APPENDIX F

Selected Provisions from the Explanation of the Technical and Miscellaneous Revenue Act of 1988

HOUSE WAYS AND MEANS COMMITTEE REPORT NO. 100-795, JULY 26, 1988 (“HOUSE COMMITTEE REPORT”)

SENATE FINANCE COMMITTEE REPORT NO. 100-445, AUGUST 3, 1988 (“SENATE COMMITTEE REPORT”)

JOINT COMMITTEE ON TAXATION EXPLANATION OF SENATE CONSENSUS AMENDMENT, JCX-28-88, SEPTEMBER 12, 1988

CONFERENCE COMMITTEE REPORT, STATEMENT OF THE MANAGERS, OCTOBER 24, 1988 (“CONFERENCE COMMITTEE REPORT”)

Special Limitations on Net Operating Loss and Other Carryforwards 2

Recognition of Gain or Loss on Liquidating Sales and Distributions of Property (General Utilities) 8

Joint Committee Explanation of Senate Consensus Amendment 15

House Committee Report 16

Conference Committee Report 18

Act Sec. 4012 and IRC § 382: Financial Institutions 19

Act Sec. 1004 and IRC § 108(G): Treatment of Discharge of Indebtedness Income of Certain Farmers 22

Act. Sec. 1018(D)(5) and IRC § 361: Earnings and Profits 23

ACT § 1006 AND FRC § 336, 368, AND 382 SENATE COMMITTEE REPORT

SPECIAL LIMITATIONS ON NET OPERATING LOSS AND OTHER CARRYFORWARDS

Value of Loss Corporation

In lieu of regulatory authority, the bill extends the statutory rules for redemptions to other corporate contractions. The rule for redemptions was intended to apply to transactions that effect similar economic results, without regard to formal differences in the structure used or the order of events by which similar consequences are achieved. Thus, for example, the fact that a transaction might not constitute a “redemption” for other tax purposes does not determine the treatment of the transaction under this provision. As one example, a “bootstrap” acquisition, in which aggregate corporate value is directly or indirectly reduced or burdened by debt to provide funds to the old shareholders, could generally be subject to the provision. This may include cases in which debt used to pay the old shareholders remains an obligation of an acquisition corporation or an affiliate, where the acquired loss corporation is directly or indirectly the source of funds for repayment of the obligation.

The bill also clarifies that if the old loss corporation is a foreign corporation, except as provided in regulations its value shall be determined taking into account only assets and liabilities treated as connected with the conduct of a trade or business in the United States.1

The provision extending the rules for redemptions to other corporate contractions applies to ownership changes occurring after June 10, 1987.

Definition of Ownership Change

The bill amends section 382(g)(4)(C) to clarify that rules similar to the segregation rule apply to acquisitions by groups of less-than-five-percent shareholders through corporations as well as other entities (e.g., partnerships), and in transactions that do not constitute equity structure shifts.

The regulatory authority in section 382(g)(3)(B)—to treat transactions under the rules for equity structure shifts—does not limit the scope of section 382(g)(4)(C). Section 382(g)(4)(C), by its terms, generally causes the segregation of the less-than-five-percent shareholders of separate entities where an entity other than a single corporation is involved in a transaction. Section 382(g)(3)(B) merely provides additional authority, as does section 382(m), for cases in which only one corporation is involved.

Special Rules for Built-In Gains and Losses and Section 338 Gains

The bill provides that a redemption or other corporate contraction occurring in connection with an ownership change that occurs on or after July 21, 1988, shall be taken into account in determining whether a loss corporation has a net unrealized built-in gain or a net unrealized built-in loss only to the extent provided in regulations. The committee was concerned that loss corporations and their acquirors would engage in redemptions and other corporate contractions in order to meet the 25 percent threshold for built-in gains, but would avoid such transactions if the loss corporation would, as a result, meet the 25 percent threshold for built-in losses. It is expected that regulations permitting a redemption or other corporate contraction to be taken into account, if any, will in no event permit a loss corporation or its acquirors to manipulate the 25 percent thresholds for net unrealized built-in and loss through selective redemptions or other corporate contractions.

The bill clarifies the treatment of built-in gain if a section 338 election is made in connection with an ownership change, and if the 25 percent built-in gain threshold was not met with respect to the ownership change, so that no post-change built-in gains would generally be allowed to increase the section 382 limitation. The bill provides that in such a case, the section 382 limitation for the postchange year in which gain is recognized by reason of the section 338 election is increased by the lesser of (i) the amount of net unrealized built-in gain (determined as of the date of the section 382 ownership change), computed without regard to the 25-percent threshold requirement, or (ii) the gain recognized by reason of section 338.

Also, regarding the allocation rule for the taxable year in which an ownership change occurs, taxable income is computed without regard to recognized built-in gains to the extent such gains increased the section 382 limitation for the year, and without regard to recognized built-in losses to the extent such losses are treated as per-change losses. That is, such gains or losses are disregarded for this purpose only to the extent they did not exceed the limitations on the total amount of recognized built-in gain or loss, as the case may be, for the year of recognition.

The amendment clarifies that any item of income which is properly taken into account during the recognition period but that is attributable to periods before the change date shall be treated as a recognized built-in gain for the taxable year in which it is properly taken into account. Such items would include accounts receivable of a cash basis taxpayer that arose before the change date and are collected after that date, the gain on completion of a long-term contract performed by a taxpayer using the completed contract method of accounting that is attributable to periods before the change date, and the recognition of income attributable to periods before the change date pursuant to section 481 adjustments, for example, where the loss contraction was required to change to the accrual method of accounting pursuant to Code section 448.

Also, any amount which is allowable as a deduction during the recognition period but which is attributable to periods before the change date shall be treated as a recognized built-in loss for the taxable year for which it is allowable as a deduction. The committee intends that this provision shall be effective with respect to amounts allowable as depreciation, amortization, or depletion only to the extent consistent with the special effective date provided in the Revenue Act of 1987 for such items.2

The amount of net unrealized built-in gain or loss shall be properly adjusted to include items of income or deduction attributable to periods before the change date.

Under the bill, except as provided in regulations, in computing net unrealized built-in gain or loss for purposes of determining whether the 25 percent threshold applies, there shall not be taken into account any (1) cash, (2) cash items (as determined for purposes of section 368(a)(2)(F)(iv), or (3) marketable securities that have a value that does not substantially differ from adjusted basis.

It is expected that regulations will generally require receivables acquired in the ordinary course of business to be treated in the same manner as other items involving built-in gain or loss, and that such receivables thus will generally be taken into account in determining whether the 25 percent threshold has been met.

On the other hand, it is expected that the Treasury Department will continue to treat receivables as items that are excluded from the computation of any 25 percent threshold, in any case where there is a potential for taxpayer manipulation of the threshold, for example, by purchasing, issuing, or otherwise acquiring receivables in a different amount or to a different extent than has previously been the case, in effect substituting a built-in gain or loss item for cash or eliminating a normal built-in gain or loss item.

Treasury regulations are also expected to address the treatment of marketable securities with a value that does not differ substantially from adjusted basis. In appropriate cases it is expected that Treasury regulations will permit such marketable securities to be taken into account in determining whether the threshold has been met. For example, in cases where the business of the taxpayer is the holding of marketable securities (such as the case of entities described in section 382(l)(4)(B)(ii), such marketable securities may be taken into account, provided there is no evidence of manipulation of the marketable securities involved in a manner favorable to the taxpayer.

In applying section 382, it may be to the taxpayer’s advantage to meet the 25 percent threshold with respect to built-in gains, or not to meet the threshold with respect to built-in losses. It is expected that receivables and any other cash item, as well as marketable securities, will continue to be excluded from the computation in any case in which there is a variation from the taxpayer’s past business practice, or in any other appropriate case with a result that causes the threshold to be met or not met in a manner favorable to the taxpayer; and that prophylactic rules may be utilized for this purpose.3

Finally, the bill clarifies that a recognized built-in loss that is disallowed retains its character as a capital loss or ordinary loss and is carried forward under the rules applicable to a loss of that character.

Testing Period

The bill clarifies that the testing period does not begin before the earlier of (1) the first day of the first taxable year from which there is a loss carryforward, or (2) the first day of the taxable year in which the transaction being tested occurs. Thus, where there is a current net operating loss for the taxable year in which an ownership change occurs, the testing period is determined by taking such taxable year into account.

Loss Corporations

The bill clarifies that the definition of a loss corporation includes a corporation entitled to use a prechange loss (that is, a net operating loss for the taxable year in which an ownership change occurs, as well as a net operating loss carryover to such year). Thus, for example, the definition of a new loss corporation includes a corporation that is entitled to use a net operating loss that was incurred in the taxable year in which an ownership change occurred.

Except as provided in regulations, any entity and any predecessor or successor of such entity is treated as one entity. As an example, if a corporation purchases 100 percent of the stock of an unrelated loss corporation, the loss corporation would become a new loss corporation. If the new loss corporation liquidates in a tax-free transaction pursuant to section 332 (so the new loss corporation’s net operating loss carryforwards carry over to the acquiring corporation), the acquiring corporation—as successor—will continue to be treated as a new loss corporation.

The bill also modifies the definition of ownership change by eliminating the references to “old” and “new” loss corporations. This change merely eliminates circularity in the definition of ownership change, and is not intended to have any substantive effect.

Operating Rules Relating to Stock Ownership

The bill clarifies that the constructive ownership rules of section 318 are applied only to “stock” that is taken into account for purposes of section 382. For example, assume a corporation owns both common stock and stock of a type that is not counted in determining whether there has been an ownership change (referred to as “pure preferred”) in a holding company. The pure preferred represents 55 percent of the holding company’s value. The holding company’s only asset consists of 100 percent of the common stock in an operating subsidiary that is a loss corporation. The sale of the pure preferred would not constitute an ownership change because no stock in the loss corporation may be attributed through pure preferred. On the other hand, assume 100 percent of the stock in a loss corporation is transferred in a section 351 exchange, in which the loss corporation’s sole shareholder receives pure preferred representing 51 percent of the transferee’s value, and an unrelated party receives 100 percent of the transferee’s common stock. Here, an ownership change would result with respect to the loss corporation. Similar rules apply where a loss corporation is owned directly or indirectly by a partnership (or other intermediary) that has outstanding ownership interests substantially similar to a pure preferred stock interest.

The bill also clarifies that the rule with respect to options extends beyond options that have been subject to section 318(a)(4).

Bankruptcy Proceedings

The bill clarifies that, for purposes of the 50-percent test, stock of a shareholder is taken into account only to the extent such stock was received in exchange for stock or a qualified creditor’s interest that was held immediately before the ownership change. Thus, for example, stock received by a former stockholder for new consideration, such as the provision of funds to the corporation, a guarantee of corporate obligations, or any other consideration, is not taken into account. Similarly, stock purchased from other shareholders in the transaction is not counted. The bill also clarifies that stock received by a qualified creditor is taken into account only to the extent such stock was received in satisfaction of qualified indebtedness.

The bill clarifies the attribute reduction that occurs with respect to amounts that would be cancellation of indebtedness income. The amount of the reduction is 50 percent of the amount that (but for section 108(e)(10)(B)) would have been applied to reduce tax attributes under section 108(b), that is, the excess of the amount of cancelled debt over the fair market value of stock issued in satisfaction of the debt. The bill also clarifies that the amount of the debt outstanding for this purpose does not include previously accrued but unpaid interest that has already been deducted from net operating loss carryforwards under the rule requiring reduction for interest deducted during the three-year period prior to the ownership change.

The bill also clarifies that the denial of a deduction for interest paid or accrued by the old loss corporation during the 3 years preceding the year of the ownership change, on indebtedness which is converted into stock pursuant to a title 11 or similar case, applies not only for purposes of computing any net operating loss deduction but also for purposes of computing any excess credits which may be carried to a post-change year.

In addition, the bill clarifies that if an election to forego the bankruptcy rule is made, the value of the new loss corporation will reflect any increase in value resulting from the surrender of cancellation of creditors’ claims in the transaction.

Regarding qualified thrift reorganizations, the bill clarifies that the fair market value of the outstanding stock of the new loss corporation includes the amount of deposits in such corporation immediately after the change. Also, it is clarified that the voting power requirement will not cause a failure of the 20-percent test solely because deposits do not carry adequate voting power.

Effective Dates

The bill clarifies that the provisions of the Act apply to ownership changes occurring after December 31, 1986. For purposes of this transition rule, and for purposes of determining when a new testing period starts under section 382(i), any equity structure shift pursuant to a plan of reorganization adopted before January 1, 1987 is treated as occurring when such plan was adopted.4

By treating equity structure shifts pursuant to plans of reorganization that were adopted before January 1, 1987 as occurring when the plan was adopted, the bill clarifies that no equity structure shift pursuant to a plan adopted after 1986, and no other owner shift involving a 5-percent shareholder occurring after 1986, is protected under the transition provisions, even though such shifts may occur before the completion of a pre-1987 plan of reorganization; i.e., such shifts are not grandfathered by virtue of the pre-1987 plan. If however, an ownership change occurs within the testing period prior to the end of 1986 when any equity structure shift pursuant to a pre-1987 plan is considered together with other pre-1987 owner shifts, that ownership change is grandfathered and a new testing period starts. Any equity structure shift pursuant to a plan adopted after 1986, and any post-1986 owner shift involving a 5-percent shareholder, that occurs before the completion of the pre-1987 plan of reorganization will count for purposes of determining when or whether a later ownership change occurs, under section 382(i).

If, applying the foregoing provisions and the rule in section 382(l)(3) (described below), an ownership change occurs immediately following an equity structure shift pursuant to a post-1986 plan of reorganization, or immediately following any other post-1986 owner shift involving a 5-percent shareholder, the ownership change is subject to the provisions of section 382 as amended by the Act.

The bill clarifies that the May 6, 1986, testing date applies for purposes of determining whether an ownership change occurred after May 5, 1986, and before January 1, 1987. For purposes of determining whether shifts in ownership occurred between May 5, 1986, and January 1, 1987, the rule in section 382(l)(3) for options and similar interests applies. Thus, in the case of such an interest issued on or after May 6, 1986, and before January 1, 1987, the underlying stock could be treated as acquired at the time the interest was issued. For this transition period, however, in addition to the Treasury Department’s general regulatory authority under the rule in section 382(l)(3), the Treasury Department may provide for different treatment in the case of an acquisition of an option or similar interest that is not in fact exercised, as appropriate where the effect of treating the underlying stock as if it were acquired would be to cause an ownership change that would start a new testing period (and thus result in relief under the transitional rules). No inference is intended as to how pre-May 6, 1986 options or similar interests would be treated.

The 1954 Code version of section 382(a), relating to nonreorganization transactions, has continuing application to any increase in percentage points of stock ownership to which the provisions of the Act do not apply by reason of any transitional rule—including the rules prescribing measurement of the testing period by reference only to transactions after May 5, 1986, and the rules that disregard ownership changes following or resulting from certain transactions. The 1954 Code version of section 382(b), however, does not apply to any reorganization occurring pursuant to a plan of reorganization adopted after December 31, 1986.

Any regulations that have the effect of treating a group of shareholders as a separate five-percent shareholder by reason of a public offering will not apply to any public offering before January 1, 1989, for the benefit of institutions described in section 591. Further, unless the corporation otherwise elects, an underwriter of any offering of stock of a corporation before September 19, 1986 (January 1, 1989, in the case of an offering for the benefit of an institution described in section 591) will not be treated as acquiring stock in the institution by reason of a firm commitment underwriting, but only to the extent such stock is disposed of no later than 60 days after the initial offering and pursuant to the offering.

Property Transferred in Nonrecognition Transactions

The bill clarifies that the regulatory authority applies to cases where property held on the change date was acquired or is subsequently transferred in a transaction where gain or loss is not recognized in whole or in part. Thus, for example, it is clarified that property transferred in such a nonrecognition transaction prior to the date of the ownership change date is subject to the regulatory authority.

It is expected, as one example, that built-in gain with respect to property transferred in a nonrecognition transaction (including, for example, a tax-free reorganization as well as a section 351 contribution to capital) may in appropriate cases be disregarded for purposes of determining the amount of net unrealized built-in gain and for purposes of determining the addition to the section 382 limitation following an ownership change. It is expected that cases where such built-in gain will be disregarded may include transactions in which the value transferred to the corporation would be disregarded under section 382(l)(1) if the transaction had been a contribution to capital.

Certain Related Corporations

The bill clarifies that the regulatory authority is intended to include authority to provide appropriate adjustments to value, built-in gain or loss, and other items so that items are not taken into account more than once or omitted in the case of certain corporations under common ownership.

The bill defines such corporations under common ownership to include any group of corporations described in section 1563(a) (determined by substituting “50 percent” for “80 percent” each place it appears and without regard to section 1563(a)(4)).

RECOGNITION OF GAIN OR LOSS ON LIQUIDATING SALES AND DISTRIBUTIONS OF PROPERTY (GENERAL UTILITIES)

Limitations on Recognition of Loss

The bill clarifies that an acquisition of property by a corporation after the date two years before the date the corporation adopts a plan of complete liquidation (rather than merely during the two-year period ending on the date of the adoption of the plan) shall, except as provided in regulations, be treated as acquired as part of a plan a principal purpose of which was to recognize loss by the liquidating corporation in connection with the liquidation.

The bill also clarifies that the provision denying recognition of loss to the distributing corporation in a section 332 liquidation is intended to apply to a distribution to the corporation meeting the control requirement of section 332 only if the distribution does not result in gain recognition to the distributing corporation, pursuant to section 337(a) or (b)(1). Thus, the provision denies loss recognition on a taxable distribution to minority shareholders in such a liquidation. If the section 332 liquidation is not described in section 337(b)(1) or (2) (for example, in the case of certain liquidations into a tax exempt parent corporation) the special loss disallowance provision of section 336(d)(3) does not apply. Such a transaction would be subject to any other applicable loss disallowance provisions, however.

Election to Treat Certain Stock Sales and Distributions as Asset Transfers

The bill clarifies that Congress did not intend to require the election to be made unilaterally by the selling or distributing corporation. The bill thus provides that, under regulations prescribed by the Secretary, an election may be made to treat the certain sales and distributions of subsidiary stock as asset sales. Compare section 338(h)(10).

Treatment of Distributing Corporation

The bill clarifies that the provision with respect to use in an unrelated trade or business was intended to apply to use in an activity the income from which is subject to tax under section 511(a).5

Basis Adjustment in Taxable Section 332 Liquidation

The bill clarifies that if gain is recognized on a distribution of property in a liquidation described in section 332(a) to a corporate distributee meeting the stock ownership requirements of section 332(b), a corresponding increase in the distributee’s basis occurs.

Use of Installment Method by Shareholders in Certain Liquidations

The bill clarifies that, as under the law prior to the enactment of the Act, in the case of inventory the corporate sale or exchange must have been not only to one person but to one person in one transaction.

Distributions of Partnership or Interests

The bill generally repeals section 386 of the Code as deadwood in light of the Act’s amendments to sections 311, 336 and 337 of the Code. However, the bill restates, in section 311, the provision contained in present-law section 386(d), that the Secretary may by regulations provide that the amount of gain recognized on a nonliquidating distribution of a partnership interest shall be computed without regard to any loss attributable to property contributed to the partnership for the principal purpose of recognizing such loss on the distribution (i.e., thereby reducing the gain otherwise recognized on the distribution and effectively recognizing a loss not permitted in a nonliquidating distribution).6

Transactions between Related Taxpayers

The bill clarifies that section 267(a) does not apply either to any loss of the distributee or to any loss of the distributing corporation in the case of a distribution in complete liquidation. Losses may be denied under other provisions of law or judicially created doctrine as under present law.

Distributions of Property to Shareholders

Certain portions of section 301 are repealed as deadwood. Thus, section 301 of the Code is amended to provide that the amount distributed and the basis of property in the hands of a corporate distributee is the fair market value of the property. The holding period of such distributed property in the hands of the distributee begins on the date of the distribution, as under present law, but section 301(e) is not necessary to reach this result and is repealed.7

Certain Transfers to Foreign Corporations

The bill clarifies that a transfer of property to a foreign corporation in a transaction that would otherwise qualify as a tax-free reorganization is treated in the same manner as a liquidating transfer of such property to an 80-percent foreign corporate distributee. Thus, in the case of a transfer of property described in section 361(a) or (b) (as amended by the bill) by a U.S. corporation to a foreign corporation, the provisions of section 367(a)(2) and (3) do not apply, and gain is recognized unless regulations provide otherwise. However, subject to such basis adjustments and such other conditions as shall be provided in regulations, this rule does not apply if the U.S. corporate transferor is 80-percent controlled (within the meaning of section 368(c)) by five or fewer domestic corporations. For this purpose, all members of the same affiliated group (within the meaning of section 1504) are treated as one corporation. This provision applies only to transactions occurring after June 10, 1987.

It is expected that regulations will provide this relief only if the U.S. corporate shareholders in the transferor agree to take a basis in the stock they receive in a foreign corporation that is a party to the reorganization equal to the lesser of (a) the U.S. corporate shareholders’ basis in such stock received pursuant to section 358, or (b) their proportionate share of the basis in the assets of the transferor corporation transferred to the foreign corporation. The requirements that five or fewer domestic corporations own at least 80 percent of the U.S. transferor corporation’s stock assures that the bulk of the built-in gain will remain subject to U.S. taxing jurisdiction. In addition, it is also expected that regulations will require the U.S. corporate transferor to recognize immediately any built-in gain that does not remain subject to U.S. taxing jurisdiction by virtue of a substituted stock basis. This would occur, for example, where 20 percent or less of the U.S. corporate transferor is owned by foreign shareholders who receive substituted basis stock in the transferee corporation, which stock would not be subject to U.S. taxing jurisdiction on disposition.

Gain from Sales or Exchanges of Stock

The bill amends section 1248(f) to conform to the changes under the Act that generally cause gain to be recognized, and earnings and profits to be created, on a liquidating sale or distribution or on a nonliquidating distribution, and that treat liquidating and nonliquidating distributions as sales or exchanges for this purpose. Section 1248(f)(1) under the bill applies only to certain distributions that are still nonrecognition events to the distributing corporation and are not treated as a sale by such corporation to the distributee—that is, distributions that would be tax-free to the recipient under the reorganization provisions of section 361(c) of the Code (as amended by the bill) or under section 355 of the Code and certain liquidating distributions to an 80-percent distributee. As under present law, section 1248(f)(2) excepts those situations in which the recipients U.S. corporation satisfies the stock ownership requirements of section 1248(f)(2) and is treated as holding stock for the period the stock was held by the distributing corporation.

It is contemplated that the Treasury Department may exercise its regulatory authority under section 1248(f) to provide that, in cases where a distribution that would be tax-free but for section 1248(f)(1) occurs within a controlled group, and section 1248(f)(2) does not otherwise apply, the recipient corporation may be required to take a carryover basis in the stock received (rather than a substituted basis under section 358, for example, in the case of a section 355 or 361 distribution) and section 1248(f)(1) will not apply to such distribution.

The bill repeals sections 1248(f)(3) and 1248(d)(2) as deadwood.

The bill makes certain other related clerical and conforming amendments.

* * * *

Distributions by S Corporations

The bill provides that the distribution by an S corporation of an installment obligation with respect to which the shareholder is entitled to report the shareholder’s stock gain on the installment method (by reason of section 453(h)) will not be treated as a disposition of the obligation. This rule will allow the shareholder to report the gain over the same period of years as if the amendments made by the 1986 Act had not been enacted. This special rule does not apply for purposes of determining the corporation’s tax liability under subchapter S. In addition, the character of the shareholder’s gain shall be determined as if the corporate level gain had been passed through to the shareholder under section 1366.

The special distribution rules provided in Code section 1363(d) and (e) of the Code are repealed as deadwood. Thus, for example, it is clarified that, pursuant to section 1371 of the Code, the provisions of subchapter C of the Code apply to determine the recognition of gain and loss in the case of a distribution by an S corporation.

Regulatory Authority to Prevent Circumvention of Provisions

The bill clarifies that the regulatory authority to prevent circumvention of the provisions of the Act extend to all the amendments made by subtitle D of Title VI of the Act. The bill also clarifies in connection with the built-in gain provisions of the Act that the Treasury Department shall prescribe such regulations as may be necessary or appropriate to carry out those provisions, including provisions dealing with the use of such pass-through entities, other than S corporations, as regulated investment companies (RICs) or real estate investment trusts (REITs). For example, this includes rules to require the recognition of gain if appreciated property of a C corporation is transferred to a RIC or a REIT or to a tax-exempt entity8 in a carryover basis transaction that would otherwise eliminate corporate level tax on the built-in appreciation.

It is expected that Treasury shall also prevent the avoidance of the section through contributions of property with built-in loss to a corporation before it becomes an S corporation.

It is also expected that the Treasury Department will prevent the manipulation of accounting methods or other provisions that may have the result of deferring gain recognition beyond the 10-year recognition period—for example, in the case of a C corporation with appreciated FIFO inventory that converts to S status and elects the LIFO method of accounting.

Section 704(c) of the Code generally requires that gain attributable to appreciated property contributed to a partnership by a partner be allocated to that partner; it is expected that this rule would generally prevent the use of a partnership to avoid the purposes of the amendments made by subtitle D of Title VI of the Act (for example, by attempting to shift the tax on C corporation appreciation to another party or to a non-C corporation regime). However, if and to the extent that partners might utilize allocation rules or other partnership provisions (including the so-called “ceiling rule” contained in the regulations under section 704(c)) to defer the recognition of built-in gain to a corporate partner by shifting the incidence of current gain recognition, it is intended that the Treasury Department may exercise its authority to prevent such results.

Transition Provisions

Built-in gains of S corporations. The bill clarifies that, for purposes of the transition provisions, if a corporation was a C corporation at any time prior to December 31, 1986, any “S” status of such corporation prior to its “C” corporation status is disregarded. Thus, the bill provides that (subject to the special small-corporation transition rules of the Act) the built-in gains provisions apply to taxable years beginning after December 31, 1986, in cases where the return for the taxable year is filed pursuant to an S election made after December 31, 1986.

The bill clarifies that a 34-percent tax rate applies to capital gain that is subject to prior law section 1374 in taxable years beginning after December 31, 1986.

General transition rule based on pre-August 1, 1986 action. The bill clarifies that the transition rule applies if more than 50 percent (rather than 50 percent or more) of the voting stock is acquired pursuant to the binding written contract.

A clarification is made regarding the exception for a qualified stock purchase pursuant to a binding contract in effect before August 1, 1986. For purposes of this exception, a modification of a contract for the purchase of stock in more than one corporation that arises because of third party rights in the stock to be acquired (such as a right of first refusal), or because of the rules and rulings of government agencies or courts, is not intended to cause a contract to be deemed nonbinding, so long as the stock acquired was a part of the original contract. This clarification is not intended to create any inference regarding the meaning of binding contract in other contexts.

Transitional rules for certain small corporations. The bill provides that a qualified corporation eligible for the special delayed effect dates does not recognize gain on a distribution of installment obligations that are received in exchange for long-term capital gain property (including section 1231 property the disposition of which would produce long-term capital gain) where the distribution of such obligations would not have caused corporate level recognition under sections 337 and 453B(d)(2) as in effect prior to the Act. However, distributions of such installment obligations received in exchange for ordinary income property or short-term capital gain property do require the recognition of corporate level gain.

It is intended that a taxpayer that purchases the stock of a qualified corporation in a qualified stock purchase prior to January 1, 1989, is entitled to apply prior-law rules (modified as in the case of actual liquidations) with respect to an election under section 338, even though in the hands of the acquiring corporation the qualified corporation no longer satisfies the stock holding period requirements and may not satisfy the size or shareholder requirements due to the size or shareholders of the acquiring corporation.

The bill clarifies that, although the Act repealed section 333 of the Code, in the case of a liquidating distribution to which section 333 of prior law would apply, a shareholder of a qualified corporation electing such treatment is entitled to apply section 333 without any phase-out of shareholder level relief under the Act. However, an increase in shareholder-level gain could result from an increase in corporate earnings and profits resulting from application of the corporate-level phase-out of relief.

The bill clarifies that for distributions before January 1, 1989, qualifying corporations continue to be eligible for relief under prior-law rules relating to nonliquidating distributions with respect to qualified stock, (prior law sec. 311(d)(2)), without regard to whether the corporation liquidates before January 1, 1989. However, this relief does not apply to distributions of ordinary income property or short-term capital gain property.

The bill provides that a corporation is not a qualified corporation unless more than 50 percent (by value) of the stock of such corporation is owned (on August 1, 1986 and at all times thereafter before the corporation is completely liquidated) by the same 10 or fewer qualified persons who at all times during the 5-year period ending on the date of the adoption of the plan of liquidation (or, if shorter, the period during which the corporation or any predecessor was in existence) owned (or were treated as owning under the attribution rules) more than 50 percent (by value) of the stock of such corporation. This change to the statutory language of the Act, incorporating a holding period requirement, does not apply to nonliquidating distributions before March 31, 1988 (the date of introduction of the bill), to liquidating sales or distributions pursuant to a plan of liquidation adopted before March 31, 1988, or to deemed liquidating sales pursuant to an election under section 338 where the acquisition date under section 338 occurs before March 31, 1988. Also, for purposes of applying section 1374 in the case of a qualified corporation, the provision does not apply if the S election was filed before March 31, 1988.

Where stock passes to an estate, the holding period of the estate includes that of the decedent. Also, the “look-through” attribution rules that apply under this provision do not apply in the case of trusts qualifying under section 1361(c)(2)(ii) or (iii), just as they do not apply under the Act in the case of estates. Thus, stock held by such entities, like stock held by an estate, is to be treated as held by a single qualified person, so that the 10-shareholder test will not cease to be satisfied merely because a decedent’s stock passes to such a trust. (In the case of other trusts holding stock, the “look-through” attribution rules apply to determine whether more than 10 qualified persons ultimately own the stock.)

The bill also clarifies that the holding period of a decedent’s estate (or a section 1361(c)(2)(A)(ii) or (iii) trust) is tacked with that of any beneficiary, as well as with that of the decedent, for purposes of determining the holding period. However, except in the case of beneficiaries who are treated as being “one person” with the decedent, once stock has been distributed to beneficiaries, the 10-shareholder requirement might fail to be satisfied due to an increase in the number of shareholders. Property acquired by reason of the death of an individual is treated as owned at all times during which the property was treated as owned (in addition to actually owned) by the decedent (as one example, property treated as owned by the decedent under the grantor trust rules, as well as property treated as owned by the decedent pursuant to attribution rules, would have a tacked holding period for this purpose).

In the case of indirect ownership through an entity, the rules described above are the only rules that apply to determine ownership and holding period. Thus, it is not intended that holding periods could otherwise be “bootstrapped” through analogy to or application of any provision of section 1223. For example, if a partnership owns all the stock of a corporation, a new partner who contributes other property to the partnership in exchange for a partnership interest is deemed under section 1223 to have a holding period in the partnership interest that includes such person’s holding period for the property contributed. However, such a person would not be deemed thereby to have owned stock in the corporation that the partnership owned for any period prior to the time the person became a partner. In such cases, under the attribution and other holding period rules of the transitional provision a qualified person’s holding period for the underlying stock is the lesser of (1) the period during which the entity held the stock in the qualified corporation, or (2) the period during which the qualified person held the interest in the entity. In other situations, the basic attribution and holding period rules of the transitional rule provision may provide a different result.9

The bill clarifies that the rule that all members of a controlled group of corporations (as defined in section 267(f)(1)) are treated as a single corporation applies solely for purposes of determining whether the corporation meets the size requirements for relief. Thus, it is clarified that it is not necessary for all members of a group that, in the aggregate, meets the size requirements for a qualified corporation, to liquidate before January 1, 1989, in order for the liquidation of one member of the group to qualify for relief. It is not intended that an S corporation be included as a member of the group unless such corporation was a C corporation for its taxable year including August 1, 1986 or was an S corporation that was not described in section 1374(c)(1) or (2) of prior law for such taxable year.

The bill also provides a rule to prevent the use of qualified corporations as conduits for the sale of assets by corporations that are not qualified. It is expressly provided that the transition rules do not apply where a principal purpose of a carryover basis transfer of an asset to a qualified corporation is to secure the benefits of the special transition rules. This provision is not intended to limit the application of the step transaction doctrine or other doctrines that would prevent the use of the transition rules. It is expected that a similar step transaction approach would be applied in the case of any transfer of assets to any corporation that qualified for transition under any of the other provisions of the Act, if a principal purpose of the transfer was to secure the benefit of transition for an otherwise non-qualified transaction.

The bill makes certain other clerical and conforming changes.

Effective Dates

In general, the provisions of the bill are effective as of January 1, 1987.

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JOINT COMMITTEE EXPLANATION OF SENATE CONSENSUS AMENDMENT

Outbound liquidations. Provide that the technical correction relating to transfers of property to a foreign corporation that would otherwise qualify as a tax-free reorganization would apply only to transactions occurring after June 21, 1988, except that such technical correction would not apply to reorganizations for which a plan of reorganization had been adopted before June 22, 1988.

Mirror subsidiary transition rule. Clarify that, for purposes of the exception from the effective date provision concerning mirror subsidiary transactions in cases where 80 percent of the stock of the distributing corporation is acquired by the distributee, the ownership of distributees which are members of the same affiliated group may be aggregated in certain cases.

Section 384 and common control exception. Provide that if the gain corporation, the loss corporation or both were not in existence throughout the five year period, the exception will be applied by substituting the shorter of the periods during which the gain corporation, the loss corporation, or both were in existence.

Section 384 and treatment of affiliated corporations. Clarify in legislative history that not only postaffiliation gains or losses, but also pre-affiliation gains or losses which were not limited under section 384, are not subject to the limitations of section 384 upon the merger of members of the same affiliated group.

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Special rule relating to 1976 Act net operating loss limitations. Clarify that warrants would not be treated as stock under section 382 of the 1976 Act.

HOUSE COMMITTEE REPORT

Tax Imposed on Certain Built-In Gains of S Corporations

The bill modifies the operation of the built-in gains tax. The bill retains the net income limitation of the Act by providing that a net recognized built-in gain for a year will not be taxed to the extent the corporation would not otherwise have taxable income for the year if it were a C corporation (determined in accordance with section 1375(b)(1)(B)). Under the bill, therefore, recognized built-in gain in any post-conversion year is reduced for purposes of the built-in gains tax by any recognized built-in loss for that year, and also by any other post-conversion losses for that year.

Although the committee believes it is appropriate not to impose the built-in gains tax in a year in which the taxpayer experiences losses, the committee also believes it is appropriate to reduce the potential for taxpayers to manipulate the timing of post-conversion losses in a manner that might entirely avoid the built-in gains tax on the net unrealized built-in gain of the former C corporation. Accordingly, the bill provides that any net recognized built-in gain that is not subject of the built-in gains tax due to the net income limitation will be carried forward.

Thus, an amount equal to any net recognized built-in gain that is not subject to the built-in gains tax because of the net income limitation will be carried forward and will be subject to the built-in gains tax to the extent the corporation subsequently has other taxable income (that is not already otherwise subject to the built-in gains tax) for any taxable year within the 10-year recognition period. This provision of the bill applies only in the case of subchapter S elections made on or after March 31, 1988.

The provision is illustrated by the following example: Corporation A elects S status on March 31, 1988. The corporation has two assets, one with a value of $200 and an adjusted basis of $0 and the other with a value of $0 and an adjusted basis of $100. It has no other items of built-in gain or loss. The corporation thus has a net unrealized built-in gain of $100. In its first taxable year for which it is an S corporation, the corporation sells both assets for their fair market value and has a net recognized built-in gain of $100. It also has an additional $100 loss from other post-conversion activities. The corporation is not subject to any built-in gains tax in that year because its net recognized built-in gain ($100) exceeds its net income determined in accordance with section 1375(b)(1)(B) ($0). In its next taxable year, the corporation has $200 of taxable income. $100 is subject to the built-in gains tax in that year, because of the carryforward of the $100 of net unrecognized built-in gain that had been untaxed due to the net income limitation.

The bill clarifies that the built-in gain provision applies not only when a C corporation converts to S status but also in any case in which an S corporation acquires an asset and the basis of such asset in the hands of the S corporation is determined (in whole or in part) by reference to the basis of such asset (or any other property) in the hands of the C corporation. In such cases, each acquisition of assets from a C corporation is subject to a separate determination of the amount of net built-in gain, and is subject to the provision for a separate 10-year recognition period. The bill clarifies that the Treasury Department has authority to prescribe regulations providing for the appropriate treatment of successor corporations—for example, in situations in which an S corporation engages in a transaction that results in carryover basis of assets to a successor corporation pursuant to subchapter C of the Code.

The bill clarifies that, for purposes of this built-in gains tax under section 1374, any item of income which is properly taken into account for any taxable year in the recognition period but which is attributable to periods before the first taxable year for which the corporation was an S corporation is treated as a recognized built-in gain for the taxable year in which it is properly taken into account. Thus, the term “disposition of any asset” includes not only sales or exchanges but other income recognition events that effectively dispose of or relinquish a taxpayer’s right to claim or receive income. For example, the term “disposition of any asset” for purposes of this provision also includes the collection of accounts receivable by a cash method taxpayer and the completion of a long-term contract performed by a taxpayer using the completed contract method of accounting.

Similarly, the bill clarifies that amounts that are allowable as a deduction during the recognition period but that are attributable to periods before the first S corporation taxable year are thus treated as recognized built-in losses in the year of the deduction.

As an example of these built-in gain and loss provisions, in the case of a cash basis personal service corporation that converts to S status and that has receivables at the time of the conversion, the receivables, when received, are built-in gain items. At the same time, built-in losses would include otherwise deductible compensation paid after the conversion to the persons who performed the services that produced the receivables, to the extent such compensation is attributable to such pre-conversion services. To the extent such built-in loss items offset the built-in gains from the receivables, there would be no amount subject to the built-in gains tax.

The bill clarifies that capital loss carryforwards may also be used to offset recognized built-in gains.

Finally, the bill makes certain clerical and conforming changes.

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CONFERENCE COMMITTEE REPORT

Senate Amendment

Corporate. The Senate amendment is the same as the House bill, except—

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Conference Agreement

The conference agreement follows the Senate amendment; except the agreement . . . does follow the House version of the S corporation tax on net built in gains.

Section 621(f)(5) of the Tax Reform Act of 1986 provides relief from the amendments made by that Act to sections 382 and 383 of the Code in the case of certain transactions involving a title 11 or similar case if a petition in such case was filed with the court before August 14, 1986. The relevant provisions of section 368 that define a title 11 or similar case provide that in certain proceedings involving specified financial institutions where the relevant proceeding is before a Federal or State agency, the agency shall be treated as a court. The conferees clarify that for purposes of the transaction rule contained in section 621(f)(5), the petition shall be considered filed with the court in the case of such agency proceedings no later than the time the relevant agency action has occurred. As one example, in the case of an insolvent thrift institution subject to regulation by the Federal Savings and Loan Insurance corporation (“FSLIC”), a petition will be deemed to have been filed no later than the date such agency assumes control over such institution through the appointment of a receiver. No inference is intended that other action might not also constitute the filing of a petition in appropriate cases, consistent with the relief granted to transactions covered by the relevant provisions of section 368.

The conference agreement clarifies that the tax on transfers of residual interests of REMICs to disqualified organizations and the tax on pass-through entities and nominees are treated as excise taxes for administrative purposes, except that the Tax Court has jurisdiction over deficiencies of these taxes.

The conferees clarify the definition of a “qualified corporation” under the transition rules of section 633(d)(5) of the Tax Reform Act of 1986 in the case of a corporation which adopted a plan of liquidation prior to March 31, 1988, and is completely liquidated prior to January 1, 1989. If, on August 1, 1986, and at all times thereafter before such liquidation, more than 50 percent, by value, of the corporation’s stock was owned by 10 or fewer qualified persons, such corporation would come within the definition of “qualified corporation” under section 633(d)(5) of the Tax Reform Act of 1986 regardless of how long any such shareholders have held their stock and regardless of whether or not such shareholders were the same throughout the applicable period.

In addition, the conferees clarify the definition of a “qualified group” under section 633(d) of the Tax Reform Act of 1986, as amended by this Act, in connection with the following case. One hundred percent of the shares of a corporation are owned by two shareholders until mid-1987, each holding 50 percent of the issued and outstanding shares. These shareholders had owned their shares for more than five years. Subsequently, after mid-1987, 100 percent of the issued and outstanding shares of the corporation were owned by one of the two original shareholders. This shareholder had owned his shares for more than five years. These shareholders would come within the definition of “qualified group” under section 633(d) of the Tax Reform Act of 1986. However, it may not be appropriate to extend this treatment to situations where an insubstantial shareholder acquires more than 50 percent of the stock of a corporation.

Finally, the conference agreement clarifies the provision in the Act relating to the treatment of accounts receivable for purposes of the 25-percent built-in gain or loss rule in connection with the limitations on net operating losses. Under the Tax Reform Act of 1986, for purposes of calculating the 25-percent threshold test, assets are to be reduced by cash and cash items, which include accounts receivable. The Act provides the Treasury authority to change this rule by regulation. The conferees expect that such regulations would be prospective in effect and thus would not apply to ownership changes in completed transactions and in transactions as to which there is a binding contract, including a binding purchase offer, before the date of issuance of such regulations.

ACT SEC. 4012 AND IRC § 382: FINANCIAL INSTITUTIONS

Conference Committee Report

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Financially troubled financial institutions: Reorganizations, NOLs, and FSLIC/FDIC Assistance Payments. The following three rules applying to financially troubled thrift institutions are scheduled to expire December 31, 1988.

Senate Amendment

Under the Senate amendment, the three present law rules for financially troubled thrift institutions are extended for six months, through June 30, 1989, with a modification. Under the modification, net operating losses exist at the time of the regulatory assistance, interest expense, and loan portfolio built-in losses are reduced by an amount equal to 50 percent of the tax-free FSLIC assistance payments. In the case of taxable asset acquisitions, there is no reduction in deductions on account of any payments made at the time of the acquisition to the person acquiring such assets to make up the difference between the fair market value of the assets transferred and the liabilities assumed.

The above rules are also applied during the six-month period to financially troubled banks and to payments made to such banks by the Federal Deposit Insurance Corporation (“FDIC”).

The provisions are effective as follows:

Conference Agreement

The conference agreement follows the Senate bill with modifications.

Tax attribute reduction: definition of recognized built-in portfolio losses. The conference agreement modifies the definition of the recognized built-in losses that are subject to the 50-percent cutback. Such losses include all recognized built-in portfolio losses, without regard to whether or not the amount of net unrealized built-in portfolio losses exceeds the 25-percent threshold of section 382(h)(3)(B) of the Code.

Recognized built-in portfolio losses include built-in losses on property described in section 595(a) of the Code, and losses on marketable securities as defined in section 453(f)(2) of the Code, as well as loan portfolio built-in losses.

Certain taxable asset acquisitions: 50-percent cutback and basis recovery provisions. The conference agreement modifies the application of the 50-percent cutback in the case of taxable asset acquisitions. In the case of any acquisition of assets of any applicable financial institution to which section 381 does not apply, the 50-percent cutback does not apply with respect to assistance payments made at the time of the acquisition to the person acquiring such assets that are excludable under section 597(a) of the Code. For purposes of this subsection, payments made at the time of the acquisition shall only include cash payments. Payments made after the acquisition pursuant to notes or other rights to receive future payments (including income maintenance payments with respect to loans, payments under guarantees against loss on certain assets, or any other rights) shall be subject to the 50-percent cutback to the extent they exceed the cumulative recovery (as prescribed by the Treasury Department) of the basis that is properly allocated to such rights.

It is expected that basis shall be properly allocated to such rights under this provision and that such basis allocation shall reflect the full present value, at the time of the acquisition, of the amounts that may be received pursuant to the notes or other rights, and shall include the value of any guarantee against further declines in value with respect to guaranteed assets that may occur after the acquisition of such assets.

It is expected that the Treasury Department shall not permit the basis with respect to such rights to be recovered over a period shorter than the actual period of the note, guarantee, or other right (including extensions, if any). It is also expected that the basis recovery method prescribed by the Treasury Department may take into account yield-to-maturity principles, so that a smaller amount of basis shall generally be recovered in the earlier years than in the later years; and payments made earlier than the time reflected in the present value basis computation would be subject to the 50-percent cutback.

No deduction for tax purposes shall be allowed for any basis recovery with respect to such rights unless and until such rights finally expire. At that time, a deduction shall be allowed for the excess, if any, of the amount of basis properly allocated to such rights over the amount of payments actually received pursuant to such rights.

Repayments of assistance payments for which a prior attribute cutback occurred. The conference agreement provides that if a taxpayer repays an amount and the 50-percent cutback applied to that taxpayer with respect to such amount in a preceding taxable year, there shall be allowed as a deduction for the taxable year of repayment an amount equal to the reduction in tax attributes that was attributable to the amount repaid.

Application of section 265. Under the conference agreement, no provision of section 265 of the Code shall deny a deduction by reason of such deduction being allocable to amounts excluded from gross income under section 597 of the Code.

General effective dates of extensions and related attribute cutback. The conference agreement modifies the effective dates of the basic extension of the three special present law provisions for financially troubled thrift institutions, and for the related attribute cutback rules (including the special taxable asset acquisition provisions), as follows:

Application to banks. The conference agreement clarifies that the provisions with respect to assistance payments made to financially troubled banks by the Federal Deposit Insurance Corporation (“FDIC”) extend to payments made pursuant to 12 U.S.C. sections 1823(c)(1) and (2), as well as to payments made pursuant to 12 U.S.C. section 1821(f).

The conference agreement modifies the effective date of the provisions with respect to financially troubled banks and payments made to such banks by the FDIC. The application of the tax-free treatment of assistance payments and the attribute cutback rules in these cases apply to assistance payments made pursuant to acquisitions occurring after the date of enactment of the provision and before January 1, 1990, and to other assistance payments made during such period unless pursuant to an acquisition occurring on or before the date of enactment.

The extension of the tax-free reorganization rules to banks applies to acquisitions after the date of enactment and before January 1, 1990.

The extension of the carryforward rules to banks applies to ownership changes occurring after the date of enactment and before January 1, 1990.

Application to certain other entities. The conference agreement also extends the provisions that apply to banks and FDIC assistance payments to entities that would be domestic building and loan associations under section 7701(a)(19) but for the fact that they do not satisfy the 60-percent asset test prescribed in section 7701(a)(19)(C), and to FSLIC assistance payments to such entities. The effective dates of the provisions with respect to such entities, including the attribute cutback rule, are the same as the effective dates of the provisions with respect to banks.

ACT SEC. 1004 AND IRC § 108(G): TREATMENT OF DISCHARGE OF INDEBTEDNESS INCOME OF CERTAIN FARMERS

House Committee Report

The bill clarifies that, for purposes of determining whether a taxpayer’s indebtedness is qualified farm indebtedness, the gross receipts test is applied by dividing the taxpayer’s aggregate gross receipts from farming for the three-taxable-year period preceding the taxable year of the discharge by the taxpayer’s aggregate gross receipts from all sources for that period. In addition, the term “qualified person” is modified to include a Federal, State, or local government or agency or instrumentality thereof.

The bill provides that, after reducing tax attributes on the order prescribed for insolvent taxpayers, amounts excluded from income under the qualified farm indebtedness provision may be applied to reduce basis in assets used or held for use in a trade or business or for the produ ction of income (i.e., in “qualified property”). Basis reduction occurs first with respect to depreciable property, then with respect to land used in the business of farming, and then with respect to other qualified property.

The amount excluded under this provision may not exceed the taxpayer’s total available attributes and basis in qualified property. Accordingly, to the extent there is unabsorbed discharge of indebtedness income after the taxpayer has reduced tax attributes and basis in qualified property, income will be recognized.

Conference Agreement

The conference agreement follows the House bill.

ACT SEC. 1018(D)(5) AND IRC § 361: EARNINGS AND PROFITS

Senate Committee Report

Treatment of reorganization exchange.—The bill restores the provisions of section 361, relating to the nonrecognition treatment of an exchange pursuant to a plan of reorganization, as in effect prior to the amendments made by the 1986 Act. Thus, as under prior law, gain or loss will generally not be recognized to a corporation which exchanges property, in pursuance of the plan of reorganization, for stock and securities in another corporation a party to the reorganization. However, as under prior law, gain will be recognized to the extent the corporation receives property other than such stock or securities and does not distribute the other property pursuant to the plan of reorganization.10

The bill amends prior law by providing that transfers of property to creditors in satisfaction of the corporation’s indebtedness in connection with the reorganization are treated as distributions pursuant to the plan of reorganization for this purpose.11 The Secretary of the Treasury may prescribe regulations necessary to prevent tax avoidance by reason of this provision. This amendment is not intended to change in any way the definition of a reorganization within the meaning of section 368.

Treatment of distributions in reorganizations.—The bill also conforms the treatment of distributions of property by a corporation to its shareholders in pursuance of a plan of reorganization to the treatment of nonliquidating distributions (under section 311). Under the bill, the distributing corporation generally will recognize gain, but not loss, or the distribution of property in pursuance of the plan of reorganization. However, no gain will be recognized on the distribution of “qualified property”. For this purpose, qualified property means (1) stock (or rights to acquire stock) in, or the obligation of, the distributing corporation and (2) stock (or rights to acquire stock) in, or the obligation of, another corporation which is a party to the reorganization and which were received by the distributing corporation in the exchange.12 The bill also provides that the transfer of qualified property by a corporation to its creditors in satisfaction of indebtedness is treated as distribution pursuant to the plan of reorganization.13

Basis.—The bill clarifies that the basis of property received in an exchange to which section 361 applies, other than stock or securities in another corporation a party to the reorganization, is the fair market value of the property at the time of the transaction (pursuant to section 358(a)(2)). Thus the distributing corporation will recognize only post-acquisition gain on any taxable disposition of such property received pursuant to the plan of reorganization. Of course, the other corporation will recognize gain or loss on the transfer of its property under the usual tax principles governing the recognition of gain or loss.

Treatment of section 355 distributions, etc.—Finally, the bill provides that the rules of section 311 shall apply to the distribution or property in a section 355 transaction which is not in pursuance of a plan of reorganization. Thus, gain (but not loss) will be recognized on the distribution of property other than the stock or securities in the controlled corporation in a transfer to which section 355 (or so much of section 356 as relates to section 355) applies. For this purpose, the gain recognition provisions of section 311(b) will not apply to the distribution of securities notwithstanding that the recipient may be taxed by reason of the excess principal amount rule of section 355(a)(3)(A), but the gain recognition rule will apply to stock which is not permitted to be received tax-free under section 355.

Effective for transfers on or after June 21, 1988, a similar rule applies to the transfer of property to a shareholder by a corporation in an exchange to which section 351(b) applies to the shareholder. Thus, gain (but not loss) will be recognized to the controlled corporation on the transfer of property to its shareholder as if the transfer were a distribution to which section 311(b). No inference is intended as to the tax treatment of such a transfer under present law.

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Conference Agreement

The conference agreement follows the Senate amendment.

1 This provision relating to foreign corporations applies only to ownership changes occurring after June 10, 1987.

2 Section 10225(b) of the Revenue Act of 1987 provides that these items are included in the term “recognized built-in loss” in the case of ownership changes after December 15, 1987, except for any ownership change pursuant to a binding written contract which was in effect on December 15, 1987, and at all times thereafter before such ownership change.

3 See, e.g., section 382(l)(1)(B), which disregards any changes that might benefit the taxpayer that occur within 2 years prior to the ownership change.

4 The bill thus clarifies that the transition rule for equity structure shifts pursuant to pre-1987 plans of reorganization is applicable even though such an equity structure shift may also be an owner shift involving a 5-percent shareholder.

5 A distribution to a charitable trust would not qualify as a distribution to an 80-percent distributee (since only a corporation can qualify as an 80-percent distributee). Accordingly, the bill deletes the reference to section 511(b)(2) in section 377(b)(2).

6 This provision is not intended to limit the operation of any present-law step-transaction or other doctrines that would disregard such loss. Such doctrines would also apply if a corporation with property on which loss would be disallowed under other Code provisions (such as sections 336(d)(1) or (d)(2)) contributed such property to a partnership to reduce the gain on distribution of the partnership interest and thus indirectly recognize the loss.

7 This change is made solely as deadwood and is not intended to alter the consequences of a distribution under the consolidated return regulations or any other provision of law or regulation.

8 The Act generally requires recognition of gain if a C corporation transfers appreciated assets to a tax exempt entity in a section 332 liquidation. See Code section 337(b)(2).

9 For example, if a qualified person held stock of a corporation and subsequently contributed that stock to a partnership, the person’s holding period would include the entire period of stock was held, directly or indirectly. The bill does not make any statutory change with respect to section 1223 since section 1223 does not by its terms operate to extend attribution periods, as explained above.

10 This could occur, for example, where liabilities are assumed in a transaction to which section 357(b) or (c) applies.

11 This overrules the holding in Minnesota Tea Company v. Helvering, 302 U.S. 609 (1938).

12 For analysis that acquiring corporation voting stock held by the acquired corporation in a Type C reorganization is transferred to the acquiring corporation in exchange for the same stock, see Rev. Rul. 78-47, 1978-1 C.B. 113.

13 These amendments are not intended to affect the treatment of any income from the discharge of indebtedness arising in connection with a corporate reorganization.