

(i) Optional reporting method for qualifying stablecoins.

(A) In general.

(B) Aggregate reporting method for designated sales of qualifying stablecoins.

(D) Examples.

(ii) Qualifying stablecoin.

(A) Designed to track certain other currencies.

(B) Stabilization mechanism.

(D) Examples.

(iii) Optional reporting method for specified nonfungible tokens.

(A) In general.

(B) Reporting method for specified nonfungible tokens.

(iv) Specified nonfungible token.

(A) Indivisible.

(B) Unique.

(D) Examples.

(v) Joint accounts.

(11) Collection and retention of additional information with respect to the sale of a digital asset.

(e) Reporting of barter exchanges.

(1) Requirement of reporting.

(2) Exchanges required to be reported.

(i) In general.

(ii) Exemption.

(iii) Coordination rules for exchanges of digital assets made through barter exchanges.

(f) Information required.

(1) In general.

(2) Transactional reporting.

(i) In general.

(ii) Exception for corporate member or client.

(iii) Definition.

(3) Exchange date.

(4) Amount received.

(5) Meaning of terms.

(6) Reporting period.

(g) Exempt foreign persons.

(1) Brokers.

(2) Barter exchanges.

(3) Applicable rules.

(i) Joint owners.

(ii) Special rules for determining who the customer is.

(iii) Place of effecting sale.

(A) Sale outside the United States.

(B) Sale inside the United States.

(iv) Special rules where the customer is a foreign intermediary or certain U.S. branches.

(4) Rules for sales of digital assets.

(i) Definitions.

(A) U.S. digital asset broker.

(B) [Reserved]

(ii) Rules for U.S. digital asset brokers.

(A) Place of effecting sale.

(B) Determination of foreign status.

(iii) Rules for CFC digital asset brokers not conducting activities as money services businesses.

(iv) Rules for non-U.S. digital asset brokers not conducting activities as money services businesses.

(A) [Reserved]

(B) Sale treated as effected at an office inside the United States.

(1) [Reserved]

(2) U.S. indicia.

(v) [Reserved]

(vi) Rules applicable to brokers that obtain or are required to obtain documentation for a customer and presumption rules.

(A) In general.

(1) Documentation of foreign status.

(2) Presumption rules.

(i) In general.

(ii) Presumption rule specific to U.S. digital asset brokers.

(iii) [Reserved]

(3) Grace period to collect valid documentation in the case of indicia of a foreign customer.

(4) Blocked income.

(B) Reliance on beneficial ownership withholding certificates to determine foreign status.

(1) Collection of information other than U.S. place of birth.

(i) In general.

(ii) [Reserved]

(2) Collection of information showing U.S. place of birth.

(D) Joint owners.

(E) Special rules for customer that is a foreign intermediary, a flow-through entity, or certain U.S. branches.

(1) Foreign intermediaries in general.

(i) Presumption rule specific to U.S. digital asset brokers.

(ii) [Reserved]

(2) Foreign flow-through entities.

(3) U.S. branches that are not beneficial owners.

(F) Transition rule for obtaining documentation to treat a customer as an exempt foreign person.

(vii) Barter exchanges.

(5) Examples.

(h) Identity of customer.

(1) In general.

(2) Examples.

(i) [Reserved]

(j) Time and place for filing; cross-references to penalty and magnetic media filing requirements.

(k) Requirement and time for furnishing statement; cross-reference to penalty.

(1) General requirements.

(2) Time for furnishing statements.

(3) Consolidated reporting.

(4) Cross-reference to penalty.

(l) Use of magnetic media or electronic form.

(m) Additional rules for option transactions.

(1) In general.

(2) Scope.

(i) In general.

(ii) Delayed effective date for certain options.

(iii) Compensatory option.

(3) Option subject to section 1256.

(4) Option not subject to section 1256.

(i) Physical settlement.

(ii) Cash settlement.

(iii) Rules for warrants and stock rights acquired in a section 305 distribution.

(iv) Examples.

(5) Multiple options documented in a single contract.

(6) Determination of index status.

(n) Reporting for debt instrument transactions.

(1) In general.

(2) Debt instruments subject to January 1, 2014, reporting.

(i) In general.

(ii) Exceptions.

(iii) Remote or incidental.

(iv) Penalty rate.

(3) Debt instruments subject to January 1, 2016, reporting.

(4) Holder elections.

(i) Election to amortize bond premium.

(ii) Election to currently include accrued market discount.

(iii) Election to accrue market discount based on a constant yield.

(iv) Election to treat all interest as OID.

(v) Election to translate interest income and expense at the spot rate.

(5) Broker assumptions and customer notice to brokers.

(i) Broker assumptions if the customer does not notify the broker.

(ii) Effect of customer notification of an election or revocation.

(A) Election to amortize bond premium.

(B) Other debt elections.

(iii) Electronic notification.

(6) Reporting of accrued market discount.

(i) Sale.

(ii) Current inclusion election.

(7) Adjusted basis.

(i) Original issue discount.

(ii) Amortizable bond premium.

(A) Taxable bond.

(B) Tax-exempt bonds.

(iii) Acquisition premium.

(iv) Market discount.

(v) Principal and certain other payments.

(8) Accrual period.

(9) Premium on convertible bond.

(10) Effect of broker assumptions on customer.

(11) Additional rules for certain holder elections.

(i) In general.

(A) Election to treat all interest as OID.

(B) Election to accrue market discount based on a constant yield.

(ii) [Reserved]

(12) Certain debt instruments treated as noncovered securities.

(i) In general.

(ii) Effective/applicability date.

(o) [Reserved]

(p) Electronic filing.

(q) Applicability dates.

(r) Cross-references.

[T.D. 10000, 89 FR 56548, July 9, 2024, as amended by T.D. 10021, 89 FR 106958, Dec. 30, 2024; T.D. 10021, 90 FR 30825, July 11, 2025]

Editorial Note:At 90 FR 30825, July 11, 2025, as required by the Congressional Review Act and Public Law 119-5, the Internal Revenue Service removed all amendments to §§ 1.6045-0 and 1.6045-1 published at 89 FR 106928, Dec. 30, 2024.

§ 1.6045-1 Returns of information of brokers and barter exchanges.

(a) Definitions. The following definitions apply for purposes of this section and §§ 1.6045-2 and 1.6045-4.

(1) Broker. The term broker means any person (other than a person who is required to report a transaction under section 6043 of the Code), U.S. or foreign, that, in the ordinary course of a trade or business during the calendar year, stands ready to effect sales to be made by others. A broker includes an obligor that regularly issues and retires its own debt obligations, a corporation that regularly redeems its own stock, or a person that regularly offers to redeem digital assets that were created or issued by that person. A broker also includes a real estate reporting person under § 1.6045-4(e) who (without regard to any exceptions provided by § 1.6045-4(c) and (d)) would be required to make an information return with respect to a real estate transaction under § 1.6045-4(a). However, with respect to a sale (including a redemption or retirement) effected at an office outside the United States under paragraph (g)(3)(iii) of this section (relating to sales other than sales of digital assets), a broker includes only a person described as a U.S. payor or U.S. middleman in § 1.6049-5(c)(5). In the case of a sale of a digital asset, a broker includes only a U.S. digital asset broker as defined in paragraph (g)(4)(i)(A)(1) of this section. In addition, a broker does not include an international organization described in § 1.6049-4(c)(1)(ii)(G) that redeems or retires an obligation of which it is the issuer.

(2) Customer—(i) In general. The term customer means, with respect to a sale effected by a broker, the person (other than such broker) that makes the sale, if the broker acts as—

(A) An agent for such person in the sale;

(B) A principal in the sale;

(C) The participant in the sale responsible for paying to such person or crediting to such person's account the gross proceeds on the sale; or

(D) A digital asset middleman, as defined in paragraph (a)(21) of this section, that effects the sale of a digital asset for such person.

(ii) Special rules for payment transactions involving digital assets. In addition to the persons defined as customers in paragraph (a)(2)(i) of this section, the term customer includes:

(A) The person who transfers digital assets in a sale described in paragraph (a)(9)(ii)(D) of this section to a processor of digital asset payments that has an agreement or other arrangement with such person for the provision of digital asset payment services that provides that the processor of digital asset payments may verify such person's identity or otherwise comply with anti-money laundering (AML) program requirements under 31 CFR part 1010, or any other AML program requirements, as are applicable to that processor of digital asset payments. For purposes of the previous sentence, an agreement or other arrangement includes any arrangement under which, as part of customary onboarding procedures, such person is treated as having agreed to general terms and conditions.

(B) The person who transfers digital assets or directs the transfer of digital assets—

(1) In exchange for property of a type the later sale of which, if effected by such broker, would constitute a sale of that property under paragraph (a)(9) of this section; or

(2) In exchange for the acquisition of services performed by such broker; and

(C) In the case of a real estate reporting person under § 1.6045-4(e) with respect to a real estate transaction as defined in § 1.6045-4(b)(1), the person who transfers digital assets or directs the transfer of digital assets to the transferor of real estate (or the seller's nominee or agent) to acquire such real estate.

(3) Security. The term security means:

(i) A share of stock in a corporation (foreign or domestic);

(ii) An interest in a trust;

(iii) An interest in a partnership;

(iv) A debt obligation;

(v) An interest in or right to purchase any of the foregoing in connection with the issuance thereof from the issuer or an agent of the issuer or from an underwriter that purchases any of the foregoing from the issuer;

(vi) An interest in a security described in paragraph (a)(3)(i) or (iv) of this section (but not including executory contracts that require delivery of such type of security);

(vii) An option described in paragraph (m)(2) of this section; or

(viii) A securities futures contract.

(4) Barter exchange. The term barter exchange means any person with members or clients that contract either with each other or with such person to trade or barter property or services either directly or through such person. The term does not include arrangements that provide solely for the informal exchange of similar services on a noncommercial basis.

(5) Commodity. The term commodity means:

(i) Any type of personal property or an interest therein (other than securities as defined in paragraph (a)(3) of this section), the trading of regulated futures contracts in which has been approved by or has been certified to the Commodity Futures Trading Commission (see 17 CFR 40.3 or 40.2);

(ii) Lead, palm oil, rapeseed, tea, tin, or an interest in any of the foregoing; or

(iii) Any other personal property or an interest therein that is of a type the Secretary determines is to be treated as a commodity under this section, from and after the date specified in a notice of such determination published in the Federal Register.

(6) Regulated futures contract. The term regulated futures contract means a regulated futures contract within the meaning of section 1256(b) of the Code.

(7) Forward contract. The term forward contract means:

(i) An executory contract that requires delivery of a commodity in exchange for cash and which contract is not a regulated futures contract;

(ii) An executory contract that requires delivery of personal property or an interest therein in exchange for cash, or a cash settlement contract, if such executory contract or cash settlement contract is of a type the Secretary determines is to be treated as a forward contract under this section, from and after the date specified in a notice of such determination published in the Federal Register; or

(iii) An executory contract that—

(A) Requires delivery of a digital asset in exchange for cash, stored-value cards, a different digital asset, or any other property or services described in paragraph (a)(9)(ii)(B) or (C) of this section; and

(B) Is not a regulated futures contract.

(8) Closing transaction. The term closing transaction means a lapse, expiration, settlement, abandonment, or other termination of a position. For purposes of the preceding sentence, a position includes a right or an obligation under a forward contract, a regulated futures contract, a securities futures contract, or an option.

(9) Sale—(i) In general. The term sale means any disposition of securities, commodities, options, regulated futures contracts, securities futures contracts, or forward contracts, and includes redemptions of stock, retirements of debt instruments (including a partial retirement attributable to a principal payment received on or after January 1, 2014), and enterings into short sales, but only to the extent any of these actions are conducted for cash. In the case of an option, a regulated futures contract, a securities futures contract, or a forward contract, a sale includes any closing transaction. When a closing transaction for a contract described in section 1256(b)(1)(A) involves making or taking delivery, there are two sales, one resulting in profit or loss on the contract, and a separate sale on the delivery. When a closing transaction for a contract described in section 988(c)(5) of the Code involves making delivery, there are two sales, one resulting in profit or loss on the contract, and a separate sale on the delivery. For purposes of the preceding sentence, a broker may assume that any customer's functional currency is the U.S. dollar. When a closing transaction in a forward contract involves making or taking delivery, the broker may treat the delivery as a sale without separating the profit or loss on the contract from the profit or loss on the delivery, except that taking delivery for U.S. dollars is not a sale. The term sale does not include entering into a contract that requires delivery of personal property or an interest therein, the initial grant or purchase of an option, or the exercise of a purchased call option for physical delivery (except for a contract described in section 988(c)(5)). For purposes of this section only, a constructive sale under section 1259 of the Code and a mark to fair market value under section 475 or 1296 of the Code are not sales.

(ii) Sales with respect to digital assets—(A) In general. In addition to the specific rules provided in paragraphs (a)(9)(ii)(B) through (D) of this section, the term sale also includes:

(1) Any disposition of a digital asset in exchange for cash or stored-value cards;

(2) Any disposition of a digital asset in exchange for a different digital asset; and

(3) The delivery of a digital asset pursuant to the settlement of a forward contract, option, regulated futures contract, any similar instrument, or any other executory contract which would be treated as a sale of a digital asset under this paragraph (a)(9)(ii) if the contract had not been executory. In the case of a transaction involving a contract described in the previous sentence, see paragraph (a)(9)(i) of this section for rules applicable to determining whether a sale has occurred and how to report the making or taking delivery of the underlying asset.

(B) Dispositions of digital assets for certain property. Solely in the case of a broker that is a real estate reporting person defined in § 1.6045-4(e) with respect to real property or is in the business of effecting sales of property for others, which sales when effected would constitute sales under paragraph (a)(9)(i) of this section, the term sale also includes any disposition of a digital asset in exchange for such property.

(C) Dispositions of digital assets for certain services. The term sale also includes any disposition of a digital asset in consideration for any services provided by a broker that is a real estate reporting person defined in § 1.6045-4(e) with respect to real property or a broker that is in the business of effecting sales of property described in paragraph (a)(9)(i), paragraphs (a)(9)(ii)(A) and (B), or paragraph (a)(9)(ii)(D) of this section.

(D) Special rule for certain sales effected by processors of digital asset payments. In the case of a processor of digital asset payments as defined in paragraph (a)(22) of this section, the term sale also includes the payment by one party of a digital asset to a processor of digital asset payments in return for the payment of that digital asset, cash, or a different digital asset to a second party. If any sale of digital assets described in this paragraph (a)(9)(ii)(D) would also be subject to reporting under one of the definitions of sale described in paragraphs (a)(9)(ii)(A) through (C) of this section as a sale effected by a broker other than as a processor of digital asset payments, the broker must treat the sale solely as a sale under such other paragraph and not as a sale under this paragraph (a)(9)(ii)(D).

(10) Effect—(i) In general. The term effect means, with respect to a sale, to act as—

(A) An agent for a party in the sale wherein the nature of the agency is such that the agent ordinarily would know the gross proceeds from the sale;

(B) In the case of a broker described in the second sentence of paragraph (a)(1) of this section, a person that is an obligor retiring its own debt obligations, a corporation redeeming its own stock, or an issuer of digital assets redeeming those digital assets;

(D) A digital asset middleman as defined in paragraph (a)(21) of this section for a party in a sale of digital assets.

(ii) Actions relating to certain options and forward contracts. For purposes of paragraph (a)(10)(i) of this section, acting as an agent, principal, or digital asset middleman with respect to grants or purchases of options, exercises of call options, or enterings into contracts that require delivery of personal property or an interest therein is not of itself effecting a sale. A broker that has on its books a forward contract under which delivery is made effects such delivery.

(11) Foreign currency. The term foreign currency means currency of a foreign country.

(12) Cash. The term cash means United States dollars or any convertible foreign currency that is issued by a government or a central bank, whether in physical or digital form.

(13) Person. The term person includes any governmental unit and any agency or instrumentality thereof.

(14) Specified security. The term specified security means:

(i) Any share of stock (or any interest treated as stock, including, for example, an American Depositary Receipt) in an entity organized as, or treated for Federal tax purposes as, a corporation, either foreign or domestic (provided that, solely for purposes of this paragraph (a)(14)(i), a security classified as stock by the issuer is treated as stock, and if the issuer has not classified the security, the security is not treated as stock unless the broker knows that the security is reasonably classified as stock under general Federal tax principles);

(ii) Any debt instrument described in paragraph (a)(17) of this section, other than a debt instrument subject to section 1272(a)(6) of the Code (certain interests in or mortgages held by a real estate mortgage investment conduit (REMIC), certain other debt instruments with payments subject to acceleration, and pools of debt instruments the yield on which may be affected by prepayments) or a short-term obligation described in section 1272(a)(2)(C);

(iii) Any option described in paragraph (m)(2) of this section;

(iv) Any securities futures contract;

(v) Any digital asset as defined in paragraph (a)(19) of this section; or

(vi) Any forward contract described in paragraph (a)(7)(iii) of this section requiring the delivery of a digital asset.

(15) Covered security. The term covered security means a specified security described in this paragraph (a)(15).

(i) In general. Except as provided in paragraph (a)(15)(iv) of this section, the following specified securities are covered securities:

(A) A specified security described in paragraph (a)(14)(i) of this section acquired for cash in an account on or after January 1, 2011, except stock for which the average basis method is available under § 1.1012-1(e).

(B) Stock for which the average basis method is available under § 1.1012-1(e) acquired for cash in an account on or after January 1, 2012.

(C) A specified security described in paragraphs (a)(14)(ii) and (n)(2)(i) of this section (not including the debt instruments described in paragraph (n)(2)(ii) of this section) acquired for cash in an account on or after January 1, 2014.

(D) A specified security described in paragraphs (a)(14)(ii) and (n)(3) of this section acquired for cash in an account on or after January 1, 2016.

(E) Except for an option described in paragraph (m)(2)(ii)(C) of this section (relating to an option on a digital asset), an option described in paragraph (a)(14)(iii) of this section granted or acquired for cash in an account on or after January 1, 2014.

(F) A securities futures contract described in paragraph (a)(14)(iv) of this section entered into in an account on or after January 1, 2014.

(G) A specified security transferred to an account if the broker or other custodian of the account receives a transfer statement (as described in § 1.6045A-1) reporting the security as a covered security.

(H) An option on a digital asset described in paragraphs (a)(14)(iii) and (m)(2)(ii)(C) of this section (other than an option described in paragraph (a)(14)(v) of this section) granted or acquired in an account on or after January 1, 2026.

(I) [Reserved]

(J) A specified security described in paragraph (a)(14)(v) of this section that is acquired in a customer's account by a broker providing custodial services for such specified security on or after January 1, 2026, in exchange for cash, stored-value cards, different digital assets, or any other property or services described in paragraph (a)(9)(ii)(B) or (C) of this section, respectively.

(K) A specified security described in paragraph (a)(14)(vi) of this section, not described in paragraph (a)(14)(v) of this section, that is entered into or acquired in an account on or after January 1, 2026.

(ii) Acquired in an account. For purposes of this paragraph (a)(15), a security is considered acquired in a customer's account at a broker or custodian if the security is acquired by the customer's broker or custodian or acquired by another broker and delivered to the customer's broker or custodian. Acquiring a security in an account includes granting an option and entering into a forward contract or short sale.

(iii) Corporate actions and other events. For purposes of this paragraph (a)(15), a security acquired due to a stock dividend, stock split, reorganization, redemption, stock conversion, recapitalization, corporate division, or other similar action is considered acquired for cash in an account.

(iv) Exceptions. Notwithstanding paragraph (a)(15)(i) of this section, the following specified securities are not covered securities:

(A) Stock acquired in 2011 that is transferred to a dividend reinvestment plan (as described in § 1.1012-1(e)(6)) in 2011. However, a covered security acquired in 2011 that is transferred to a dividend reinvestment plan after 2011 remains a covered security.

(B) A specified security, other than a specified security described in paragraph (a)(14)(v) or (vi) of this section, acquired through an event described in paragraph (a)(15)(iii) of this section if the basis of the acquired security is determined from the basis of a noncovered security.

(C) A specified security that is excepted at the time of its acquisition from reporting under paragraph (c)(3) or (g) of this section. However, a broker cannot treat a specified security as acquired by an exempt foreign person under paragraph (g)(1)(i) or paragraphs (g)(4)(ii) through (v) of this section at the time of acquisition if, at that time, the broker knows or should have known (including by reason of information that the broker is required to collect under section 1471 or 1472 of the Code) that the customer is not a foreign person.

(D) A security for which reporting under this section is required by § 1.6049-5(d)(3)(ii) (certain securities owned by a foreign intermediary or flow-through entity).

(E) Digital assets in a sale required to be reported under paragraph (g)(4)(vi)(E) of this section by a broker making a payment of gross proceeds from the sale to a foreign intermediary, flow-through entity, or U.S. branch.

(16) Noncovered security. The term noncovered security means any specified security that is not a covered security.

(17) Debt instrument, bond, debt obligation, and obligation. For purposes of this section, the terms debt instrument, bond, debt obligation, and obligation mean a debt instrument as defined in § 1.1275-1(d) and any instrument or position that is treated as a debt instrument under a specific provision of the Code (for example, a regular interest in a REMIC as defined in section 860G(a)(1) of the Code and § 1.860G-1). Solely for purposes of this section, a security classified as debt by the issuer is treated as debt. If the issuer has not classified the security, the security is not treated as debt unless the broker knows that the security is reasonably classified as debt under general Federal tax principles or that the instrument or position is treated as a debt instrument under a specific provision of the Code.

(18) Securities futures contract. For purposes of this section, the term securities futures contract means a contract described in section 1234B(c) of the Code whose underlying asset is described in paragraph (a)(14)(i) of this section and which is entered into on or after January 1, 2014.

(19) Digital asset—(i) In general. For purposes of this section, the term digital asset means any digital representation of value that is recorded on a cryptographically secured distributed ledger (or any similar technology), without regard to whether each individual transaction involving that digital asset is actually recorded on that ledger, and that is not cash as defined in paragraph (a)(12) of this section.

(ii) No inference. Nothing in this paragraph (a)(19) or elsewhere in this section may be construed to mean that a digital asset is or is not properly classified as a security, commodity, option, securities futures contract, regulated futures contract, or forward contract for any other purpose of the Code.

(20) Digital asset address. For purposes of this section, the term digital asset address means the unique set of alphanumeric characters, in some cases referred to as a quick response or QR Code, that is generated by the wallet into which the digital asset will be transferred.

(21) Digital asset middleman—(i) In general. The term digital asset middleman means any person who provides a facilitative service as described in paragraph (a)(21)(iii) of this section with respect to a sale of digital assets.

(ii) [Reserved]

(iii) Facilitative service.

(A) [Reserved]

(B) Special rule involving sales of digital assets under paragraphs (a)(9)(ii)(B) through (D) of this section. A facilitative service means:

(1) The acceptance or processing of digital assets as payment for property of a type which when sold would constitute a sale under paragraph (a)(9)(i) of this section by a broker that is in the business of effecting sales of such property.

(2) Any service performed by a real estate reporting person as defined in § 1.6045-4(e) with respect to a real estate transaction in which digital assets are paid by the real estate buyer in full or partial consideration for the real estate, provided the real estate reporting person has actual knowledge or ordinarily would know that digital assets were used by the real estate buyer to make payment to the real estate seller. For purposes of this paragraph (a)(21)(iii)(B)(2), a real estate reporting person is considered to have actual knowledge that digital assets were used by the real estate buyer to make payment if the terms of the real estate contract provide for payment using digital assets.

(3) The acceptance or processing of digital assets as payment for any service provided by a broker described in paragraph (a)(1) of this section determined without regard to any sales under paragraph (a)(9)(ii)(C) of this section that are effected by such broker.

(4) Any payment service performed by a processor of digital asset payments described in paragraph (a)(22) of this section, provided the processor of digital asset payments has actual knowledge or ordinarily would know the nature of the transaction and the gross proceeds therefrom.

(5) The acceptance of digital assets in return for cash, stored-value cards, or different digital assets, to the extent provided by a physical electronic terminal or kiosk.

(22) Processor of digital asset payments. For purposes of this section, the term processor of digital asset payments means a person who in the ordinary course of a trade or business stands ready to effect sales of digital assets as defined in paragraph (a)(9)(ii)(D) of this section by regularly facilitating payments from one party to a second party by receiving digital assets from the first party and paying those digital assets, cash, or different digital assets to the second party.

(23) Stored-value card. For purposes of this section, the term stored-value card means a card, including any gift card, with a prepaid value in U.S. dollars, any convertible foreign currency, or any digital asset, without regard to whether the card is in physical or digital form.

(24) Transaction identification. For purposes of this section, the term transaction identification, or transaction ID, means the unique set of alphanumeric identification characters that a digital asset distributed ledger associates with a transaction involving the transfer of a digital asset from one digital asset address to another. The term transaction ID includes terms such as a TxID or transaction hash.

(25) Wallet, hosted wallet, unhosted wallet, and held in a wallet or account—(i) Wallet. A wallet is a means of storing, electronically or otherwise, a user's private keys to digital assets held by or for the user.

(ii) Hosted wallet. A hosted wallet is a custodial service that electronically stores the private keys to digital assets held on behalf of others.

(iii) Unhosted wallet. An unhosted wallet is a non-custodial means of storing, electronically or otherwise, a user's private keys to digital assets held by or for the user. Unhosted wallets, sometimes referred to as self-hosted or self-custodial wallets, can be provided through software that is connected to the internet (a hot wallet) or through hardware or physical media that is disconnected from the internet (a cold wallet).

(iv) Held in a wallet or account. A digital asset is referred to in this section as held in a wallet or account if the wallet, whether hosted or unhosted, or account stores the private keys necessary to transfer control of the digital asset. A digital asset associated with a digital asset address that is generated by a wallet, and a digital asset associated with a sub-ledger account of a wallet, are similarly referred to as held in a wallet. References to variations of held in a wallet or account, such as held at a broker, held with a broker, held by the user of a wallet, held on behalf of another, acquired in a wallet or account, or transferred into a wallet or account, each have a similar meaning.

(b) Examples. The following examples illustrate the definitions in paragraph (a) of this section.

(1) Example 1. The following persons generally are brokers within the meaning of paragraph (a)(1) of this section—

(i) A mutual fund, an underwriter of the mutual fund, or an agent for the mutual fund, any of which stands ready to redeem or repurchase shares in such mutual fund.

(ii) A professional custodian (such as a bank) that regularly arranges sales for custodial accounts pursuant to instructions from the owner of the property.

(iii) A depositary trust or other person who regularly acts as an escrow agent in corporate acquisitions, if the nature of the activities of the agent is such that the agent ordinarily would know the gross proceeds from sales.

(iv) A stock transfer agent for a corporation, which agent records transfers of stock in such corporation, if the nature of the activities of the agent is such that the agent ordinarily would know the gross proceeds from sales.

(v) A dividend reinvestment agent for a corporation that stands ready to purchase or redeem shares.

(vi) A person who in the ordinary course of a trade or business provides users with hosted wallet services to the extent such person stands ready to effect the sale of digital assets on behalf of its customers, including by acting as an agent for a party in the sale wherein the nature of the agency is as described in paragraph (a)(10)(i)(A) of this section.

(vii) A processor of digital asset payments as described in paragraph (a)(22) of this section.

(viii) A person who in the ordinary course of a trade or business either owns or operates one or more physical electronic terminals or kiosks that stand ready to effect the sale of digital assets for cash, stored-value cards, or different digital assets, regardless of whether the other person is the disposer or the acquirer of the digital assets in such an exchange.

(ix) [Reserved]

(x) A person who in the ordinary course of a trade or business stands ready at a physical location to effect sales of digital assets on behalf of others.

(xi) [Reserved]

(2) Example 2. The following persons are not brokers within the meaning of paragraph (a)(1) of this section in the absence of additional facts that indicate the person is a broker—

(i) A stock transfer agent for a corporation, which agent daily records transfers of stock in such corporation, if the nature of the activities of the agent is such that the agent ordinarily would not know the gross proceeds from sales.

(ii) A person (such as a stock exchange) that merely provides facilities in which others effect sales.

(iii) An escrow agent or nominee if such agency is not in the ordinary course of a trade or business.

(iv) An escrow agent, otherwise a broker, which agent effects no sales other than such transactions as are incidental to the purpose of the escrow (such as sales to collect on collateral).

(v) A floor broker on a commodities exchange, which broker maintains no records with respect to the terms of sales.

(vi) A corporation that issues and retires long-term debt on an irregular basis.

(vii) A clearing organization.

(viii) A merchant who is not otherwise required to make a return of information under section 6045 of the Code and who regularly sells goods or other property (other than digital assets) or services in return for digital assets.

(ix) A person solely engaged in the business of validating distributed ledger transactions, through proof-of-work, proof-of-stake, or any other similar consensus mechanism, without providing other functions or services.

(x) A person solely engaged in the business of selling hardware or licensing software, the sole function of which is to permit a person to control private keys which are used for accessing digital assets on a distributed ledger, without providing other functions or services.

(3) Example 3: Barter exchange. A, B, and C belong to a carpool in which they commute to and from work. Every third day, each member of the carpool provides transportation for the other two members. Because the carpool arrangement provides solely for the informal exchange of similar services on a noncommercial basis, the carpool is not a barter exchange within the meaning of paragraph (a)(4) of this section.

(4) Example 4: Barter exchange. X is an organization whose members include retail merchants, wholesale merchants, and persons in the trade or business of performing services. X's members exchange property and services among themselves using credits on the books of X as a medium of exchange. Each exchange through X is reflected on the books of X by crediting the account of the member providing property or services and debiting the account of the member receiving such property or services. X also provides information to its members concerning property and services available for exchange through X. X charges its members a commission on each transaction in which credits on its books are used as a medium of exchange. X is a barter exchange within the meaning of paragraph (a)(4) of this section.

(5) Example 5: Commodity, forward contract. A warehouse receipt is an interest in personal property for purposes of paragraph (a) of this section. Consequently, a warehouse receipt for a quantity of lead is a commodity under paragraph (a)(5)(ii) of this section. Similarly, an executory contract that requires delivery of a warehouse receipt for a quantity of lead is a forward contract under paragraph (a)(7)(ii) of this section.

(6) Example 6: Customer. The only customers of a depositary trust acting as an escrow agent in corporate acquisitions, which trust is a broker, are shareholders to whom the trust makes payments or shareholders for whom the trust is acting as an agent.

(7) Example 7: Customer. The only customers of a stock transfer agent, which agent is a broker, are shareholders to whom the agent makes payments or shareholders for whom the agent is acting as an agent.

(8) Example 8: Customer. D, an individual not otherwise exempt from reporting, is the holder of an obligation issued by P, a corporation. R, a broker, acting as an agent for P, retires such obligation held by D. Such obligor payments from R represent obligor payments by P. D, the person to whom the gross proceeds are paid or credited by R, is the customer of R.

(9) Example 9: Covered security. E, an individual not otherwise exempt from reporting, maintains an account with S, a broker. On June 1, 2012, E instructs S to purchase stock that is a specified security for cash. S places an order to purchase the stock with T, another broker. E does not maintain an account with T. T executes the purchase. Custody of the purchased stock is transferred to E's account at S. Under paragraph (a)(15)(ii) of this section, the stock is considered acquired for cash in E's account at S. Because the stock is acquired on or after January 1, 2012, under paragraph (a)(15)(i) of this section, it is a covered security.

(10) Example 10: Covered security. F, an individual not otherwise exempt from reporting, is granted 100 shares of stock in F's employer by F's employer. Because F does not acquire the stock for cash or through a transfer to an account with a transfer statement (as described in § 1.6045A-1), under paragraph (a)(15) of this section, the stock is not a covered security.

(11) Example 11: Covered security. G, an individual not otherwise exempt from reporting, owns 400 shares of stock in Q, a corporation, in an account with U, a broker. Of the 400 shares, 100 are covered securities and 300 are noncovered securities. Q takes a corporate action to split its stock in a 2-for-1 split. After the stock split, G owns 800 shares of stock. Because the adjusted basis of 600 of the 800 shares that G owns is determined from the basis of noncovered securities, under paragraphs (a)(15)(iii) and (a)(15)(iv)(B) of this section, these 600 shares are not covered securities and the remaining 200 shares are covered securities.

(12) Example 12: Processor of digital asset payments, sale, and customer—(i) Facts. Company Z is an online merchant that accepts digital asset DE as a form of payment for the merchandise it sells. The merchandise Z sells does not include digital assets. Z does not provide any other service that could be considered as standing ready to effect sales of digital assets or any other property subject to reporting under section 6045. CPP is in the business of facilitating payments made by users of digital assets to merchants with which CPP has an account. CPP also has contractual arrangements with users of digital assets for the provision of digital asset payment services that provide that CPP may verify such user's identity pursuant to AML program requirements. Z contracts with CPP to help Z's customers to make payments to Z using digital assets. Under Z's agreement with CPP, when purchasers of merchandise initiate payment on Z's website using DE, they are directed to CPP's website to complete the payment part of the transaction. CPP is a third party settlement organization, as defined in § 1.6050W-1(c)(2), with respect to the payments it makes to Z. Customer R seeks to purchase merchandise from Z that is priced at $6,000 (which is 6,000 units of DE). After R initiates a purchase, R is directed to CPP's website where R is directed to enter into an agreement with CPP, which as part of CPP's customary onboarding procedures developed pursuant to AML program requirements, requires R to submit information to CPP to verify R's identity. Thereafter, R is instructed to transfer 6,000 units of DE to a digital asset address controlled by CPP. CPP then pays $6,000 in cash to Z, who in turn processes R's order.

(ii) Analysis. CPP is a processor of digital asset payments within the meaning of paragraph (a)(22) of this section because CPP, in the ordinary course of its business, regularly effects sales of digital assets as defined in paragraph (a)(9)(ii)(D) of this section by receiving digital assets from one party and paying those digital assets, cash, or different digital assets to a second party. Based on CPP's contractual relationship with Z, CPP has actual knowledge that R's payment was a payment transaction and the amount of gross proceeds R received as a result. Accordingly, CPP's services are facilitative services under paragraph (a)(21)(iii)(B) of this section and CPP is acting as a digital asset middleman under paragraph (a)(21) of this section to effect R's sale of digital assets under paragraph (a)(10)(i)(D) of this section. R's payment of 6,000 units of DE to CPP in return for the payment of $6,000 cash to Z is a sale of digital assets under paragraph (a)(9)(ii)(D) of this section. Additionally, because CPP has an arrangement with R for the provision of digital asset payment services that provides that CPP may verify R's identity pursuant to AML program requirements, R is CPP's customer under paragraph (a)(2)(ii)(A) of this section. Finally, CPP is also required to report the payment to Z under § 1.6050W-1(a) because the payment is a third party network transaction under § 1.6050W-1(c). The answer would be the same if CPP paid Z the 6,000 units of DE or another digital asset instead of cash.

(13) Example 13: Broker. The facts are the same as in paragraph (b)(12)(i) of this section (the facts in Example 12), except that Z accepts digital asset DE from its purchasers directly without the services of CPP or any other processor of digital asset payments. To pay for the merchandise R purchases on Z's website, R is directed by Z to transfer 15 units of DE directly to Z's digital asset address. Z is not a broker under the definition of paragraph (a)(1) of this section because Z does not stand ready as part of its trade or business to effect sales as defined in paragraph (a)(9) of this section made by others. That is, the sales that Z is in the business of conducting are of property that is not subject to reporting under section 6045.

(14) Example 14: Processor of digital asset payments—(i) Facts. Customer S purchases goods that are not digital assets with 10 units of digital asset DE from Merchant M using a digital asset DE credit card issued by Bank BK. BK has a contractual arrangement with customers using BK's credit cards that provides that BK may verify such customer identification information pursuant to AML program requirements. In addition, as part of BK's customary onboarding procedures, BK requires credit card applicants to submit information to BK to verify their identity. M is one of a network of unrelated persons that has agreed to accept digital asset DE credit cards issued by BK as payment for purchase transactions under an agreement that provides standards and mechanisms for settling the transaction between a merchant acquiring bank and the persons who accept the cards. Bank MAB is the merchant acquiring entity with the contractual obligation to make payments to M for goods provided to S in this transaction. To make payment for S's purchase of goods from M, S transfers 10 units of digital asset DE to BK. BK pays the 10 units of DE, less its processing fee, to Bank MAB, which amount Bank MAB pays, less its processing fee, to M.

(ii) Analysis. BK is a processor of digital asset payments as defined in paragraph (a)(22) of this section because BK, in the ordinary course of its business, regularly effects sales of digital assets as defined in paragraph (a)(9)(ii)(D) of this section by receiving digital assets from one party and paying those digital assets, cash, or different digital assets to a second party. Bank BK has actual knowledge that payment made by S is a payment transaction and also knows S's gross proceeds therefrom. Accordingly, BK's services are facilitative services under paragraph (a)(21)(iii)(B) of this section and BK is acting as a digital asset middleman under paragraph (a)(21) of this section to effect sales of digital assets under paragraph (a)(10)(i)(D) of this section. S's payment of 10 units of DE to BK for the payment of those units, less BK's processing fee, to Bank MAB is a sale by S of digital assets under paragraph (a)(9)(ii)(D) of this section. Additionally, because S transferred digital assets to BK in a sale described in paragraph (a)(9)(ii)(D) of this section and because BK has an arrangement with S for the provision of digital asset payment services that provides that BK may verify S's identity, S is BK's customer under paragraph (a)(2)(ii)(A) of this section.

(15) Example 15: Digital asset middleman and effect—(i) Facts. SBK is in the business of effecting sales of stock and other securities on behalf of customers. To open an account with SBK, each customer must provide SBK with its name, address, and tax identification number. SBK accepts 20 units of digital asset DE from Customer P as payment for 10 shares of AB stock. Additionally, P pays SBK an additional 1 unit of digital asset DE as a commission for SBK's services.

(ii) Analysis. SBK's acceptance of 20 units of DE as payment for the AB stock is a facilitative service under paragraph (a)(21)(iii)(B) of this section because the payment is for property (the AB stock) that when sold would constitute a sale under paragraph (a)(9)(i) of this section by a broker that is in the business of effecting sales of stock and other securities. SBK's acceptance of 1 unit of DE as payment for SBK's commission is also a facilitative service under paragraph (a)(21)(iii)(B) of this section because SBK is a broker under paragraph (a)(1) of this section with respect to a sale of stock under paragraph (a)(9)(i) of this section. Accordingly, SBK is acting as a digital asset middleman to effect P's sale of 10 units of DE in return for the AB stock and P's sale of 1 unit of DE as payment for SBK's commission under paragraphs (a)(10)(i)(D) and (a)(21) of this section.

(16) Example 16: Digital asset middleman and effect—(i) Facts. J, an unmarried individual not otherwise exempt from reporting, enters into a contractual agreement with B, an individual not otherwise exempt from reporting, to exchange J's principal residence, Blackacre, which has a fair market value of $225,000 for units of digital asset DE with a value of $225,000. Prior to closing, J provides closing agent CA, who is a real estate reporting person under § 1.6045-4(e), with the certifications required under § 1.6045-4(c)(2)(iv) (to exempt the transaction from reporting under § 1.6045-4(a) due to Blackacre being J's principal residence). Prior to closing, B transfers the digital assets directly from B's wallet to J's wallet, and J certifies to the closing agent (CA) that J received the digital assets required to be paid under the contract.

(ii) Analysis. CA is performing services as a real estate reporting person with respect to a real estate transaction in which the real estate buyer (B) pays digital assets in full or partial consideration for the real estate. In addition, CA has actual knowledge that payment made to B included digital assets because the terms of the real estate contract provide for such payment. Accordingly, the closing services provided by CA are facilitative services under paragraph (a)(21)(iii)(B)(2) of this section, and CA is acting as a digital asset middleman under paragraph (a)(21) of this section to effect B's sale of 1,000 DE units under paragraph (a)(10)(i)(D) of this section. These conclusions are not impacted by whether or not CA is required to report the sale of the real estate by J under § 1.6045-4(a).

(17) Example 17: Digital asset and cash—(i) Facts. Y is a privately held corporation that issues DL, a digital representation of value designed to track the value of the U.S. dollar. DL is backed in part or in full by U.S. dollars held by Y, and Y offers to redeem units of DL for U.S. dollars at par at any time. Transactions involving DL utilize cryptography to secure transactions that are digitally recorded on a cryptographically secured distributed ledger called the DL blockchain. CRX is a digital asset broker that also provides hosted wallet services for its customers seeking to make trades of digital assets using CRX. R is a customer of CRX. R exchanges 100 units of DL for $100 in cash from CRX. CRX does not record this transaction on the DL blockchain, but instead records the transaction on CRX's own centralized private ledger.

(ii) Analysis. DL is not cash under paragraph (a)(12) of this section because it is not issued by a government or central bank. DL is a digital asset under paragraph (a)(19) of this section because it is a digital representation of value that is recorded on a cryptographically secured distributed ledger. The fact that CRX recorded R's transaction on its own private ledger and not on the DL blockchain does not change this conclusion.

(18) Example 18: Broker and effect—(i) Facts. Individual J is an artist in the business of creating and selling nonfungible tokens that reference J's digital artwork. To find buyers and to execute these transactions, J uses the services of P2X, an unrelated digital asset marketplace that provides a service for nonfungible token sellers to find buyers and automatically executing contracts in return for a transaction fee. J does not perform any other services with respect to these transactions. Using P2X's platform, buyer K purchases J's newly created nonfungible token (DA-J) for 1,000 units of digital asset DE. Using the interface provided by P2X, J and K execute their exchange using an automatically executing contract, which automatically transfers DA-J to K and K's payment of DE units to J.

(ii) Analysis. Although J is a principal in the exchange of DA-J for 1,000 units of DE, J is not acting as an obligor retiring its own debt obligations, a corporation redeeming its own stock, or an issuer of digital assets that is redeeming those digital assets, as described in paragraph (a)(10)(i)(B) of this section. Because J created DA-J as part of J's business of creating and selling specified nonfungible tokens, J is also not acting in these transactions as a dealer as described in paragraph (a)(10)(i)(C) of this section, as an agent for another party as described in paragraph (a)(10)(i)(A) of this section, or as a digital asset middleman described in paragraph (a)(10)(i)(D) of this section. Accordingly, J is not a broker under paragraph (a)(1) of this section because J does not effect sales of digital assets on behalf of others under the definition of effect under paragraph (a)(10)(i) of this section.

(19) Example 19: Broker, sale, and effect—(i) Facts. HWP is a person that regularly provides hosted wallet services for customers. HWP does not operate a digital asset trading platform, but at the direction of its customers regularly executes customer exchange orders using the services of digital asset trading platforms. Individual L maintains digital assets with HWP. L places an order with HWP to exchange 10 units of digital asset DE held by L with HWP for 100 units of digital asset RN. To execute the order, HWP places the order with PRX, a person, as defined in section 7701(a)(1) of the Code, that operates a digital asset trading platform. HWP debits L's account for the disposed DE units and credits L's account for the RN units received in exchange.

(ii) Analysis. The exchange of L's DE units for RN units is a sale under paragraph (a)(9)(ii)(A)(2) of this section. HWP acts as an agent for L in this sale, and the nature of this agency is such that HWP ordinarily would know the gross proceeds from the sale. Accordingly, HWP has effected the sale under paragraph (a)(10)(i)(A) of this section. Additionally, HWP is a broker under paragraph (a)(1) of this section because in the ordinary course of its trade or business, HWP stands ready to effect sales to be made by others. If PRX is also a broker, see the multiple broker rule in paragraph (c)(3)(iii)(B) of this section.

(20) Example 20: Digital asset and security. M owns 10 ownership units of a fund organized as a trust described in § 301.7701-4(c) of this chapter that was formed to invest in digital assets. M's units are held in a securities brokerage account and are not recorded using cryptographically secured distributed ledger technology. Although the underlying investments are comprised of one or more digital assets, M's investment is in ownership units of a trust, and the units are not themselves digital assets under paragraph (a)(19) of this section because transactions involving these units are not secured using cryptography and are not digitally recorded on a distributed ledger, such as a blockchain. The answer would be the same if the fund is organized as a C corporation or partnership.

(21) Example 21: Forward contract, closing transaction, and sale—(i) Facts. On February 24, Year 1, J contracts with broker CRX to sell J's 10 units of digital asset DE to CRX at an agreed upon price, with delivery under the contract to occur at 4 p.m. on March 10, Year 1. Pursuant to this agreement, J delivers the 10 units of DE to CRX, and CRX pays J the agreed upon price in cash.

(ii) Analysis. Under paragraph (a)(7)(iii) of this section, the contract between J and CRX is a forward contract. J's delivery of digital asset DE pursuant to the forward contract is a closing transaction described in paragraph (a)(8) of this section that is treated as a sale of the underlying digital asset DE under paragraph (a)(9)(ii)(A)(3) of this section. Pursuant to the rules of paragraphs (a)(9)(i) and (a)(9)(ii)(A)(3) of this section, CRX may treat the delivery of DE as a sale without separating the profit or loss on the forward contract from the profit or loss on the delivery.

(22) Example 22: Digital asset—(i) Facts. On February 7, Year 1, J purchases a regulated futures contract on digital asset DE through futures commission merchant FCM. The contract is not recorded using cryptographically secured distributed ledger technology. The contract expires on the last Friday in June, Year 1. On May 1, Year 1, J enters into an offsetting closing transaction with respect to the regulated futures contract.

(ii) Analysis. Although the regulated futures contract's underlying assets are comprised of digital assets, J's investment is in the regulated futures contract, which is not a digital asset under paragraph (a)(19) of this section because transactions involving the contract are not secured using cryptography and are not digitally recorded using cryptographically secured distributed ledger technology, such as a blockchain. When J disposes of the contract, the transaction is a sale of a regulated futures contract covered by paragraph (a)(9)(i) of this section.

(23) Example 23: Closing transaction and sale—(i) Facts. On January 15, Year 1, J purchases digital asset DE through Broker. On March 1, Year 1, J sells a regulated futures contract on DE through Broker. The contract expires on the last Friday in June, Year 1. On the last Friday in June, Year 1, J delivers the DE in settlement of the regulated futures contract.

(ii) Analysis. J's delivery of the DE pursuant to the regulated futures contract is a closing transaction described in paragraph (a)(8) of this section that is treated as a sale of the regulated futures contract under paragraph (a)(9)(i) of this section. In addition, under paragraph (a)(9)(ii)(A)(3) of this section, J's delivery of digital asset DE pursuant to the settlement of the regulated futures contract is a sale of the underlying digital asset DE.

(c) Reporting by brokers—(1) Requirement of reporting. Any broker shall, except as otherwise provided, report in the manner prescribed in this section.

(2) Sales required to be reported. Except as provided in paragraphs (c)(3), (c)(5), and (g) of this section, a broker is required to make a return of information for each sale by a customer of the broker if, in the ordinary course of a trade or business in which the broker stands ready to effect sales to be made by others, the broker effects the sale or closes the short position opened by the sale.

(3) Exceptions—(i) Sales effected for exempt recipients—(A) In general. No return of information is required with respect to a sale effected for a customer that is an exempt recipient under paragraph (c)(3)(i)(B) of this section.

(B) Exempt recipient defined. The term exempt recipient means—

(1) A corporation as defined in section 7701(a)(3), whether domestic or foreign, except that this exclusion does not apply to sales of covered securities acquired on or after January 1, 2012, by an S corporation as defined in section 1361(a);

(2) An organization exempt from taxation under section 501(a) or an individual retirement plan;

(3) The United States or a State, the District of Columbia, the Commonwealth of Puerto Rico, Guam, the Commonwealth of Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa, a political subdivision of any of the foregoing, a wholly owned agency or instrumentality of any one or more of the foregoing, or a pool or partnership composed exclusively of any of the foregoing;

(4) A foreign government, a political subdivision thereof, an international organization, or any wholly owned agency or instrumentality of the foregoing;

(5) A foreign central bank of issue as defined in § 1.895-1(b)(1) (i.e., a bank that is by law or government sanction the principal authority, other than the government itself, issuing instruments intended to circulate as currency);

(6) A dealer in securities or commodities registered as such under the laws of the United States or a State;

(7) A futures commission merchant registered as such with the Commodity Futures Trading Commission;

(8) A real estate investment trust (as defined in section 856);

(9) An entity registered at all times during the taxable year under the Investment Company Act of 1940 (15 U.S.C. 80a-1, et seq.);

(10) A common trust fund (as defined in section 584(a));

(11) A financial institution such as a bank, mutual savings bank, savings and loan association, building and loan association, cooperative bank, homestead association, credit union, industrial loan association or bank, or other similar organization; or

(12) A U.S. digital asset broker as defined in paragraph (g)(4)(i)(A)(1) of this section other than an investment adviser registered either under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1, et seq.) or with a state securities regulator and that investment adviser is not otherwise an exempt recipient in one or more of paragraphs (c)(3)(i)(B)(1) through (11) of this section.

(C) Exemption certificate—(1) In general. Except as provided in paragraph (c)(3)(i)(C)(2) or (3) of this section, a broker may treat a person described in paragraph (c)(3)(i)(B) of this section as an exempt recipient based on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter); the broker's actual knowledge that the customer is a person described in paragraph (c)(3)(i)(B) of this section; or the applicable indicators described in § 1.6049-4(c)(1)(ii)(A) through (M). A broker may require an exempt recipient to file a properly completed exemption certificate and may treat an exempt recipient that fails to do so as a recipient that is not exempt.

(2) Limitation for corporate customers. For sales of covered securities acquired on or after January 1, 2012, a broker may not treat a customer as an exempt recipient described in paragraph (c)(3)(i)(B)(1) of this section based on the indicators of corporate status described in § 1.6049-4(c)(1)(ii)(A). However, for sales of all securities and for sales of digital assets, a broker may treat a customer as an exempt recipient if one of the following applies—

(i) The name of the customer contains the term insurance company, indemnity company, reinsurance company, or assurance company.

(ii) The name of the customer indicates that it is an entity listed as a per se corporation under § 301.7701-2(b)(8)(i) of this chapter.

(iii) The broker receives a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that asserts that the customer is not an S corporation as defined in section 1361(a).

(iv) The broker receives a withholding certificate described in § 1.1441-1(e)(2)(i) that includes a certification that the person whose name is on the certificate is a foreign corporation.

(3) Limitation for U.S. digital asset brokers. For sales of digital assets, a broker may not treat a customer as an exempt recipient described in paragraph (c)(3)(i)(B)(12) of this section unless it obtains from that customer a certification on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that the customer is a U.S. digital asset broker described in paragraph (g)(4)(i)(A)(1) of this section.

(ii) Excepted sales. No return of information is required with respect to a sale effected by a broker for a customer if the sale is an excepted sale. The inclusion in this paragraph (c)(3)(ii) of a digital asset transaction is not intended to create an inference that the transaction is a sale of a digital asset under paragraph (a)(9)(ii) of this section. For this purpose, a sale is an excepted sale if it is—

(A) So designated by the Internal Revenue Service in a revenue ruling or revenue procedure (see § 601.601(d)(2) of this chapter);

(B) A sale with respect to which a return is not required by applying the rules of § 1.6049-4(c)(4) (by substituting the term a sale subject to reporting under section 6045 for the term an interest payment);

(C) A sale of digital asset units withheld by the broker from digital assets received by the customer in any underlying digital asset sale to pay for the customer's digital asset transaction costs;

(D) A sale for cash of digital asset units withheld by the broker from digital assets received by the customer in a sale of digital assets for different digital assets (underlying sale) that is undertaken immediately after the underlying sale to satisfy the broker's obligation under section 3406 of the Code to deduct and withhold a tax with respect to the underlying sale;

(E) A disposition of a digital asset representing loyalty program credits or loyalty program rewards offered by a provider of non-digital asset goods or services to its customers, in exchange for non-digital asset goods or services from the provider or other merchants participating with the developer as part of the program, provided that the digital asset is not capable of being transferred, exchanged, or otherwise used outside the cryptographically secured distributed ledger network of the loyalty program;

(F) A disposition of a digital asset created and designed for use within a video game or network of video games in exchange for different digital assets also created and designed for use within that video game or video game network, provided the disposed of digital assets are not capable of being transferred, exchanged, or otherwise used outside of the video game or video game network;

(G) Except in the case of digital assets cleared or settled on a limited-access regulated network as described in paragraph (c)(8)(iii) of this section, a disposition of a digital asset representing information with respect to payment instructions or the management of inventory that does not consist of digital assets, within a cryptographically secured distributed ledger (or network of interoperable distributed ledgers) that provides access only to users of such information provided the digital assets disposed of are not capable of being transferred, exchanged, or otherwise used outside such distributed ledger or network; or

(H) A disposition of a digital asset offered by a seller of goods or provider of services to its customers that can be exchanged or redeemed only by those customers for goods or services provided by such seller or provider if the digital asset is not capable of being transferred, exchanged, or otherwise used outside the cryptographically secured distributed ledger network of the seller or provider and cannot be sold or exchanged for cash, stored-value cards, or qualifying stablecoins at a market rate inside the seller or provider's distributed ledger network.

(iii) Multiple brokers—(A) In general. If a broker is instructed to initiate a sale by a person that is an exempt recipient described in paragraph (c)(3)(i)(B)(6), (7), or (11) of this section, no return of information is required with respect to the sale by that broker. In a redemption of stock or retirement of securities, only the broker responsible for paying the holder redeemed or retired, or crediting the gross proceeds on the sale to that holder's account, is required to report the sale.

(B) Special rule for sales of digital assets. If more than one broker effects a sale of a digital asset on behalf of a customer, the broker responsible for first crediting the gross proceeds on the sale to the customer's wallet or account is required to report the sale. A broker that did not first credit the gross proceeds on the sale to the customer's wallet or account is not required to report the sale if prior to the sale that broker obtains a certification on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that the broker first crediting the gross proceeds on the sale is a person described in paragraph (c)(3)(i)(B)(12) of this section.

(iv) Cash on delivery transactions. In the case of a sale of securities through a cash on delivery account, a delivery versus payment account, or other similar account or transaction, only the broker that receives the gross proceeds from the sale against delivery of the securities sold is required to report the sale. If, however, the broker's customer is another broker (second-party broker) that is an exempt recipient, then only the second-party broker is required to report the sale.

(v) Fiduciaries and partnerships. No return of information is required with respect to a sale effected by a custodian or trustee in its capacity as such or a redemption of a partnership interest by a partnership, provided the sale is otherwise reported by the custodian or trustee on a properly filed Form 1041, or the redemption is otherwise reported by the partnership on a properly filed Form 1065, and all Schedule K-1 reporting requirements are satisfied.

(vi) Money market funds—(A) In general. No return of information is required with respect to a sale of shares in a regulated investment company that is permitted to hold itself out to investors as a money market fund under Rule 2a-7 under the Investment Company Act of 1940 (17 CFR 270.2a-7).

(B) Effective/applicability date. Paragraph (c)(3)(vi)(A) of this section applies to sales of shares in calendar years beginning on or after July 8, 2016. Taxpayers and brokers (as defined in § 1.6045-1(a)(1)), however, may rely on paragraph (c)(3)(vi)(A) of this section for sales of shares in calendar years beginning before July 8, 2016.

(vii) Obligor payments on certain obligations. No return of information is required with respect to payments representing obligor payments on—

(A) Nontransferable obligations (including savings bonds, savings accounts, checking accounts, and NOW accounts);

(B) Obligations as to which the entire gross proceeds are reported by the broker on Form 1099 under provisions of the Internal Revenue Code other than section 6045 (including stripped coupons issued prior to July 1, 1982); or

(C) Retirement of short-term obligations (i.e., obligations with a fixed maturity date not exceeding 1 year from the date of issue) that have original issue discount, as defined in section 1273(a)(1), with or without application of the de minimis rule. The preceding sentence does not apply to a debt instrument issued on or after January 1, 2014. For a short-term obligation issued on or after January 1, 2014, see paragraph (c)(3)(xiii) of this section.

(D) Demand obligations that also are callable by the obligor and that have no premium or discount. The preceding sentence does not apply to a debt instrument issued on or after January 1, 2014.

(viii) Foreign currency. No return of information is required with respect to a sale of foreign currency other than a sale pursuant to a forward contract or regulated futures contract that requires delivery of foreign currency.

(ix) Fractional share. No return of information is required with respect to a sale of a fractional share of stock if the gross proceeds on the sale of the fractional share are less than $20.

(x) Certain retirements. No return of information is required from an issuer or its agent with respect to the retirement of book entry or registered form obligations as to which the relevant books and records indicate that no interim transfers have occurred. The preceding sentence does not apply to a debt instrument issued on or after January 1, 2014.

(xi) Short sales—(A) In general. A broker may not make a return of information under this section for a short sale of a security entered into on or after January 1, 2011, until the year a customer delivers a security to satisfy the short sale obligation. The return must be made without regard to the constructive sale rule in section 1259 or to section 1233(h). In general, the broker must report on a single return the information required by paragraph (d)(2)(i)(A) of this section for the short sale except that the broker must report the date the short sale was closed in lieu of the sale date. In applying paragraph (d)(2)(i)(A) of this section, the broker must report the relevant information regarding the security sold to open the short sale and the adjusted basis of the security delivered to close the short sale and whether any gain or loss on the closing of the short sale is long-term or short-term (within the meaning of section 1222).

(B) Short sale closed by delivery of a noncovered security. A broker is not required to report adjusted basis and whether any gain or loss on the closing of the short sale is long-term or short-term if the short sale is closed by delivery of a noncovered security and the return so indicates. A broker that chooses to report this information is not subject to penalties under section 6721 or 6722 for failure to report this information correctly if the broker indicates on the return that the short sale was closed by delivery of a noncovered security.

(C) Short sale obligation transferred to another account. If a short sale obligation is satisfied by delivery of a security transferred into a customer's account accompanied by a transfer statement (as described in § 1.6045A-1(b)(7)) indicating that the security was borrowed, the broker receiving custody of the security may not file a return of information under this section. The receiving broker must furnish a statement to the transferor that reports the amount of gross proceeds received from the short sale, the date of the sale, the quantity of shares, units, or amounts sold, and the Committee on Uniform Security Identification Procedures (CUSIP) number of the sold security (if applicable) or other security identifier number that the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter). The statement to the transferor also must include the transfer date, the name and contact information of the receiving broker, the name and contact information of the transferor, and sufficient information to identify the customer. If the customer subsequently closes the short sale obligation in the transferor's account with non-borrowed securities, the transferor must make the return of information required by this section. In that event, the transferor must take into account the information furnished under this paragraph (c)(3)(xi)(C) on the return unless the transferor knows that the information furnished under this paragraph (c)(3)(xi)(C) is incorrect or incomplete. A failure to report correct information that arises solely from this reliance is deemed to be due to reasonable cause for purposes of penalties under sections 6721 and 6722. See § 301.6724-1(a)(1) of this chapter.

(xii) Cross reference. For an exception for certain sales of agricultural commodities and certificates issued by the Commodity Credit Corporation after January 1, 1993, see paragraph (c)(7) of this section.

(xiii) Short-term obligations issued on or after January 1, 2014. No return of information is required under this section with respect to a sale (including a retirement) of a short-term obligation, as described in section 1272(a)(2)(C), that is issued on or after January 1, 2014.

(xiv) Certain redemptions. No return of information is required under this section for payments made by a stock transfer agent (as described in § 1.6045-1(b)(iv)) with respect to a redemption of stock of a corporation described in section 1297(a) with respect to a shareholder in the corporation if—

(A) The stock transfer agent obtains from the corporation a written certification signed by a person authorized to sign on behalf of the corporation, that states that the corporation is described in section 1297(a) for each calendar year during which the stock transfer agent relies on the provisions of this paragraph (c)(3)(xiv), and the stock transfer agent has no reason to know that the written certification is unreliable or incorrect;

(B) The stock transfer agent identifies, prior to payment, the corporation as a participating FFI (including a reporting Model 2 FFI) (as defined in § 1.6049-4(f)(10) or (14), respectively), or reporting Model 1 FFI (as defined in § 1.6049-4(f)(13)), in accordance with the requirements of § 1.1471-3(d)(4) (substituting the terms stock transfer agent and corporation for the terms withholding agent and payee, respectively) and validates that status annually;

(C) The stock transfer agent obtains a written certification representing that the corporation shall report the payment as part of its account holder reporting obligations under chapter 4 of the Code or an applicable IGA (as defined in § 1.6049-4(f)(7)) and provided the stock transfer agent does not know that the corporation is not reporting the payment as required. The paying agent may rely on the written certification until there is a change in circumstances or the paying agent knows or has reason to know that the statement is unreliable or incorrect. A stock transfer agent that knows that the corporation is not reporting the payment as required under chapter 4 of the Code or an applicable IGA must report all payments reportable under this section that it makes during the year in which it obtains such knowledge; and

(D) The stock transfer agent is not also acting in its capacity as a custodian, nominee, or other agent of the payee with respect to the payment.

(4) Examples. The following examples illustrate the application of the rules in paragraph (c)(3) of this section:

(i) Example 1. P, an individual who is not an exempt recipient, places an order with B, a person generally known in the investment community to be a federally registered broker/dealer, to effect a sale of P's stock in a publicly traded corporation. B, in turn, places an order to sell the stock with C, a second broker, who will execute the sale. B discloses to C the identity of the customer placing the order. C is not required to make a return of information with respect to the sale because C was instructed by B, an exempt recipient as defined in paragraph (c)(3)(i)(B)(6) of this section, to initiate the sale. B is required to make a return of information with respect to the sale because P is B's customer and is not an exempt recipient.

(ii) Example 2. Assume the same facts as in paragraph (c)(4)(i) of this section (the facts in Example 1) except that B has an omnibus account with C so that B does not disclose to C whether the transaction is for a customer of B or for B's own account. C is not required to make a return of information with respect to the sale because C was instructed by B, an exempt recipient as defined in paragraph (c)(3)(i)(B)(6) of this section, to initiate the sale. B is required to make a return of information with respect to the sale because P is B's customer and is not an exempt recipient.

(iii) Example 3. D, an individual who is not an exempt recipient, enters into a cash on delivery stock transaction by instructing K, a federally registered broker/dealer, to sell stock owned by D, and to deliver the proceeds to L, a custodian bank. Concurrently with the above instructions, D instructs L to deliver D's stock to K (or K's designee) against delivery of the proceeds from K. The records of both K and L with respect to this transaction show an account in the name of D. Pursuant to paragraph (h)(1) of this section, D is considered the customer of K and L. Under paragraph (c)(3)(iv) of this section, K is not required to make a return of information with respect to the sale because K will pay the gross proceeds to L against delivery of the securities sold. L is required to make a return of information with respect to the sale because D is L's customer and is not an exempt recipient.

(iv) Example 4. Assume the same facts as in paragraph (c)(4)(iii) of this section (the facts in Example 3) except that E, a federally registered investment adviser, instructs K to sell stock owned by D and to deliver the proceeds to L. Concurrently with the above instructions, E instructs L to deliver D's stock to K (or K's designee) against delivery of the proceeds from K. The records of both K and L with respect to the transaction show an account in the name of D. Pursuant to paragraph (h)(1) of this section, D is considered the customer of K and L. Under paragraph (c)(3)(iv) of this section, K is not required to make a return of information with respect to the sale because K will pay the gross proceeds to L against delivery of the securities sold. L is required to make a return of information with respect to the sale because D is L's customer and is not an exempt recipient.

(v) Example 5. Assume the same facts as in paragraph (c)(4)(iv) of this section (the facts in Example 4) except that the records of both K and L with respect to the transaction show an account in the name of E. Pursuant to paragraph (h)(1) of this section, E is considered the customer of K and L. Under paragraph (c)(3)(iv) of this section, K is not required to make a return of information with respect to the sale because K will pay the gross proceeds to L against delivery of the securities sold. L is required to make a return of information with respect to the sale because E is L's customer and is not an exempt recipient. E is required to make a return of information with respect to the sale because D is E's customer and is not an exempt recipient.

(vi) Example 6. F, an individual who is not an exempt recipient, owns bonds that are held by G, a federally registered broker/dealer, in an account for F with G designated as nominee for F. Upon the retirement of the bonds, the gross proceeds are automatically credited to the account of F. G is required to make a return of information with respect to the retirement because G is the broker responsible for making payments of the gross proceeds to F.

(vii) Example 7. On June 24, 2010, H, an individual who is not an exempt recipient, opens a short sale of stock in an account with M, a broker. Because the short sale is entered into before January 1, 2011, paragraph (c)(3)(xi) of this section does not apply. Under paragraphs (c)(2) and (j) of this section, M must make a return of information for the year of the sale regardless of when the short sale is closed.

(viii) Example 8—(A) Facts. On August 25, 2011, H opens a short sale of stock in an account with M, a broker. H closes the short sale with M on January 25, 2012, by purchasing stock of the same corporation in the account in which H opened the short sale and delivering the stock to satisfy H's short sale obligation. The stock H purchased is a covered security.

(B) Analysis. Because the short sale is entered into on or after January 1, 2011, under paragraphs (c)(2) and (c)(3)(xi) of this section, the broker closing the short sale must make a return of information reporting the sale for the year in which the short sale is closed. Thus, M is required to report the sale for 2012. M must report on a single return the relevant information for the sold stock, the adjusted basis of the purchased stock, and whether any gain or loss on the closing of the short sale is long-term or short-term (within the meaning of section 1222). Thus, M must report the information about the short sale opening and closing transactions on a single return for taxable year 2012.

(ix) Example 9—(A) Facts. Assume the same facts as in paragraph (c)(4)(viii) of this section (the facts in Example 8) except that H also has an account with N, a broker, and satisfies the short sale obligation with M by borrowing stock of the same corporation from N and transferring custody of the borrowed stock from N to M. N indicates on the transfer statement that the transferred stock was borrowed in accordance with § 1.6045A-1(b)(7).

(B) Analysis with respect to M. Under paragraph (c)(3)(xi)(C) of this section, M may not file the return of information required under this section. M must furnish a statement to N that reports the gross proceeds from the short sale on August 25, 2011, the date of the sale, the quantity of shares sold, the CUSIP number or other security identifier number of the sold stock, the transfer date, the name and contact information of M and N, and information identifying H such as H's name and the account number from which H transferred the borrowed stock.

(C) Analysis with respect to N. N must report the gross proceeds from the short sale, the date the short sale was closed, the adjusted basis of the stock acquired to close the short sale, and whether any gain or loss on the closing of the short sale is long-term or short-term (within the meaning of section 1222) on the return of information N is required to file under paragraph (c)(2) of this section when H closes the short sale in the account with N.

(x) Example 10: Excepted sale of digital assets representing payment instructions—(A) Facts. BNK is a bank that uses a cryptographically secured distributed ledger technology system (DLT) that provides access only to other member banks to securely transfer payment instructions that are not securities or commodities described in paragraph (c)(8)(iii) of this section. These payment instructions are exchanged between member banks through the use of digital asset DX. Dispositions of DX do not give rise to sales of other digital assets within the cryptographically secured distributed ledger (or network of interoperable distributed ledgers) and are not capable of being transferred, exchanged, or otherwise used, outside the DLT system. BNK disposes of DX using the DLT system to make a payment instruction to another bank within the DLT system.

(B) Analysis. BNK's disposition of DX using the DLT system to make a payment instruction to another bank within the DLT system is a disposition of a digital asset representing payment instructions that are not securities or commodities within a cryptographically secured distributed ledger that provides access only to users of such information. Because DX cannot be transferred, exchanged, or otherwise used, outside of DLT, and because the payment instructions are not dual classification assets under paragraph (c)(8)(iii) of this section, BNK's disposition of DX is an excepted sale under paragraph (c)(3)(ii)(G) of this section.

(xi) Example 11: Excepted sale of digital assets representing a loyalty program—(A) Facts. S created a loyalty program as a marketing tool to incentivize customers to make purchases at S's store, which sells non-digital asset goods and services. Customers that join S's loyalty program receive 1 unit of digital asset LY at the end of each month for every $1 spent in S's store. Units of LY can only be disposed of within S's cryptographically secured distributed ledger (DLY) in exchange for goods or services provided by S or merchants, such as M, that have contractually agreed to provide goods or services to S's loyalty customers in exchange for a predetermined payment from S. Customer C is a participant in S's loyalty program and has earned 1,000 units of LY. C redeems 1,000 units of LY in exchange for non-digital asset goods in M's store.

(B) Analysis. Customer C's disposition of LY using the DLY system in exchange for non-digital asset goods in M's store is a disposition of a digital asset representing loyalty program credits in exchange for non-digital asset goods or services from M, a merchant participating with S's loyalty program. Because LY cannot be transferred, exchanged, or otherwise used outside of DLY, C's disposition of LY is an excepted sale under paragraph (c)(3)(ii)(E) of this section.

(xii) Example 12: Multiple brokers—(A) Facts. L, an individual who is not an exempt recipient, maintains digital assets with HWP, a U.S. corporation that provides hosted wallet services. L also maintains an account at CRX, a U.S. corporation that operates a digital asset trading platform and that also provides custodial services for digital assets held by L. L places an order with HWP to exchange 10 units of digital asset DE for 100 units of digital asset RN. To effect the order, HWP places the order with CRX and communicates to CRX that the order is on behalf of L. Prior to initiating the transaction, CRX obtains a certification from HWP on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that HWP is a U.S. digital asset broker described in paragraph (g)(4)(i)(A)(1) of this section. CRX completes the transaction and transfers the 100 units of RN to HWP. HWP, in turn, credits L's account with the 100 units of RN.

(B) Analysis. HWP is the broker responsible for first crediting the gross proceeds on the sale to L's wallet. Accordingly, because CRX has obtained from HWP a certification on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that HWP is a U.S. digital asset broker described in paragraph (g)(4)(i)(A)(1) of this section, CRX is not required to make a return of information with respect to the sale of 100 units of RN effected on behalf of L under paragraph (c)(3)(iii)(B) of this section. In contrast, because HWP is the broker that credits the 100 units of RN to L's account, HWP is required to make a return of information with respect to the sale.

(xiii) Example 13: Multiple brokers—(A) Facts. The facts are the same as in paragraph (c)(4)(xii)(A) of this section (the facts in Example 12), except that CRX deposits the 100 units of RN into L's account with CRX after the transaction is effected by CRX. Thereafter, L transfers the 100 units of RN in L's account with CRX to L's account with HWP. Prior to the transaction, HWP obtained a certification from CRX on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that CRX is a U.S. digital asset broker described in paragraph (g)(4)(i)(A)(1) of this section.

(B) Analysis. Under paragraph (c)(3)(iii)(B) of this section, despite being instructed by HWP to make the sale of 100 units of RN on behalf of L, CRX is required to make a return of information with respect to the sale effected on behalf of L because CRX is the broker that credits the 100 units of RN to L's account. In contrast, HWP is not required to make a return of information with respect to the sale effected on behalf of L because HWP obtained from CRX a certification on a properly completed exemption certificate (as provided in § 31.3406(h)-3 of this chapter) that CRX is a U.S. digital asset broker described in paragraph (g)(4)(i)(A)(1) of this section.

(5) Form of reporting for regulated futures contracts—(i) In general. A broker effecting closing transactions in regulated futures contracts shall report information with respect to regulated futures contracts solely in the manner prescribed in this paragraph (c)(5). In the case of a sale that involves making delivery pursuant to a regulated futures contract, only the profit or loss on the contract is reported as a transaction with respect to regulated futures contracts under this paragraph (c)(5); such sales are, however, subject to reporting under paragraph (d)(2)(i)(A). The information required under this paragraph (c)(5) must be reported on a calendar year basis, unless the broker is advised in writing by an account's owner that the owner's taxable year is other than a calendar year and the broker elects to report with respect to regulated futures contracts in such account on the basis of the owner's taxable year. The following information must be reported as required by Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or any successor form, with respect to regulated futures contracts held in a customer's account:

(A) The name, address, and taxpayer identification number of the customer.

(B) The net realized profit or loss from all regulated futures contracts closed during the calendar year.

(D) The net unrealized profit or loss in all open regulated futures contracts at the end of the calendar year.

(E) The aggregate profit or loss from regulated futures contracts ((b) + (d)−(c)).

(F) Any other information required by Form 1099-B. See 17 CFR 1.33. For this purpose, the end of a year is the close of business of the last business day of such year. In reporting under this paragraph (c)(5), the broker shall make such adjustments for commissions that have actually been paid and for option premiums as are consistent with the books of the broker. No additional returns of information with respect to regulated futures contracts so reported are required.

(ii) Determination of profit or loss from foreign currency contracts. A broker effecting a closing transaction in foreign currency contracts (as defined in section 1256(g)) shall report information with respect to such contracts in the manner prescribed in paragraph (c)(5)(i) of this section. If a foreign currency contract is closed by making or taking delivery, the net realized profit or loss for purposes of paragraph (c)(5)(i)(B) of this section is determined by comparing the contract price to the spot price for the contract currency at the time and place specified in the contract. If a foreign currency contract is closed by entry into an offsetting contract, the net realized profit or loss for purposes of paragraph (c)(5)(i)(B) of this section is determined by comparing the contract price to the price of the offsetting contract. The net unrealized profit or loss in a foreign currency contract for purposes of paragraphs (c)(5)(i) (C) and (D) of this section is determined by comparing the contract price to the broker's price for similar contracts at the close of business of the relevant year.

(iii) Examples. The following examples illustrate the application of the rules in this paragraph (c)(5):

Example 1.On October 30, 1984, A, an individual who is a calendar year taxpayer not otherwise exempt from reporting, buys one March 1985 put on Treasury Bond futures (i.e. A purchases an option to enter into a short regulated futures contract of $100,000 face value U.S. Treasury bonds). A pays $500 for the option. On December 19, 1984, A, through B, exercises the option and enters into the futures contract. On February 15, 1985, A, through B, enters into a closing transaction with respect to the futures contract. These are A's only transactions in the account. Since B's books list A's regulated futures contract on December 31, 1984, B must report for A, for 1984, the unrealized profit or loss in the contract as of December 31, 1984. For 1985, B will report the same amount for A as the unrealized profit or loss at the beginning of 1985. The return of information for 1985 will also include the gain or loss from the contract in the net realized profit or loss from all regulated futures contracts sales during 1985.

Example 2.The facts are the same as in Example (1) except that A does not enter into the closing transaction, but instead, on March 20, 1985, B informs A that A will make delivery under the contract. On March 22, 1985, A does so; consequently, A becomes entitled to the gross proceeds. B enters the closing transaction on its books on March 20, 1985. In addition to the returns of information required by paragraph (c)(5), as described in Example (1), B must report the March 22, 1985 delivery as a separate transaction. B may use as the sale date for the delivery either March 20, 1985, the date the transaction is entered on the books of B, or March 22, 1985, the date A becomes entitled to the gross proceeds. B may not deduct the $500 premium from the gross proceeds with respect to the March 22, 1985 delivery.

Example 3.The facts are the same as in Example (2) except that A buys a call on Treasury bond futures and takes delivery. B will supply the returns of information required by paragraph (c)(5), as described in Example (1). B is not required to make a return of information with respect to A's taking delivery.

Example 4.C, an individual who is a calendar year taxpayer not otherwise exempt from reporting, has an account with D, a broker. C trades both regulated futures contracts and forward contracts through C's account with D. D must report C's regulated futures contracts on an annual basis as required by paragraph (c)(5). With respect to C's forward contracts, D may elect to use the calendar month, quarter, or year as D's reporting period as provided in paragraph (c)(6).

(6) Reporting periods and filing groups—(i) Reporting period—(A) In general. A broker may elect to use the calendar month, quarter, or year as the broker's reporting period. A broker may separately elect a reporting period for each filing group.

(B) Election. For each calendar year, a broker shall elect a reporting period by filing Forms 1096 and 1099 in the manner elected. A different reporting period may be subsequently elected by filing in the manner subsequently elected, provided no duplication of reported transactions results.

(ii) Filing group—(A) In general. A broker may elect to group customers or customer accounts by office, branch, department or other method of operational classification and separately file Forms 1096 and 1099 for each filing group.

(B) Election. For each calendar year, a broker shall elect filing groups by filing Forms 1096 and 1099 in the manner elected. Different filing groups may be subsequently elected by filing in the manner subsequently elected, provided no duplication of reported transactions results.

(iii) Example. The following example illustrates the rules of this paragraph (c)(6):

Example.The A department of C, a broker, files a separate report for each month of 1984, whereas the B department of C files one report for all of 1984. C makes no other reports or returns of information under section 6045 for 1984. C had thereby elected two filing groups for 1984, the A department and the B department. The A department has the calendar month as its 1984 reporting period, whereas the B department has the calendar year as its 1984 reporting period. The same result would occur if A and B were offices or branches of C.

(7) Exception for certain sales of agricultural commodities and commodity certificates—(i) Agricultural commodities. No return of information is required under section 6045 for a spot or forward sale of an agricultural commodity. This paragraph (c)(7)(i) does not except from reporting sales of agricultural commodities pursuant to regulated futures contracts, sales of derivative interests in agricultural commodities, or sales described in paragraph (c)(7)(iii) of this section.

(ii) Commodity Credit Corporation certificates. Except as otherwise provided in a revenue ruling or revenue procedure, no return of information is required under section 6045 with respect to a sale of a commodity certificate issued by the Commodity Credit Corporation under 7 CFR 1470.4 (1990).

(iii) Sales involving designated warehouses. Paragraph (c)(7)(i) of this section does not apply to any sale involving a warehouse receipt for an agricultural commodity issued by a designated warehouse for an agricultural commodity of the type for which the warehouse is a designated warehouse.

(iv) Definitions. For purposes of this paragraph (c)(7):

(A) Agricultural commodity. An “agricultural commodity” includes, but is not limited to, a commodity within the meaning of paragraph (a)(5) of this section that is a grain, feed, livestock, meat, oil seed, timber, or fiber.

(B) Spot sale. A spot sale is a sale that results in the substantially contemporaneous delivery of a commodity.

(C) Forward sale. A forward sale is a sale pursuant to a forward contract within the meaning of paragraph (a)(7) of this section.

(D) Designated warehouse. A designated warehouse is a warehouse, depository, or other similar entity, designated by a commodity exchange under 7 CFR 1.43 (1992), in which or out of which a particular type of agricultural commodity is deliverable in satisfaction of a regulated futures contract.

(8) Special coordination rules for reporting digital assets that are dual classification assets—(i) General rule for reporting dual classification assets as digital assets. Except in the case of a sale described in paragraph (c)(8)(ii), (iii), or (iv) of this section, for any sale of a digital asset under paragraph (a)(9)(ii) of this section that also constitutes a sale under paragraph (a)(9)(i) of this section, the broker must treat the transaction as set forth in paragraphs (c)(8)(i)(A) through (D). For purposes of this section, an asset described in this paragraph (c)(8)(i) is a dual classification asset.

(A) The broker must report the sale only as a sale of a digital asset under paragraph (a)(9)(ii) of this section and not as a sale under paragraph (a)(9)(i) of this section.

(B) The broker must treat the sale only as a sale of a specified security under paragraph (a)(14)(v) or (vi) of this section, as applicable, and not as a specified security under paragraph (a)(14)(i), (ii), (iii), or (iv) of this section.

(C) The broker must apply the reporting rules set forth in paragraphs (d)(2)(i)(B) through (D) of this section, as applicable, for the information required to be reported for such sale.

(D) For a sale of a dual classification asset that is treated as a tokenized security, the broker must report the information set forth in paragraph (c)(8)(i)(D)(3) of this section.

(1) A tokenized security is a dual classification asset that:

(i) Provides the holder with an interest in another asset that is a security described in paragraph (a)(3) of this section, other than a security that is also a digital asset; or

(ii) Constitutes an asset the offer and sale of which was registered with the U.S. Securities and Exchange Commission, other than an asset treated as a security for securities law purposes solely as an investment contract.

(2) For purposes of paragraph (c)(8)(i)(D)(1) of this section, a qualifying stablecoin is not treated as a tokenized security.

(3) In the case of a sale of a tokenized security, the broker must report the information set forth in paragraph (d)(2)(i)(B)(6) of this section, as applicable. In the case of a tokenized security that is a specified security under paragraph (a)(14)(i), (ii), (iii), or (iv) of this section, the broker must also report the information set forth in paragraph (d)(2)(i)(D)(4) of this section.

(ii) Reporting of dual classification assets that constitute contracts covered by section 1256(b) of the Code. For a sale of a digital asset on or after January 1, 2025, that is also a contract covered by section 1256(b), the broker must report the sale only under paragraph (c)(5) of this section including, as appropriate, the application of the rules in paragraph (m)(3) of this section.

(iii) Reporting of dual classification assets cleared or settled on a limited-access regulated network—(A) General rule. The coordination rule of paragraph (c)(8)(i) of this section does not apply to any sale of a dual classification asset that is a digital asset solely because the sale of such asset is cleared or settled on a limited-access regulated network described in paragraph (c)(8)(iii)(B) of this section. In such case, the broker must report such sale only as a sale under paragraph (a)(9)(i) of this section and not as a sale under paragraph (a)(9)(ii) of this section and must treat the sale as a sale of a specified security under paragraph (a)(14)(i), (ii), (iii), or (iv) of this section, to the extent applicable, and not as a sale of a specified security under paragraph (a)(14)(v) or (vi) of this section. For all other purposes of this section including transfers, a dual classification asset that is a digital asset solely because it is cleared or settled on a limited-access regulated network is not treated as a digital asset and is not reportable as a digital asset. See paragraph (d)(2)(i)(A) of this section for the information required to be reported for such a sale.

(B) Limited-access regulated network. For purposes of this section, a limited-access regulated network is described in paragraph (c)(8)(iii)(B)(1) or (2) of this section.

(1) A cryptographically secured distributed ledger, or network of interoperable cryptographically secured distributed ledgers, that provides clearance or settlement services and that either:

(i) Provides access only to persons described in one or more of paragraphs (c)(3)(i)(B)(6), (7), (10), or (11) of this section; or

(ii) Is provided exclusively to its participants by an entity that has registered with the U.S. Securities and Exchange Commission as a clearing agency, or that has received an exemption order from the U.S. Securities and Exchange Commission as a clearing agency, under section 17A of the Securities Exchange Act of 1934.

(2) A cryptographically secured distributed ledger controlled by a single person described in one of paragraphs (c)(3)(i)(B)(6) through (11) of this section that permits the ledger to be used solely by itself and its affiliates, and therefore does not provide access to the ledger to third parties such as customers or investors, in order to clear or settle sales of assets.

(iv) Reporting of dual classification assets that are interests in money market funds. The coordination rule of paragraph (c)(8)(i) of this section does not apply to any sale of a dual classification asset that is a share in a regulated investment company that is permitted to hold itself out to investors as a money market fund under Rule 2a-7 under the Investment Company Act of 1940 (17 CFR 270.2a-7). In such case, the broker must treat such sale only as a sale under paragraph (a)(9)(i) of this section and not as a sale under paragraph (a)(9)(ii) of this section. See paragraph (c)(3)(vi) of this section, providing that no return of information is required for shares described in the first sentence of this paragraph (c)(8)(iv).

(v) Example: Digital asset securities—(A) Facts. Brokers registered under the securities laws of the United States have formed a large network (broker network) that maintains accounts for customers seeking to purchase and sell stock. The broker network clears and settles sales of this stock using a cryptographically secured distributed ledger (DLN) that provides clearance or settlement services to the broker network. DLN may not be used by any person other than a registered broker in the broker network.

(B) Analysis. DLN is a limited-access regulated network described in paragraph (c)(8)(iii)(B)(1)(i) of this section because it is a cryptographically secured distributed ledger that provides clearance or settlement services and that provides access only to brokers described in paragraph (c)(3)(i)(B)(6) of this section. Additionally, sales of stock cleared on DLN are sales of securities under paragraph (a)(9)(i) of this section and sales of digital assets under paragraph (a)(9)(ii) of this section. Accordingly, sales of stock cleared on DLN are described in paragraph (c)(8)(iii) of this section and the coordination rule of paragraph (c)(8)(i) of this section does not apply to these sales. Therefore, the sales of stock cleared on DLN are reported only under paragraph (a)(9)(i) of this section. See paragraph (d)(2)(i)(A) of this section for the method for reporting the information required to be reported for such a sale.

(d) Information required—(1) In general. A broker that is required to make a return of information under paragraph (c) of this section during a reporting period is required to report for each filing group on a separate Form 1096, “Annual Summary and Transmittal of U.S. Information Returns,” or any successor form, the information required by the form in the manner and number of copies required by the form.

(2) Transactional reporting—(i) Required information—(A) General rule for sales described in paragraph (a)(9)(i) of this section. Except as provided in paragraph (c)(5) of this section, for each sale described in paragraph (a)(9)(i) of this section for which a broker is required to make a return of information under this section, the broker must report on Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or any successor form, the name, address, and taxpayer identification number of the customer, the property sold, the Committee on Uniform Security Identification Procedures (CUSIP) number of the security sold (if applicable) or other security identifier number that the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter), the adjusted basis of the security sold, whether any gain or loss with respect to the security sold is long-term or short-term (within the meaning of section 1222 of the Code), the gross proceeds of the sale, the sale date, and other information required by the form in the manner and number of copies required by the form. In addition, for a sale of a covered security on or after January 1, 2014, a broker must report on Form 1099-B whether any gain or loss is ordinary. See paragraph (m) of this section for additional rules related to options and paragraph (n) of this section for additional rules related to debt instruments. See paragraph (c)(8) of this section for rules related to sales of securities or sales of commodities under paragraph (a)(9)(i) of this section that are also sales of digital assets under paragraph (a)(9)(ii) of this section.

(B) Required information for digital asset transactions. Except in the case of a sale of a qualifying stablecoin or a specified nonfungible token for which the broker reports in the manner set forth in paragraph (d)(10) of this section and subject to the exception described in paragraph (d)(2)(i)(C) of this section for sales of digital assets described in paragraph (a)(9)(ii)(D) of this section (sales effected by processors of digital asset payments), for each sale of a digital asset described in paragraph (a)(9)(ii) of this section for which a broker is required to make a return of information under this section, the broker must report on Form 1099-DA, Digital Asset Proceeds From Broker Transactions, or any successor form, in the manner required by such form or instructions the following information:

(1) The name, address, and taxpayer identification number of the customer;

(2) The name and number of units of the digital asset sold;

(3) The sale date;

(4) The gross proceeds amount (after reduction for the allocable digital asset transaction costs as defined and allocated pursuant to paragraph (d)(5)(iv) of this section);

(5) Whether the sale was for cash, stored-value cards, or in exchange for services or other property;

(6) In the case of a sale that is reported as a digital asset sale pursuant to the rule in paragraph (c)(8)(i) of this section and is described as a tokenized security in paragraph (c)(8)(i)(D) of this section, the broker must also report to the extent required by Form 1099-DA or instructions: the CUSIP number of the security sold (if applicable) or other security identifier number that the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter); any information required under paragraph (m) of this section (related to options); any information required under paragraph (n) of this section (related to debt instruments); and any other information required by the form or instructions;

(7) For each such sale of a digital asset that was held by the broker in a hosted wallet on behalf of a customer and was previously transferred into an account at the broker (transferred-in digital asset), the broker must also report the date of such transfer in and the number of units transferred in by the customer;

(8) Whether the broker took into account customer-provided acquisition information from the customer or the customer's agent as described in paragraph (d)(2)(ii)(B)(4) of this section when determining the identification of the units sold (without regard to whether the broker's determination with respect to the particular unit sold was derived from the broker's own records or from that information); and

(9) Any other information required by the form or instructions.

(C) Exception for certain sales effected by processors of digital asset payments. A broker is not required to report any information required by paragraph (d)(2)(i)(B) of this section with respect to a sale of a digital asset described in paragraph (a)(9)(ii)(D) of this section (sales effected by processors of digital asset payments) by a customer if the gross proceeds (after reduction for the allocable digital asset transaction costs) from all such sales of digital assets effected by that broker for the year by the customer do not exceed $600. Gross proceeds from sales of qualifying stablecoins or specified nonfungible tokens that are reported in the manner set forth in paragraph (d)(10) of this section are not included in determining if this $600 threshold has been met. For the rules applicable for determining who the customer is for purposes of calculating this $600 threshold in the case of a joint account, see paragraph (d)(10)(v) of this section.

(D) Acquisition information for sales of certain digital assets. Except in the case of a sale of a qualifying stablecoin or a specified nonfungible token for which the broker reports in the manner set forth in paragraph (d)(10) of this section, for each sale described in paragraph (a)(9)(ii) of this section on or after January 1, 2026, of a covered security defined in paragraph (a)(15)(i)(H), (J), or (K) of this section that was acquired by the broker for the customer and held in the customer's account, for which a broker is required to make a return of information under paragraph (d)(2)(i)(B) of this section, the broker must also report the following information:

(1) The adjusted basis of the covered security sold calculated in accordance with paragraph (d)(6) of this section;

(2) The date such covered security was purchased, and whether any gain or loss with respect to the covered security sold is long-term or short-term in accordance with paragraph (d)(7) of this section;

(3) For purpose of determining the information required in paragraphs (d)(2)(i)(D)(1) through (2) in the case of an option and any asset delivered in settlement of an option, the broker must apply any applicable rules set forth in paragraph (m) of this section; and

(4) In the case of a sale that is reported as a digital asset sale pursuant to the rule in paragraph (c)(8)(i) of this section and is described as a tokenized security in paragraph (c)(8)(i)(D) of this section, see paragraphs (d)(6)(iii)(A)(2) and (d)(7)(ii)(A)(2) of this section regarding the basis and holding period adjustments required for wash sales, paragraph (d)(6)(v) of this section for rules regarding the application of the average basis method, paragraph (m) of this section for rules related to options, paragraph (n) of this section for rules related to debt instruments, and any other information required by the form or instructions.

(ii) Specific identification of specified securities—(A) In general. Except as provided in § 1.1012-1(e)(7)(ii), for a specified security described in paragraph (a)(14)(i) of this section sold on or after January 1, 2011, or for a specified security described in paragraph (a)(14)(ii) of this section sold on or after January 1, 2014, a broker must report a sale of less than the entire position in an account of a specified security that was acquired on different dates or at different prices consistently with a customer's adequate and timely identification of the security to be sold. See § 1.1012-1(c). If the customer does not provide an adequate and timely identification for the sale, the broker must first report the sale of securities in the account for which the broker does not know the acquisition or purchase date followed by the earliest securities purchased or acquired, whether covered securities or noncovered securities.

(B) Identification of digital assets sold, disposed of, or transferred. For a specified security described in paragraph (a)(14)(v) of this section, a broker must determine the unit sold, disposed of, or transferred, if less than the entire position in an account of such specified security that was acquired on different dates or at different prices, consistently with the adequate identification of the digital asset to be sold, disposed of, or transferred.

(1) No identification of units by customer. In the case of multiple units of the same digital asset that are held by a broker for a customer, if the customer does not provide the broker with an adequate identification of which units of a digital asset are sold, disposed of, or transferred by the date and time of the sale, disposition, or transfer, and the broker does not have adequate transfer-in date records and does not have or take into account customer-provided acquisition information as defined by paragraph (d)(2)(ii)(B)(4) of this section, then the broker must first report the sale, disposition, or transfer of units that were not acquired by the broker for the customer. After the disposition of all such units of digital assets, the broker must treat units as sold, disposed of, or transferred in order of time from the earliest date on which units of the same digital asset were acquired by the customer. See paragraph (d)(2)(ii)(B)(4) of this section for circumstances under which a broker may use information provided by the customer or the customer's agent to determine when units of a digital asset were acquired by the customer. If the broker does not receive customer-provided acquisition information with respect to digital assets that were transferred into the customer's account or otherwise does not take such information into account, the broker must treat those units as acquired as of the date and time of the transfer.

(2) Adequate identification of units by customer. Except as provided in paragraph (d)(2)(ii)(B)(3) of this section, when multiple units of the same digital asset are left in the custody of the broker, an adequate identification occurs if, no later than the date and time of the sale, disposition, or transfer, the customer specifies to the broker the particular units of the digital asset to be sold, disposed of, or transferred by reference to any identifier that the broker designates as sufficiently specific to determine the units sold, disposed of, or transferred. For example, a customer's reference to the purchase date and time of the units to be sold may be designated by the broker as sufficiently specific to determine the units sold, disposed of, or transferred if no other unidentified units were purchased at that same purchase date and time or purchase price. To the extent permitted by paragraph (d)(2)(ii)(B)(4) of this section, a broker may take into account customer-provided acquisition information with respect to transferred-in digital assets for purposes of enabling a customer to make a sufficiently specific reference. A standing order or instruction for the specific identification of digital assets is treated as an adequate identification made at the date and time of sale, disposition, or transfer. In the case of a broker that offers only one method of making a specific identification, such method is treated as a standing order or instruction within the meaning of the prior sentence.

(3) Special rule for the identification of certain units withheld from a transaction. Notwithstanding paragraphs (d)(2)(ii)(B)(1) and (2) of this section, in the case of a sale of digital assets in exchange for other digital assets differing materially in kind or in extent and for which the broker withholds units of the digital assets received for either the broker's obligation to deduct and withhold a tax under section 3406, or for payment of the customer's digital asset transaction costs as defined in paragraph (d)(5)(iv)(A) of this section, the customer is deemed to have made an adequate identification, within the meaning of paragraph (d)(2)(ii)(B)(2) of this section, for such withheld units as from the units received in the underlying transaction regardless of any other adequate identification within the meaning of paragraph (d)(2)(ii)(B)(2) of this section designating other units of the same digital asset as the units sold, disposed of, or transferred.

(4) Customer-provided acquisition information for digital assets. For purposes of identifying which units are sold, disposed of, or transferred under paragraph (d)(2)(ii)(A) of this section, a broker is permitted, but not required, to take into account customer-provided acquisition information. For purposes of this section, customer-provided acquisition information means reasonably reliable information, such as the date and time of acquisition of units of a digital asset, provided by a customer or the customer's agent to the broker no later than the date and time of a sale, disposition, or transfer. Reasonably reliable information includes purchase or trade confirmations at other brokers or immutable data on a public distributed ledger. Solely for purposes of penalties under sections 6721 and 6722, a broker that takes into account customer-provided acquisition information for purposes of identifying which units are sold, disposed of, or transferred is deemed to have relied upon this information in good faith if the broker neither knows nor has reason to know that the information is incorrect. See § 301.6724-1(c)(6) of this chapter.

(iii) Penalty relief for reporting information not subject to reporting—(A) Noncovered securities. A broker is not required to report adjusted basis and the character of any gain or loss for the sale of a noncovered security if the return identifies the sale as a sale of a noncovered security. A broker that chooses to report this information for a noncovered security is not subject to penalties under section 6721 or 6722 of the Code for failure to report this information correctly if the return identifies the sale as a sale of a noncovered security. For purposes of this paragraph (d)(2)(iii)(A), a broker must treat a security for which a broker makes the single-account election described in § 1.1012-1(e)(11)(i) as a covered security.

(B) Gross proceeds from digital assets sold before applicability date. A broker is not required to report the gross proceeds from the sale of a digital asset as described in paragraph (a)(9)(ii) of this section if the sale is effected prior to January 1, 2025. A broker that chooses to report this information on either the Form 1099-B, or when available the Form 1099-DA, pursuant to paragraph (d)(2)(i)(B) of this section is not subject to penalties under section 6721 or 6722 for failure to report this information correctly. See paragraph (d)(2)(iii)(A) of this section for the reporting of adjusted basis and the character of any gain or loss for the sale of a noncovered security that is a digital asset.

(iv) Information from other parties and other accounts—(A) Transfer and issuer statements. When reporting a sale of a covered security, a broker must take into account all information, other than the classification of the security (such as stock), furnished on a transfer statement (as described in § 1.6045A-1) and all information furnished or deemed furnished on an issuer statement (as described in § 1.6045B-1) unless the statement is incomplete or the broker has actual knowledge that it is incorrect. A broker may treat a customer as a minority shareholder when taking the information on an issuer statement into account unless the broker knows that the customer is a majority shareholder and the issuer statement reports the action's effect on the basis of majority shareholders. A failure to report correct information that arises solely from reliance on information furnished on a transfer statement or issuer statement is deemed to be due to reasonable cause for purposes of penalties under sections 6721 and 6722. See § 301.6724-1(a)(1) of this chapter.

(B) Other information with respect to securities. Except in the case of a covered security that is described in paragraph (a)(15)(i)(H), (J), or (K) of this section, a broker is permitted, but not required, to take into account information about a covered security other than what is furnished on a transfer statement or issuer statement, including any information the broker has about securities held by the same customer in other accounts with the broker. For purposes of penalties under sections 6721 and 6722, a broker that takes into account information with respect to securities described in the previous sentence that is received from a customer or third party other than information furnished on a transfer statement or issuer statement is deemed to have relied upon this information in good faith if the broker neither knows nor has reason to know that the information is incorrect. See § 301.6724-1(c)(6) of this chapter.

(v) Failure to receive a complete transfer statement for securities. A broker that has not received a complete transfer statement as required under § 1.6045A-1(a)(3) for a transfer of a specified security described in paragraphs (a)(14)(i) through (iv) of this section must request a complete statement from the applicable person effecting the transfer unless, under § 1.6045A-1(a), the transferor has no duty to furnish a transfer statement for the transfer. The broker is only required to make this request once. If the broker does not receive a complete transfer statement after requesting it, the broker may treat the security as a noncovered security upon its subsequent sale or transfer. A transfer statement for a covered security is complete if, in the view of the receiving broker, it provides sufficient information to comply with this section when reporting the sale of the security. A transfer statement for a noncovered security is complete if it indicates that the security is a noncovered security.

(vi) Reporting by other parties after a sale of securities—(A) Transfer statements. If a broker receives a transfer statement indicating that a security is a covered security after the broker reports the sale of the security, the broker must file a corrected return within thirty days of receiving the statement unless the broker reported the required information on the original return consistently with the transfer statement.

(B) Issuer statements. If a broker receives or is deemed to receive an issuer statement after the broker reports the sale of a covered security, the broker must file a corrected return within thirty days of receiving the issuer statement unless the broker reported the required information on the original return consistently with the issuer statement.

(C) Exception. A broker is not required to file a corrected return under this paragraph (d)(2)(vi) if the broker receives the transfer statement or issuer statement more than three years after the broker filed the return.

(vii) Examples. The following examples illustrate the rules of this paragraph (d)(2). Unless otherwise indicated, all events and transactions described in paragraphs (d)(2)(vii)(C) and (D) of this section (Examples 3 and 4) occur on or after January 1, 2026.

(A) Example 1—(1) Facts. On February 22, 2012, K sells 100 shares of stock of C, a corporation, at a loss in an account held with F, a broker. On March 15, 2012, K purchases 100 shares of C stock for cash in an account with G, a different broker. Because K acquires the stock purchased on March 15, 2012, for cash in an account after January 1, 2012, under paragraph (a)(15) of this section, the stock is a covered security. K asks G to increase K's adjusted basis in the stock to account for the application of the wash sale rules under section 1091 to the loss transaction in the account held with F.

(2) Analysis. Under paragraph (d)(2)(iv)(B) of this section, G is not required to take into account the information provided by K when subsequently reporting the adjusted basis and whether any gain or loss on the sale is long-term or short-term. If G chooses to take this information into account, under paragraph (d)(2)(iv)(B) of this section, G is deemed to have relied upon the information received from K in good faith for purposes of penalties under sections 6721 and 6722 if G neither knows nor has reason to know that the information provided by K is incorrect.

(B) Example 2—(1) Facts. L purchases shares of stock of a single corporation in an account with F, a broker, on April 17, 1969, April 17, 2012, April 17, 2013, and April 17, 2014. In January 2015, L sells all the stock.

(2) Analysis. Under paragraph (d)(2)(i)(A) of this section, F must separately report the gross proceeds and adjusted basis attributable to the stock purchased in 2014, for which the gain or loss on the sale is short-term, and the combined gross proceeds and adjusted basis attributable to the stock purchased in 2012 and 2013, for which the gain or loss on the sale is long-term. Under paragraph (d)(2)(iii)(A) of this section, F must also separately report the gross proceeds attributable to the stock purchased in 1969 as the sale of noncovered securities in order to avoid treatment of this sale as the sale of covered securities.

(C) Example 3: Ordering rule—(1) Facts. On August 1, Year 1, TP opens a hosted wallet account at CRX, a digital asset broker that owns and operates a digital asset trading platform, and purchases within the account 10 units of digital asset DE for $9 per unit. On January 1, Year 2, TP opens a hosted wallet account at BEX, another digital asset broker that owns and operates a digital asset trading platform, and purchases within this account 20 units of digital asset DE for $5 per unit. On August 1, Year 3, TP transfers the digital asset units held in TP's hosted wallet account with CRX into TP's hosted wallet account with BEX. On September 1, Year 3, TP directs BEX to sell 10 units of DE but does not specify which units are to be sold and does not provide to BEX purchase date and time information with respect to the DE units transferred into TP's account with BEX. BEX has adequate transfer-in date records with respect to TP's transfer of the 10 units of DE on August 1, Year 3. BEX effects the sale on TP's behalf for $10 per unit.

(2) Analysis. TP did not make an adequate identification of the units to be sold in a sale of DE units that was less than TP's entire position in digital asset DE. Therefore, BEX must treat the units of digital asset DE sold according to the ordering rule provided in paragraph (d)(2)(ii)(B) of this section. Pursuant to that rule, because BEX has adequate transfer-in date records with respect to TP's transfer of the 10 units of DE on August 1, Year 3, and because TP did not give BEX customer-provided acquisition information as defined by paragraph (d)(2)(ii)(B)(4) of this section with respect to the units transferred into TP's account at BEX, the units sold must be attributed to the earliest units of digital asset DE acquired by TP. Additionally, because TP did not give BEX customer-provided acquisition information, BEX must treat those units as acquired as of the date and time of the transfer (August 1, Year 3). Accordingly, the 10 units sold must be attributed to 10 of the 20 DE units purchased by TP on January 1, Year 2, in the BEX account because based on the information known to BEX these units were purchased prior to the date (August 1, Year 3) when TP transferred the other units purchased at CRX into the account. The DE units are digital assets that were acquired on or after January 1, 2026, for TP by a broker (BEX) providing custodial services, and, thus, constitute covered securities under paragraph (a)(15)(i)(J) of this section. Accordingly, in addition to the gross proceeds and other information required to be reported under paragraph (d)(2)(i)(B) of this section, BEX must also report the adjusted basis of the DE units sold, the date the DE units were purchased, and whether any gain or loss with respect to the DE units sold is long-term or short-term as required by paragraph (d)(2)(i)(D) of this section. Finally, because TP did not give BEX customer-provided acquisition information, TP will be required to treat different units as sold under the rules provided by § 1.1012-1(j)(3) from those units that BEX treats as sold under this section unless TP adopts a standing order to follow the ordering rule result required by BEX. See § 1.1012-1(j)(5)(iv) (Example 4).

(D) Example 4: Ordering rule—(1) Facts. The facts are the same as in paragraph (d)(2)(vii)(C)(1) of this section (the facts in Example 3), except on September 1, Year 3, TP's agent (CRX) provides BEX with purchase confirmations showing that the 10 units TP transferred into TP's account at BEX were purchased on August 1, Year 1. BEX neither knows nor has reason to know that the information supplied by CRX is incorrect and chooses to take this information into account for purposes of identifying which of the TP's units are sold, disposed of, or transferred.

(2) Analysis. Because TP did not make an adequate identification of the units to be sold in a sale of DE units that was less than TP's entire position in digital asset DE, BEX must treat the units of digital asset DE sold as the earliest units of digital asset DE acquired by TP. The purchase confirmations (showing a purchase date of August 1, Year 1) for the 10 units that were transferred into TP's account at BEX constitute customer-provided acquisition information under paragraph (d)(2)(ii)(B)(4) of this section, which BEX is permitted, but not required, to take into account. Accordingly, BEX is permitted to treat the 10 units sold by TP as the 10 DE units TP purchased on August 1, Year 1 (and transferred into BEX's account on August 1, Year 3), because these were the earliest units of digital asset DE acquired by TP. The DE units are digital assets that were acquired on or after January 1, 2026, for TP by a broker (CRX) providing custodial services, and, thus, constitute covered securities under paragraph (a)(15)(i)(J) of this section. However, because these covered securities were not acquired and thereafter held by the selling broker (BEX), BEX is not required to report the acquisition information required by paragraph (d)(2)(i)(D) of this section. Finally, because TP provided the purchase information with respect to the transferred in units to BEX, the units determined as sold by BEX are the same units that TP must treat as sold under § 1.1012-1(j)(3)(i). See § 1.1012-1(j)(5)(iv) (Example 4).

(3) Sales between interest payment dates. For each sale of a debt instrument prior to maturity with respect to which a broker is required to make a return of information under this section, a broker must show separately on Form 1099 the amount of accrued and unpaid qualified stated interest as of the sale date that must be reported by the customer as interest income under § 1.61-7(d). See § 1.1273-1(c) for the definition of qualified stated interest. Such interest information must be shown in the manner and at the time required by Form 1099 and section 6049.

(4) Sale date—(i) In general. For sales of property that are reportable under this section other than digital assets, a broker must report a sale as occurring on the date the sale is entered on the books of the broker.

(ii) Special rules for digital asset sales. For sales of digital assets that are effected when digitally recorded using cryptographically secured distributed ledger technology, such as a blockchain or similar technology, the broker must report the date of sale as the date when the transactions are recorded on the ledger. For sales of digital assets that are effected by a broker and recorded in the broker's books and records (commonly referred to as an off-chain transaction) and not directly on a distributed ledger or similar technology, the broker must report the date of sale as the date when the transactions are recorded on its books and records without regard to the date that the transactions may be later recorded on the distributed ledger or similar technology.

(5) Gross proceeds—(i) In general. Except as otherwise provided in paragraph (d)(5)(ii) of this section with respect to digital asset sales, for purposes of this section, gross proceeds on a sale are the total amount paid to the customer or credited to the customer's account as a result of the sale reduced by the amount of any qualified stated interest reported under paragraph (d)(3) of this section and increased by any amount not paid or credited by reason of repayment of margin loans. In the case of a closing transaction (other than a closing transaction related to an option) that results in a loss, gross proceeds are the amount debited from the customer's account. For sales before January 1, 2014, a broker may, but is not required to, reduce gross proceeds by the amount of commissions and transfer taxes, provided the treatment chosen is consistent with the books of the broker. For sales on or after January 1, 2014, a broker must reduce gross proceeds by the amount of commissions and transfer taxes related to the sale of the security. For securities sold pursuant to the exercise of an option granted or acquired before January 1, 2014, a broker may, but is not required to, take the option premiums into account in determining the gross proceeds of the securities sold, provided the treatment chosen is consistent with the books of the broker. For securities sold pursuant to the exercise of an option granted or acquired on or after January 1, 2014, or for the treatment of an option granted or acquired on or after January 1, 2014, see paragraph (m) of this section. A broker must report the gross proceeds of identical stock (within the meaning of § 1.1012-1(e)(4)) by averaging the proceeds of each share if the stock is sold at separate times on the same calendar day in executing a single trade order and the broker executing the trade provides a single confirmation to the customer that reports an aggregate total price or an average price per share. However, a broker may not average the proceeds if the customer notifies the broker in writing of an intent to determine the proceeds of the stock by the actual proceeds per share and the broker receives the notification by January 15 of the calendar year following the year of the sale. A broker may extend the January 15 deadline but not beyond the due date for filing the return required under this section.

(ii) Sales of digital assets. The rules contained in paragraphs (d)(5)(ii)(A) and (B) of this section apply solely for purposes of this section.

(A) Determining gross proceeds. Except as otherwise provided in this section, gross proceeds from the sale of a digital asset are equal to the sum of the total cash paid to the customer or credited to the customer's account from the sale plus the fair market value of any property or services received (including services giving rise to digital asset transaction costs), reduced by the amount of digital asset transaction costs, as defined and allocated under paragraph (d)(5)(iv) of this section. In the case of a debt instrument issued in exchange for the digital asset and subject to § 1.1001-1(g), the amount realized attributable to the debt instrument is determined under § 1.1001-7(b)(1)(iv) rather than by reference to the fair market value of the debt instrument. See paragraph (d)(5)(iv)(C) of this section for a special rule setting forth how cascading digital asset transaction costs are to be allocated in certain exchanges of one digital asset for a different digital asset.

(1) Determining fair market value. Fair market value is measured at the date and time the transaction was effected. Except as provided in the next sentence, in determining the fair market value of services or property received or credited in exchange for a digital asset, the broker must use a reasonable valuation method that looks to contemporaneous evidence of value, such as the purchase price of the services, goods or other property, the exchange rate, and the U.S. dollar valuation applied by the broker to effect the exchange. In determining the fair market value of services giving rise to digital asset transaction costs, the broker must look to the fair market value of the digital assets used to pay for such transaction costs. In determining the fair market value of a digital asset, the broker may perform its own valuations or rely on valuations performed by a digital asset data aggregator as defined in paragraph (d)(5)(ii)(B) of this section, provided such valuations apply a reasonable valuation method for digital assets as described in paragraph (d)(5)(ii)(A)(3) of this section.

(2) Consideration value not readily ascertainable. When valuing services or property (including digital assets) received in exchange for a digital asset, the value of what is received should ordinarily be identical to the value of the digital asset exchanged. If there is a disparity between the value of services or property received and the value of the digital asset exchanged, the gross proceeds received by the customer is the fair market value at the date and time the transaction was effected of the services or property, including digital assets, received. If the broker or digital asset data aggregator, in the case of digital assets, reasonably determines that the fair market value of the services or property received cannot be determined with reasonable accuracy, the fair market value of the received services or property must be determined by reference to the fair market value of the transferred digital asset at the time of the exchange. See § 1.1001-7(b)(4). If the broker or digital asset data aggregator, in the case of a digital asset, reasonably determines that neither the value of the received services or property nor the value of the transferred digital asset can be determined with reasonable accuracy, the broker must report that the received services or property has an undeterminable value.

(3) Reasonable valuation method for digital assets. A reasonable valuation method for digital assets is a method that considers and appropriately weighs the pricing, trading volumes, market capitalization and other factors relevant to the valuation of digital assets traded through digital asset trading platforms. A valuation method is not a reasonable valuation method for digital assets if it, for example, gives an underweight effect to exchange prices lying near the median price value, an overweight effect to digital asset trading platforms having low trading volume, or otherwise inappropriately weighs factors associated with a price that would make that price an unreliable indicator of value.

(B) Digital asset data aggregator. A digital asset data aggregator is an information service provider that provides valuations of digital assets based on any reasonable valuation method.

(iii) Digital asset transactions effected by processors of digital asset payments. The amount of gross proceeds under paragraph (d)(5)(ii) of this section received by a party who sells a digital asset under paragraph (a)(9)(ii)(D) of this section (effected by a processor of digital asset payments) is equal to: the sum of the amount paid in cash, and the fair market value of the amount paid in digital assets by that processor to a second party, plus any digital asset transaction costs and other fees charged to the second party that are withheld (whether withheld from the digital assets transferred by the first party or withheld from the amount due to the second party); and reduced by the amount of digital asset transaction costs paid by or withheld from the first party, as defined and allocated under the rules of paragraph (d)(5)(iv) of this section.

(iv) Definition and allocation of digital asset transaction costs—(A) Definition. The term digital asset transaction costs means the amount paid in cash or property (including digital assets) to effect the sale, disposition, or acquisition of a digital asset. Digital asset transaction costs include transaction fees, transfer taxes, and commissions.

(B) General allocation rule. Except as provided in paragraph (d)(5)(iv)(C) of this section, in the case of a sale or disposition of digital assets, the total digital asset transaction costs paid by the customer are allocable to the sale or disposition of the digital assets.

(C) Special rule for allocation of certain cascading digital asset transaction costs. In the case of a sale of one digital asset in exchange for another digital asset differing materially in kind or in extent (original transaction) and for which digital assets received in the original transaction are withheld to pay digital asset transaction costs, the total digital asset transaction costs paid by the taxpayer to effect both the original transaction and the disposition of the withheld digital assets are allocable exclusively to the disposition of digital assets in the original transaction.

(v) Examples. The following examples illustrate the rules of this paragraph (d)(5). Unless otherwise indicated, all events and transactions in the following examples occur on or after January 1, 2025.

(A) Example 1: Determination of gross proceeds when digital asset transaction costs paid in digital assets—(1) Facts. CRX, a digital asset broker, buys, sells, and exchanges various digital assets for cash or different digital assets on behalf of its customers. For this service, CRX charges a transaction fee equal to 1 unit of CRX's proprietary digital asset CM per transaction. Using the services of CRX, customer K, an individual not otherwise exempt from reporting, purchases 15 units of CM and 10 units of digital asset DE. On April 28, Year 1, when the CM units have a value of $2 per unit, the DE units have a value of $8 per unit, and digital asset ST units have a value of $0.80 per unit, K instructs CRX to exchange K's 10 units of DE for 100 units of digital asset ST. CRX charges K one unit of CM as a transaction fee for the exchange.

(2) Analysis. Under paragraph (d)(5)(iv)(A) of this section, K has digital asset transaction costs of $2, which is the value of 1 CM unit. Under paragraph (d)(5)(ii)(A) of this section, the gross proceeds amount that CRX must report from K's sale of the 10 units of DE is equal to the fair market value of the 100 units of ST that K received (less the value of the CM unit sold to pay the digital asset transaction cost to CRX and allocable to the sale of the DE units). The fair market value of the 100 units of ST at the date and time the transaction was effected is equal to $80 (the product of $0.80 and 100 units). Accordingly, CRX must report gross proceeds of $78 from K's sale of the 10 units of DE. CRX must also report the gross proceeds from K's sale of one CM unit to pay for CRX's services. Under paragraph (d)(5)(ii)(A) of this section, the gross proceeds from K's sale of one unit of CM is equal to the fair market value of the digital assets used to pay for such transaction costs. Accordingly, CRX must report $2 as gross proceeds from K's sale of one unit of CM.

(B) Example 2: Determination of gross proceeds when digital asset transaction costs are withheld from transferred digital assets—(1) Facts. K owns a total of 10 units of digital asset A that K deposits with broker BEX that provides custodial services for digital assets. K directs BEX to effect the exchange of 10 units of K's digital asset A for 20 units of digital asset B. At the time of the exchange, each unit of digital asset A has a fair market value of $2 and each unit of digital asset B has a fair market value of $1. BEX charges a fee of $2 per transaction, which BEX withholds from the units of the digital asset A transferred. At the time of the transaction, BEX withholds 1 unit of digital asset A. TP exchanges the remaining 9 units of digital asset A for 18 units of digital asset B.

(2) Analysis. The withholding of 1 unit of digital asset A is a sale of a digital asset for BEX's services within the meaning of paragraph (a)(9)(ii)(C) of this section. Under paragraph (d)(5)(iv)(A) of this section, K has digital asset transaction costs of $2. Under paragraph (d)(5)(iv)(C) of this section, TP must allocate such costs to the disposition of the 10 units of digital asset A. Under paragraphs (d)(5)(ii)(A) and (d)(5)(iv)(C) of this section, TP's gross proceeds from the sale of the 10 units of digital asset A is $18, which is the excess of the fair market value of the 18 units of digital asset B received ($18) and the fair market value of the broker services received ($2) as of the date and time of the transaction over the allocated digital asset transaction costs ($2). Accordingly, BEX must report $18 as gross proceeds from K's sale of 10 units of digital asset A.

(C) Example 3: Determination of gross proceeds when digital asset transaction costs are withheld from acquired digital assets in an exchange of digital assets—(1) Facts. The facts are the same as in paragraph (d)(5)(v)(B)(1) of this section (the facts in Example 2), except that BEX requires its payment be withheld from the units of the digital asset acquired. At the time of the transaction, BEX withholds 3 units of digital asset B, two units of which effect the exchange of digital asset A for digital asset B and one unit of which effects the disposition of digital asset B for payment of the transaction fees.

(2) Analysis. The withholding of 3 units of digital asset B is a disposition of digital assets for BEX's services within the meaning of paragraph (a)(9)(ii)(C) of this section. Under paragraph (d)(5)(iv)(A) of this section, K has digital asset transaction costs of $3. Under paragraph (d)(5)(iv)(C) of this section, K must allocate such costs to the disposition of the 10 units of digital asset A. Under paragraphs (d)(5)(ii)(A) and (d)(5)(iv)(C) of this section, K's gross proceeds from the sale of the 10 units of digital asset A is $17, which is the excess of the fair market value of the 20 units of digital asset B received ($20) as of the date and time of the transaction over the allocated digital asset transaction costs ($3). K's gross proceeds from the sale of the 3 units of digital asset B used to pay digital asset transaction costs is $3, which is the fair market value of BEX's services received at the time of the transaction. Accordingly, BEX must report $17 as gross proceeds from K's sale of 10 units of digital asset A. Additionally, pursuant to paragraph (c)(3)(ii)(C) of this section, BEX is not required to report K's sale of the 3 withheld units of digital asset B because the 3 units of digital asset B were units withheld from digital assets received by K to pay for K's digital asset transaction costs.

(D) Example 4: Determination of gross proceeds—(1) Facts. CPP, a processor of digital asset payments, offers debit cards to its customers who hold digital asset FE in their accounts with CPP. The debit cards allow CPP's customers to use digital assets held in accounts with CPP to make payments to merchants who do not accept digital assets. CPP charges its card holders a 2% transaction fee for purchases made using the debit card and sets forth in its terms and conditions the process CPP will use to determine the exchange rate provided at the date and time of its customers' transactions. CPP has issued a debit card to B, an individual not otherwise exempt from reporting, who wants to make purchases using digital assets. B transfers 1,000 units of FE into B's account with CPP. B then uses the debit card to purchase merchandise from a U.S. merchant STR for $1,000. An exchange rate of 1 FE = $2 USD is applied to effect the transaction, based on the exchange rate at that date and time and pursuant to B's account agreement. To settle the transaction, CPP removes 510 units of FE from B's account equal to $1,020 ($1,000 plus a 2% transaction fee equal to $20). CPP then pays STR $1,000 in cash.

(2) Analysis. B paid $20 of digital asset transaction costs as defined in paragraph (d)(5)(iv)(A) of this section. Under paragraph (d)(5)(iii) of this section, the gross proceeds amount that CPP must report with respect to B's sale of the 510 units of FE to purchase the merchandise is $1,000, which is the sum of the amount of cash paid by CPP to STR plus the $20 digital asset transaction costs withheld by CPP, reduced by the $20 digital asset transaction costs as allocated under paragraph (d)(5)(iv)(B) of this section. CPP's payment of cash to STR is also a payment card transaction under § 1.6050W-1(b) subject to reporting under § 1.6050W-1(a).

(E) Example 5: Determination of gross proceeds—(1) Facts. STR, a U.S. merchant corporation, advertises that it accepts digital asset FE as payment for its merchandise that is not digital assets. Customers making purchases at STR using digital asset FE are directed to create an account with CXX, a processor of digital asset payments, which, pursuant to a preexisting agreement with STR, accepts digital asset FE in return for payments in cash made to STR. CXX charges a 2% transaction fee, which is paid by STR and not STR's customers. S, an individual not otherwise exempt from reporting, seeks to purchase merchandise from STR for $10,000. To effect payment, S is directed by STR to CXX, with whom S has an account. An exchange rate of 1 FE = $2 USD is applied to effect the purchase transaction. Pursuant to this exchange rate, S then transfers 5,000 units of FE to CXX, which, in turn, pays STR $9,800 ($10,000 less a 2% transaction fee equal to $200).

(2) Analysis. Under paragraph (d)(5)(iii) of this section, the gross proceeds amount that CXX must report with respect to this sale is $10,000, which is the sum of the amount in U.S. dollars paid by CPP to STR ($9,800) plus the $200 digital asset transaction costs withheld from the payment due to STR. Because S does not have any digital asset transaction costs, the $9,800 amount is not reduced by any digital asset transaction costs charged to STR because that fee was not paid by S. In addition, CXX's payment of cash to STR (plus the withheld transaction fee) may be reportable under § 1.6050W-1(a) as a third party network transaction under § 1.6050W-1(c) if CXX is a third party settlement organization under the definition in § 1.6050W-1(c)(2).

(F) Example 6: Determination of gross proceeds in a real estate transaction—(1) Facts. J, an unmarried individual not otherwise exempt from reporting, enters into a contractual agreement with B, an individual not otherwise exempt from reporting, to exchange J's principal residence, Blackacre, which has a fair market value of $300,000, for cash in the amount of $75,000 and units of digital asset DE with a value of $225,000. Prior to closing, B transfers the digital asset portion of the payment directly from B's wallet to J's wallet. At closing, J certifies to the closing agent (CA) that J received the DE units required to be paid under the contractual agreement. CA is also a real estate reporting person under § 1.6045-4, and a digital asset middleman under paragraph (a)(21) of this section with respect to the transaction.

(2) Analysis. CA is required to report on Form 1099-DA the gross proceeds received by B in exchange for B's sale of digital assets in this transaction. The gross proceeds amount to be reported under paragraph (d)(5)(ii)(A) of this section is equal to $225,000, which is the $300,000 value of Blackacre less $75,000 that B paid in cash. In addition, under § 1.6045-4, CA is required to report on Form 1099-S the $300,000 of gross proceeds received by J ($75,000 cash and $225,000 in digital assets) as consideration for J's disposition of Blackacre.

(6) Adjusted basis—(i) In general. For purposes of this section, the adjusted basis of a specified security is determined from the initial basis under paragraph (d)(6)(ii) of this section as of the date the specified security is acquired in an account, increased by the commissions and transfer taxes related to its sale to the extent not accounted for in gross proceeds as described in paragraph (d)(5) of this section. A broker is not required to consider transactions or events occurring outside the account except for an organizational action taken by an issuer of a specified security other than a digital asset during the period the broker holds custody of the security (beginning with the date that the broker receives a transferred security) reported on an issuer statement (as described in § 1.6045B-1) furnished or deemed furnished to the broker. Except as otherwise provided in paragraph (n) of this section, a broker is not required to consider customer elections. For rules related to the adjusted basis of a debt instrument, see paragraph (n) of this section.

(ii) Initial basis—(A) Cost basis for specified securities acquired for cash. For a specified security acquired for cash, the initial basis generally is the total amount of cash paid by the customer or credited against the customer's account for the specified security, increased by the commissions, transfer taxes, and digital asset transaction costs related to its acquisition. A broker may, but is not required to, take option premiums into account in determining the initial basis of securities purchased or acquired pursuant to the exercise of an option granted or acquired before January 1, 2014. For rules related to options granted or acquired on or after January 1, 2014, see paragraph (m) of this section. A broker may, but is not required to, increase initial basis for income recognized upon the exercise of a compensatory option or the vesting or exercise of other equity-based compensation arrangements, granted or acquired before January 1, 2014. A broker may not increase initial basis for income recognized upon the exercise of a compensatory option or the vesting or exercise of other equity-based compensation arrangements, granted or acquired on or after January 1, 2014, or upon the vesting or exercise of a digital asset-based compensation arrangement granted or acquired on or after January 1, 2025. A broker must report the basis of identical stock (within the meaning of § 1.1012-1(e)(4)) by averaging the basis of each share if the stock is purchased at separate times on the same calendar day in executing a single trade order and the broker executing the trade provides a single confirmation to the customer that reports an aggregate total price or an average price per share. However, a broker may not average the basis if the customer timely notifies the broker in writing of an intent to determine the basis of the stock by the actual cost per share in accordance with § 1.1012-1(c)(1)(ii).

(B) Basis of transferred securities—(1) In general. The initial basis of a security transferred to an account is generally the basis reported on the transfer statement (as described in § 1.6045A-1).

(2) Securities acquired by gift. If a transfer statement indicates that the security is acquired as a gift, a broker must apply the relevant basis rules for property acquired by gift in determining the initial basis, but is not required to adjust basis for gift tax. A broker must treat the initial basis as equal to the gross proceeds from the sale determined under paragraph (d)(5) of this section if the relevant basis rules for property acquired by gift prevent recognizing both gain and loss, or if the relevant basis rules treat the initial basis of the security as its fair market value as of the date of the gift and the broker neither knows nor can readily ascertain this value. If the transfer statement did not report a date for the gift, the broker must treat the settlement date for the transfer as the date of the gift.

(C) Digital assets acquired in exchange for property—(1) In general. This paragraph (d)(6)(ii)(C) applies solely for purposes of this section. For a digital asset acquired in exchange for property that is not a debt instrument described in § 1.1012-1(h)(1)(v) or another digital asset differing materially in kind or extent, the initial basis of the digital asset is the fair market value of the digital asset received at the time of the exchange, increased by any digital asset transaction costs allocable to the acquisition of the digital asset. The fair market value of the digital asset received must be determined using a reasonable valuation method as of the date and time the exchange transaction was effected. In valuing the digital asset received, the broker may perform its own valuations or rely on valuations performed by a digital asset data aggregator as defined in paragraph (d)(5)(ii)(B) of this section, provided such valuations apply a reasonable valuation method for digital assets as described in paragraph (d)(5)(ii)(A)(3) of this section. If the broker or digital asset data aggregator reasonably determines that the fair market value of the digital asset received cannot be determined with reasonable accuracy, the fair market value of the digital asset received must be determined by reference to the property transferred at the time of the exchange. If the broker or digital asset data aggregator reasonably determines that neither the value of the digital asset received nor the value of the property transferred can be determined with reasonable accuracy, the fair market value of the received digital asset must be treated as zero. For a digital asset acquired in exchange for another digital asset differing materially in kind or extent, see paragraph (d)(6)(ii)(C)(2) of this section. For a digital asset acquired in exchange for a debt instrument described in § 1.1012-1(h)(1)(v), the initial basis of the digital asset attributable to the debt instrument is the amount determined under § 1.1012-1(h)(1)(v).

(2) Allocation of digital asset transaction costs. Except as provided in the following sentence, in the case of a sale of one digital asset in exchange for another digital asset differing materially in kind or extent, the total digital asset transaction costs paid by the customer are allocable to the digital assets disposed. In the case of a transaction described in paragraph (d)(5)(iv)(C) of this section, the digital asset transaction costs paid by the customer to acquire the digital assets received are allocable as provided therein.

(iii) Adjustments for wash sales—(A) Securities in the same account or wallet—(1) In general. A broker must apply the wash sale rules under section 1091 if both the sale and purchase transactions are of covered securities, other than covered securities reportable as digital assets after the application of paragraph (c)(8) of this section, with the same CUSIP number or other security identifier number that the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter). When reporting the sale transaction that triggered the wash sale, the broker must report the amount of loss that is disallowed by section 1091 in addition to gross proceeds and adjusted basis. The broker must increase the basis of the purchased covered security by the amount of loss disallowed on the sale transaction.

(2) Special rules for covered securities that are also digital assets. In the case of a purchase or sale of a tokenized security described in paragraph (c)(8)(i)(D) of this section that is a stock or security for purposes of section 1091, a broker must apply the wash sale rules under section 1091 if both the sale and purchase transactions are of covered securities with the same CUSIP number or other security identifier number that the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter). When reporting the sale transaction that triggered the wash sale, the broker must report the amount of loss that is disallowed by section 1091 in addition to gross proceeds and adjusted basis. The broker must increase the basis of the purchased covered security by the amount of loss disallowed on the sale transaction.

(B) Covered securities in different accounts or wallets. A broker is not required to apply paragraph (d)(6)(iii)(A) of this section if the covered securities are purchased and sold from different accounts or wallets, if the purchased covered security is transferred to another account or wallet before the wash sale, or if the covered securities are treated as held in separate accounts under § 1.1012-1(e). A covered security is not purchased in an account or wallet if it is purchased in another account or wallet and transferred into the account or wallet.

(C) Effect of election under section 475(f)(1). A broker is not required to apply paragraph (d)(6)(iii)(A) of this section to securities in an account if a customer has in writing both informed the broker that the customer has made a valid and timely election under section 475(f)(1) and identified the account as solely containing securities subject to the election. For purposes of this paragraph (d)(6)(iii)(C), a writing may be in electronic format. If a customer subsequently informs a broker that the election no longer applies to the customer or the account, the broker must prospectively apply paragraph (d)(6)(iii)(A) of this section but is not required to apply paragraph (d)(6)(iii)(A) of this section for the period covered by the customer's prior instruction to the broker. A taxpayer that is not a trader in securities within the meaning of section 475(f)(1) does not become a trader in securities, or create an inference that it is a trader in securities, by notifying a broker that it has made a valid and timely election under section 475(f)(1).

(D) Reporting at or near the time of sale. If a wash sale occurs after a broker has completed a return or statement reporting a sale of a covered security, the broker must redetermine adjusted basis under this paragraph (d)(6)(iii) and, if the return or statement included information inconsistent with this redetermination, correct the return or statement by the applicable original due date set forth in this section for the return or statement.

(iv) Certain adjustments not taken into account. A broker is not required to apply section 1259 (regarding constructive sales), section 475 (regarding the mark-to-market method of accounting), section 1296 (regarding the mark-to-market method of accounting for marketable stock in a passive foreign investment company), or section 1092 (regarding straddles) when reporting adjusted basis.

(v) Average basis method adjustments. For a covered security for which basis may be determined by the average basis method, a broker must compute basis using the average basis method if a customer validly elects that method for the covered securities sold or, in the absence of any instruction from the customer, if the broker chooses that method as its default basis determination method. See § 1.1012-1(e). The previous sentence applies to any stock that is also a tokenized security described in paragraph (c)(8)(i)(D) of this section.

(vi) Regulated investment company and real estate investment trust adjustments. A broker must adjust the basis of a covered security issued by a regulated investment company or real estate investment trust for the effects of undistributed capital gains reported to or by the broker under section 852(b)(3)(D) or section 857(b)(3)(D).

(vii) Treatment of de minimis errors. For purposes of this section, a customer's adjusted basis generally must be determined by treating any incorrect dollar amount that is not required to be corrected by reason of section 6721(c)(3) or 6722(c)(3) as the correct amount. However, if a broker, upon identifying a dollar amount as incorrect, voluntarily or is required to file a corrected information return and furnish the corresponding corrected payee statement showing the correct dollar amount, then regardless of any provision under section 6721 or 6722, the adjusted basis for purposes of this section must be based on and consistent with the correct dollar amount as reported on the corrected information return and corrected payee statement.

(viii) Examples. The following examples, in which all the securities are covered securities, illustrate the rules of this paragraph (d)(6):

(A)Example 1.—1) On September 21, 2012, P purchases 100 shares of stock in an account with J, a broker. On December 14, 2012, P purchases 100 shares of stock with the same CUSIP number in the same account. On January 4, 2013, P sells the 100 shares purchased on September 21, 2012, at a loss.

(2) Because the sale of stock on January 4, 2013, and the purchase of stock on December 14, 2012, are of covered securities with the same CUSIP number, under paragraph (d)(6)(iii)(A) of this section, J must report the amount of loss disallowed by section 1091 in addition to the gross proceeds of the sale and the adjusted basis of the September 21, 2012, stock.

(3) P later sells the stock acquired on December 14, 2012. When reporting the sale of the stock, under paragraph (d)(6)(iii)(A) of this section, J must increase the adjusted basis of the stock acquired on December 14, 2012, by the amount of loss disallowed on the January 4, 2013, sale.

(B) Example 2. Assume the same facts as in paragraph (d)(6)(viii)(A)(1) of this section (Example 1) except that the December 14, 2012, purchase occurs in another account P maintains with J. Because the December 14, 2012, purchase does not occur in the same account as the sale of the September 21, 2012, stock, under paragraph (d)(6)(iii)(B) of this section, J is not required to apply the wash sale rules in reporting the sale of stock acquired on September 21, 2012, or December 14, 2012. Under paragraphs (d)(2)(iii) and (d)(2)(iv)(B) of this section, J may choose to apply the wash sale rules as if the transactions occurred in the same account. The result is the same whether P keeps the stock purchased on December 14, 2012, in the other account or transfers the stock into the account from which P sells the stock sold on January 4, 2013.

(C) Example 3.—(1) K, a regulated investment company, offers two funds for sale, Fund D and Fund E. On April 22, 2012, Q purchases shares of Fund D and pays a separate load charge. By paying the load charge, Q acquires a reinvestment right in shares of Fund E. On April 23, 2012, at the request of Q, Fund D redeems the shares. Q uses the proceeds to purchase shares of Fund E in a separate account. As a result of the reinvestment right, Q pays no load charge in purchasing the Fund E shares. (2) Under paragraph (d)(6)(i) of this section, when reporting adjusted basis of the Fund D and Fund E shares at the time of their redemption, K is not required to adjust basis for any deferral of the load charge under section 852(f), because the transactions concerning Fund D and Fund E occur in separate accounts. Under paragraph (d)(2)(iv)(B) of this section, K may choose to apply the provisions of section 852(f).

(D) Example 4. R, an employee of C, a corporation, participates in C's stock option plan. On April 2, 2014, C grants R a nonstatutory option under the plan to buy 100 shares of stock. The option becomes substantially vested on April 2, 2015. On October 2, 2015, R exercises the option and purchases 100 shares. On December 2, 2015, R sells the 100 shares. Under paragraph (d)(6)(ii)(A) of this section, C is required to determine adjusted basis from the amount R pays under the terms of the option. Under paragraph (d)(6)(ii)(A) of this section, C is not permitted to adjust basis for any amount R must include as wage income with respect to the October 2, 2015, stock purchase.

(ix) Applicability date. Paragraph (d)(6)(vii) of this section applies with respect to information returns required to be filed and payee statements required to be furnished on or after January 1, 2024.

(x) Examples. The following examples illustrate the rules of paragraph (d)(5) of this section and this paragraph (d)(6) as applied to digital assets. Unless otherwise indicated, all events and transactions in the following examples occur using the services of CRX, an entity that owns and operates a digital asset trading platform and provides digital asset broker and hosted wallet services. In performing these services, CRX holds and records all customer purchase and sale transactions using CRX's centralized omnibus account. CRX does not record any of its customer's purchase or sale transactions on the relevant cryptographically secured distributed ledgers. Additionally, unless otherwise indicated, all events and transactions in the following examples occur on or after January 1, 2026.

(A) Example 1: Determination of gross proceeds and basis in digital assets—(1) Facts. As a digital asset broker, CRX generally charges transaction fees equal to 1 unit of CRX's proprietary digital asset CM per transaction. CRX does not, however, charge transaction fees for the purchase of CM. On March 9, Year 1, K, an individual not otherwise exempt from reporting, purchases 20 units of CM for $20 in cash in K's account at CRX. A week later, on March 16, Year 1, K uses CRX's services to purchase 10 units of digital asset DE for $80 in cash. To pay for CRX's transaction fee, K directs CRX to debit 1 unit of CM (worth $1 at the time of transfer) from K's account.

(2) Analysis. Under paragraph (d)(2)(i)(B) of this section, CRX must report the gross proceeds from K's sale of 1 unit of CM. Additionally, because the units of CM were purchased in K's account at a broker providing custodial services for digital assets that are specified securities described in paragraph (a)(14)(v) of this section, the units of CM purchased by K are covered securities under paragraph (a)(15)(i)(J) of this section. Accordingly, under paragraphs (d)(2)(i)(D)(1) and (2) of this section, CRX must report K's adjusted basis in the 1 unit of CM and whether any gain or loss with respect to the CM unit sold is long-term or short-term. The gross proceeds from that sale is equal to the fair market value of the CM units on March 16, Year 1 ($1), and the adjusted basis of that unit is equal to the amount K paid in cash for the CM unit on March 9, Year 1 ($1). This reporting is required regardless of the fact that there is $0 of gain or loss associated with this sale. Additionally, K's adjusted basis in the 10 units of DE acquired is equal to the $81 initial basis in DE, which is $80 plus the $1 value of 1 unit of CM paid as a digital asset transaction cost for the purchase of the DE units.

(B) Example 2: Determination of gross proceeds and basis in digital assets—(1) Facts. The facts are the same as in paragraph (d)(6)(x)(A)(1) of this section (the facts in Example 1), except that on June 12, Year 2, K instructs CRX to exchange K's 10 units of DE for 50 units of digital asset ST. CRX effects this exchange using its own omnibus account holdings of ST at an exchange rate of 1 DE = 5 ST. The total value of the 50 units of ST received by K is $100. K directs CRX to debit 1 CM unit (worth $2 at the time of the transfer) from K's account to pay CRX for the transaction fee.

(2) Analysis. K has digital asset transaction costs of $2 as defined in paragraph (d)(5)(iv)(A) of this section, which is the value of 1 unit of CM. Under paragraph (d)(2)(i)(B) of this section, CRX must report the gross proceeds from K's exchange of DE for ST (as a sale of K's 10 units of DE) and the gross proceeds from K's disposition of 1 unit of CM for CRX's services. Additionally, because the units of DE and CM were purchased in K's account at a broker providing custodial services for digital assets that are specified securities described in paragraph (a)(14)(v) of this section, the units of DE and CM are covered securities under paragraph (a)(15)(i)(J) of this section, and, pursuant to paragraphs (d)(2)(i)(D)(1) and (2) of this section, CRX must report K's adjusted basis in the 10 units of DE and 1 unit of CM and whether any gain or loss with respect to the those units is long-term or short-term. Under paragraph (d)(5)(ii)(A) of this section, the gross proceeds from K's sale of the DE units is $98 (the fair market value of the 50 units of ST that K received less the $2 digital asset transaction costs paid by K using 1 unit of CM), that is allocable to the sale of the DE units. Under this paragraph (d)(6), K's adjusted basis in the 10 units of DE is $81 (which is $80 plus the $1 value of 1 unit of CM paid as a digital asset transaction cost for the purchase of the DE units), resulting in a long-term capital gain to K of $17 ($98-$81). The gross proceeds from K's sale of the single unit of CM is $2, and K's adjusted basis in the single unit of CM is $1, resulting in a long-term capital gain to K of $1 ($2-$1). K's adjusted basis in the ST units under paragraph (d)(6)(ii)(C) of this section is equal to the initial basis in ST, which is $100.

(C) Example 3: Determination of gross proceeds and basis when digital asset transaction costs are withheld from transferred digital assets—(1) Facts. K has an account with digital asset broker BEX. On December 20, Year 1, K acquired 10 units of digital asset A, for $2 per unit, and 100 units of digital asset B, for $0.50 per unit. (Assume that K did not incur any digital asset transaction costs on the units acquired on December 20, Year 1.) On July 20, Year 2, K directs BEX to effect the exchange of 10 units of digital asset A for 50 units of digital asset B. At the time of the exchange, each unit of digital asset A has a fair market value of $5 per unit and each unit of digital asset B has a fair market value of $1 per unit. For the exchange of 10 units of digital asset A for 50 units of digital asset B, BEX charges K a transaction fee equal to 2 units of digital asset B, which BEX withholds from the units of the digital asset B credited to K's account on July 20, Year 2. For the disposition of 2 units of digital asset B withheld, BEX charges an additional transaction fee equal to 1 unit of digital asset B, which BEX also withholds from the units of digital asset B credited to K's account on July 20, Year 2. K has a standing order with BEX for the specific identification of digital assets as from the earliest units acquired.

(2) Reporting with respect to the disposition of the A units. The withholding of 3 units of digital asset B is a disposition of digital assets for BEX's services within the meaning of paragraph (a)(9)(ii)(C) of this section. Under paragraph (d)(5)(iv)(A) of this section, K has digital asset transaction costs of $3. Under paragraph (d)(5)(iv)(C) of this section, the exchange of 10 units of digital asset A for 50 units of digital asset B is the original transaction. Accordingly, BEX must allocate the digital asset transaction costs of $3 exclusively to the disposition of the 10 units of digital asset A. Additionally, because the units of A are specified securities described in paragraph (a)(14)(v) of this section and were purchased in K's account at BEX by a broker providing custodial services for such specified securities, the units of A are covered securities under paragraph (a)(15)(i)(J) of this section, and BEX must report K's adjusted basis in the 10 units of A. Under paragraphs (d)(5)(ii)(A) and (d)(5)(iv)(C) of this section, K's gross proceeds from the sale of the 10 units of digital asset A is $47, which is the excess of the fair market value of the 50 units of digital asset B received ($50) as of the date and time of the transaction over the allocated digital asset transaction costs ($3). Under this paragraph (d)(6), K's adjusted basis in the 10 units of A is $20, resulting in a short-term capital gain to K of $27 ($47-$20).

(3) Reporting with respect to the disposition of the withheld B units. K's gross proceeds from the sale of the 3 units of digital asset B used to pay digital asset transaction costs is $3, which is the fair market value of the digital assets used to pay for such transaction costs. Pursuant to the special rule for the identification of units withheld from digital assets received in a transaction to pay a customer's digital asset transaction costs under paragraph (d)(2)(ii)(B)(3) of this section and regardless of K's standing order, the withheld units sold are treated as from the units received in the original (A for B) transaction. Accordingly, the basis of the 3 withheld units of digital asset B is $3, which is the fair market value of the 3 units of digital asset B received. Finally, pursuant to paragraph (c)(3)(ii)(C) of this section, BEX is not required to report K's sale of the 3 withheld units of digital asset B because the 3 units of digital asset B were units withheld from digital assets received by K to pay for K's digital asset transaction costs.

(D) Example 4: Determination of gross proceeds and basis for digital assets—(1) Facts. On August 26, Year 1, Customer P purchases 10 units of digital asset DE for $2 per unit in cash in an account at CRX. CRX charges P a fixed transaction fee of $5 in cash for the exchange. On October 26, Year 2, P directs CRX to exchange P's 10 units of DE for units of digital asset FG. At the time of the exchange, CRX determines that each unit of DE has a fair market value of $100 and each unit of FG has a fair market value of $50. As a result of this determination, CRX effects an exchange of P's 10 units of DE for 20 units of FG. CRX charges P a fixed transaction fee of $20 in cash for the exchange.

(2) Analysis. Under paragraph (d)(5)(iv)(B) of this section, P has digital asset transaction costs of $20 associated with the exchange of DE for FG which must be allocated to the sale of the DE units. For the transaction that took place on October 26, Year 2, under paragraph (d)(2)(i)(B) of this section, CRX must report the amount of gross proceeds from the sale of DE in the amount of $980 (the $1,000 fair market value of FG received on the date and time of transfer, less all of the digital asset transaction costs of $20 allocated to the sale). Under paragraph (d)(6)(ii)(C) of this section, the adjusted basis of P's DE units is equal to $25, which is the $20 paid in cash for the 10 units increased by the $5 digital asset transaction costs allocable to that purchase. Finally, P's adjusted basis in the 20 units of FG is equal to the fair market value of the FG received, $1,000, because none of the $20 transaction fee may be allocated under paragraph (d)(6)(ii)(C)(2) of this section to the acquisition of P's FG units.

(7) Long-term or short-term gain or loss—(i) In general. In determining whether any gain or loss on the sale of a covered security is long-term or short-term within the meaning of section 1222 for purposes of this section, the following rules apply:

(A) A broker must consider the information reported on a transfer statement (as described in § 1.6045A-1).

(B) A broker is not required to consider transactions, elections, or events occurring outside the account except for an organizational action taken by an issuer during the period the broker holds custody of the covered security (beginning with the date that the broker receives a transferred security) reported on an issuer statement (as described in § 1.6045B-1) furnished or deemed furnished to the broker.

(C) A broker is required to apply the relevant rules for property acquired from a decedent or by gift for all covered securities.

(ii) Adjustments for wash sales—(A) Securities in the same account or wallet—(1) In general. A broker must apply the wash sale rules under section 1091 if both the sale and purchase transactions are of covered securities, other than covered securities reportable as digital assets after the application of paragraph (c)(8) of this section, with the same CUSIP number or other security identifier number that the Secretary may designate by publication in the Federal Register or in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter).

(B) Covered securities in different accounts or wallets. A broker is not required to apply paragraph (d)(7)(ii)(A) of this section if the covered securities are purchased and sold from different accounts or wallets, if the purchased covered security is transferred to another account or wallet before the wash sale, or if the covered securities are treated as held in separate accounts under § 1.1012-1(e). A covered security is not purchased in an account or wallet if it is purchased in another account or wallet and transferred into the account or wallet.

(C) Effect of election under section 475(f)(1). A broker is not required to apply paragraph (d)(7)(ii)(A) of this section to securities in an account if a customer has in writing both informed the broker that the customer has made a valid and timely election under section 475(f)(1) and identified the account as solely containing securities subject to the election. For purposes of this paragraph (d)(7)(ii)(C), a writing may be in electronic format. If a customer subsequently informs a broker that the election no longer applies to the customer or the account, the broker must prospectively apply paragraph (d)(7)(ii)(A) of this section but is not required to apply paragraph (d)(7)(ii)(A) of this section for the period covered by the customer's prior instruction to the broker. A taxpayer that is not a trader in securities within the meaning of section 475(f)(1) does not become a trader in securities, or create an inference that it is a trader in securities, by notifying a broker that it has made a valid and timely election under section 475(f)(1).

(D) Reporting at or near the time of sale. If a wash sale occurs after a broker has completed a return or statement reporting a sale of a covered security, the broker must redetermine whether gain or loss on the sale is long-term or short-term under this paragraph (d)(7)(ii) and, if the return or statement included information inconsistent with this redetermination, correct the return or statement by the applicable original due date set forth in this section for the return or statement.

(iii) Constructive sale and mark-to-market adjustments. A broker is not required to apply section 1259 (regarding constructive sales), section 475 (regarding the mark-to-market method of accounting), or section 1296 (regarding the mark-to-market method of accounting for marketable stock in a passive foreign investment company) when determining whether any gain or loss on the sale of a security is long-term or short-term.

(iv) Regulated investment company and real estate investment trust adjustments. A broker is not required to apply sections 852(b)(4)(A) and 857(b)(8) (regarding effect of distributed and undistributed capital gain dividends on a loss on sale of regulated investment company or real estate investment trust shares held six months or less) or section 852(b)(4)(B) (regarding loss disallowance on sale of regulated investment company shares held six months or less due to receipt of tax-exempt dividends) when determining whether any gain or loss on the sale of a security is long-term or short-term.

(v) No adjustments for hedging transactions or offsetting positions. A broker is not required to apply section 1092 (regarding straddles), section 1233(b)(2) (regarding effect of short sale on holding period of substantially identical property), or § 1.1221-2(b) (regarding hedging transactions) when determining whether any gain or loss on the sale of a security is long-term or short-term.

(8) Conversion into United States dollars of amounts paid or received in foreign currency—(i) Conversion rules. (A) When a payment other than a payment of interest is made in a foreign currency, a broker must determine the U.S. dollar amount of the payment by converting the foreign currency into U.S. dollars on the date it receives, credits, or makes the payment, as applicable, at the spot rate (as defined in § 1.988-1(d)(1)) or pursuant to a reasonable spot rate convention. (For interest payments, see paragraph (n)(4)(v) of this section concerning a customer's spot rate election.) When reporting the sale of a security traded on an established securities market, however, a broker must determine the U.S. dollar amounts at the spot rate or pursuant to a reasonable spot rate convention as of the settlement date of the purchase or sale, as applicable.

(B) A reasonable spot rate convention includes a month-end spot rate or a monthly average spot rate. A spot rate convention must be used consistently for all non-dollar amounts reported and from year to year. The convention may not be changed without the consent of the Commissioner or his or her delegate.

(ii) Effect of identification under § 1.988-5(a), (b), or (c) when the taxpayer effects a sale and a hedge through the same broker. In lieu of the amounts reportable under paragraph (d)(8)(i) of this section, the gross proceeds and adjusted basis must each be the integrated amount computed under § 1.988-5(a), (b) or (c) if—

(A) A taxpayer effects through a broker a sale or exchange of nonfunctional currency (as defined in § 1.988-1(c)) and hedges all or a part of the sale as provided in § 1.988-5(a), (b) or (c) with the same broker; and

(B) The taxpayer complies with the requirements of § 1.988-5(a), (b) or (c) and so notifies the broker prior to the end of the calendar year in which the sale occurs.

(iii) Example. The following example illustrates the rules of this paragraph (d)(8):

Example. (i) Z, an individual, is a U.S. citizen. On July 4, 2012, Z purchases stock of C, SA, a French corporation traded on an established securities market, in an account with Q, a broker. Q uses a daily spot rate for converting euro and U.S. dollars. Z pays €1,200 for the stock. On the settlement date for the purchase, the spot rate is €1 = $1.30. On October 4, 2012, Z sells the stock for €1,000. On the settlement date for the sale, the spot rate is €1 = $1.35. On October 5, 2012, Z purchases additional shares of C, SA, that cause the €200 loss on the stock sold on October 4, 2012, to be disallowed under section 1091.

(ii) Under paragraph (d)(8)(i)(A) of this section, Q must determine adjusted basis by converting the €1,200 paid on behalf of Z into U.S. dollars using the €1 = $1.30 spot rate on the settlement date of the purchase. Q must convert the €1,000 gross proceeds into U.S. dollars using the €1 = $1.35 spot rate on the settlement date for the sale. Thus, Q must report adjusted basis equal to $1,560, gross proceeds equal to $1,350, and $210 in loss disallowed by section 1091.

(9) Coordination with the reporting rules for widely held fixed investment trusts under § 1.671-5. Information required to be reported under section 6045(a) for a sale of a security or a digital asset in a widely held fixed investment trust (WHFIT) (as defined under § 1.671-5) and the sale of an interest in a WHFIT must be reported as provided by this section unless the information is also required to be reported under § 1.671-5. To the extent that this section requires additional information under section 6045(g), those requirements are deemed to be met through compliance with the rules in § 1.671-5.

(10) Optional reporting methods for qualifying stablecoins and specified nonfungible tokens. This paragraph (d)(10) provides optional reporting rules for sales of qualifying stablecoins as defined in paragraph (d)(10)(ii) of this section and sales of specified nonfungible tokens as defined in paragraph (d)(10)(iv) of this section. A broker may report sales of qualifying stablecoins or report sales of specified nonfungible tokens under the optional method provided in this paragraph (d)(10) instead of under paragraphs (d)(2)(i)(B) and (D) of this section for some or all customers and may change its reporting method for any customer from year to year; however, the method chosen for a particular customer must be applied for the entire year of that customer's sales.

(i) Optional reporting method for qualifying stablecoins—(A) In general. In lieu of reporting all sales of qualifying stablecoins under paragraphs (d)(2)(i)(B) and (D) of this section, a broker may report designated sales of qualifying stablecoins, as defined in paragraph (d)(10)(i)(C) of this section, on an aggregate basis as provided in paragraph (d)(10)(i)(B) of this section. A broker reporting under this paragraph (d)(10)(i) is not required to report sales of qualifying stablecoins under this paragraph (d)(10)(i) or under paragraphs (d)(2)(i)(B) through (D) of this section if such sales are non-designated sales of qualifying stablecoins or if the gross proceeds (after reduction for the allocable digital asset transaction costs) from all designated sales effected by that broker of qualifying stablecoins by the customer do not exceed $10,000 for the year as described in paragraph (d)(10)(i)(B) of this section.

(B) Aggregate reporting method for designated sales of qualifying stablecoins. If a customer's aggregate gross proceeds (after reduction for the allocable digital asset transaction costs) from all designated sales effected by that broker of qualifying stablecoins exceed $10,000 for the year, the broker must make a separate return for each qualifying stablecoin that includes the information set forth in this paragraph (d)(10)(i)(B). If the aggregate gross proceeds reportable under the previous sentence exceed $10,000, reporting is required with respect to each qualifying stablecoin for which there are designated sales even if the aggregate gross proceeds for a particular qualifying stablecoin does not exceed $10,000. A broker reporting under this paragraph (d)(10)(i)(B) must report the following information with respect to designated sales of each qualifying stablecoin on a separate Form 1099-DA or any successor form in the manner required by such form or instructions—

(1) The name, address, and taxpayer identification number of the customer;

(2) The name of the qualifying stablecoin sold;

(3) The aggregate gross proceeds for the year from designated sales of the qualifying stablecoin (after reduction for the allocable digital asset transaction costs as defined and allocated pursuant to paragraph (d)(5)(iv) of this section);

(4) The total number of units of the qualifying stablecoin sold in designated sales of the qualifying stablecoin;

(5) The total number of designated sale transactions of the qualifying stablecoin; and

(6) Any other information required by the form or instructions.

(C) Designated sale of a qualifying stablecoin. For purposes of this paragraph (d)(10), the term designated sale of a qualifying stablecoin means: any sale as defined in paragraphs (a)(9)(ii)(A) through (D) of this section of a qualifying stablecoin other than a sale of a qualifying stablecoin in exchange for different digital assets that are not qualifying stablecoins. In addition, the term designated sale of a qualifying stablecoin includes the delivery of a qualifying stablecoin pursuant to the settlement of any executory contract which would be treated as a designated sale of the qualifying digital asset under the previous sentence if the contract had not been executory. Finally, the term non-designated sale of a qualifying stablecoin means any sale of a qualifying stablecoin other than a designated sale of a qualifying stablecoin as defined in this paragraph (d)(10)(i)(C).

(D) Examples. For purposes of the following examples, assume that digital asset WW and digital asset YY are qualifying stablecoins, and digital asset DL is not a qualifying stablecoin. Additionally, assume that the transactions set forth in each example include all sales of qualifying stablecoins on behalf of the customer during Year 1, and that no transaction costs were imposed on the sales described therein.

(1) Example 1: Optional reporting method for qualifying stablecoins—(i) Facts. CRX is a digital asset broker that provides services to customer K, an individual not otherwise exempt from reporting. CRX effects the following sales on behalf of K: sale of 1,000 units of WW in exchange for cash of $1,000; sale of 5,000 units of WW in exchange for YY, with a value of $5,000; sale of 10,000 units of WW in return for DL, with a value of $10,000; and sale of 3,000 units of YY in exchange for cash of $3,000.

(ii) Analysis. In lieu of reporting all of K's sales of WW and YY under paragraph (d)(2)(i)(B) of this section, CRX may report K's designated sales of WW and YY under the optional reporting method set forth in paragraph (d)(10)(i)(B) of this section. In this case, K's designated sales of qualifying stablecoins resulted in total gross proceeds of $9,000, which is the total of $1,000 from sale of WW for cash, $5,000 from the sale of WW in exchange for YY, and $3,000 from the sale of YY for cash. Because K's designated sales of WW and YY did not exceed $10,000, CRX is not required to make a return of information under this section for any of K's qualifying stablecoin sales. The $10,000 of gross proceeds from the sale of WW for DL, which is not a qualifying stablecoin, is not included in this calculation to determine if the de minimis threshold has been exceeded because that sale is not a designated sale and, as such, is not reportable.

(2) Example 2: Optional reporting method for qualifying stablecoins—(i) Facts. The facts are the same as in paragraph (d)(10)(i)(D)(1)(i) of this section (the facts in Example 1), except that CRX also effects an additional sale of 4,000 units of YY in exchange for cash of $4,000 on behalf of K.

(ii) Analysis. In lieu of reporting all of K's sales of WW and YY under paragraph (d)(2)(i)(B) of this section, CRX may report K's designated sales of WW and YY under the optional reporting method set forth in paragraph (d)(10)(i)(B) of this section. In this case, K's designated sales of qualifying stablecoins resulted in total gross proceeds of $13,000, which is the total of $1,000 from sale of WW for cash, $5,000 from the sale of WW for YY, $3,000 from the sale of YY for cash, and $4,000 from the sale of YY for cash. Because K's designated sales of all types of qualifying stablecoins exceeds $10,000, CRX must make two returns of information under this section: one for all of K's designated sales of WW and another for all of K's designated sales of YY.

(ii) Qualifying stablecoin. For purposes of this section, the term qualifying stablecoin means any digital asset that satisfies the conditions set forth in paragraphs (d)(10)(ii)(A) through (C) of this section for the entire calendar year.

(A) Designed to track certain other currencies. The digital asset is designed to track on a one-to-one basis a single convertible currency issued by a government or a central bank (including the U.S. dollar).

(B) Stabilization mechanism. Either:

(1) The digital asset uses a stabilization mechanism that causes the unit value of the digital asset not to fluctuate from the unit value of the convertible currency it was designed to track by more than 3 percent over any consecutive 10-day period, determined using Coordinated Universal Time (UTC), during the calendar year; or

(2) The issuer of the digital asset is required by regulation to redeem a unit of the digital asset at any time on a one-to-one basis for the same convertible currency that the digital asset was designed to track.

(C) Accepted as payment. The digital asset is generally accepted as payment by persons other than the issuer. A digital asset that satisfies the conditions set forth in paragraphs (d)(10)(ii)(A) and (B) of this section that is accepted by a broker pursuant to a sale of another digital asset, or that is accepted by a second party pursuant to a sale effected by a processor of digital asset payments described in paragraph (a)(9)(ii)(D) of this section, meets the condition set forth in this paragraph (d)(10)(ii)(C).

(D) Examples—(1) Example 1—(i) Facts. Y is a privately held corporation that issues DL1, a digital asset designed to track the value of the U.S. dollar. Pursuant to regulatory requirements, DL1 is backed in full by U.S. dollars and other liquid short-term U.S. dollar-denominated assets held by Y, and Y offers to redeem units of DL1 for U.S. dollars at par at any time. Y's retention of U.S. dollars and other liquid short-term U.S. dollar-denominated assets as collateral and Y's offer to redeem units of DL for U.S. dollars at par at any time are intended to cause DL1 to track the U.S. dollar on a one-to-one basis. Broker B accepts DL1 as payment in return for sales of other digital assets.

(ii) Analysis. DL1 satisfies the three conditions set forth in paragraphs (d)(10)(ii)(A) through (C) of this section. First, DL1 was designed to track on a one-to-one basis the U.S. dollar, which is a single convertible currency issued by a government or a central bank. Second, DL1 uses a stabilization mechanism, as described in paragraph (d)(10)(ii)(B)(2) of this section, that pursuant to regulatory requirements requires Y to offer to redeem one unit of DL1 for one U.S. dollar at any time. Finally, because B accepts DL1 as payment for sales of other digital assets, DL1 is generally accepted as payment by persons other than Y. Accordingly, DL1 is a qualifying stablecoin under this paragraph (d)(10)(ii).

(2) Example 2—(i) Facts. Z is a privately held corporation that issues DL2, a digital asset designed to track the value of the U.S. dollar on a one-to-one basis that has a mechanism that is intended to effect that tracking. On April 28, Year X, Broker B effects the sale of units of DL2 for cash on behalf of customer C. During Year X, the unit value of DL2 did not fluctuate from the U.S. dollar by more than 3 percent over any consecutive 10-day period. Merchant M accepts payment in DL2 in return for goods and services in connection with sales effected by processors of digital asset payments.

(ii) Analysis. DL2 satisfies the three conditions set forth in paragraphs (d)(10)(ii)(A) through (C) of this section. First, DL2 was designed to track on a one-to-one basis the U.S. dollar, which is a single convertible currency issued by a government or a central bank. Second, DL2 uses a stabilization mechanism, as described in paragraph (d)(10)(ii)(B)(2) of this section, that results in the unit value of DL2 not fluctuating from the U.S. dollar by more than 3 percent over any consecutive 10-day period during the calendar year (Year X). Third, Merchant M accepts payment in DL2 in return for goods and services in connection with sales effected by processors of digital asset payments DL2 is generally accepted as payment by persons other than Z. Accordingly, DL2 is a qualifying stablecoin under this paragraph (d)(10)(ii).

(iii) Optional reporting method for specified nonfungible tokens—(A) In general. In lieu of reporting sales of specified nonfungible tokens under the reporting rules provided under paragraph (d)(2)(i)(B) of this section, a broker may report sales of specified nonfungible tokens as defined in paragraph (d)(10)(iv) of this section on an aggregate basis as provided in this paragraph (d)(10)(iii). Other digital assets, including nonfungible tokens that are not specified nonfungible tokens, are not eligible for the optional reporting method in this paragraph (d)(10)(iii).

(B) Reporting method for specified nonfungible tokens. A broker reporting under this paragraph (d)(10)(iii) must report sales of specified nonfungible tokens if the customer's aggregate gross proceeds (after reduction for the allocable digital asset transaction costs) from all sales of specified nonfungible tokens exceed $600 for the year. If the customer's aggregate gross proceeds (after reduction for the allocable digital asset transaction costs) from such sales effected by that broker do not exceed $600 for the year, no report is required. A broker reporting under this paragraph (d)(10)(iii)(B) must report on a Form 1099-DA or any successor form in the manner required by such form or instructions the following information with respect to the customer's sales of specified nonfungible tokens—

(1) The name, address, and taxpayer identification number of the customer;

(2) The aggregate gross proceeds for the year from all sales of specified nonfungible tokens (after reduction for the allocable digital asset transaction costs as defined and allocated pursuant to paragraph (d)(5)(iv) of this section);

(3) The total number of specified nonfungible token sales;

(4) To the extent ordinarily known by the broker, the aggregate gross proceeds that is attributable to the first sale by a creator or minter of the specified nonfungible token; and

(5) Any other information required by the form or instructions.

(1) Example 1: Optional reporting method for specified nonfungible tokens—(i) Facts. CRX is a digital asset broker that provides services to customer J, an individual not otherwise exempt from reporting. In Year 1, CRX sells on behalf of J, ten specified nonfungible tokens for a gross proceeds amount equal to $1,500. CRX does not sell any other specified nonfungible tokens for J during Year 1.

(ii) Analysis. In lieu of reporting J's sales of the ten specified nonfungible tokens under paragraph (d)(2)(i)(B) of this section, CRX may report these sales under the reporting method set forth in this paragraph (d)(10)(iii). In this case, J's sales of the ten specified nonfungible tokens gave rise to total gross proceeds of $1,500 for Year 1. Because the total gross proceeds from J's sales of the ten specified nonfungible tokens exceeds $600, CRX must make a single return of information under this section for these sales.

(2) Example 2: Optional reporting method for specified nonfungible tokens—(i) Facts. The facts are the same as in paragraph (d)(10)(iii)(C)(1)(i) of this section (the facts in Example 1), except that the total gross proceeds from the sale of J's ten specified nonfungible tokens is $500.

(ii) Analysis. Because J's sales of the specified nonfungible tokens result in total gross proceeds of $500, CRX is not required to make a return of information under this section for J's sales of the specified nonfungible tokens.

(iv) Specified nonfungible token. For purposes of this section, the term specified nonfungible token means a digital asset that satisfies the conditions set forth in paragraphs (d)(10)(iv)(A) through (C) of this section.

(A) Indivisible. The digital asset cannot be subdivided into smaller units without losing its intrinsic value or function.

(B) Unique. The digital asset itself includes a unique digital identifier, other than a digital asset address, that distinguishes that digital asset from all other digital assets.

(C) Excluded property. The digital asset is not and does not directly or through one or more other digital assets that satisfy the conditions described in paragraphs (d)(10)(iv)(A) and (B) of this section, provide the holder with any interest in any of the following excluded property—

(1) A security under paragraph (a)(3) of this section;

(2) A commodity under paragraph (a)(5) of this section;

(3) A regulated futures contract under paragraph (a)(6) of this section;

(4) A forward contract under paragraph (a)(7) of this section; or

(5) A digital asset that does not satisfy the conditions described in paragraphs (d)(10)(iv)(A) and (B) of this section.

(D) Examples. The following examples illustrate the rules of this paragraph (d)(10)(iv).

(1) Example 1: Specified nonfungible token—(i) Facts. Individual J is an artist in the business of creating and selling digital assets that reference J's artwork. J creates a unique digital asset (DA-J) that represents J's artwork. The digital asset includes a unique digital identifier, other than a digital asset address, that distinguishes DA-J from all other digital assets. DA-J cannot be subdivided into smaller units.

(ii) Analysis. DA-J is a digital asset that satisfies the three conditions described in paragraphs (d)(10)(iv)(A) through (C) of this section. DA-J cannot be subdivided into smaller units without losing its intrinsic value or function. Additionally, DA-J includes a unique digital identifier that distinguishes DA-J from all other digital assets. Finally, DA-J does not provide the holder with any interest in excluded property listed in paragraphs (d)(10)(iv)(C)(1) through (5) of this section Accordingly, DA-J is a specified nonfungible token under this paragraph (d)(10)(iv).

(2) Example 2: Specified nonfungible token—(i) Facts. K creates a unique digital asset (DA-K) that provides the holder with the right to redeem DA-K for 100 units of digital asset DE. Units of DE can be subdivided into smaller units and do not include a unique digital identifier, other than a digital asset address, that distinguishes one unit of DE from any other unit of DE. DA-K cannot be subdivided into smaller units and includes a unique digital identifier, other than a digital asset address, that distinguishes DA-K from all other digital assets.

(ii) Analysis. DA-K provides its holder with an interest in 100 units of digital asset DE, which is excluded property, as described in paragraph (d)(10)(iv)(C)(5) of this section, because DE units can be subdivided into smaller units and do not include unique digital identifiers that distinguishes one unit of DE from any other unit of DE. Accordingly, DA-K is not a specified nonfungible token under this paragraph (d)(10)(iv).

(3) Example 3: Specified nonfungible token—(i) Facts. The facts are the same as in paragraph (d)(10)(iv)(D)(2)(i) of this section (the facts in Example 2) except that in addition to providing its holder with an interest in the 100 units of DE, DA-K also provides rights to or access to a unique work of art.

(ii) Analysis. Because DA-K provides its holder with an interest in excluded property described in paragraph (d)(10)(iv)(C)(5) of this section, it is not a specified nonfungible token under paragraph this (d)(10)(iv) without regard to whether it also references property that is not excluded property.

(4) Example 4: Specified nonfungible token—(i) Facts. B creates a unique digital asset (DA-B) that provides the holder with the right to redeem DA-B for physical merchandise in B's store. DA-B cannot be subdivided into smaller units and includes a unique digital identifier, other than a digital asset address, that distinguishes DA-B from all other digital assets.

(ii) Analysis. DA-B is a digital asset that satisfies the three conditions described in paragraphs (d)(10)(iv)(A) through (C) of this section. DA-B cannot be subdivided into smaller units without losing its intrinsic value or function. Additionally, DA-B includes a unique digital identifier that distinguishes DA-B from all other digital assets. Finally, DA-B does not provide the holder with any interest in excluded property listed in paragraphs (d)(10)(iv)(C)(1) through (5) of this section. Accordingly, DA-B is a specified nonfungible token under this paragraph (d)(10)(iv).

(v) Joint accounts. For purposes of determining if the gross proceeds thresholds set forth in paragraphs (d)(10)(i)(B) and (d)(10)(iii)(B) of this section have been met for the customer, the customer is the person whose tax identification number would be required to be shown on the information return (but for the application of the relevant threshold) after the application of the backup withholding rules under § 31.3406(h)-2(a) of this chapter.

(11) Collection and retention of additional information with respect to the sale of a digital asset. A broker required to make an information return under paragraph (c) of this section with respect to the sale of a digital asset must collect the following additional information, retain it for seven years from the date of the due date for the information return required to be filed under this section, and make it available for inspection upon request by the Internal Revenue Service:

(i) The transaction ID as defined in paragraph (a)(24) of this section in connection with the sale, if any; and the digital asset address as defined in paragraph (a)(20) of this section (or digital asset addresses if multiple) from which the digital asset was transferred in connection with the sale, if any;

(ii) For each sale of a digital asset that was held by the broker in a hosted wallet on behalf of a customer and was previously transferred into an account at the broker (transferred-in digital asset), the transaction ID of such transfer in and the digital asset address (or digital asset addresses if multiple) from which the digital asset was transferred, if any.

(e) Reporting of barter exchanges—(1) Requirement of reporting. A barter exchange shall, except as otherwise provided, report in the manner prescribed in this section.

(2) Exchanges required to be reported—(i) In general. Except as provided in paragraphs (e)(2)(ii) and (g) of this section, a barter exchange must make a return of information for exchanges of personal property or services through the barter exchange during the calendar year among its members or clients or between these persons and the barter exchange. For this purpose, property or services are exchanged through a barter exchange if payment for property or services is made by means of a credit on the books of the barter exchange or scrip issued by the barter exchange or if the barter exchange arranges a direct exchange of property or services among its members or clients or exchanges property or services with a member or client.

(ii) Exemption. A barter exchange through which there are fewer than 100 exchanges during the calendar year is not required to report for, or make a return of information with respect to exchanges during, such calendar year. The Commissioner may require multiple barter exchanges to be combined for purposes of the proceeding sentence upon a determination that a material purpose for the formation or continuation of one or more of the barter exchanges to be combined was to receive one or more exemptions pursuant to this subparagraph.

(iii) Coordination rules for exchanges of digital assets made through barter exchanges. Exchange transactions involving the exchange of one digital asset held by one customer of a broker for a different digital asset held by a second customer of the same broker must be treated as a sale under paragraph (a)(9)(ii) of this section subject to reporting under paragraphs (c) and (d) of this section, and not as an exchange of personal property through a barter exchange subject to reporting under this paragraph (e) and paragraph (f) of this section, with respect to both customers involved in the exchange transaction. In the case of an exchange transaction that involves the transfer of a digital asset for personal property or services that are not also digital assets, if the digital asset payment also is a reportable payment transaction subject to reporting by the barter exchange under § 1.6050W-1(a)(1), the exchange transaction must be treated as a reportable payment transaction and not as an exchange of personal property through a barter exchange subject to reporting under this paragraph (e) and paragraph (f) of this section with respect to the member or client disposing of personal property or services. Additionally, an exchange transaction described in the previous sentence must be treated as a sale under paragraph (a)(9)(ii)(D) of this section subject to reporting under paragraphs (c) and (d) of this section and not as an exchange of personal property through a barter exchange subject to reporting under this paragraph (e) and paragraph (f) of this section with respect to the member or client disposing of the digital asset. Nothing in this paragraph (e)(2)(iii) may be construed to mean that any broker is or is not properly classified as a barter exchange.

(f) Information required—(1) In general. A person that is a barter exchange during a calendar year shall report on Form 1096 showing the information required thereon for such year.

(2) Transactional reporting—(i) In general. As to each exchange for which a barter exchange is required to make a return of information under this section, the barter exchange must show on Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” or any successor form the name, address, and taxpayer identification number of each member or client providing property or services in the exchange, the property or services provided, the amount received by the member or client for the property or services, the date on which the exchange occurred, and other information required by the form in the manner and number of copies required by the form.

(ii) Exception for corporate member or client. As to each corporate member or client providing property or services in an exchange for which a return of information is required under this section, the barter exchange may report the name, address, and taxpayer identification number of the corporate member or client, the aggregate amount received by the corporate member or client during the reporting period for property or services provided by such corporate member or client in exchange for which a return of information is required, and such other information as may be required by Form 1099, in the form, manner, and number of copies required by Form 1099.

(iii) Definition. For purposes of paragraph (f)(2)(ii) of this section, the term “corporate member or client” means a member or client of a barter exchange which is a corporation as defined in section 7701(a)(3) (including an insurance company). The term corporation includes a pool, syndicate, partnership, or unincorporated association composed exclusively of corporations. A barter exchange may treat a member or client as a corporation (and therefore as a corporate member or client) if such member or client provides an exemption certificate as described in § 31.3406(h)-3(a) of this chapter or provided that—

(A) The name of the member or client contains the term “insurance company,” “indemnity company,” “reinsurance company,” or “assurance company”;

(B) The name of the member or client contains one of the following unambiguous expressions of corporate status: Incorporated, Inc., Corporation, Corp., or P.C., but not Company or Co.; or

(C) The member or client is known to the barter exchange to be a corporation through a corporate resolution or similar document on file with the barter exchange clearly indicating corporate status.

(3) Exchange date. For purposes of this section an exchange is considered to occur with respect to a member or client of a barter exchange on the date cash, property, a credit, or scrip is actually or constructively received by the member or client as a result of the exchange. (See § 1.451-2 for rules pertaining to constructive receipt.)

(4) Amount received. The amount received by a member or client in an exchange includes cash received, the fair market value of any property or services received, and the fair market value of any credits to the account of the member or client on the books of the barter exchange or scrip issued to the member or client by the barter exchange, but does not include any amount received by the member or client in a subsequent exchange of credits or scrip. For purposes of this section, the fair market value of a credit or scrip is the value assigned to such credit or scrip by the issuing barter exchange for the purpose of exchanges unless the Commissioner requires the use of a different value that the Commissioner determines more accurately reflects fair market value.

(5) Meaning of terms. For purposes of this paragraph (f)—

(i) A credit is an amount on the books of the barter exchange that is transferable from one member or client of the barter exchange to another such member or client, or to the barter exchange in payment for property or services;

(ii) Scrip is a token issued by the barter exchange that is transferable from one member or client, of the barter exchange to another such member or client, or to the barter exchange, in payment for property or services; and

(iii) Property does not include a credit or scrip.

(6) Reporting period. A barter exchange shall use the calendar year as the reporting period.

(g) Exempt foreign persons—(1) Brokers. No return of information is required to be made by a broker with respect to a customer who is considered to be an exempt foreign person under paragraphs (g)(1)(i) through (iii) or paragraph (g)(4) of this section. See paragraph (a)(1) of this section for when a person is not treated as a broker under this section for a sale effected at an office outside the United States. See paragraphs (g)(1)(i) through (g)(3) of this section for rules relating to sales as defined in paragraph (a)(9)(i) of this section and see paragraph (g)(4) of this section for rules relating to sales of digital assets as defined in paragraph (a)(9)(ii) of this section.

(i) With respect to a sale as defined in paragraph (a)(9)(i) of this section (relating to sales other than sales of digital assets) that is effected at an office of a broker either inside or outside the United States, the broker may treat the customer as an exempt foreign person if the broker can, prior to the payment, reliably associate the payment with documentation upon which it can rely in order to treat the customer as a foreign beneficial owner in accordance with § 1.1441-1(e)(1)(ii), as made to a foreign payee in accordance with § 1.6049-5(d)(1), or presumed to be made to a foreign payee under § 1.6049-5(d)(2) or (3). For purposes of this paragraph (g)(1)(i), the provisions in § 1.6049-5(c) regarding rules applicable to documentation of foreign status shall apply with respect to a sale when the broker completes the acts necessary to effect the sale at an office outside the United States, as described in paragraph (g)(3)(iii)(A) of this section, and no office of the same broker within the United States negotiated the sale with the customer or received instructions with respect to the sale from the customer. The provisions in § 1.6049-5(c) regarding the definitions of U.S. payor, U.S. middleman, non-U.S. payor, and non-U.S. middleman shall also apply for purposes of this paragraph (g)(1)(i). The provisions of § 1.1441-1 shall apply by substituting the terms broker and customer for the terms withholding agent and payee, respectively, and without regard for the fact that the provisions apply to amounts subject to withholding under chapter 3 of the Code. The provisions of § 1.6049-5(d) shall apply by substituting the terms broker and customer for the terms payor and payee, respectively. For purposes of this paragraph (g)(1)(i), a broker that is required to obtain, or chooses to obtain, a beneficial owner withholding certificate described in § 1.1441-1(e)(2)(i) from an individual may rely on the withholding certificate only to the extent the certificate includes a certification that the beneficial owner has not been, and at the time the certificate is furnished, reasonably expects not to be present in the United States for a period aggregating 183 days or more during each calendar year to which the certificate pertains. The certification is not required if a broker receives documentary evidence under § 1.6049-5(c)(1) or (4).

(ii) With respect to a redemption or retirement of stock or an obligation (the interest or original issue discount on, which is described in § 1.6049-5(b)(6), (7), (10), or (11) or the dividends on, which are described in § 1.6042-3(b)(1)(iv)) that is effected at an office of a broker outside the United States by the issuer (or its paying or transfer agent), the broker may treat the customer as an exempt foreign person if the broker is not also acting in its capacity as a custodian, nominee, or other agent of the payee.

(iii) With respect to a sale as defined in paragraph (a)(9)(i) of this section (relating to sales other than sales of digital assets) that is effected by a broker at an office of the broker either inside or outside the United States, the broker may treat the customer as an exempt foreign person for the period that those proceeds are assets blocked as described in § 1.1441-2(e)(3). For purposes of this paragraph (g)(1)(iii) and section 3406, a sale is deemed to occur in accordance with paragraph (d)(4) of this section. The exemption in this paragraph (g)(1)(iii) shall terminate when payment of the proceeds is deemed to occur in accordance with the provisions of § 1.1441-2(e)(3).

(2) Barter exchange. No return of information is required by a barter exchange under the rules of paragraphs (e) and (f) of this section with respect to a client or a member that the barter exchange may treat as an exempt foreign person pursuant to the procedures described in paragraph (g)(1) of this section.

(3) Applicable rules—(i) Joint owners. Amounts paid to joint owners for which a certificate or documentation is required as a condition for being exempt from reporting under paragraph (g)(1)(i) or (g)(2) of this section are presumed made to U.S. payees who are not exempt recipients if, prior to payment, the broker or barter exchange cannot reliably associate the payment either with a Form W-9 furnished by one of the joint owners in the manner required in §§ 31.3406(d)-1 through 31.3406(d)-5 of this chapter, or with documentation described in paragraph (g)(1)(i) of this section furnished by each joint owner upon which it can rely to treat each joint owner as a foreign payee or foreign beneficial owner. For purposes of applying this paragraph (g)(3)(i), the grace period described in § 1.6049-5(d)(2)(ii) shall apply only if each payee qualifies for such grace period.

(ii) Special rules for determining who the customer is. For purposes of paragraph (g)(1) of this section, the determination of who the customer is shall be made on the basis of the provisions in § 1.6049-5(d) by substituting in that section the terms payor and payee with the terms broker and customer.

(iii) Place of effecting sale—(A) Sale outside the United States. For purposes of this paragraph (g), a sale as defined in paragraph (a)(9)(i) of this section (relating to sales other than sales of digital assets) is considered to be effected by a broker at an office outside the United States if, in accordance with instructions directly transmitted to such office from outside the United States by the broker's customer, the office completes the acts necessary to effect the sale outside the United States. The acts necessary to effect the sale may be considered to have been completed outside the United States without regard to whether—

(1) Pursuant to instructions from an office of the broker outside the United States, an office of the same broker within the United States undertakes one or more steps of the sale in the United States; or

(2) The gross proceeds of the sale are paid by a draft drawn on a United States bank account or by a wire or other electronic transfer from a United States account.

(B) Sale inside the United States. For purposes of this paragraph (g), a sale that is considered to be effected by a broker at an office outside the United States under paragraph (g)(3)(iii)(A) of this section shall nevertheless be considered to be effected by a broker at an office inside the United States if either—

(1) The customer has opened an account with a United States office of that broker;

(2) The customer has transmitted instructions concerning this and other sales to the foreign office of the broker from within the United States by mail, telephone, electronic transmission or otherwise (unless the transmissions from the United States have taken place in isolated and infrequent circumstances);

(3) The gross proceeds of the sale are paid to the customer by a transfer of funds into an account (other than an international account as defined in § 1.6049-5(e)(4)) maintained by the customer in the United States or mailed to the customer at an address in the United States;

(4) The confirmation of the sale is mailed to a customer at an address in the United States; or

(5) An office of the same broker within the United States negotiates the sale with the customer or receives instructions with respect to the sale from the customer.

(iv) Special rules where the customer is a foreign intermediary or certain U.S. branches. A foreign intermediary, as defined in § 1.1441-1(c)(13), is an exempt foreign person, except when the broker has actual knowledge (within the meaning of § 1.6049-5(c)(3)) that the person for whom the intermediary acts is a U.S. person that is not exempt from reporting under paragraph (c)(3) of this section or the broker is required to presume under § 1.6049-5(d)(3) that the payee is a U.S. person that is not an exempt recipient. If a foreign intermediary, as described in § 1.1441-1(c)(13), or a U.S. branch that is not treated as a U.S. person receives a payment from a payor or middleman (as defined in § 1.6049-4(a) and (f)(4)), which payment the payor or middleman can reliably associate with a valid withholding certificate described in § 1.1441-1(e)(3)(ii), (iii) or (v), respectively, furnished by such intermediary or branch, then the intermediary or branch is not required to report such payment when it, in turn, pays the amount, unless, and to the extent, the intermediary or branch knows that the payment is required to be reported under this section and was not so reported. For example, if a U.S. branch described in § 1.1441-1(b)(2)(iv) fails to provide information regarding U.S. persons that are not exempt from reporting under paragraph (c)(3) of this section to the person from whom the U.S. branch receives the payment, the U.S. branch must report the payment on an information return. See, however, paragraph (c)(3)(ii) of this section for when reporting under section 6045 is coordinated with reporting under chapter 4 of the Code or an applicable IGA (as defined in § 1.6049-4(f)(7)). The exception of this paragraph (g)(3)(iv) for amounts paid by a foreign intermediary shall not apply to a qualified intermediary that assumes reporting responsibility under chapter 61 of the Code except as provided under the agreement described in § 1.1441-1(e)(5)(iii).

(4) Rules for sales of digital assets. The rules of this paragraph (g)(4) apply to a sale of a digital asset as defined in paragraph (a)(9)(ii) of this section. See paragraph (a)(1) of this section for when a person is treated as a broker under this section with respect to a sale of a digital asset. See paragraph (c) of this section for rules requiring brokers to report sales. See paragraph (g)(1) of this section providing that no return of information is required to be made by a broker effecting a sale of a digital asset for a customer who is considered to be an exempt foreign person under this paragraph (g)(4).

(i) Definitions. The following definitions apply for purposes of this section.

(A) U.S. digital asset broker. A U.S. digital asset broker is a person that effects sales of digital assets on behalf of others and that is—

(1) A U.S. payor or U.S. middleman as defined in § 1.6049-5(c)(5)(i)(A) that is not a foreign branch or office of such person, § 1.6049-5(c)(5)(i)(B) or (F) that is not a territory financial institution described in § 1.1441-1(b)(2)(iv).

(2) [Reserved]

(B) [Reserved]

(ii) Rules for U.S. digital asset brokers—(A) Place of effecting sale. For purposes of this section, a sale of a digital asset that is effected by a U.S. digital asset broker is considered a sale effected at an office inside the United States.

(B) Determination of foreign status. A U.S. digital asset broker may treat a customer as an exempt foreign person with respect to a sale effected at an office inside the United States provided that, prior to the payment to such customer of the gross proceeds from the sale, the broker has a beneficial owner withholding certificate described in § 1.1441-1(e)(2)(i) that the broker may treat as valid under § 1.1441-1(e)(2)(ii) and that satisfies the requirements of paragraph (g)(4)(vi) of this section. Additionally, a U.S. digital asset broker may treat a customer as an exempt foreign person with respect to a sale effected at an office inside the United States under an applicable presumption rule as provided in paragraph (g)(4)(vi)(A)(2)(i) of this section. A beneficial owner withholding certificate provided by an individual must include a certification that the beneficial owner has not been, and at the time the certificate is furnished reasonably expects not to be, present in the United States for a period aggregating 183 days or more during each calendar year to which the certificate pertains. See paragraphs (g)(4)(vi)(A) through (D) of this section for additional rules applicable to withholding certificates, when a broker may rely on a withholding certificate, presumption rules that apply in the absence of documentation, and rules for customers that are joint account holders. See paragraph (g)(4)(vi)(E) of this section for the extent to which a U.S. digital asset broker may treat a customer as an exempt foreign person with respect to a payment treated as made to a foreign intermediary, flow-through entity or certain U.S. branches. See paragraph (g)(4)(vi)(F) of this section for a transition rule for preexisting accounts.

(iii) Rules for CFC digital asset brokers not conducting activities as money services businesses.

(iv) Rules for non-U.S. digital asset brokers not conducting activities as money services businesses.

(A) [Reserved]

(B) Sale treated as effected at an office inside the United States—(1) [Reserved]

(2) U.S. indicia. The U.S. indicia relevant for purposes of this paragraph (g)(4)(iv)(B) are as follows—

(i) A permanent residence address (as defined in § 1.1441-1(c)(38)) in the U.S. or a U.S. mailing address for the customer, a current U.S. telephone number and no non-U.S. telephone number for the customer, or the broker's classification of the customer as a U.S. person in its records;

(ii) An unambiguous indication of a U.S. place of birth for the customer; or

(v) [Reserved]

(vi) Rules applicable to brokers that obtain or are required to obtain documentation for a customer and presumption rules—(A) In general. Paragraph (g)(4)(vi)(A)(1) of this section describes rules applicable to documentation permitted to be used under this paragraph (g)(4) to determine whether a customer may be treated as an exempt foreign person. Paragraph (g)(4)(vi)(A)(2) of this section provides presumption rules that apply if the broker does not have documentation on which the broker may rely to determine a customer's status. Paragraph (g)(4)(vi)(A)(3) of this section provides a grace period for obtaining documentation in circumstances where there are indicia that a customer is a foreign person. Paragraph (g)(4)(vi)(A)(4) of this section provides rules relating to blocked income. Paragraph (g)(4)(vi)(B) of this section provides rules relating to reliance on beneficial ownership withholding certificates to determine whether a customer is an exempt foreign person. Paragraph (g)(4)(vi)(C) of this section provides rules relating to reliance on documentary evidence to determine whether a customer is an exempt foreign person. Paragraph (g)(4)(vi)(D) of this section provides rules relating to customers that are joint account holders. Paragraph (g)(4)(vi)(E) of this section provides special rules for a customer that is a foreign intermediary, a flow-through entity, or certain U.S. branches. Paragraph (g)(4)(vi)(F) of this section provides a transition rule for obtaining documentation to treat a customer as an exempt foreign person.

(1) Documentation of foreign status. A broker may treat a customer as an exempt foreign person when the broker obtains valid documentation permitted to support a customer's foreign status as described in paragraph (g)(4)(ii), (iii), or (iv) of this section (as applicable) that the broker can reliably associate (within the meaning of § 1.1441-1(b)(2)(vii)(A)) with a payment of gross proceeds, provided that the broker is not required to treat the documentation as unreliable or incorrect under paragraph (g)(4)(vi)(B) or (C) of this section. For rules regarding the validity period of a withholding certificate, or of documentary evidence (when permitted to be relied upon under paragraph (g)(4)(vi)(C) of this section), retention of documentation, electronic transmission of documentation, information required to be provided on a withholding certificate, who may sign a withholding certificate, when a substitute withholding certificate may be accepted, and general reliance rules on documentation (including when a prior version of a withholding certificate may be relied upon), the provisions of §§ 1.1441-1(e)(4)(i) through (ix) and 1.6049-5(c)(1)(ii) apply, with the following modifications—

(i) The provisions in § 1.1441-1(e)(4)(i) through (ix) apply by substituting the terms broker and customer for the terms withholding agent and payee, respectively, and disregarding the fact that the provisions under § 1.1441-1 apply only to amounts subject to withholding under chapter 3 of the Code;

(ii) The provisions of § 1.6049-5(c)(1)(ii) (relating to general requirements for when a payor may rely upon and must maintain documentary evidence with respect to a payee) apply (as applicable to the broker) by substituting the terms broker and customer for the terms payor and payee, respectively;

(iii) To apply § 1.1441-1(e)(4)(viii) (reliance rules for documentation), the reference to § 1.1441-7(b)(4) through (6) is replaced by the provisions of paragraph (g)(4)(vi)(B) or (C) of this section, as applicable, and the reference to § 1.1441-6(c)(2) is disregarded; and

(iv) To apply § 1.1441-1(e)(4)(viii) (reliance rules for documentation) and (ix) (certificates to be furnished to a withholding agent for each obligation unless an exception applies), the provisions applicable to a financial institution apply to a broker described in this paragraph (g)(4) whether or not it is a financial institution.

(2) Presumption rules—(i) In general. If a broker is not permitted to treat a customer as an exempt foreign person under paragraph (g)(4)(vi)(A)(1) of this section because the broker has not collected the documentation permitted to be collected under this paragraph (g)(4) or is not permitted to rely on the documentation it has collected, the broker must determine the classification of a customer (as an individual, entity, etc.) by applying the presumption rules of § 1.1441-1(b)(3)(ii), except that references in § 1.1441-1(b)(3)(ii)(B) to exempt recipient categories under section 6049 are replaced by the exempt recipient categories in paragraph (c)(3)(i) of this section. With respect to a customer that a broker has classified as an entity, the broker must determine the status of the customer as U.S. or foreign by applying §§ 1.1441-1(b)(3)(iii)(A) and 1.1441-5(d) and (e)(6), except that § 1.1441-1(b)(3)(iii)(A)(1)(iv) does not apply. For presumption rules to treat a payment as made to an intermediary or flow-through entity and whether the payment is also treated as made to an exempt foreign person, see paragraph (g)(4)(vi)(E) of this section. Notwithstanding the provisions of this paragraph (g)(4)(vi)(A)(2), a broker may not treat a customer as a foreign person under this paragraph (g)(4)(vi)(A)(2) if the broker has actual knowledge or reason to know that the customer is a U.S. person. For purposes of applying the presumption rules of this paragraph (g)(4)(vi)(A)(2), a broker must identify its customer by applying the rules of § 1.6049-5(d)(1), substituting the terms customer and broker for the terms payee and payor, respectively.

(ii) Presumption rule specific to U.S. digital asset brokers. With respect to a customer that a U.S. digital asset broker has classified as an individual, the broker must treat the customer as a U.S. person.

(3) Grace period to collect valid documentation in the case of indicia of a foreign customer. If a broker has not obtained valid documentation that it can reliably associate with a payment of gross proceeds to a customer to treat the customer as an exempt foreign person, or if the broker is unable to rely upon documentation under the rules described in paragraph (g)(4)(vi)(A)(1) of this section or is required to treat documentation obtained for a customer as unreliable or incorrect (after applying paragraphs (g)(4)(vi)(B) and (C) of this section), the broker may apply the grace period described in § 1.6049-5(d)(2)(ii) (generally allowing in certain circumstances a payor to treat an account as owned by a foreign person for a 90 day period). In applying § 1.6049-5(d)(2)(ii), references to securities described in § 1.1441-6(c)(2) are replaced with digital assets.

(4) Blocked income. A broker may apply the provisions in paragraph (g)(1)(iii) of this section to treat a customer as an exempt foreign person when the proceeds are blocked income as described in § 1.1441-2(e)(3).

(B) Reliance on beneficial ownership withholding certificates to determine foreign status. For purposes of determining whether a customer may be treated as an exempt foreign person under this section, except as otherwise provided in this paragraph (g)(4)(vi)(B), a broker may rely on a beneficial owner withholding certificate described in paragraph (g)(4)(ii)(B) of this section unless the broker has actual knowledge or reason to know that the certificate is unreliable or incorrect. With respect to a U.S. digital asset broker described in paragraph (g)(4)(i)(A)(1) of this section, reason to know is limited to when the broker has any of the U.S. indicia set forth in paragraph (g)(4)(iv)(B)(2)(i) or (ii) of this section in its account opening files or other files pertaining to the account (account information), including documentation collected for purposes of an AML program or the beneficial owner withholding certificate. A broker will not be considered to have reason to know that a certificate is unreliable or incorrect based on documentation collected for an AML program until the date that is 30 days after the account is opened. A broker may rely, however, on a beneficial owner withholding certificate notwithstanding the presence of any of the U.S. indicia set forth in paragraph (g)(4)(iv)(B)(2)(i) or (ii) of this section on the withholding certificate or in the account information for a customer in the circumstances described in paragraphs (g)(4)(vi)(B)(1) and (2) of this section.

(1) Collection of information other than U.S. place of birth—(i) In general. With respect to any of the U.S. indicia described in paragraph (g)(4)(iv)(B)(2)(i) of this section, the broker has in its possession for a customer who is an individual documentary evidence establishing foreign status (as described in § 1.1471-3(c)(5)(i)) that does not contain a U.S. address and the customer provides the broker with a reasonable explanation (as defined in § 1.1441-7(b)(12)) from the customer, in writing, supporting the claim of foreign status. Notwithstanding the preceding sentence, in a case in which the broker classified an individual customer as a U.S. person in its account information, the broker may treat the customer as an exempt foreign person only if it has in its possession documentary evidence described in § 1.1471-3(c)(5)(i)(B) evidencing citizenship in a country other than the United States. In the case of a customer that is an entity, the broker may treat the customer as an exempt foreign person if it has in its possession documentation establishing foreign status that substantiates that the entity is actually organized or created under the laws of a foreign country.

(ii) [Reserved]

(2) Collection of information showing U.S. place of birth. With respect to the U.S. indicia described in paragraph (g)(4)(iv)(B)(2)(ii) of this section, the broker has in its possession documentary evidence described in § 1.1471-3(c)(5)(i)(B) evidencing citizenship in a country other than the United States and the broker has in its possession either a copy of the customer's Certificate of Loss of Nationality of the United States or a reasonable written explanation of the customer's renunciation of U.S. citizenship or the reason the customer did not obtain U.S. citizenship at birth.

(D) Joint owners. In the case of amounts paid to customers that are joint account holders for which a certificate or documentation is required as a condition for being exempt from reporting under this paragraph (g)(4), such amounts are presumed made to U.S. payees who are not exempt recipients (as defined in paragraph (c)(3)(i)(B) of this section) when the conditions of paragraph (g)(3)(i) of this section are met.

(E) Special rules for customer that is a foreign intermediary, a flow-through entity, or certain U.S. branches—(1) Foreign intermediaries in general. For purposes of this paragraph (g)(4), a broker may determine the status of a customer as a foreign intermediary (as defined in § 1.1441-1(c)(13)) by reliably associating (under § 1.1441-1(b)(2)(vii)) a payment of gross proceeds with a valid foreign intermediary withholding certificate described in § 1.1441-1(e)(3)(ii) or (iii), without regard to whether the withholding certificate contains a withholding statement and withholding certificates or other documentation for each account holder. In the case of a payment of gross proceeds from a sale of a digital asset that a broker treats as made to a foreign intermediary under this paragraph (g)(4)(vi)(E)(1), the broker must treat the foreign intermediary as an exempt foreign person except to the extent required by paragraph (g)(3)(iv) of this section (rules for when a broker is required to treat a payment as made to a U.S. person that is not an exempt recipient under paragraph (c)(3) of this section and for reporting that may be required by the foreign intermediary).

(i) Presumption rule specific to U.S. digital asset brokers. A U.S. digital asset broker that does not have a valid foreign intermediary withholding certificate or a valid beneficial owner withholding certificate described in paragraph (g)(4)(ii)(B) of this section for the customer applies the presumption rules in § 1.1441-1(b)(3)(ii)(B) (which would presume that the entity is not an intermediary). For purposes of applying the presumption rules referenced in the preceding sentence, a U.S. digital asset broker must identify its customer by applying the rules of § 1.6049-5(d)(1), substituting the terms customer and U.S. digital asset broker for the terms payee and payor, respectively. See § 1.1441-1(b)(3)(iii) for presumption rules relating to the U.S. or foreign status of a customer.

(ii) [Reserved]

(2) Foreign flow-through entities. For purposes of this paragraph (g)(4), a broker may determine the status of a customer as a foreign flow-through entity (as defined in § 1.1441-1(c)(23)) by reliably associating (under § 1.1441-1(b)(2)(vii)) a payment of gross proceeds with a valid foreign flow-through withholding certificate described in § 1.1441-5(c)(3)(iii) (relating to nonwithholding foreign partnerships) or § 1.1441-5(e)(5)(iii) (relating to foreign simple trusts and foreign grantor trusts that are nonwithholding foreign trusts), without regard to whether the withholding certificate contains a withholding statement and withholding certificates or other documentation for each partner. A broker may alternatively determine the status of a customer as a foreign flow-through entity based on the presumption rules in §§ 1.1441-1(b)(3)(ii)(B) (relating to entity classification), 1.1441-5(d) (relating to partnership status as U.S. or foreign) and 1.1441-5(e)(6) (relating to the status of trusts and estates as U.S. or foreign). For purposes of applying the presumption rules referenced in the preceding sentence, a broker must identify its customer by applying the rules of § 1.6049-5(d)(1), substituting the terms customer and broker for the terms payee and payor, respectively. In the case of a payment of gross proceeds from a sale of a digital asset that a broker treats as made to a foreign flow-through entity under this paragraph (g)(4)(vi)(E)(2), the broker must treat the foreign flow-through entity as an exempt foreign person except to the extent required by § 1.6049-5(d)(3)(ii) (rules for when a broker is required to treat a payment as made to a U.S. person other than an exempt recipient (substituting exempt recipient under § 1.6045-1(c)(3) for exempt recipient described in § 1.6049-4(c))).

(3) U.S. branches that are not beneficial owners. For purposes of this paragraph (g)(4), a broker may determine the status of a customer as a U.S. branch (as described in § 1.1441-1(b)(2)(iv)) that is not a beneficial owner (as defined in § 1.1441-1(c)(6)) of a payment of gross proceeds by reliably associating (under § 1.1441-1(b)(2)(vii)) the payment with a valid U.S. branch withholding certificate described in § 1.1441-1(e)(3)(v) without regard to whether the withholding certificate contains a withholding statement and withholding certificates or other documentation for each person for whom the branch receives the payment. If a U.S. branch certifies on a U.S. branch withholding certificate described in the preceding sentence that it agrees to be treated as a U.S. person under § 1.1441-1(b)(2)(iv)(A), the broker provided the certificate must treat the U.S. branch as an exempt foreign person. If a U.S. branch does not certify as described in the preceding sentence on its U.S. branch withholding certificate, the broker provided the certificate must treat the U.S. branch as an exempt foreign person except to the extent required by paragraph (g)(3)(iv) of this section (rules for when a broker is required to treat a payment as made to a U.S. person that is not an exempt recipient under paragraph (c)(3) of this section and for reporting that may be required by the U.S. branch). In a case in which a broker cannot reliably associate a payment of gross proceeds made to a U.S. branch with a U.S. branch withholding certificate described in § 1.1441-1(e)(3)(v) or a valid beneficial owner withholding certificate described in paragraph (g)(4)(ii)(B) of this section, see paragraph (g)(4)(vi)(E)(1) of this section for determining the status of the U.S. branch as a beneficial owner or intermediary.

(F) Transition rule for obtaining documentation to treat a customer as an exempt foreign person. Notwithstanding the rules of this paragraph (g)(4) for determining the status of a customer as an exempt foreign person, for a sale of a digital asset effected before January 1, 2027, that was held in an account established for the customer by a broker before January 1, 2026, the broker may treat the customer as an exempt foreign person provided that the customer has not previously been classified as a U.S. person by the broker, and the information that the broker has in the account opening files or other files pertaining to the account, including documentation collected for purposes of an AML program, includes a residence address for the customer that is not a U.S. address.

(vii) Barter exchanges. No return of information is required by a barter exchange under the rules of paragraphs (e) and (f) of this section with respect to a client or a member that the barter exchange may treat as an exempt foreign person pursuant to the procedures described in this paragraph (g)(4).

(5) Examples. The application of the provisions of paragraphs (g)(1) through (3) of this section may be illustrated by the following examples:

(i) Example 1. FC is a foreign corporation that is not a U.S. payor or U.S. middleman described in § 1.6049-5(c)(5) that regularly issues and retires its own debt obligations. A is an individual whose residence address is inside the United States, who holds a bond issued by FC that is in registered form (within the meaning of section 163(f) and the regulations under that section). The bond is retired by FP, a foreign corporation that is a broker within the meaning of paragraph (a)(1) of this section and the designated paying agent of FC. FP mails the proceeds to A at A's U.S. address. The sale would be considered to be effected at an office outside the United States under paragraph (g)(3)(iii)(A) of this section except that the proceeds of the sale are mailed to a U.S. address. For that reason, the sale is considered to be effected at an office of the broker inside the United States under paragraph (g)(3)(iii)(B) of this section. Therefore, FC is a broker under paragraph (a)(1) of this section with respect to this transaction because, although it is not a U.S. payor or U.S. middleman, as described in § 1.6049-5(c)(5), it is deemed to effect the sale in the United States. FP is a broker for the same reasons. However, under the multiple broker exception under paragraph (c)(3)(iii) of this section, FP, rather than FC, is required to report the payment because FP is responsible for paying the holder the proceeds from the retired obligations. Under paragraph (g)(1)(i) of this section, FP may not treat A as an exempt foreign person and must make an information return under section 6045 with respect to the retirement of the FC bond, unless FP obtains the certificate or documentation described in paragraph (g)(1)(i) of this section.

(ii) Example 2. The facts are the same as in paragraph (g)(5)(i) of this section (the facts in Example 1) except that FP mails the proceeds to A at an address outside the United States. Under paragraph (g)(3)(iii)(A) of this section, the sale is considered to be effected at an office of the broker outside the United States. Therefore, under paragraph (a)(1) of this section, neither FC nor FP is a broker with respect to the retirement of the FC bond. Accordingly, neither is required to make an information return under section 6045.

(iii) Example 3. The facts are the same as in paragraph (g)(5)(ii) of this section (the facts in Example 2) except that FP is also the agent of A. The result is the same as in paragraph (g)(5)(ii) of this section (Example 2). Neither FP nor FC are brokers under paragraph (a)(1) of this section with respect to the sale since the sale is effected outside the United States and neither of them are U.S. payors (within the meaning of § 1.6049-5(c)(5)).

(iv) Example 4. The facts are the same as in paragraph (g)(5)(i) of this section (the facts in Example 1) except that the registered bond held by A was issued by DC, a domestic corporation that regularly issues and retires its own debt obligations. Also, FP mails the proceeds to A at an address outside the United States. Interest on the bond is not described in paragraph (g)(1)(ii) of this section. The sale is considered to be effected at an office outside the United States under paragraph (g)(3)(iii)(A) of this section. DC is a broker under paragraph (a)(1)(i)(B) of this section. DC is not required to report the payment under the multiple broker exception under paragraph (c)(3)(iii) of this section. FP is not required to make an information return under section 6045 because FP is not a U.S. payor described in § 1.6049-5(c)(5) and the sale is effected outside the United States. Accordingly, FP is not a broker under paragraph (a)(1) of this section.

(v) Example 5. The facts are the same as in paragraph (g)(5)(iv) of this section (the facts in Example 4) except that FP is also the agent of A. DC is a broker under paragraph (a)(1) of this section. DC is not required to report under the multiple broker exception under paragraph (c)(3)(iii) of this section. FP is not required to make an information return under section 6045 because FP is not a U.S. payor described in § 1.6049-5(c)(5) and the sale is effected outside the United States and therefore FP is not a broker under paragraph (a)(1) of this section.

(vi) Example 6. The facts are the same as in paragraph (g)(5)(iv) of this section (the facts in Example 4) except that the bond is retired by DP, a broker within the meaning of paragraph (a)(1) of this section and the designated paying agent of DC. DP is a U.S. payor under § 1.6049-5(c)(5). DC is not required to report under the multiple broker exception under paragraph (c)(3)(iii) of this section. DP is required to make an information return under section 6045 because it is the person responsible for paying the proceeds from the retired obligations unless DP obtains the certificate or documentary evidence described in paragraph (g)(1)(i) of this section.

(vii) Example 7—(A) Facts. Customer A owns U.S. corporate bonds issued in registered form after July 18, 1984, and carrying a stated rate of interest. The bonds are held through an account with foreign bank, X, and are held in street name. X is a wholly-owned subsidiary of a U.S. company and is not a qualified intermediary within the meaning of § 1.1441-1(e)(5)(ii). X has no documentation regarding A. A instructs X to sell the bonds. In order to effect the sale, X acts through its agent in the United States, Y. Y sells the bonds and remits the sales proceeds to X. X credits A's account in the foreign country. X does not provide documentation to Y and has no actual knowledge that A is a foreign person but it does appear that A is an entity (rather than an individual).

(B) Analysis with respect to Y's obligations to withhold and report. Y treats X as the customer, and not A, because Y cannot treat X as an intermediary because it has received no documentation from X. Y is not required to report the sales proceeds under the multiple broker exception under paragraph (c)(3)(iii) of this section, because X is an exempt recipient. Further, Y is not required to report the amount of accrued interest paid to X on Form 1042-S under § 1.1461-1(c)(2)(ii) because accrued interest is not an amount subject to reporting under chapter 3 unless the withholding agent knows that the obligation is being sold with a primary purpose of avoiding tax.

(C) Analysis with respect to X's obligations to withhold and report. Although X has effected, within the meaning of paragraph (a)(1) of this section, the sale of a security at an office outside the United States under paragraph (g)(3)(iii) of this section, X is treated as a broker, under paragraph (a)(1) of this section, because as a wholly-owned subsidiary of a U.S. corporation, X is a controlled foreign corporation and therefore is a U.S. payor. See § 1.6049-5(c)(5). Under the presumptions described in § 1.6049-5(d)(2) (as applied to amounts not subject to withholding under chapter 3), X must apply the presumption rules of § 1.1441-1(b)(3)(i) through (iii), with respect to the sales proceeds, to treat A as a partnership that is a U.S. non-exempt recipient because the presumption of foreign status for offshore obligations under § 1.1441-1(b)(3)(iii)(D) does not apply. See paragraph (g)(1)(i) of this section. Therefore, unless X is an FFI (as defined in § 1.1471-1(b)(47)) that is excepted from reporting the sales proceeds under paragraph (c)(3)(ii) of this section, the payment of proceeds to A by X is reportable on a Form 1099 under paragraph (c)(2) of this section. X has no obligation to backup withhold on the payment based on the exemption under § 31.3406(g)-1(e) of this chapter, unless X has actual knowledge that A is a U.S. person that is not an exempt recipient. X is also required to separately report the accrued interest (see paragraph (d)(3) of this section) on Form 1099 under section 6049 because A is also presumed to be a U.S. person who is not an exempt recipient with respect to the payment because accrued interest is not an amount subject to withholding under chapter 3 and, therefore, the presumption of foreign status for offshore obligations under § 1.1441-1(b)(3)(iii)(D) does not apply. See § 1.6049-5(d)(2)(i).

(viii) Example 8—(A) Facts. The facts are the same as in paragraph (g)(5)(vii) of this section (the facts in Example 7) except that X is a foreign corporation that is not a U.S. payor under § 1.6049-5(c).

(B) Analysis with respect to Y's obligations to withhold and report. Y is not required to report the sales proceeds under the multiple broker exception under paragraph (c)(3)(iii) of this section, because X is the person responsible for paying the proceeds from the sale to A.

(C) Analysis with respect to X's obligations to withhold and report. Although A is presumed to be a U.S. payee under the presumptions of § 1.6049-5(d)(2), X is not considered to be a broker under paragraph (a)(1) of this section because it is a not a U.S. payor under § 1.6049-5(c)(5). Therefore, X is not required to report the sale under paragraph (c)(2) of this section.

(h) Identity of customer—(1) In general. For purposes of this section, a broker or barter exchange shall treat the person who appears on the books and records of the broker or barter exchange with respect to property or services as the principals with respect thereto.

(2) Examples. The following examples illustrate the rule of this paragraph (h):

Example 1.The records of A, a broker, show an account in the name of “B”. B is a nominee for C. All reporting with respect to such account shall treat B as the customer.

Example 2.J, an individual, places an order with H, a broker, to sell J's stock that is held by P, a broker/dealer, in an account for J with P designated as nominee for J, and to credit the gross proceeds from the sale to J's account with P. The account is in the name of P, so that H's customer is P.

(i) [Reserved]

(j) Time and place for filing; cross-references to penalty and magnetic media filing requirements. Forms 1096 and 1099 required under this section shall be filed after the last calendar day of the reporting period elected by the broker or barter exchange and on or before February 28 of the following calendar year with the appropriate Internal Revenue Service Center, the address of which is listed in the instructions for Form 1096. For a digital asset sale effected prior to January 1, 2025, for which a broker chooses under paragraph (d)(2)(iii)(B) of this section to file an information return, Form 1096 and the Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or the Form 1099-DA, Digital Asset Proceeds from Broker Transactions, must be filed on or before February 28 of the calendar year following the year of that sale. See paragraph (l) of this section for the requirement to file certain returns on magnetic media. For provisions relating to the penalty provided for the failure to file timely a correct information return under section 6045(a), see § 301.6721-1 of this chapter. See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

(k) Requirement and time for furnishing statement; cross-reference to penalty—(1) General requirements. A broker or barter exchange making a return of information under this section must furnish to the person whose identifying number is (or is required to be) shown on the return a written statement showing the information required by paragraph (c)(5), (d), or (f) of this section and containing a legend stating that the information is being reported to the Internal Revenue Service. If the return of information is not made on magnetic media, this requirement may be satisfied by furnishing to the person a copy of all Forms 1099 or any successor form for the person filed with the Internal Revenue Service Center. A statement is considered to be furnished to a person to whom a statement is required to be made under this paragraph (k) if it is mailed to the person at the last address of the person known to the broker or barter exchange.

(2) Time for furnishing statements. A broker or barter exchange may furnish the statements required under this paragraph (k) yearly, quarterly, monthly, or on any other basis, without regard to the reporting period the broker or barter exchange elects; however, all statements required to be furnished under this paragraph (k) for a calendar year must be furnished on or before February 15 of the following calendar year.

(3) Consolidated reporting. (i) The term consolidated reporting statement means a grouping of statements the same broker or barter exchange furnishes to the same customer or group of customers on the same date for the same reporting year that includes a statement required under this section. A consolidated reporting statement is limited to statements based on the same relationship of broker or barter exchange to customer as the statement required to be furnished under this section. For purposes of this paragraph (k)(3)(i), a broker may treat a shareholder of a broker as a customer of the broker and may treat a grouping of statements for a customer as including a statement required to be furnished under this section if the customer has an account with the broker for which a statement would be required to be furnished under this section if the customer purchased and sold stock in a corporation in the account during the year.

(ii) A consolidated reporting statement must be furnished on or before February 15 of the year following the calendar year reported. Any statement that otherwise must be furnished on or before January 31 must be furnished on or before February 15 if it is furnished in the consolidated reporting statement.

(iii) Examples. The following examples illustrate the rules of this paragraph (k)(3):

Example 1.D has a taxable account with B, a broker, consisting solely of stock in a single corporation. In 2010, D receives reportable dividends from this stock and sells the stock. Under this section and § 1.6042-4, B must furnish a Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” and Form 1099-DIV, “Dividends and Distributions,” to D in 2011 for the sale and the dividends. Under paragraph (k)(2) of this section, B is required to furnish the required statement under this section to D by February 15, 2011. B must furnish the statement reporting the dividends by the January 31, 2011, due date provided in § 1.6042-4. However, under paragraph (k)(3)(ii) of this section, B must furnish the statement reporting the dividends by February 15, 2011, if furnished in a consolidated reporting statement as defined in paragraph (k)(3)(i) of this section.

Example 2.Assume the same facts as in Example 1 except that D has invested solely in a money market fund for which sales are excepted from the reporting required under this section. B therefore is not required to issue a statement under this section if D sells an interest in the money market fund. Under paragraph (k)(3)(i) of this section, B may treat a grouping of statements for D as including a required statement under this section because D has an account for which a statement would be required under this section if D purchased and sold stock in a corporation in the account during the year. Therefore, under paragraph (k)(3)(ii) of this section, B must furnish the statement reporting the dividends by February 15, 2011.

Example 3.E has a nontaxable IRA account with B, a broker. This account is the only account E holds with B. E sells stock in 2010 in this account. E also receives a cash distribution from the account in 2010. The cash distribution from the IRA is reportable on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,” under § 1.408-7. Because the account is not taxable, sales in the account are not subject to reporting under this section. Therefore, because no statement is required under this section, under paragraph (k)(3) of this section, B may not furnish any statements to E in a consolidated reporting statement. B must furnish the Form 1099-R by the date required under § 1.408-7.

Example 4.Assume the same facts as in Example 3 except that E and F have a joint taxable account with B. Because sales in the joint taxable account are subject to reporting under this section, under paragraph (k)(3) of this section, B must furnish by February 15, 2011, all customer statements for 2010 that B otherwise must furnish jointly to E and F on or before January 31, 2011, if furnished on the same date in a consolidated reporting statement with the required statements under this section for any sales in the joint taxable account. However, B may not include any statement for E's IRA account in the consolidated reporting statement furnished jointly to E and F because the statements are not furnished to the same customer or group of customers.

(4) Cross-reference to penalty. For provisions for failure to furnish timely a correct payee statement, see § 301.6722-1 of this chapter (Procedure and Administration Regulations). See § 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect.

(l) Use of magnetic media or electronic form. See § 301.6011-2 of this chapter for rules relating to filing information returns on magnetic media or in electronic form and for rules relating to waivers granted for undue hardship. A broker or barter exchange that fails to file a proper Form 1099 electronically, when required, may be subject to a penalty under section 6721 for each such failure. See paragraph (j) of this section.

(m) Additional rules for option transactions—(1) In general. This paragraph (m) provides rules for a broker to determine and report the information required under this section for an option that is a covered security under paragraph (a)(15)(i)(E) or (H) of this section.

(2) Scope—(i) In general. Paragraph (m) of this section applies to the following types of options granted or acquired on or after January 1, 2014:

(A) An option on one or more specified securities (which includes an index substantially all the components of which are specified securities);

(B) An option on financial attributes of specified securities, such as interest rates or dividend yields; or

(ii) Delayed effective date for certain options—(A) Notwithstanding paragraph (m)(2)(i) of this section, if an option, stock right, or warrant is issued as part of an investment unit described in § 1.1273-2(h), paragraph (m) of this section applies to the option, stock right, or warrant if it is acquired on or after January 1, 2016.

(B) Notwithstanding paragraph (m)(2)(i) of this section, if the property referenced by an option (that is, the property underlying the option) is a debt instrument that is issued by a non-U.S. person or that provides for one or more payments denominated in, or determined by reference to, a currency other than the U.S. dollar, paragraph (m) of this section applies to the option if it is granted or acquired on or after January 1, 2016.

(C) Notwithstanding paragraph (m)(2)(i) of this section, if an option is an option on a digital asset or an option on derivatives with a digital asset as an underlying property, this paragraph (m) applies to the option if it is granted or acquired on or after January 1, 2026.

(iii) Compensatory option. Notwithstanding paragraphs (m)(2)(i) and (m)(2)(ii) of this section, paragraph (m) of this section does not apply to compensatory options.

(3) Option subject to section 1256. If an option described in paragraph (m)(2) of this section is also described in section 1256(b), a broker must apply the rules described in paragraph (c)(5) of this section by treating the option as if it were a regulated futures contract and must report the information required under paragraph (c)(5) of this section. A broker is permitted, but not required, to report the amounts for options and the amounts for regulated futures contracts determined under paragraph (c)(5) of this section as a net amount for each reportable item.

(4) Option not subject to section 1256. The following rules apply to an option that is described in paragraph (m)(2) of this section but is not also described in paragraph (m)(3) of this section:

(i) Physical settlement. For purposes of paragraph (d) of this section, if a specified security (other than an option) is acquired or disposed of pursuant to the exercise of an option, the broker must adjust the basis of the acquired asset or the gross proceeds amount as appropriate to account for any payment related to the option, including the premium.

(ii) Cash settlement. For purposes of paragraph (d) of this section, for an option that is settled for cash, a broker must reflect on Form 1099-B all payments made or received on the option. For a purchased option, a broker must report as basis the premium paid plus any costs (for example, commissions) related to the acquisition of the option and must report as proceeds the gross proceeds from settlement minus any costs related to the settlement of the option. For a written option, a broker must report as proceeds the premium received decreased by any amounts paid on the option and report $0 as the basis of the option.

(iii) Rules for warrants and stock rights acquired in a section 305 distribution. For a right (including a warrant) to acquire stock received in the same account as the underlying security in a distribution that is described in section 305(a), a broker is permitted, but not required, to apply the rules described in sections 305 and 307 when reporting or accounting for the basis of the option and the underlying equity. If a stock right or warrant is acquired from the initial distributee, the buyer or transferee must treat it as an option covered by either paragraph (m)(4)(i) or (m)(4)(ii) of this section.

(iv) Examples. The following examples illustrate the rules in this paragraph (m)(4):

Example 1. (i) On January 15, 2014, C, an individual who is neither a dealer nor a trader in securities, writes a 2-year exchange-traded option on 100 shares of Company X through Broker D. C receives a premium for the option of $100 and pays no commission. In C's hands, the option produces capital gain or loss and Company X stock is a capital asset. On December 16, 2014, C pays $110 to close out the option.

(ii) D is required to report information about the closing transaction because the option is a covered security as described in paragraph (a)(15)(i)(E) of this section and was part of a closing transaction described in paragraph (a)(8) of this section. Under paragraph (m)(4)(ii) of this section, D must report as gross proceeds on C's Form 1099-B -$10 (the $100 received as option premium minus the $110 C paid to close out the option) and report $0 in the basis box on the Form 1099-B. Under section 1234(b)(1) and paragraph (d)(2) of this section, D must also report the loss on the closing transaction as a short-term capital loss.

Example 2. (i) On January 15, 2014, E, an individual who is neither a dealer nor a trader in securities, buys a 2-year exchange-traded option on 100 shares of Company X through Broker F. E pays a premium of $100 for the option and pays no commission. In E's hands, both the option and Company X stock are capital assets. On December 16, 2014, E receives $110 to close out the option.

(ii) F is required to report information about the closing transaction because the option is a covered security as described in paragraph (a)(15)(i)(E) of this section and was part of a closing transaction described in paragraph (a)(8) of this section. Because the option is on the shares of a single company, it is an equity option described in section 1256(g)(6) and is not described in section 1256(b)(1)(C). Therefore, the rules of paragraph (m)(3) of this section do not apply, and F must report under paragraph (m)(4) of this section. Under paragraph (m)(4)(ii) of this section, F must report $110 as gross proceeds on the Form 1099-B for the gross proceeds E received and $100 in the basis box on the Form 1099-B to reflect the $100 option premium paid. Under section 1234(b)(1) and paragraph (d)(2) of this section, F must also report the gain on the closing transaction as a short-term capital gain.

(5) Multiple options documented in a single contract. If more than one option described in paragraph (m)(2) of this section is documented in a single contract, a broker must separately report the required information for each option as that option is sold.

(6) Determination of index status. Penalties will not be asserted under sections 6721 and 6722 if a broker in good faith determines that an index is, or is not, a narrow-based index described in section 1256(g)(6) and reports in a manner consistent with this determination.

(n) Reporting for debt instrument transactions—(1) In general. For purposes of this section, this paragraph (n) provides rules for a broker to determine and report information for a debt instrument that is a covered security under paragraph (a)(15)(i)(C) or (D) of this section. Neither a debt instrument subject to section 1272(a)(6) nor a short-term obligation described in section 1272(a)(2)(C) is subject to this paragraph (n) because neither is a specified security under paragraph (a)(14)(ii) of this section (a requirement for a debt instrument to be a covered security).

(2) Debt instruments subject to January 1, 2014, reporting—(i) In general. For purposes of paragraph (a)(15)(i)(C) of this section, except as provided in paragraph (n)(2)(ii) of this section, a debt instrument is described in this paragraph (n)(2)(i) if the debt instrument is one of the following:

(A) A debt instrument that provides for a single fixed payment schedule for which a yield and maturity can be determined for the instrument under § 1.1272-1(b);

(B) A debt instrument that provides for alternate payment schedules for which a yield and maturity can be determined for the instrument under § 1.1272-1(c); or

(ii) Exceptions. A debt instrument is not described in paragraph (n)(2)(i) of this section if the debt instrument is one of the following:

(A) A debt instrument that provides for more than one rate of stated interest (including a debt instrument that provides for stepped interest rates);

(B) A convertible debt instrument described in § 1.1272-1(e);

(D) A debt instrument that requires payment of either interest or principal in a currency other than the U.S. dollar;

(E) A debt instrument that, at one or more times in the future, entitles a holder to a tax credit;

(F) A debt instrument that provides for a payment-in-kind (PIK) feature (that is, under the terms of the debt instrument, a holder may receive one or more additional debt instruments of the issuer);

(G) A debt instrument issued by a non-U.S. issuer;

(H) A debt instrument for which the terms of the instrument are not reasonably available to the broker within 90 days of the date the debt instrument was acquired by the customer;

(I) A debt instrument that is issued as part of an investment unit described in § 1.1273-2(h); or

(J) A debt instrument evidenced by a physical certificate unless such certificate is held (whether directly or through a nominee, agent, or subsidiary) by a securities depository or by a clearing organization described in § 1.1471-1(b)(18).

(iii) Remote or incidental. For purposes of paragraphs (n)(2)(i) and (n)(2)(ii) of this section, a remote or incidental contingency (as determined under § 1.1275-2(h)) is ignored.

(iv) Penalty rate. For purposes of paragraph (n)(2)(ii)(A) of this section, a debt instrument does not provide for more than one rate of stated interest merely because the instrument provides for a penalty interest rate or an adjustment to the stated interest rate in the event of a default or similar event.

(3) Debt instruments subject to January 1, 2016, reporting. For purposes of paragraph (a)(15)(i)(D) of this section, a debt instrument is described in this paragraph (n)(3) if it is described in paragraph (n)(2)(ii) of this section or it otherwise is not described in paragraph (n)(2)(i) of this section. For example, this paragraph (n)(3) applies to variable rate debt instruments, inflation-indexed debt instruments, and contingent payment debt instruments because these instruments are not described in paragraph (n)(2)(i) of this section.

(4) Holder elections. For purposes of this section, a broker is required to take into account an election described in this paragraph (n)(4), and the broker must take the election into account in accordance with the rules in paragraph (n)(5) of this section. A broker, however, may not take into account any other election. See paragraph (n)(11) of this section for the treatment of an election described in paragraph (n)(4)(iii) of this section (election to accrue market discount based on a constant yield) and an election described in paragraph (n)(4)(iv) of this section (election to treat all interest as OID).

(i) Election to amortize bond premium. An election under section 171 and § 1.171-4 to amortize bond premium on a taxable debt instrument (this election applies to all taxable debt instruments held by a taxpayer during the taxable year the election is effective and thereafter; this election may be revoked with the consent of the Commissioner).

(ii) Election to currently include accrued market discount. An election under section 1278(b) to include market discount in income as it accrues (this election applies to all debt instruments acquired by a taxpayer during the taxable year the election is effective and thereafter; this election may be revoked with the consent of the Commissioner).

(iii) Election to accrue market discount based on a constant yield. An election under section 1276(b)(2) to compute accruals of market discount using a constant yield method (this election is generally made on an instrument-by-instrument basis and must be made for the earliest taxable year for which the taxpayer is required to determine accrued market discount on the debt instrument; this election may not be revoked).

(iv) Election to treat all interest as OID. An election under § 1.1272-3 to treat all interest on a taxable debt instrument (adjusted for any acquisition premium or premium) as original issue discount (this election is generally made on an instrument-by-instrument basis and must be made for the taxable year the debt instrument is acquired by the taxpayer; this election may be revoked with the consent of the Commissioner). However, see paragraph (n)(11)(i)(A) of this section for a debt instrument acquired on or after January 1, 2014.

(v) Election to translate interest income and expense at the spot rate. An election under § 1.988-2(b)(2)(iii)(B) to translate interest income and expense at the spot rate on the last day of the interest accrual period or, in the case of a partial accrual period, the last day of the taxable year (this election applies to all taxable debt instruments held by a taxpayer during the taxable year the election is effective and thereafter; this election may be revoked with the consent of the Commissioner).

(5) Broker assumptions and customer notice to brokers—(i) Broker assumptions if the customer does not notify the broker. Except as provided in paragraph (n)(5)(ii)(A) of this section, a broker must report the information required under paragraph (d) of this section by assuming that a customer has made the election to amortize bond premium described in paragraph (n)(4)(i) of this section. In addition, except as provided in paragraph (n)(5)(ii)(B) of this section, a broker must report the information required under paragraph (d) of this section by assuming that a customer has not made an election described in paragraph (n)(4)(ii), (n)(4)(iii), (n)(4)(iv), or (n)(4)(v) of this section. However, see paragraph (n)(11) of this section for the treatment of an election described in paragraph (n)(4)(iii) of this section (election to accrue market discount based on a constant yield) and an election described in paragraph (n)(4)(iv) of this section (election to treat all interest as OID).

(ii) Effect of customer notification of an election or revocation—(A) Election to amortize bond premium. If a customer notifies a broker in writing that the customer does not want the broker to take into account the election to amortize bond premium, the broker must report the information required under paragraph (d) of this section without taking into account the election to amortize bond premium. The customer must provide this notification to the broker by the end of the calendar year for which the customer does not want to amortize bond premium. If for a subsequent calendar year, the customer wants the broker to take into account the election to amortize bond premium, the customer must notify the broker in writing by the end of the calendar year that the customer wants to amortize bond premium. If the customer provides such notification, the broker must report the information required under paragraph (d) of this section as if the customer made the election to amortize bond premium for that year.

(B) Other debt elections. If a customer notifies a broker in writing that the customer has made or will make an election described in paragraph (n)(4)(ii), (iii), (iv), or (v) of this section, the broker must report the information required under paragraph (d) of this section by taking into account the election. A customer must notify the broker in writing of the election by the end of the calendar year in which a debt instrument subject to the election is acquired in, or transferred into, an account with the broker or, if later, by the end of the calendar year for which the election is effective. If a customer has revoked or will revoke an election described in paragraph (n)(4)(ii), (n)(4)(iv), or (n)(4)(v) of this section for a calendar year, the customer must notify the broker of the revocation in writing by the end of the calendar year for which the revocation is effective. If the customer provides such notification, the broker must report the information required under paragraph (d) of this section by taking into account the revocation.

(iii) Electronic notification. For purposes of paragraph (n)(5)(ii) of this section, the written notification to the broker includes a writing in electronic format.

(6) Reporting of accrued market discount. In addition to the information required to be reported under paragraph (d) of this section, if a debt instrument is subject to the market discount rules in sections 1276 through 1278, a broker also must report the information described in paragraph (n)(6)(i) or (n)(6)(ii) of this section, whichever is applicable. Such information must be shown in the manner and at the time required by Form 1099 and section 6045.

(i) Sale. A broker must report the amount of market discount that has accrued on a debt instrument as of the date of the instrument's sale, as defined in paragraph (a)(9)(i) of this section. See paragraphs (n)(5) and (n)(11)(i)(B) of this section to determine whether the amount reported should take into account a customer election under section 1276(b)(2). See paragraph (n)(8) of this section to determine the accrual period to be used to compute the accruals of market discount. This paragraph (n)(6)(i) does not apply if the customer notifies the broker under the rules in paragraph (n)(5) of this section that the customer elects under section 1278(b) to include market discount in income as it accrues.

(ii) Current inclusion election. If a customer notifies a broker under the rules in paragraph (n)(5) of this section that the customer elects under section 1278(b) to include market discount in income as it accrues, the broker is required to report to the customer the amount of market discount that accrued on a debt instrument during a taxable year while held by the customer in the account. The broker also must adjust basis in accordance with section 1278(b)(4). If a customer notifies a broker under the rules in paragraph (n)(5) of this section that the customer is revoking its election under section 1278(b), the broker will not report the market discount accrued during the taxable year of the revocation and thereafter and will cease to adjust basis in accordance with section 1278(b)(4). See paragraph (n)(8) of this section to determine the accrual period to be used to compute the accruals of market discount. See paragraphs (n)(5) and (n)(11)(i)(B) of this section to determine whether the amount reported should take into account a customer election under section 1276(b)(2).

(7) Adjusted basis. For purposes of this section, a broker must use the rules in paragraph (n) of this section to determine the adjusted basis of a debt instrument.

(i) Original issue discount. If a debt instrument is subject to the original issue discount rules in sections 1271 through 1275, section 1286, or section 1288, a broker must increase a customer's basis in the debt instrument by the amount of original issue discount that accrued on the debt instrument while held by the customer in the account. See paragraph (n)(8) of this section to determine the accrual period to be used to compute the accruals of original issue discount.

(ii) Amortizable bond premium—(A) Taxable bond. A broker is required to adjust the customer's basis for any taxable bond acquired at a premium and held in the account in accordance with § 1.1016-5(b). If a customer, however, informs a broker under the rules in paragraph (n)(5)(ii)(A) of this section that the customer does not want to amortize bond premium, the broker must not adjust the customer's basis for any premium.

(B) Tax-exempt bonds. A broker is required to adjust the customer's basis for any tax-exempt obligation acquired at a premium and held in the account in accordance with § 1.1016-5(b).

(iii) Acquisition premium. If a debt instrument is acquired at an acquisition premium (as determined under § 1.1272-2(b)(3)), a broker must decrease the customer's basis in the debt instrument by the amount of acquisition premium that is taken into account each year to reduce the amount of the original issue discount that is otherwise includible in the customer's income for that year. See § 1.1272-2(b)(4) to determine the amount of the acquisition premium taken into account each year. However, if a broker took into account a customer election under § 1.1272-3 in 2014, the broker must decrease the customer's basis in the debt instrument by the amount of acquisition premium that is taken into account each year to reduce the amount of the original issue discount that is otherwise includible in the customer's income for that year in accordance with §§ 1.1272-2(b)(5) and 1.1272-3.

(iv) Market discount. See paragraph (n)(6) of this section for rules to determine the adjusted basis of a debt instrument with market discount.

(v) Principal and certain other payments. A broker must decrease the customer's basis in a debt instrument by the amount of any payment made to the customer during the period the debt instrument is held in the account, other than a payment of qualified stated interest as defined in § 1.1273-1(c).

(8) Accrual period. For purposes of this section, a broker generally must use the same accrual period that is used to report any original issue discount or stated interest to a customer under section 6049 for a debt instrument. In any other situation, a broker must use a semi-annual accrual period or, if a debt instrument provides for scheduled payments of principal or interest at regular intervals of less than six months over the entire term of the debt instrument, a broker must use an accrual period equal in length to this shorter interval. For example, if a debt instrument provides for monthly payments of interest over the entire term of the debt instrument, the broker must use a monthly accrual period. The rules in § 1.1272-1(b)(4)(iii) apply for purposes of an initial short accrual period. In computing the length of an accrual period, any reasonable counting convention may be used (for example, 30 days per month/360 days per year, or actual days per month/365 days per year).

(9) Premium on convertible bond. If a customer acquires a convertible bond (as defined in § 1.171-1(e)(1)(iii)(C)) at a premium (as determined under § 1.171-1(d)), then, solely for purposes of this section and § 1.6049-9, a broker must assume that the premium is attributable to the conversion feature. Based on this assumption, no portion of the premium is amortizable for purposes of this section and § 1.6049-9.

(10) Effect of broker assumptions on customer. The rules in this paragraph (n) only apply for purposes of a broker's reporting obligation under section 6045. A customer is not bound by the assumptions that the broker uses to satisfy the broker's reporting obligations under section 6045. In addition, a notification to the broker under paragraph (n)(5) of this section does not constitute an effective election or revocation under the applicable rules for the election.

(11) Additional rules for certain holder elections—(i) In general. For purposes of this section, the rules in this paragraph (n)(11) apply notwithstanding any other rule in paragraph (n) of this section.

(A) Election to treat all interest as OID. A broker must report the information required under paragraph (d) of this section without taking into account any election described in paragraph (n)(4)(iv) of this section (the election to treat all interest as OID in § 1.1272-3). As a result, for example, a broker must determine the amount of any acquisition premium taken into account each year for purposes of this section in accordance with § 1.1272-2(b)(4). This paragraph (n)(11)(i)(A) applies to a debt instrument acquired on or after January 1, 2015. A broker, however, may rely on this paragraph (n)(11)(i)(A) for a debt instrument acquired on or after January 1, 2014, and before January 1, 2015.

(B) Election to accrue market discount based on a constant yield. A broker must report the information required under paragraph (d) of this section by assuming that a customer has made the election described in paragraph (n)(4)(iii) of this section (the election to accrue market discount based on a constant yield). However, if a customer notifies a broker in writing that the customer does not want the broker to take into account this election, the broker must report the information required under paragraph (d) of this section without taking into account this election. The customer must provide this notification to the broker by the end of the calendar year in which the customer acquired the debt instrument in an account with the broker. This paragraph (n)(11)(i)(B) applies to a debt instrument acquired on or after January 1, 2015. A broker, however, may rely on this paragraph (n)(11)(i)(B) to report accrued market discount for a debt instrument that is a covered security acquired on or after January 1, 2014, and before January 1, 2015, if the customer had not informed the broker that the customer had made a section 1278(b) election and there were no principal payments on the debt instrument during this period.

(ii) [Reserved].

(12) Certain debt instruments treated as noncovered securities—(i) In general. Notwithstanding paragraph (a)(15) of this section, a debt instrument is treated as a noncovered security for purposes of this section if the terms of the debt instrument are not reasonably available to the broker within 90 days of the date the debt instrument was acquired by the customer and the debt instrument is either—

(A) A debt instrument issued by a non-U.S. issuer; or

(B) A tax-exempt obligation issued before January 1, 2014.

(ii) Effective/applicability date. Paragraph (n)(12)(i) of this section applies to a debt instrument described in paragraph (n)(12)(i)(A) or (B) of this section that is acquired on or after February 18, 2016. However, a broker may rely on paragraph (n)(12)(i) of this section for a debt instrument described in paragraph (n)(12)(i)(A) or (B) of this section acquired before February 18, 2016.

(o) Additional reporting by stock transfer agents. [Reserved]

(p) Electronic filing. Notwithstanding the time prescribed for filing in paragraph (j) of this section, Forms 1096 and 1099 required under this section for reporting periods ending during a calendar year shall, if filed electronically, be filed after the last calendar day of the reporting period elected by the broker or barter exchange and on or before March 31 of the following calendar year.

(q) Applicability dates. Except as otherwise provided in paragraphs (d)(6)(ix), (m)(2)(ii), and (n)(12)(ii) of this section, and in this paragraph (q), this section applies on or after January 6, 2017. Paragraphs (k)(4) and (l) of this section apply with respect to information returns required to be filed and payee statements required to be furnished on or after January 1, 2024. (For rules that apply after June 30, 2014, and before January 6, 2017, see 26 CFR 1.6045-1, as revised April 1, 2016.) Except in the case of a sale of digital assets for real property as described in paragraph (a)(9)(ii)(B) of this section, this section applies to sales of digital assets on or after January 1, 2025. In the case of a sale of digital assets for real property as described in paragraph (a)(9)(ii)(B) of this section, this section applies to sales of digital assets on or after January 1, 2026. For assets that are commodities pursuant to the Commodity Futures Trading Commission's certification procedures described in 17 CFR 40.2, this section applies to sales of such commodities on or after January 1, 2025, without regard to the date such certification procedures were undertaken. Paragraphs (a)(21), (b)(2)(ix) through (xi), and (b)(24) and (25) of this section apply to sales of digital assets on or after January 1, 2027.

(r) Cross-references. For provisions relating to backup withholding for reportable transactions under this section, see § 31.3406(b)(3)-2 of this chapter for rules treating gross proceeds as reportable payments, § 31.3406(d)-1 of this chapter for rules with respect to backup withholding obligations, and § 31.3406(h)-3 of this chapter for the prescribed form for the certification of information required under this section.

[T.D. 7873, 48 FR 10304, Mar. 11, 1983]

Editorial Note:For Federal Register citations affecting § 1.6045-1, see the List of CFR Sections Affected, which appears in the Finding Aids section of the printed volume and at www.govinfo.gov.