Adjustment To Net Unrealized Built-in Gain, 8727-8729 [05-3462]
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Federal Register / Vol. 70, No. 35 / Wednesday, February 23, 2005 / Rules and Regulations
verification or copying of any such
required record, is a prohibited act
under section 301 of the act.
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n 9. In § 1.368, revise paragraph (a) to
read as follows:
§ 1.368 What are the compliance dates for
this subpart?
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(a) The compliance date for the
requirements in this subpart is June
9,2006, for small businesses employing
fewer that 500, but more than 10 fulltime equivalent employees.
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Dated: February 16, 2005.
Jeffrey Shuren,
Assistant Commissioner for Policy.
[FR Doc. 05–3424 Filed 2–22–05; 8:45 am]
BILLING CODE 4160–01–S
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9180]
RIN 1545–BC29
Adjustment To Net Unrealized Built-in
Gain
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final
regulations under section 1374 that
provide for an adjustment to the amount
that may be subject to tax under section
1374 in certain cases in which an S
corporation acquires assets from a C
corporation in an acquisition to which
section 1374(d)(8) applies. These final
regulations provide guidance to certain
S corporations that acquire assets from
a C corporation in a carryover basis
transaction.
DATES: Effective Date: These regulations
are effective February 23, 2005.
Applicability Dates: For dates of
applicability, see § 1.1374–10.
FOR FURTHER INFORMATION CONTACT:
Jennifer D. Sledge, (202) 622–7750 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background and Explanation of
Provisions
This document contains amendments
to Income Tax Regulations (26 CFR part
1) under section 1374 of the Internal
Revenue Code (Code), relating to the tax
imposed on certain recognized built-in
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Jkt 205001
gains of S corporations. Section 1374
imposes a tax on an S corporation’s net
recognized built-in gain attributable to
assets that it held on the date it
converted from a C corporation to an S
corporation for the 10-year period
beginning on the first day the
corporation is an S corporation and
assets that it acquired from a C
corporation in a carryover basis
transaction for the 10-year period
beginning on the day of the acquisition.
A separate determination of the amount
subject to tax under section 1374 is
required for those assets the S
corporation held on the date it
converted to C status and each pool of
assets the S corporation acquired in a
carryover basis transaction from a C
corporation. The total amount subject to
tax under section 1374 for each pool of
assets is limited to that pool’s net
unrealized built-in gain (NUBIG) on the
date of the conversion or acquisition.
Under the current rules, if X, a C
corporation, elects to be an S
corporation when it owns some or all of
the stock of Y, a C corporation, and Y
subsequently transfers its assets to X in
a liquidation to which sections 332 and
337(a) apply or in a reorganization
described in section 368(a), the built-in
gain or built-in loss in Y’s assets may be
wholly or partially reflected twice: once
in the NUBIG attributable to the assets
X owned on the date of its conversion
(including the Y stock) and a second
time in the NUBIG attributable to Y’s
former assets acquired by X in the
liquidation of Y. The IRS and Treasury
Department recognize that continuing to
reflect the built-in gain or the built-in
loss in the Y stock at the time of X’s
conversion after the liquidation or
reorganization is inconsistent with the
fact that such liquidation or
reorganization has the effect of
eliminating that built-in gain or built-in
loss. Therefore, on June 25, 2004, the
IRS and Treasury Department published
in the Federal Register (69 FR 35544) a
notice of proposed rulemaking (REG–
131486–03) that includes regulations
proposing an adjustment to the NUBIG
in these cases. In particular, the
proposed regulations generally provide
that, if an S corporation acquires assets
of a C corporation in a carryover basis
transaction, some or all of the stock of
the C corporation from which such
assets were acquired was taken into
account in the computation of NUBIG
for a pool of assets of the S corporation,
and some or all of such stock is
redeemed or canceled in such
transaction, then, subject to certain
limitations, such NUBIG is adjusted to
eliminate any effect any built-in gain or
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8727
built-in loss in the redeemed or
canceled stock had on the initial
computation of NUBIG for that pool of
assets. These regulations are proposed
to apply for taxable years beginning
after the date they are published as final
regulations in the Federal Register.
No public hearing was requested or
held regarding the proposed regulations.
One written comment, however, was
received. That comment requested that
the proposed regulations be made
effective as soon as possible.
These final regulations adopt the
proposed regulations without
substantive change as final regulations.
However, the final regulations do
modify the proposed effective date of
the regulations. The final regulations
apply to section 1374(d)(8) transactions
that occur in taxable years beginning
after February 23, 2005. The final
regulations also provide that an S
corporation may apply the regulations
to section 1374(d)(8) transactions that
occur in taxable years beginning on or
before February 23, 2005, if the S
corporation (and any predecessors or
successors) and all affected shareholders
file original or amended returns that are
consistent with the regulations for
taxable years of the S corporation during
the recognition period of the pool of
assets the NUBIG of which would be
adjusted pursuant to the regulations that
are not closed as of the first date after
February 23, 2005, that the S
corporation files an original or amended
return.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations and, because the
regulations do not impose a collection
of information on small entities, the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Therefore, a
Regulatory Flexibility Analysis is not
required. Pursuant to section 7805(f) of
the Code, this regulation was submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for
comment on their impact on small
business.
Drafting Information
The principal author of these
regulations is Jennifer D. Sledge of the
Office of Associate Chief Counsel
(Corporate). Other personnel from
Treasury and the IRS participated in
their development.
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8728
Federal Register / Vol. 70, No. 35 / Wednesday, February 23, 2005 / Rules and Regulations
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
n
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read, in part, as
follows:
n
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.1374–3 is amended
by:
n 1. Revising paragraph (b).
n 2. Adding paragraph (c).
The revision and addition read as
follows:
n
§ 1.1374–3
Net unrealized built-in gain.
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(b) Adjustment to net unrealized builtin gain—(1) In general. If section
1374(d)(8) applies to an S corporation’s
acquisition of assets, some or all of the
stock of the corporation from which
such assets were acquired was taken
into account in the computation of the
net unrealized built-in gain for a pool of
assets of the S corporation, and some or
all of such stock is redeemed or
canceled in such transaction, then,
subject to the limitations of paragraph
(b)(2) of this section, such net
unrealized built-in gain is adjusted to
eliminate any effect that any built-in
gain or built-in loss in the redeemed or
canceled stock (other than stock with
respect to which a loss under section
165 is claimed) had on the initial
computation of net unrealized built-in
gain for that pool of assets. For purposes
of this paragraph, stock described in
section 1374(d)(6) shall be treated as
taken into account in the computation
of the net unrealized built-in gain for a
pool of assets of the S corporation.
(2) Limitations on adjustment—(i)
Recognized built-in gain or loss. Net
unrealized built-in gain for a pool of
assets of the S corporation is only
adjusted under paragraph (b)(1) of this
section to reflect built-in gain or builtin loss in the redeemed or canceled
stock that has not resulted in recognized
built-in gain or recognized built-in loss
during the recognition period.
(ii) Anti-duplication rule. Paragraph
(b)(1) of this section shall not be applied
to duplicate an adjustment to the net
unrealized built-in gain for a pool of
assets made pursuant to paragraph (b)(1)
of this section.
(3) Effect of adjustment. Any
adjustment to the net unrealized built-
in gain made pursuant to this paragraph
(b) only affects computations of the
amount subject to tax under section
1374 for taxable years that end on or
after the date of the acquisition to which
section 1374(d)(8) applies.
(4) Pool of assets. For purposes of this
section, a pool of assets means—
(i) The assets held by the corporation
on the first day it became an S
corporation, if the corporation was
previously a C corporation; or
(ii) The assets the S corporation
acquired from a C corporation in a
section 1374(d)(8) transaction.
(c) Examples. The following examples
illustrate the rules of this section:
Example 1. Computation of net unrealized
built-in gain. (i)(A) X, a calendar year C
corporation using the cash method, elects to
become an S corporation on January 1, 1996.
On December 31, 1995, X has assets and
liabilities as follows:
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Jkt 205001
Assets
FMV
Basis
Factory ....................
Accounts Receivable .....................
Goodwill ..................
$500,000
$900,000
300,000
250,000
0
0
Total ....................
1,050,000
900,000
Liabilities
Amount
Mortgage .......................................
Accounts Payable .........................
$200,000
100,000
Total ..........................................
300,000
(B) Further, X must include a total of
$60,000 in taxable income in 1996, 1997, and
1998 under section 481(a).
(ii) If, on December 31, 1995, X sold all its
assets to a third party that assumed all its
liabilities, X’s amount realized would be
$1,050,000 ($750,000 cash received +
$300,000 liabilities assumed = $1,050,000).
Thus, X’s net unrealized built-in gain is
determined as follows:
Amount realized ......................
Deduction allowed (A/P) .........
Basis of X’s assets .................
Section 481 adjustments ........
Net unrealized built-in gain .....
$1,050,000
(100,000)
(900,000)
60,000
110,000
Example 2. Adjustment to net unrealized
built-in gain for built-in gain in eliminated C
corporation stock. (i) X, a calendar year C
corporation, elects to become an S
corporation effective January 1, 2005. On that
date, X’s assets (the first pool of assets) have
a net unrealized built-in gain of $15,000.
Among the assets in the first pool of assets
is all of the outstanding stock of Y, a C
corporation, with a fair market value of
$33,000 and an adjusted basis of $18,000. On
March 1, 2009, X sells an asset that it owned
on January 1, 2005, and as a result has
$10,000 of recognized built-in gain. X has
had no other recognized built-in gain or
built-in loss. X’s taxable income limitation
for 2009 is $50,000. Effective June 1, 2009,
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X elects under section 1361 to treat Y as a
qualified subchapter S subsidiary (QSub).
The election is treated as a transfer of Y’s
assets to X in a liquidation to which sections
332 and 337(a) apply.
(ii) Under paragraph (b) of this section, the
net unrealized built in-gain of the first pool
of assets is adjusted to account for the
elimination of the Y stock in the liquidation.
The net unrealized built-in gain of the first
pool of assets, therefore, is decreased by
$15,000, the amount by which the fair market
value of the Y stock exceeded its adjusted
basis as of January 1, 2005. Accordingly, for
taxable years ending after June 1, 2009, the
net unrealized built-in gain of the first pool
of assets is $0.
(iii) Under § 1.1374–2(a), X’s net
recognized built-in gain for any taxable year
equals the least of X’s pre-limitation amount,
taxable income limitation, and net unrealized
built-in gain limitation. In 2009, X’s prelimitation amount is $10,000, X’s taxable
income limitation is $50,000, and X’s net
unrealized built-in gain limitation is $0.
Because the net unrealized built-in gain of
the first pool of assets has been adjusted to
$0, despite the $10,000 of recognized builtin gain in 2009, X has $0 net recognized
built-in gain for the taxable year ending on
December 31, 2009.
Example 3. Adjustment to net unrealized
built-in gain for built-in loss in eliminated C
corporation stock. (i) X, a calendar year C
corporation, elects to become an S
corporation effective January 1, 2005. On that
date, X’s assets (the first pool of assets) have
a net unrealized built-in gain of negative
$5,000. Among the assets in the first pool of
assets is 10 percent of the outstanding stock
of Y, a C corporation, with a fair market value
of $18,000 and an adjusted basis of $33,000.
On March 1, 2009, X sells an asset that it
owned on January 1, 2005, resulting in
$8,000 of recognized built-in gain. X has had
no other recognized built-in gains or built-in
losses. X’s taxable income limitation for 2009
is $50,000. On June 1, 2009, Y transfers its
assets to X in a reorganization under section
368(a)(1)(C).
(ii) Under paragraph (b) of this section, the
net unrealized built in-gain of the first pool
of assets is adjusted to account for the
elimination of the Y stock in the
reorganization. The net unrealized built-in
gain of the first pool of assets, therefore, is
increased by $15,000, the amount by which
the adjusted basis of the Y stock exceeded its
fair market value as of January 1, 2005.
Accordingly, for taxable years ending after
June 1, 2009, the net unrealized built-in gain
of the first pool of assets is $10,000.
(iii) Under § 1.1374–2(a), X’s net
recognized built-in gain for any taxable year
equals the least of X’s pre-limitation amount,
taxable income limitation, and net unrealized
built-in gain limitation. In 2009, X’s prelimitation amount is $8,000 and X’s taxable
income limitation is $50,000. The net
unrealized built-in gain of the first pool of
assets has been adjusted to $10,000, so X’s
net unrealized built-in gain limitation is
$10,000. X, therefore, has $8,000 net
recognized built-in gain for the taxable year
ending on December 31, 2009. X’s net
unrealized built-in gain limitation for 2010 is
$2,000.
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Federal Register / Vol. 70, No. 35 / Wednesday, February 23, 2005 / Rules and Regulations
Example 4. Adjustment to net unrealized
built-in gain in case of prior gain recognition.
(i) X, a calendar year C corporation, elects to
become an S corporation effective January 1,
2005. On that date, X’s assets (the first pool
of assets) have a net unrealized built-in gain
of $30,000. Among the assets in the first pool
of assets is all of the outstanding stock of Y,
a C corporation, with a fair market value of
$45,000 and an adjusted basis of $10,000. Y
has no current or accumulated earnings and
profits. On April 1, 2007, Y distributes
$18,000 to X, $8,000 of which is treated as
gain to X from the sale or exchange of
property under section 301(c)(3). That $8,000
is recognized built-in gain to X under section
1374(d)(3), and results in $8,000 of net
recognized built-in gain to X for 2007. X’s net
unrealized built-in gain limitation for 2008 is
$22,000. On June 1, 2009, Y transfers its
assets to X in a liquidation to which sections
332 and 337(a) apply.
(ii) Under paragraph (b) of this section, the
net unrealized built in-gain of the first pool
of assets is adjusted to account for the
elimination of the Y stock in the liquidation.
The net unrealized built-in gain of that pool
of assets, however, can only be adjusted to
reflect the amount of built-in gain that was
inherent in the Y stock on January 1, 2005
that has not resulted in recognized built-in
gain during the recognition period. In this
case, therefore, the net unrealized built-in
gain of the first pool of assets cannot be
reduced by more than $27,000 ($35,000, the
amount by which the fair market value of the
Y stock exceeded its adjusted basis as of
January 1, 2005, minus $8,000, the
recognized built-in gain with respect to the
stock during the recognition period).
Accordingly, for taxable years ending after
June 1, 2009, the net unrealized built-in gain
of the first pool of assets is $3,000. The net
unrealized built-in gain limitation for 2009 is
$0.
Par. 3. Paragraph (a) of § 1.1374–10 is
revised to read as follows:
n
§ 1.1374–10
rules.
Effective date and additional
(a) In general. Sections 1.1374–1
through 1.1374–9, other than § 1.1374–
3(b) and (c) Examples 2 through 4, apply
for taxable years ending on or after
December 27, 1994, but only in cases
where the S corporation’s return for the
taxable year is filed pursuant to an S
election or a section 1374(d)(8)
transaction occurring on or after
December 27, 1994. Section 1.1374–3(b)
and (c) Examples 2 through 4 apply to
section 1374(d)(8) transactions that
occur in taxable years beginning after
February 23, 2005. In addition, an S
corporation may apply § 1.1374–3(b)
and (c) Examples 2 through 4 to section
1374(d)(8) transactions that occur in
taxable years beginning on or before
February 23, 2005, if the S corporation
(and any predecessors or successors)
and all affected shareholders file
original or amended returns that are
consistent with these provisions for
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16:23 Feb 22, 2005
Jkt 205001
taxable years of the S corporation during
the recognition period of the pool of
assets the net unrealized built-in gain of
which would be adjusted pursuant to
those provisions that are not closed as
of the first date after February 23, 2005,
that the S corporation files an original
or amended return. For purposes of this
section, affected shareholders means all
shareholders who received distributive
shares of S corporation items in such
taxable years. However, the
Commissioner may, in appropriate
circumstances, permit taxpayers to
apply these provisions even if all
affected shareholders cannot file
consistent returns. In addition, for this
purpose, a predecessor of an S
corporation is a corporation that
transfers its assets to the S corporation
in a transaction to which section 381
applies. A successor of an S corporation
is a corporation to which the S
corporation transfers its assets in a
transaction to which section 381
applies.
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Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
Approved: February 14, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the
Treasury.
FR Doc. 05–3462 Filed 2–22–05; 8:45 am]
BILLING CODE 4830–01–P
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9179]
RIN 1545–BB62
Uniform Capitalization of Interest
Expense in Safe Harbor Sale and
Leaseback Transactions
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
amendments to regulations relating to
the capitalization of interest expense
incurred in sale and leaseback
transactions under the Economic
Recovery Tax Act of 1981 (ERTA) safe
harbor leasing provisions. The
regulations affect taxpayers that provide
purchase money obligations in
connection with these transactions.
DATES: Effective Date: These regulations
are effective February 23, 2005.
Applicability Dates: For dates of
applicability, see § 1.263A–15(a)(3).
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8729
FOR FURTHER INFORMATION CONTACT:
Christian Wood, 202–622–4930 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments
to 26 CFR part 1. On May 20, 2004, the
IRS and Treasury Department published
in the Federal Register a notice of
proposed rulemaking (REG–148399–02;
69 FR 29113) by cross reference to
temporary regulations (TD 9129; 69 FR
29066) under section 263A(f) of the
Internal Revenue Code (Code). These
amendments pertain to the treatment of
certain interest expense incurred by the
lessor in a sale and leaseback
transaction under the ERTA safe harbor
leasing provisions (former section
168(f)(8), as enacted by section 201(a) of
ERTA, Public Law 97–34, 95 Stat. 214).
No comments in response to the
proposed regulations or requests to
speak at a public hearing were received,
and no hearing was held. The proposed
regulations under section 263A(f) are
adopted by this Treasury decision.
Effective Date
These final regulations generally
apply to interest incurred in taxable
years beginning on or after May 20,
2004. In the case of property that is
inventory in the hands of the taxpayer,
these regulations apply to taxable years
beginning on or after May 20, 2004.
Taxpayers may elect to apply these
regulations to interest incurred in
taxable years beginning on or after
January 1, 1995, or, in the case of
property that is inventory in the hands
of the taxpayer, to taxable years
beginning on or after January 1, 1995
(the general effective date of the interest
capitalization regulations).
In addition, for purposes of § 1.263A–
15(a)(2), the exclusion of purchase
money obligations given by the lessor to
the lessee (or a party related to the
lessee) in a sale and leaseback
transaction under former section
168(f)(8) as enacted by ERTA will be
considered to be a reasonable position
for the application of section 263A(f) in
taxable years beginning before January
1, 1995. Consequently, a taxpayer
changing a method of accounting for
property that is not inventory in the
hands of the taxpayer to conform to
these regulations may elect to include
interest incurred after December 31,
1986, in taxable years beginning on or
after December 31, 1986 (the general
effective date of section 263A), and
before January 1, 1995, in the
determination of its adjustment under
section 481(a). A taxpayer changing a
method of accounting for property that
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]]>Agencies
[Federal Register Volume 70, Number 35 (Wednesday, February 23, 2005)]
[Rules and Regulations]
[Pages 8727-8729]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-3462]
=======================================================================
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9180]
RIN 1545-BC29
Adjustment To Net Unrealized Built-in Gain
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations under section 1374
that provide for an adjustment to the amount that may be subject to tax
under section 1374 in certain cases in which an S corporation acquires
assets from a C corporation in an acquisition to which section
1374(d)(8) applies. These final regulations provide guidance to certain
S corporations that acquire assets from a C corporation in a carryover
basis transaction.
DATES: Effective Date: These regulations are effective February 23,
2005.
Applicability Dates: For dates of applicability, see Sec. 1.1374-
10.
FOR FURTHER INFORMATION CONTACT: Jennifer D. Sledge, (202) 622-7750
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background and Explanation of Provisions
This document contains amendments to Income Tax Regulations (26 CFR
part 1) under section 1374 of the Internal Revenue Code (Code),
relating to the tax imposed on certain recognized built-in gains of S
corporations. Section 1374 imposes a tax on an S corporation's net
recognized built-in gain attributable to assets that it held on the
date it converted from a C corporation to an S corporation for the 10-
year period beginning on the first day the corporation is an S
corporation and assets that it acquired from a C corporation in a
carryover basis transaction for the 10-year period beginning on the day
of the acquisition. A separate determination of the amount subject to
tax under section 1374 is required for those assets the S corporation
held on the date it converted to C status and each pool of assets the S
corporation acquired in a carryover basis transaction from a C
corporation. The total amount subject to tax under section 1374 for
each pool of assets is limited to that pool's net unrealized built-in
gain (NUBIG) on the date of the conversion or acquisition.
Under the current rules, if X, a C corporation, elects to be an S
corporation when it owns some or all of the stock of Y, a C
corporation, and Y subsequently transfers its assets to X in a
liquidation to which sections 332 and 337(a) apply or in a
reorganization described in section 368(a), the built-in gain or built-
in loss in Y's assets may be wholly or partially reflected twice: once
in the NUBIG attributable to the assets X owned on the date of its
conversion (including the Y stock) and a second time in the NUBIG
attributable to Y's former assets acquired by X in the liquidation of
Y. The IRS and Treasury Department recognize that continuing to reflect
the built-in gain or the built-in loss in the Y stock at the time of
X's conversion after the liquidation or reorganization is inconsistent
with the fact that such liquidation or reorganization has the effect of
eliminating that built-in gain or built-in loss. Therefore, on June 25,
2004, the IRS and Treasury Department published in the Federal Register
(69 FR 35544) a notice of proposed rulemaking (REG-131486-03) that
includes regulations proposing an adjustment to the NUBIG in these
cases. In particular, the proposed regulations generally provide that,
if an S corporation acquires assets of a C corporation in a carryover
basis transaction, some or all of the stock of the C corporation from
which such assets were acquired was taken into account in the
computation of NUBIG for a pool of assets of the S corporation, and
some or all of such stock is redeemed or canceled in such transaction,
then, subject to certain limitations, such NUBIG is adjusted to
eliminate any effect any built-in gain or built-in loss in the redeemed
or canceled stock had on the initial computation of NUBIG for that pool
of assets. These regulations are proposed to apply for taxable years
beginning after the date they are published as final regulations in the
Federal Register.
No public hearing was requested or held regarding the proposed
regulations. One written comment, however, was received. That comment
requested that the proposed regulations be made effective as soon as
possible.
These final regulations adopt the proposed regulations without
substantive change as final regulations. However, the final regulations
do modify the proposed effective date of the regulations. The final
regulations apply to section 1374(d)(8) transactions that occur in
taxable years beginning after February 23, 2005. The final regulations
also provide that an S corporation may apply the regulations to section
1374(d)(8) transactions that occur in taxable years beginning on or
before February 23, 2005, if the S corporation (and any predecessors or
successors) and all affected shareholders file original or amended
returns that are consistent with the regulations for taxable years of
the S corporation during the recognition period of the pool of assets
the NUBIG of which would be adjusted pursuant to the regulations that
are not closed as of the first date after February 23, 2005, that the S
corporation files an original or amended return.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations and, because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Code, this regulation was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on their impact on small business.
Drafting Information
The principal author of these regulations is Jennifer D. Sledge of
the Office of Associate Chief Counsel (Corporate). Other personnel from
Treasury and the IRS participated in their development.
[[Page 8728]]
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.1374-3 is amended by:
0
1. Revising paragraph (b).
0
2. Adding paragraph (c).
The revision and addition read as follows:
Sec. 1.1374-3 Net unrealized built-in gain.
* * * * *
(b) Adjustment to net unrealized built-in gain--(1) In general. If
section 1374(d)(8) applies to an S corporation's acquisition of assets,
some or all of the stock of the corporation from which such assets were
acquired was taken into account in the computation of the net
unrealized built-in gain for a pool of assets of the S corporation, and
some or all of such stock is redeemed or canceled in such transaction,
then, subject to the limitations of paragraph (b)(2) of this section,
such net unrealized built-in gain is adjusted to eliminate any effect
that any built-in gain or built-in loss in the redeemed or canceled
stock (other than stock with respect to which a loss under section 165
is claimed) had on the initial computation of net unrealized built-in
gain for that pool of assets. For purposes of this paragraph, stock
described in section 1374(d)(6) shall be treated as taken into account
in the computation of the net unrealized built-in gain for a pool of
assets of the S corporation.
(2) Limitations on adjustment--(i) Recognized built-in gain or
loss. Net unrealized built-in gain for a pool of assets of the S
corporation is only adjusted under paragraph (b)(1) of this section to
reflect built-in gain or built-in loss in the redeemed or canceled
stock that has not resulted in recognized built-in gain or recognized
built-in loss during the recognition period.
(ii) Anti-duplication rule. Paragraph (b)(1) of this section shall
not be applied to duplicate an adjustment to the net unrealized built-
in gain for a pool of assets made pursuant to paragraph (b)(1) of this
section.
(3) Effect of adjustment. Any adjustment to the net unrealized
built-in gain made pursuant to this paragraph (b) only affects
computations of the amount subject to tax under section 1374 for
taxable years that end on or after the date of the acquisition to which
section 1374(d)(8) applies.
(4) Pool of assets. For purposes of this section, a pool of assets
means--
(i) The assets held by the corporation on the first day it became
an S corporation, if the corporation was previously a C corporation; or
(ii) The assets the S corporation acquired from a C corporation in
a section 1374(d)(8) transaction.
(c) Examples. The following examples illustrate the rules of this
section:
Example 1. Computation of net unrealized built-in gain. (i)(A)
X, a calendar year C corporation using the cash method, elects to
become an S corporation on January 1, 1996. On December 31, 1995, X
has assets and liabilities as follows:
------------------------------------------------------------------------
Assets FMV Basis
------------------------------------------------------------------------
Factory.......................................... $500,000 $900,000
Accounts Receivable.............................. 300,000 0
Goodwill......................................... 250,000 0
-------------
Total.......................................... 1,050,000 900,000
------------------------------------------------------------------------
Liabilities Amount
------------------------------------------------------------------------
Mortgage..................................................... $200,000
Accounts Payable............................................. 100,000
----------
Total...................................................... 300,000
------------------------------------------------------------------------
(B) Further, X must include a total of $60,000 in taxable income
in 1996, 1997, and 1998 under section 481(a).
(ii) If, on December 31, 1995, X sold all its assets to a third
party that assumed all its liabilities, X's amount realized would be
$1,050,000 ($750,000 cash received + $300,000 liabilities assumed =
$1,050,000). Thus, X's net unrealized built-in gain is determined as
follows:
------------------------------------------------------------------------
------------------------------------------------------------------------
Amount realized........................................... $1,050,000
Deduction allowed (A/P)................................... (100,000)
Basis of X's assets....................................... (900,000)
Section 481 adjustments................................... 60,000
Net unrealized built-in gain.............................. 110,000
------------------------------------------------------------------------
Example 2. Adjustment to net unrealized built-in gain for built-
in gain in eliminated C corporation stock. (i) X, a calendar year C
corporation, elects to become an S corporation effective January 1,
2005. On that date, X's assets (the first pool of assets) have a net
unrealized built-in gain of $15,000. Among the assets in the first
pool of assets is all of the outstanding stock of Y, a C
corporation, with a fair market value of $33,000 and an adjusted
basis of $18,000. On March 1, 2009, X sells an asset that it owned
on January 1, 2005, and as a result has $10,000 of recognized built-
in gain. X has had no other recognized built-in gain or built-in
loss. X's taxable income limitation for 2009 is $50,000. Effective
June 1, 2009, X elects under section 1361 to treat Y as a qualified
subchapter S subsidiary (QSub). The election is treated as a
transfer of Y's assets to X in a liquidation to which sections 332
and 337(a) apply.
(ii) Under paragraph (b) of this section, the net unrealized
built in-gain of the first pool of assets is adjusted to account for
the elimination of the Y stock in the liquidation. The net
unrealized built-in gain of the first pool of assets, therefore, is
decreased by $15,000, the amount by which the fair market value of
the Y stock exceeded its adjusted basis as of January 1, 2005.
Accordingly, for taxable years ending after June 1, 2009, the net
unrealized built-in gain of the first pool of assets is $0.
(iii) Under Sec. 1.1374-2(a), X's net recognized built-in gain
for any taxable year equals the least of X's pre-limitation amount,
taxable income limitation, and net unrealized built-in gain
limitation. In 2009, X's pre-limitation amount is $10,000, X's
taxable income limitation is $50,000, and X's net unrealized built-
in gain limitation is $0. Because the net unrealized built-in gain
of the first pool of assets has been adjusted to $0, despite the
$10,000 of recognized built-in gain in 2009, X has $0 net recognized
built-in gain for the taxable year ending on December 31, 2009.
Example 3. Adjustment to net unrealized built-in gain for built-
in loss in eliminated C corporation stock. (i) X, a calendar year C
corporation, elects to become an S corporation effective January 1,
2005. On that date, X's assets (the first pool of assets) have a net
unrealized built-in gain of negative $5,000. Among the assets in the
first pool of assets is 10 percent of the outstanding stock of Y, a
C corporation, with a fair market value of $18,000 and an adjusted
basis of $33,000. On March 1, 2009, X sells an asset that it owned
on January 1, 2005, resulting in $8,000 of recognized built-in gain.
X has had no other recognized built-in gains or built-in losses. X's
taxable income limitation for 2009 is $50,000. On June 1, 2009, Y
transfers its assets to X in a reorganization under section
368(a)(1)(C).
(ii) Under paragraph (b) of this section, the net unrealized
built in-gain of the first pool of assets is adjusted to account for
the elimination of the Y stock in the reorganization. The net
unrealized built-in gain of the first pool of assets, therefore, is
increased by $15,000, the amount by which the adjusted basis of the
Y stock exceeded its fair market value as of January 1, 2005.
Accordingly, for taxable years ending after June 1, 2009, the net
unrealized built-in gain of the first pool of assets is $10,000.
(iii) Under Sec. 1.1374-2(a), X's net recognized built-in gain
for any taxable year equals the least of X's pre-limitation amount,
taxable income limitation, and net unrealized built-in gain
limitation. In 2009, X's pre-limitation amount is $8,000 and X's
taxable income limitation is $50,000. The net unrealized built-in
gain of the first pool of assets has been adjusted to $10,000, so
X's net unrealized built-in gain limitation is $10,000. X,
therefore, has $8,000 net recognized built-in gain for the taxable
year ending on December 31, 2009. X's net unrealized built-in gain
limitation for 2010 is $2,000.
[[Page 8729]]
Example 4. Adjustment to net unrealized built-in gain in case of
prior gain recognition. (i) X, a calendar year C corporation, elects
to become an S corporation effective January 1, 2005. On that date,
X's assets (the first pool of assets) have a net unrealized built-in
gain of $30,000. Among the assets in the first pool of assets is all
of the outstanding stock of Y, a C corporation, with a fair market
value of $45,000 and an adjusted basis of $10,000. Y has no current
or accumulated earnings and profits. On April 1, 2007, Y distributes
$18,000 to X, $8,000 of which is treated as gain to X from the sale
or exchange of property under section 301(c)(3). That $8,000 is
recognized built-in gain to X under section 1374(d)(3), and results
in $8,000 of net recognized built-in gain to X for 2007. X's net
unrealized built-in gain limitation for 2008 is $22,000. On June 1,
2009, Y transfers its assets to X in a liquidation to which sections
332 and 337(a) apply.
(ii) Under paragraph (b) of this section, the net unrealized
built in-gain of the first pool of assets is adjusted to account for
the elimination of the Y stock in the liquidation. The net
unrealized built-in gain of that pool of assets, however, can only
be adjusted to reflect the amount of built-in gain that was inherent
in the Y stock on January 1, 2005 that has not resulted in
recognized built-in gain during the recognition period. In this
case, therefore, the net unrealized built-in gain of the first pool
of assets cannot be reduced by more than $27,000 ($35,000, the
amount by which the fair market value of the Y stock exceeded its
adjusted basis as of January 1, 2005, minus $8,000, the recognized
built-in gain with respect to the stock during the recognition
period). Accordingly, for taxable years ending after June 1, 2009,
the net unrealized built-in gain of the first pool of assets is
$3,000. The net unrealized built-in gain limitation for 2009 is $0.
0
Par. 3. Paragraph (a) of Sec. 1.1374-10 is revised to read as follows:
Sec. 1.1374-10 Effective date and additional rules.
(a) In general. Sections 1.1374-1 through 1.1374-9, other than
Sec. 1.1374-3(b) and (c) Examples 2 through 4, apply for taxable years
ending on or after December 27, 1994, but only in cases where the S
corporation's return for the taxable year is filed pursuant to an S
election or a section 1374(d)(8) transaction occurring on or after
December 27, 1994. Section 1.1374-3(b) and (c) Examples 2 through 4
apply to section 1374(d)(8) transactions that occur in taxable years
beginning after February 23, 2005. In addition, an S corporation may
apply Sec. 1.1374-3(b) and (c) Examples 2 through 4 to section
1374(d)(8) transactions that occur in taxable years beginning on or
before February 23, 2005, if the S corporation (and any predecessors or
successors) and all affected shareholders file original or amended
returns that are consistent with these provisions for taxable years of
the S corporation during the recognition period of the pool of assets
the net unrealized built-in gain of which would be adjusted pursuant to
those provisions that are not closed as of the first date after
February 23, 2005, that the S corporation files an original or amended
return. For purposes of this section, affected shareholders means all
shareholders who received distributive shares of S corporation items in
such taxable years. However, the Commissioner may, in appropriate
circumstances, permit taxpayers to apply these provisions even if all
affected shareholders cannot file consistent returns. In addition, for
this purpose, a predecessor of an S corporation is a corporation that
transfers its assets to the S corporation in a transaction to which
section 381 applies. A successor of an S corporation is a corporation
to which the S corporation transfers its assets in a transaction to
which section 381 applies.
* * * * *
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Approved: February 14, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
FR Doc. 05-3462 Filed 2-22-05; 8:45 am]
BILLING CODE 4830-01-P
