On Monday, the IRS issued final regulations on the rules that apply when an election under Sec. 336(e) is made to treat the sale, exchange, or distribution of at least 80% of the voting power and value of a corporation’s stock (target) as a sale of all its underlying assets, i.e., a qualified stock disposition (T.D. 9619). In response to comments, the IRS made a number of significant changes to the regulations that were proposed in 2008 (REG-143544-04).
Sec. 336(e) was enacted by the Tax Reform Act of 1986, P.L. 99-514, as part of the repeal of the General Utilities doctrine. The General Utilities doctrine grew out of General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935), a Supreme Court case permitting tax-free liquidations to allow taxpayers to avoid potential multiple taxation of the same economic gain. The Sec. 336(e) election is intended to operate similarly to an election under Sec. 338(h)(10), except it does not require an acquirer of target stock to be a corporation or even necessarily a purchaser.
Also, unlike Sec. 338(h)(10), which generally requires that a single purchasing corporation acquire the stock of a target, Sec. 336(e) permits the aggregation of all stock of a target that is sold, exchanged, and distributed by a seller to different acquirers for purposes of determining whether there has been a qualified stock disposition of a target.
The final regulations, in perhaps the most major departure from the proposed rules, permit the Sec. 336(e) election to be made for S corporation targets, just as a Sec. 338(h)(10) election can be made for S corporation targets.
The other primary changes between the proposed regulations and the final rules are:
- The proposed regulations contained a rule that disallows the recognition of losses resulting from the deemed asset disposition to the extent the qualified stock disposition consisted of one or more distributions of target stock (disallowed loss rule). In response to comments, the final rules have been modified to permit the target’s realized losses in the deemed asset disposition to offset the amount of the target’s realized gains.
- Under the proposed regulations, the first type of transaction for which a Sec. 336(e) election may be made is a qualified stock disposition that does not consist of a Sec. 355(d)(2) or (e)(2) transaction (provisions requiring recognition of gain in certain corporate divisions). However, in this case, the step in the basic model in which the seller is deemed to purchase from the new target the new target stock actually distributed might be combined with the old target’s deemed sale of its assets to the new target resulting in a Sec. 351 transaction with boot (generally requiring gain recognition), which could lead to unintended consequences. To solve this problem, the final regulations modify the proposed regulations by providing that in a distribution of target stock (and also for stock in a target that a seller retains after the distribution date) the seller is deemed to purchase the new target stock that is distributed or retained not from the new target but from an unrelated person in a taxable transactionThe seller will not recognize any gain or loss on the deemed distribution of new target stock, and the purchaser will have a fair market value basis in the new target stock received without any possible application of Sec. 351.
- The final regulations retain the rule that treats transactions described in Sec. 355(d)(2) or (e)(2) as a sale to self. The final regulations change the rule in the proposed regulation that permitted the seller to make a unilateral Sec. 336(e) election. Now, sellers, or in the case of an S corporation target, all of the S corporation shareholders, must enter into a written, binding agreement to make the election, and an election statement must be attached to the relevant return. The final rules retain the proposed regulation election due date as the due date of the relevant tax return, rejecting comments suggesting a later due date.
The final regulations are effective upon their publication in the Federal Register, which is scheduled for May 15.
— Sally P. Schreiber ( email@example.com ) is a JofA senior editor.