Regulations Enabling Elections for Certain Transactions Under Section 336(e), 49965-49981 [E8-19603]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 165 (Monday, August 25, 2008)]
[Proposed Rules]
[Pages 49965-49981]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-19603]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-143544-04]
RIN 1545-BD84


Regulations Enabling Elections for Certain Transactions Under 
Section 336(e)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations under section 
336(e) of the Internal Revenue Code. These proposed regulations, when 
finalized, would permit taxpayers to make an election to treat certain 
sales, exchanges, and distributions of another corporation's stock as 
taxable sales of that corporation's assets. These proposed regulations 
will affect corporations and their shareholders.

DATES: Written or electronic comments and requests for a public hearing 
must be received by November 24, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-143544-04), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
143544-

[[Page 49966]]

04), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at https://www.regulations.gov (IRS REG-143544-04).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulation, 
Mark J. Weiss, (202) 622-7750; concerning submissions of comments and 
the hearing, Richard Hurst, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503. Comments on the collection of information should 
be received by October 24, 2008.
    The collection of information in this proposed regulation is in 
proposed Sec. Sec.  1.336-2(h) and 1.336-4(c)(4)). This information is 
required by the IRS to allow certain parties to make a section 336(e) 
election and for certain shareholders to make a gain recognition 
election. The likely recordkeepers are business or other for-profit 
institutions.
    The estimated burden is as follows:
    Estimated total annual reporting and/or recordkeeping burden: 500 
hours.
    Estimated average annual burden per respondent: 2 hours.
    Estimated number of respondents: 250.
    Estimated annual frequency of responses: Once.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be directed to the Office 
of Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503, with copies to the Internal Revenue Service, Attn: IRS Reports 
Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Any such 
comments should be submitted not later than October 24, 2008.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background and Explanation of Provisions

    Section 336(e) of the Internal Revenue Code (Code) authorizes the 
issuance of regulations under which a corporation (seller) that owns 
stock in another corporation (target) meeting the requirements of 
section 1504(a)(2) and sells, exchanges, or distributes all of such 
stock may make an election to treat the sale, exchange, or distribution 
of the target stock as a sale of all of target's underlying assets. 
Section 336(e) was enacted as part of the legislation repealing the 
General Utilities rule and, like an election under section 338(h)(10), 
is meant to provide taxpayers relief from a potential multiple taxation 
at the corporate level of the same economic gain which can result when 
a transfer of appreciated corporate stock is taxed to a corporation 
without providing a corresponding step-up in the basis of the assets of 
the corporation. See H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess., 
Vol. II, 198, 204 (1986), 1986-3 C.B., Vol. 4, 198-207.

A. Scope of the Proposed Regulations

    Pursuant to section 336(e), regulations may authorize a section 
336(e) election in a broad set of circumstances. The IRS and Treasury 
Department have limited the scope of these proposed regulations, 
however, in order to provide guidance to a large number of taxpayers in 
the most efficient manner possible. These proposed regulations, when 
finalized, will provide the requirements and mechanics for, and 
consequences of, treating a stock sale, exchange, or distribution that 
would not otherwise be eligible for a section 338 election as a deemed 
asset sale.
    The IRS and Treasury Department do not presently intend to 
authorize the making of section 336(e) elections under all the 
circumstances described within the statutory grant of authority. 
However, the IRS and Treasury Department are interested in comments 
regarding transactions beyond the scope of these proposed regulations 
for which such elections should be allowed and under what terms and 
conditions. For example, these proposed regulations do not apply to 
transactions between related persons. For this purpose, persons are 
related if stock in a corporation owned by one of the persons would be 
attributed to the other person under section 318(a), other than section 
318(a)(4). See proposed Sec.  1.336-1(b)(11). The IRS and Treasury 
Department continue to study the possibility of making a section 336(e) 
election available for such transactions. Accordingly, comments are 
requested regarding dispositions to related persons, including special 
rules needed to prevent the use of net operating losses to offset 
liquidation gains, manipulation of earnings and profits, and changes of 
accounting methods. See H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess., 
Vol. II at 204 (1986).
    Additionally, these proposed regulations do not apply to 
transactions in which either the seller or the target is a foreign 
corporation. The IRS and Treasury Department request comments regarding 
how the rules of the proposed regulations should be modified to take 
into account the policies of international tax provisions if the 
proposed regulations were extended to apply to foreign sellers and/or 
foreign targets. For example, comments are requested regarding: (1) How 
the principles of section 338(h)(16) should apply; (2) how the foreign 
tax allocation rule of Sec.  1.338-9(d) should apply; (3) the 
characterization of the gain recognized on the deemed asset disposition 
for purposes of section 954(c)(1)(B); (4) whether special earnings and 
profits rules are necessary (see, for example, the rules described in 
Prop. Treas. Reg. Sec.  1.367(b)-8); and (5) how the withholding tax 
provisions of section 1445 should apply to the deemed asset disposition 
(if relevant).
    The IRS and Treasury Department continue to study issues related to 
elections made under section 338(g) in the international area. Comments 
are requested on issues in this area, including the interaction of 
section 338(h)(16) with sections 902 and 960.
    Absent the issuance of further guidance, it is intended that these 
regulations would provide the exclusive means of making elections under 
section 336(e). See proposed Sec.  1.336-2(a).

B. General Principles

1. General Adoption of Section 338(h)(10) Principles
    The legislative history to section 336(e) provides that principles 
similar to those of section 338(h)(10) should apply in the case of a 
section 336(e) election. See H.R. Conf. Rep. No. 841, 99th Cong., 2d 
Sess., Vol. II, at 204

[[Page 49967]]

(1986). These proposed regulations implement such principles. 
Accordingly, except to the extent inconsistent with the purposes of 
section 336(e) or as otherwise described, the results of a section 
336(e) election coincide with those of a section 338(h)(10) election. 
Whenever possible, these proposed regulations rely upon and use the 
structure and principles established under section 338(h)(10) and the 
underlying regulations. For example, these regulations refer to 
principles under the section 338 regulations regarding the allocation 
of consideration, application of the asset and stock consistency rules, 
treatment of minority shareholders, and the availability of the section 
453 installment method. In other instances, definitions and concepts 
from section 338 and the underlying regulations have been modified to 
reflect principles applicable to section 336(e). For example, these 
proposed regulations generally use the term ``disposition'' rather than 
``acquisition or purchase'' and the term ``sale, exchange, or 
distribution'' instead of ``sale.'' Thus, a qualified stock disposition 
is defined as any transaction or series of transactions in which stock 
meeting the requirements of section 1504(a)(2) of a domestic 
corporation is either sold, exchanged, or distributed, or any 
combination thereof, by another domestic corporation in a disposition, 
within the meaning of proposed Sec.  1.336-1(b)(4), during the 12-month 
disposition period. See proposed Sec.  1.336-1(b)(5).
    These proposed regulations also provide that a transaction that 
satisfies the definition of both a qualified stock disposition and a 
qualified stock purchase (as defined in section 338(d)(3)) generally 
will be treated only as a qualified stock purchase and thus does not 
qualify for an election under these regulations. See proposed Sec.  
1.336-1(b)(5)(ii)).
2. Requirements for a Section 336(e) Election
    Section 336(e) requires that a seller own stock in another 
corporation meeting the requirements of section 1504(a)(2) and sell, 
exchange, or distribute all of such stock to qualify for a section 
336(e) election. For purposes of these proposed regulations, a seller 
is a domestic corporation that makes a qualified stock disposition and 
includes a transferor and a distributor of target stock. See proposed 
Sec.  1.336-1(b)(1). Generally, all members of a seller's consolidated 
group are treated as a single seller. See proposed Sec.  1.336-2(g)(2). 
Thus, similar to a section 338(h)(10) election, a section 336(e) 
election is available to a seller that directly owns stock of target 
meeting the requirements of section 1504(a)(2) and to sellers which are 
members of a consolidated group for the taxable year that includes the 
disposition date that in the aggregate own stock of target meeting the 
requirements of section 1504(a)(2). Because section 336(e) requires a 
corporate seller, the election is not available with respect to the 
stock of an S corporation. See proposed Sec.  1.336-1(b)(5). Cf. Sec.  
1.338(h)(10)-1(c)(1).
    These proposed regulations interpret section 336(e) as requiring 
only that an amount of stock meeting the requirements of section 
1504(a)(2) be disposed of and not that every share of stock owned by 
the seller be disposed of. Accordingly, the seller, or a member of 
seller's consolidated group, may retain a portion of its target stock. 
See proposed Sec. Sec.  1.336-2(b)(1)(v) and 1.336-2(b)(2)(iv). 
Furthermore, these proposed regulations permit amounts of target stock 
sold, exchanged, and distributed to be aggregated for purposes of 
determining whether there has been a qualified stock disposition. For 
example, a domestic corporation's sale of 50 percent of target's stock 
to an unrelated person and a distribution to its unrelated shareholders 
of the remaining 50 percent within a 12-month period would constitute a 
qualified stock disposition. See proposed Sec.  1.336-1(b)(5).
    In contrast to section 338, which requires a corporate purchaser, 
these proposed regulations define a purchaser as any person or persons 
who receive stock of target in a qualified stock disposition. 
Accordingly, a section 336(e) election is available for sales, 
exchanges, or distributions (or a combination thereof) of target stock 
to both corporate and non-corporate purchasers, provided that the 
target stock is not sold, exchanged, or distributed to a related 
person. See proposed Sec. Sec.  1.336-1(b)(2) and 1.336-1(b)(4)(i)(C).
    Any stock sold, exchanged, or distributed to a related party is not 
considered to be disposed of for purposes of determining whether there 
has been a qualified stock disposition. See proposed Sec. Sec.  1.336-
1(b)(4)(i)(C) and 1.336-1(b)(5)(i). Relatedness generally is determined 
immediately after the sale, exchange, or distribution of target stock 
occurs (see proposed Sec. Sec.  1.336-1(b)(4)(iii), 1.336-1(b)(11), and 
1.338-3(b)(3)).

C. Sales or Exchanges of Target Stock

    In general, if a seller sells or exchanges target stock in a 
qualified stock disposition, the treatment of old target, seller, and 
purchaser are similar to the treatment of old target (old T), S, and P 
under section 338(h)(10). See Sec.  1.338(h)(10)-1. If an election is 
made under section 336(e), the seller disregards the actual sale or 
exchange of target stock. Instead, target (old target) is treated as 
selling all of its assets to an unrelated corporation in a single 
transaction at the close of the disposition date (the deemed asset 
disposition). Old target recognizes the deemed disposition tax 
consequences from the deemed asset disposition before the close of the 
disposition date while it is a subsidiary of seller. After the deemed 
asset disposition, old target is then treated as liquidating into 
seller which in most cases will be treated as a distribution in 
complete liquidation to which section 332 and section 336 or 337 
applies. Additionally, consistent with a section 338 election, the 
deemed purchase of the assets of old target by new target constitutes a 
deemed purchase of any subsidiary stock owned by target. Accordingly, a 
section 336(e) election is available for the deemed purchase of the 
stock of a target subsidiary if it constitutes a qualified stock 
disposition. A section 336(e) election generally does not change the 
tax consequences of the acquisition to a purchaser of target stock.

D. Distributions of Target Stock Not Described in Section 355(d)(2) or 
(e)(2)

    A section 336(e) election can be made for a distribution of target 
stock, and the legislative history to section 336(e) provides that 
``[t]he conferees do not intend this election to affect the manner in 
which a corporation's distribution to its shareholders will be 
characterized for purposes of determining the shareholder level income 
tax consequences.'' H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess., Vol. 
II, at 204 (1986). Accordingly, additional rules are required to 
address distributions and to ensure that the income tax consequences to 
a distributee are generally the same as if a section 336(e) election 
was not made.
    Specifically, these proposed regulations provide that if seller 
(the distributor) distributes old target stock in the qualified stock 
disposition, seller is deemed to purchase from new target on the 
disposition date, immediately after the deemed liquidation of old 
target, the amount of stock distributed in the qualified stock 
disposition and to have distributed such new target stock

[[Page 49968]]

to its shareholders. Seller recognizes no gain or loss on the 
distribution. See proposed Sec.  1.336-2(b)(1)(iv). The distributee's 
tax consequences generally shall be the same as if it received the 
target stock pursuant to the underlying distribution. However, the 
Federal income tax consequences of the deemed asset disposition and 
liquidation of target may affect the distributee's income tax 
consequences. For example, if seller distributes the stock of target to 
its shareholders in a qualified stock disposition for which a section 
336(e) election is made, any increase in seller's earnings and profits 
as a result of old target's deemed asset disposition and liquidation 
into seller may alter the amount of the distribution to the 
shareholders constituting a dividend under section 301(c)(1) from the 
amount that would have resulted if seller recognized gain on the stock 
distribution. See proposed Sec.  1.336-2(c).
    If a seller actually distributed stock of a subsidiary or assets 
under section 301, it generally would be prevented from recognizing any 
loss. See section 311(a). The IRS and Treasury Department believe that 
it would be inconsistent with the general treatment of distributions to 
allow losses to be recognized on the section 336(e) deemed asset 
disposition to the extent the qualified stock disposition was the 
result of a stock distribution. Therefore, under these proposed 
regulations, only a portion of the losses realized on the deemed asset 
disposition may be recognized. The portion of any realized loss that 
may be recognized is based on a fraction equal to the value of the 
target stock sold or exchanged in the qualified stock disposition on or 
before the disposition date over the total value of target stock 
disposed of in the qualified stock disposition on or before the 
disposition date. In the case of a section 336(e) election for a 
subsidiary of target, for purposes of determining the amount of loss 
that may be recognized by the subsidiary on the deemed asset 
disposition, only the percentage of the stock of the target subsidiary 
deemed sold by target equal to the percentage of the stock of target 
sold or exchanged is considered to have been sold or exchanged. See 
proposed Sec. Sec.  1.336-2(b)(1)(i)(B)(2) and (3). Thus, losses 
realized in the deemed asset disposition are not recognized to the 
extent the qualified stock disposition is attributable to the 
distribution of target stock.

E. Section 355 Distributions

1. Availability of Section 336(e) Election for Certain Section 355 
Distributions
    The legislative history to section 336(e) indicates that the 
election is intended to be available for taxable transactions. 
Specifically, the Conference Report provides that, ``principles similar 
to those of section 338(h)(10) may be applied to taxable sales or 
distributions of controlled corporation stock.'' H.R. Conf. Rep. No. 
841, 99th Cong., 2d Sess., Vol. II, at 204 (1986). The legislative 
history to section 355(e) provides that although there is no adjustment 
to the basis of stock or assets as a result of the recognition of gain 
under section 355(e), ``[t]here is no intention to limit the otherwise 
applicable Treasury regulatory authority under section 336(e) of the 
Code.'' H.R. Conf. Rep. 220, 105th Cong., 1st Sess., 531-532, footnote 
13 (1997), 1997-4 C.B. Vol. 4, 531, 532. Accordingly, these proposed 
regulations would allow a corporation that would otherwise recognize 
the full amount of the gain realized with respect to a qualified stock 
disposition resulting, in whole or in part, from a disposition 
described in section 355(d)(2) or (e)(2) to make a section 336(e) 
election. Without a section 336(e) election, such provisions may create 
a triple layer of taxation, one at the controlled corporation level, 
one at the distributing corporation level and, ultimately, one at the 
shareholder level. Allowing a section 336(e) election in these 
circumstances limits taxation to two layers, one at the controlled 
corporation level and one at the shareholder level when the controlled 
corporation stock is disposed of, and thus is consistent with General 
Utilities repeal.
2. Special Rules for Distributions Described in Section 355(d)(2) or 
355(e)(2)
    Generally, a section 336(e) election, like a section 338(h)(10) 
election, results in a deemed sale of old target's assets followed by a 
liquidation of old target into seller, which if made in a transaction 
to which section 381 applied, results in old target's attributes being 
transferred to the seller. Accordingly, consistent with a taxable asset 
acquisition, after the transaction new target generally has no tax 
attributes or earnings and profits, and holds its assets with a cost 
basis. In contrast, a section 355 distribution is generally tax-free to 
the distributing corporation's shareholders, even if the transaction is 
described in section 355(d)(2) or 355(e)(2). Further, following a 
section 355 distribution, the controlled corporation generally retains 
tax attributes and earnings and profits. The IRS and Treasury 
Department believe that, except as necessary to carry out the purposes 
of section 336(e), the section 355 consequences generally should 
continue to apply in such a transaction. For example, if the controlled 
corporation were treated as a new corporation, with no earnings and 
profits, the controlled corporation may be able to distribute its 
assets to its shareholders without recognizing any dividend 
consequences under section 301(c)(1). Therefore, to preserve the 
consequences of section 355 distributions, the proposed regulations 
provide special rules.
    If a section 336(e) election is made for a distribution of the 
controlled corporation stock in a transaction described in section 
355(d)(2) or 355(e)(2), the controlled corporation is treated as if it 
sold its assets to an unrelated person in the deemed asset disposition 
and then it reacquired those assets (sale-to-self treatment). Following 
the deemed asset disposition, the controlled corporation (old target) 
is not deemed to liquidate into the distributing corporation (seller). 
See proposed Sec.  1.336-2(b)(2)(i)(A). Instead, the controlled 
corporation (old target) is treated as acquiring all of its assets from 
an unrelated person in a single, separate transaction at the close of 
the disposition date, and then the distributing corporation is treated 
as distributing the stock of the controlled corporation (old target) to 
its shareholders. See proposed Sec.  1.336-2(b)(2)(ii) and (iii). 
Because no liquidation of old target into seller is deemed to occur, 
the controlled corporation (old target) will generally retain the tax 
attributes it would have had if the section 336(e) election had not 
been made. The proposed regulations further provide that the controlled 
corporation (old target) will take the effects of the deemed asset 
disposition into account and increase or decrease its earnings and 
profits immediately before allocating earnings and profits pursuant to 
Sec.  1.312-10. See proposed Sec.  1.336-2(b)(2)(vi). Finally, the 
deemed sale and reacquisition of target's assets (and, in the case of a 
parent-subsidiary chain of corporations making section 336(e) 
elections, a target subsidiary's assets) pursuant to the deemed asset 
disposition will not cause the transaction to fail to satisfy the 
requirements of section 355. See proposed Sec.  1.336-2(b)(2)(v).
    Similar to a qualified stock disposition resulting from a 
distribution not involving a transaction described in section 355(d)(2) 
or (e)(2), old target's

[[Page 49969]]

losses in the deemed asset disposition will be recognized, but only in 
relation to the amount of stock sold or exchanged in the qualified 
stock disposition on or before the disposition date. See Sec. Sec.  
1.336-2(b)(2)(i)(B)(2) and (3).
    Notwithstanding the fact that the sale-to-self treatment applies to 
a distribution of stock described in section 355(d)(2) or (e)(2), if 
old target has any subsidiaries for which a section 336(e) election is 
made, the general deemed asset disposition methodology shall apply. 
Accordingly, old target subsidiary is treated as though it sold all its 
assets to an unrelated person, new target subsidiary is deemed to 
purchase all its assets from an unrelated person, and old target 
subsidiary is deemed to liquidate into old target. If the sale-to-self 
treatment was applied, target subsidiary's attributes would remain with 
target subsidiary. The IRS and Treasury Department do not believe that 
taxpayers should have the option of whether the attributes become those 
of target, by doing an actual sale of target subsidiary's assets 
followed by a liquidation of target subsidiary, or remain with target 
subsidiary, by making a section 336(e) election for target subsidiary. 
Accordingly, the regulations apply the general deemed asset disposition 
methodology for section 336(e) elections for target subsidiaries in a 
distribution of target stock described in section 355(d)(2) or (e)(2).
3. Intragroup Sales, Exchanges, or Distributions Prior to External 
Sales, Exchanges, or Distributions
    Generally, if the stock of a target is transferred within an 
affiliated group and then is further transferred outside the affiliated 
group, a section 336(e) election is not available for the intragroup 
transfer because a qualified stock disposition may not be made between 
related sellers and purchasers. Thus, stock level gain may be 
recognized on the intragroup transfer. While a section 336(e) election 
may be available for the external transfer, this election would result 
in the affiliated group recognizing gain both on target's assets and 
the target stock, contrary to the intent of these proposed regulations. 
Comments are requested on how to address this concern. Further, because 
section 355(f) provides that section 355 does not apply to an 
intragroup distribution prior to an external distribution described in 
section 355(e)(2), these comments should address the concerns that 
section 355(f) is intended to address for distributions described 
therein.

F. Aggregate Deemed Asset Disposition Price (ADADP) and Adjusted 
Grossed Up Basis (AGUB)

    These proposed regulations create a new term, aggregate deemed 
asset disposition price (ADADP). These proposed regulations retain the 
term adjusted grossed up basis (AGUB) as used in section 338. See Sec.  
1.338-5. In general, these proposed regulations treat ADADP and AGUB 
similarly to the way aggregate deemed sale price (ADSP) and AGUB are 
treated under the section 338 regulations. See proposed Sec. Sec.  
1.336-3 and 1.336-4. Old target recognizes all of the gain realized on 
the deemed transfer of its assets in exchange for the ADADP and 
allocates the ADADP among the assets held as of the disposition date 
(in the same manner as ADSP is allocated under Sec. Sec.  1.338-6 and 
1.338-7). See proposed Sec. Sec.  1.336-2(b)(1)(i) and 1.336-
2(b)(2)(i). ADADP is calculated by adding the grossed-up amount 
realized on the sale, exchange, or distribution of recently disposed 
target stock and the liabilities of old target. See proposed Sec.  
1.336-3(b)(1). These proposed regulations account for the fact that 
there is no actual amount realized in a distribution of stock by 
treating the grossed-up amount realized on the sale, exchange, or 
distribution as including in the amount realized the fair market value 
of recently disposed target stock distributed in the qualified stock 
disposition. See proposed Sec.  1.336-3(c)(1)(i)(B).
    These proposed regulations also create a new term, nonrecently 
disposed stock. The term nonrecently disposed stock has a similar 
meaning to the term nonrecently purchased stock in section 
338(b)(6)(B). In a transaction for which a section 338 election is 
made, there is only one purchasing corporation (or an affiliated group 
treated as a purchasing corporation). Accordingly, in most cases, it 
should be relatively easy to determine the purchaser's basis in 
nonrecently purchased stock in order to determine AGUB. However, in a 
section 336(e) election, there can be multiple purchasers or multiple 
distributees, many of whom may have acquired small amounts of target 
stock prior to the 12-month disposition period. While a more precise 
determination of AGUB would require the determination of the basis of 
all such stockholdings, the IRS and Treasury Department recognize that 
it would often be impractical to require a seller to determine and 
track all the purchasers (and distributees) possessing small amounts of 
nonrecently purchased stock. Generally, purchasers holding at least 10 
percent of the total voting power or value of the stock of target 
should be readily identifiable through mandatory SEC filings and other 
sources. Thus, in order to balance a desire for precision with a 
practical application, nonrecently disposed stock is defined as stock 
in a target corporation which is held on the disposition date by a 
purchaser or a person related to a purchaser who owns, on the 
disposition date, with the application of section 318(a), other than 
section 318(a)(4), at least 10 percent of the total voting power or 
value of the stock of target, and which is not recently disposed stock. 
See proposed Sec.  1.336-1(b)(17).
    In general, proposed Sec.  1.336-4 uses the same principles as 
paragraphs (b) through (g) of Sec.  1.338-5 to determine the amount of 
AGUB for target and the consequences of a gain recognition election. 
Proposed Sec.  1.336-4(b) contains modifications to the principles of 
Sec.  1.338-5 to reflect the principles of section 336(e).
    New target is treated as acquiring all of its assets from an 
unrelated person in a single transaction at the close of the 
disposition date, but before the deemed liquidation (or, in the case of 
a transaction described in section 355(d)(2) or (e)(2), before the 
distribution) in exchange for an amount equal to the AGUB as determined 
under proposed Sec.  1.336-4. New target allocates the consideration 
deemed paid in the same manner as new target would as described in 
Sec. Sec.  1.338-6 and 1.338-7 in order to determine the basis in each 
of the transferred assets. See proposed Sec. Sec.  1.336-2(b)(1)(ii) 
and 1.336-2(b)(2)(ii). In the case of a disposition described in 
section 355(d)(2) or (e)(2), any reference to new target is treated as 
referring to old target in its capacity as the purchaser of assets 
pursuant to the section 336(e) election. See proposed Sec.  1.336-
4(b)(4).
    Consistent with the principles of a section 338(h)(10) election, 
any stock retained by a seller or a member of seller's consolidated 
group after the 12-month disposition period is treated as acquired by 
the seller on the day after the disposition date at its fair market 
value. For this purpose, the fair market value of all the target stock 
equals the grossed-up amount realized on the sale, exchange, or 
distribution of recently disposed stock. See proposed Sec. Sec.  1.336-
2(b)(1)(v) and 1.336-2(b)(2)(iv). A minority shareholder (that is, a 
shareholder that is neither the seller that disposes of 80 percent of 
the voting power and value of target stock nor a member of seller's 
consolidated group) is generally not affected by a section 336(e) 
election. Accordingly, such a minority shareholder that disposes of its

[[Page 49970]]

target stock will recognize gain or loss on the stock without regard to 
the section 336(e) election, and a minority shareholder that retains 
its target stock retains its basis and holding period in its target 
stock. See proposed Sec.  1.336-2(d).
    Under proposed Sec.  1.336-4(c), a holder of nonrecently disposed 
stock may make a gain recognition election, similar to the gain 
recognition election under section 338, which treats the nonrecently 
disposed stock as being sold as of the disposition date. The gain 
recognition election is mandatory if a purchaser owns (after the 
application of the rules of section 318(a), other than section 
318(a)(4)) 80 percent or more of the voting power or value of target 
stock. See proposed Sec. Sec.  1.336-1(b)(15) and 1.336-4(c)(2). Cf. 
Sec. Sec.  1.338(h)(10)-1(d)(1) and 1.338-5(d). Once made, a gain 
recognition election is irrevocable. See proposed Sec.  1.336-4(c)(1). 
The IRS and Treasury Department request comments on whether the rules 
regarding gain recognition elections in these proposed regulations are 
appropriate, and whether the gain recognition election rules in 
regulations promulgated under section 338 should continue to apply. 
Also, see the ``Correction to section 1.338-5'' section of this 
preamble addressing a correction to the definition of the term basis 
amount, the amount used in determining the purchasing corporation's 
gain on the deemed sale of stock pursuant to the gain recognition 
election and in determining AGUB.

G. Making the Section 336(e) Election

    These proposed regulations provide that a section 336(e) election 
is made by seller attaching a statement to its timely filed Federal 
income tax return for the taxable year that includes the disposition 
date. See proposed Sec.  1.336-2(h). If the seller is a member of a 
consolidated group, the statement is filed with the group's 
consolidated return.
    The IRS and Treasury Department believe that it is appropriate to 
allow the seller (or the common parent of the seller's consolidated 
group) to unilaterally make the section 336(e) election. The IRS and 
Treasury Department believe that in a distribution of target stock, it 
would be impractical to require each distributee, who generally will 
hold relatively small percentages of the target stock, to join in the 
election. Further, the distributees' interests should generally be 
protected because of the distributing corporation's fiduciary 
responsibilities to its shareholders. In the case of a sale or 
exchange, the purchasers should be able to protect their interests in 
any purchase contract. Comments are requested regarding whether it is 
appropriate to allow such unilateral section 336(e) elections in all 
cases.
    The information required on a section 336(e) election statement is 
similar to that required on Form 8023, Elections Under Section 338 for 
Corporations Making Qualified Stock Purchases. In the case of a gain 
recognition election, the section 336(e) election statement must 
include information pertaining to the gain recognition election.
    When finalized, these proposed regulations will permit taxpayers to 
make a protective section 336(e) election if they are unsure of whether 
a transaction constitutes a qualified stock disposition. If such an 
election is made, it will not have any effect if the transaction does 
not constitute a qualified stock disposition but will otherwise be 
binding and irrevocable. See proposed Sec.  1.336-2(j).

H. Correction to Sec.  1.338-5

    Section 338(b)(3)(A) authorizes regulations under which the 
purchasing corporation may elect to step up its basis in nonrecently 
purchased stock (gain recognition election) to a ``basis amount.'' 
Under section 338(b)(3)(B), the basis amount is equal to the grossed-up 
basis of the purchasing corporation's recently purchased stock 
multiplied by a fraction, the numerator of which is the percentage of 
target stock attributable to the purchasing corporation's nonrecently 
purchased stock and the denominator of which is 100 percent minus the 
numerator amount.
    Section 1.338-5(d) provides for the above described gain 
recognition election. Section 1.338-5(d)(3)(ii) provides that the basis 
amount is equal to the amount in Sec.  1.338-5(c)(1) (the purchasing 
corporation's basis in recently purchased target stock determined 
without regard to acquisition costs) multiplied by a fraction, the 
numerator of which is the percentage of target stock (by value, 
determined on the acquisition date) attributable to the purchasing 
corporation's nonrecently purchased target stock and the denominator of 
which is 100 percent minus the numerator amount. Section 1.338-
5(d)(3)(ii) goes on to state, ``[t]hus, if target has a single class of 
outstanding stock, the purchasing corporation's basis in each share of 
nonrecently purchased target stock after the gain recognition election 
is equal to the average price per share of the purchasing corporation's 
recently purchased target stock.''
    However, unless the purchasing corporation purchases all of the 
outstanding stock of target (other than the purchasing corporation's 
nonrecently purchased stock) within the 12-month acquisition period on 
or before the acquisition date, the formula in the regulations will not 
result in the purchasing corporation's basis in each share of 
nonrecently purchased stock equaling the average price of the recently 
purchased stock. Only if the basis in the recently purchased stock is 
grossed-up (as provided by the Code) will such result be achieved. In 
fact, Sec.  1.338-5(g), Example 1, paragraph (v), in demonstrating the 
effect of a gain recognition election, uses the grossed-up basis in the 
recently purchased stock, not the non-grossed-up basis, consistent with 
both the Code and the intent of the regulation. Accordingly, Sec.  
1.338-5(d)(3)(ii) is corrected to use the grossed-up basis of recently 
purchased stock in determining the basis amount, rather than the non-
grossed-up basis.

I. Proposed Effective/Applicability Date

    These proposed regulations are proposed to apply to any qualified 
stock disposition for which the disposition date is on or after the 
date these regulations are published as final regulations in the 
Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. Further, it 
is hereby certified that these proposed regulations will not have a 
significant economic impact on a substantial number of small entities. 
This certification is based on the fact that these regulations do not 
have a substantial economic impact because they merely provide for an 
election in the context of certain sales, exchanges, and distributions 
of stock of corporations. Moreover, they are expected to apply 
predominantly to transactions involving larger businesses because the 
election is only applicable for certain dispositions of stock of an 
affiliated subsidiary. Accordingly, a Regulatory Flexibility Analysis 
under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not 
required. Pursuant to section 7805(f) of the Code, this notice of 
proposed rulemaking has been submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations,

[[Page 49971]]

consideration will be given to any written comments (a signed original 
and eight copies) or electronic comments that are submitted timely to 
the IRS. In addition to the specific requests for comments made 
elsewhere in this preamble, the IRS and Treasury Department request 
comments on the clarity of the proposed rules and how they can be made 
easier to understand. All comments will be available for public 
inspection and copying. A public hearing may be scheduled if requested 
in writing by any person who timely submits written comments. If a 
public hearing is scheduled, notice of the date, time, and place of the 
hearing will be published in the Federal Register.

Drafting Information

    The principal author of these regulations is Mark J. Weiss of the 
Office of Associate Chief Counsel (Corporate). Other personnel from the 
IRS and Treasury Department participated in their development.

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 proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.336-1 is also issued under 26 U.S.C. 336. * * *
    Section 1.336-2 is also issued under 26 U.S.C. 336. * * *
    Section 1.336-3 is also issued under 26 U.S.C. 336. * * *
    Section 1.336-4 is also issued under 26 U.S.C. 336. * * *
    Section 1.336-5 is also issued under 26 U.S.C. 336. * * *

    Par. 2. Sections 1.336-0 through 1.336-5 are added to read as 
follows:

Sec.  1.336-0  Table of Contents.

    This section lists captions contained in Sec. Sec.  1.336-1, 
1.336-2, 1.336-3, 1.336-4, and 1.336-5.
Sec.  1.336-1 General principles, nomenclature, and definitions for 
a section 336(e) election.
    (a) Overview.
    (b) Definitions.
    (1) Seller.
    (2) Purchaser.
    (3) Target; target corporation; old target; new target.
    (4) Disposed of; disposition.
    (i) In general.
    (ii) Exception for disposition of stock in certain section 355 
transactions.
    (iii) Transactions with related persons.
    (iv) No consideration paid.
    (v) Disposed of stock reacquired by certain persons.
    (5) Qualified stock disposition.
    (i) In general.
    (ii) Overlap with qualified stock purchase.
    (A) In general.
    (B) Exception.
    (6) 12-month disposition period.
    (7) Disposition date.
    (8) Disposition date assets.
    (9) Domestic corporation.
    (10) Section 336(e) election.
    (11) Related persons.
    (12) Liquidation.
    (13) Deemed asset disposition.
    (14) Deemed disposition tax consequences.
    (15) 80-percent purchaser.
    (16) Recently disposed stock.
    (17) Nonrecently disposed stock.
    (c) Nomenclature.
Sec.  1.336-2 Availability, mechanics, and consequences of section 
336(e) election.
    (a) Availability of election.
    (b) Deemed transaction.
    (1) Dispositions not described in section 355(d)(2) or (e)(2).
    (i) Old target--deemed asset disposition.
    (A) In general.
    (B) Gains and losses.
    (1) Gains.
    (2) Losses.
    (3) Examples.
    (C) Tiered targets.
    (ii) New target--deemed purchase.
    (iii) Old target and seller--deemed liquidation.
    (A) In general.
    (B) Tiered targets.
    (iv) Seller--distribution of target stock.
    (v) Seller--retention of target stock.
    (2) Dispositions described in section 355(d)(2) or (e)(2).
    (i) Old target--deemed asset disposition.
    (A) In general.
    (B) Gains and losses.
    (1) Gains.
    (2) Losses.
    (3) Example.
    (C) Tiered targets.
    (ii) Old target--deemed purchase.
    (A) In general.
    (B) Tiered targets.
    (iii) Seller--distribution of target stock.
    (A) In general.
    (B) Tiered targets.
    (iv) Seller--retention of target stock.
    (v) Qualification under section 355.
    (vi) Earnings and profits.
    (c) Purchaser.
    (d) Minority shareholders.
    (1) In general.
    (2) Sale, exchange, or distribution of target stock by a 
minority shareholder.
    (3) Retention of target stock by a minority shareholder.
    (e) Treatment consistent with an actual asset disposition.
    (f) Treatment of target under other provisions of the Internal 
Revenue Code.
    (g) Special rules.
    (1) Target as two corporations.
    (2) Treatment of members of a consolidated group.
    (3) Miscellaneous international provisions.
    (i) Source and foreign tax credit.
    (ii) Allocation of foreign taxes.
    (h) Making the section 336(e) election.
    (i) [Reserved].
    (j) Protective section 336(e) election.
    (k) Examples.
Sec.  1.336-3 Aggregate deemed asset disposition price; various 
aspects of taxation of the deemed asset disposition.
    (a) Scope.
    (b) Determination of ADADP.
    (1) General rule.
    (2) Time and amount of ADADP.
    (i) Original determination.
    (ii) Redetermination of ADADP.
    (c) Grossed-up amount realized on the sale, exchange, or 
distribution of recently disposed stock of target.
    (1) Determination of amount.
    (2) Example.
    (d) Liabilities of old target.
    (1) In general.
    (2) Time and amount of liabilities.
    (e) Deemed disposition tax consequences.
    (f) Other rules apply in determining ADADP.
Sec.  1.336-4 Adjusted grossed-up basis.
    (a) Scope.
    (b) Modifications to the principles in Sec.  1.338-5.
    (1) Purchasing corporation; purchaser.
    (2) Acquisition date; disposition date.
    (3) Section 338 election; section 338(h)(10) election; section 
336(e) election.
    (4) New target; old target.
    (5) Recently purchased stock; recently disposed stock.
    (6) Nonrecently purchased stock; nonrecently disposed stock.
    (c) Gain recognition election.
    (1) In general.
    (2) 80-percent purchaser.
    (3) Non-80-percent purchaser.
    (4) Gain recognition election statement.
    (d) Examples.
Sec.  1.336-5 Effective/applicability Date.

Sec.  1.336-1  General principles, nomenclature, and definitions for a 
section 336(e) election.

    (a) Overview. Section 336(e) authorizes the promulgation of 
regulations under which, in certain circumstances, a sale, exchange, or 
distribution of the stock of a subsidiary may be treated as an asset 
sale. This section and Sec. Sec.  1.336-2 through 1.336-5 provide the 
rules for and consequences of making such election. This section 
provides the definitions and nomenclature. Generally, except to the 
extent inconsistent with section 336(e), the results of a section 
336(e) election should coincide with those of a section 338(h)(10) 
election. Accordingly, to the extent not otherwise addressed in these 
regulations nor inconsistent with section 336(e), the principles of 
section 338 and the regulations under section 338 apply for purposes of 
these regulations. For example, Sec.  1.338-8 (concerning asset and 
stock consistency)

[[Page 49972]]

and Sec.  1.338(h)(10)-1(d)(8) (concerning the availability of the 
section 453 installment method) may apply with respect to a section 
336(e) election.
    (b) Definitions. For purposes of Sec. Sec.  1.336-1 through 1.336-5 
(except as otherwise provided):
    (1) Seller. The term seller means any domestic corporation that 
makes a qualified stock disposition of stock of another corporation. A 
seller includes both a transferor and a distributor of target stock. 
Generally, all members of a consolidated group that dispose of target 
stock are treated as a single seller. See Sec.  1.336-2(g)(2).
    (2) Purchaser. The term purchaser means one or more persons that 
receive the stock of another corporation in a qualified stock 
disposition. A purchaser includes both a transferee and a distributee 
of target stock.
    (3) Target; target corporation; old target; new target. The term 
target or target corporation means any domestic corporation the stock 
of which is sold, exchanged, or distributed by another domestic 
corporation in a qualified stock disposition. In the case of a 
transaction not described in section 355(d)(2) or (e)(2), ``old 
target'' refers to target for periods ending on or before the close of 
target's disposition date and ``new target'' refers to target for 
subsequent periods. In the case of a transaction described in section 
355(d)(2) or (e)(2), ``old target'' refers to target for periods ending 
on or before the disposition date as well as for subsequent periods.
    (4) Disposed of; disposition--(i) In general. The term disposed of 
refers to a transfer of stock in a disposition. The term disposition 
means any sale, exchange, or distribution of stock, but only if--
    (A) The basis of the stock in the hands of the purchaser is not 
determined in whole or in part by reference to the adjusted basis of 
such stock in the hands of the person from whom acquired or under 
section 1014(a) (relating to property acquired from a decedent),
    (B) Except as provided in paragraph (b)(4)(ii) of this section, the 
stock is not sold, exchanged, or distributed in a transaction to which 
section 351, 354, 355, or 356 applies and is not sold, exchanged, or 
distributed in any transaction described in regulations in which the 
transferor does not recognize the entire amount of the gain or loss 
realized in the transaction, and
    (C) The stock is not sold, exchanged, or distributed to a related 
person.
    (ii) Exception for disposition of stock in certain section 355 
transactions. Notwithstanding paragraph (b)(4)(i)(B) of this section, a 
distribution of stock to a person who is not a related person in a 
transaction in which the full amount of stock gain would be recognized 
pursuant to section 355(d)(2) or (e)(2) shall be considered a 
disposition.
    (iii) Transactions with related persons. In determining whether 
stock is sold, exchanged, or distributed to a related person, the 
principles of section 338(h)(3)(C) and Sec.  1.338-3(b)(3) shall apply.
    (iv) No consideration paid. Stock in a target may be considered 
disposed of if, under general principles of tax law, the seller is 
considered to sell, exchange, or distribute stock of the target 
notwithstanding that no amount may be paid for (or allocated to) the 
stock.
    (v) Disposed of stock reacquired by certain persons. Stock disposed 
of to another person under this section which is reacquired by the 
seller or a member of the seller's consolidated group within the 12-
month disposition period shall not be considered as disposed of.
    (5) Qualified stock disposition--(i) In general. The term qualified 
stock disposition means any transaction or series of transactions in 
which stock meeting the requirements of section 1504(a)(2) of a 
domestic corporation is either sold, exchanged, or distributed, or any 
combination thereof, by another domestic corporation in a disposition, 
within the meaning of paragraph (b)(4) of this section, during the 12-
month disposition period.
    (ii) Overlap with qualified stock purchase--(A) In general. Except 
as provided in paragraph (b)(5)(ii)(B) of this section, a transaction 
satisfying the definition of a qualified stock disposition under 
paragraph (b)(5)(i) of this section which also qualifies as a qualified 
stock purchase (as defined in section 338(d)(3)) will not be treated as 
a qualified stock disposition.
    (B) Exception. If, as a result of the deemed sale of old target's 
assets pursuant to a section 336(e) election, there would be, but for 
paragraph (b)(5)(ii)(A) of this section, a qualified stock disposition 
of the stock of a subsidiary of target, then paragraph (b)(5)(ii)(A) 
shall not apply.
    (6) 12-month disposition period. The term 12-month disposition 
period means the 12-month period beginning with the date of the first 
sale, exchange, or distribution of stock included in a qualified stock 
disposition.
    (7) Disposition date. The term disposition date means, with respect 
to any corporation, the first day on which there is a qualified stock 
disposition with respect to the stock of such corporation.
    (8) Disposition date assets. Disposition date assets are the assets 
of the target held at the beginning of the day after the disposition 
date (but see Sec.  1.338-1(d) (regarding certain transactions on the 
disposition date)).
    (9) Domestic corporation. The term domestic corporation has the 
same meaning as in Sec.  1.338-2(c)(9).
    (10) Section 336(e) election. A section 336(e) election is an 
election to apply section 336(e) to target. A section 336(e) election 
is made by making an election for target under Sec.  1.336-2(h).
    (11) Related persons. Two persons are related if stock of a 
corporation owned by one of the persons would be attributed under 
section 318(a), other than section 318(a)(4), to the other.
    (12) Liquidation. Any reference to a liquidation is treated as a 
reference to the transfer described in Sec.  1.336-2(b)(1)(iii) 
notwithstanding its ultimate characterization for Federal income tax 
purposes.
    (13) Deemed asset disposition. The deemed sale of old target's 
assets is, without regard to its characterization for Federal income 
tax purposes, referred to as the deemed asset disposition.
    (14) Deemed disposition tax consequences. Deemed disposition tax 
consequences refers to, in the aggregate, the Federal income tax 
consequences (generally, the income, gain, deduction, and loss) of the 
deemed asset disposition. Deemed disposition tax consequences also 
refers to the Federal income tax consequences of the transfer of a 
particular asset in the deemed asset disposition.
    (15) 80-percent purchaser. An 80-percent purchaser is any purchaser 
that, after application of the attribution rules of section 318(a), 
other than section 318(a)(4), owns 80 percent or more of the voting 
power or value of the target corporation stock.
    (16) Recently disposed stock. The term recently disposed stock 
means any stock in the target corporation which is not held by a seller 
or a member of the seller's consolidated group immediately after the 
close of the disposition date and which was sold, exchanged, or 
distributed by a seller during the 12-month disposition period. If, 
within the 12-month disposition period, stock is sold, exchanged, or 
distributed, then reacquired by a seller, and then sold, exchanged, or 
distributed again, only the last sale, exchange, or distribution of the 
reacquired stock in the 12-month disposition period may be recently 
disposed stock.
    (17) Nonrecently disposed stock. The term nonrecently disposed 
stock means stock in the target corporation which is held on the 
disposition date by a

[[Page 49973]]

purchaser or a person related (as described in Sec.  1.336-1(b)(11)) to 
the purchaser who owns, on the disposition date, with the application 
of section 318(a), other than section 318(a)(4), at least 10 percent of 
the total voting power or value of the stock of target and which is not 
recently disposed stock.
    (c) Nomenclature. For purposes of Sec. Sec.  1.336-1 through 1.336-
5, except as otherwise provided, Parent, Seller, Target, Target 
Subsidiary, and Sub are domestic corporations and A, B, C, and D are 
individuals, none of whom are related to Parent, Seller, Target, Target 
Subsidiary, Sub, or each other.


Sec.  1.336-2  Availability, mechanics, and consequences of section 
336(e) election.

    (a) Availability of election. A section 336(e) election is 
available if a seller makes a disposition of stock of another 
corporation (target) in a qualified stock disposition (as defined in 
Sec.  1.336-1(b)(5)). A section 336(e) election is irrevocable. A 
section 336(e) election is not available for transactions described in 
section 336(e) that do not constitute qualified stock dispositions, as 
defined in Sec.  1.336-1(b)(5).
    (b) Deemed transaction--(1) Dispositions not described in section 
355(d)(2) or (e)(2)--(i) Old target-deemed asset disposition--(A) In 
general. This paragraph (b)(1) provides the Federal income tax 
consequences of a section 336(e) election made with respect to a 
qualified stock disposition not described, in whole or in part, in 
section 355(d)(2) or (e)(2). For the Federal income tax consequences of 
a section 336(e) election made with respect to a qualified stock 
disposition described, in whole or in part, in section 355(d)(2) or 
(e)(2), see paragraph (b)(2) of this section. In general, if a section 
336(e) election is made, the seller is treated as not having sold, 
exchanged, or distributed the stock disposed of in the qualified stock 
disposition. Instead, old target is treated as selling its assets to an 
unrelated person in a single transaction at the close of the 
disposition date (but before the deemed liquidation described in 
paragraph (b)(1)(iii) of this section) in exchange for the aggregate 
deemed asset disposition price (ADADP) as determined under Sec.  1.336-
3. ADADP is allocated among the disposition date assets in the same 
manner as ADSP is allocated under Sec. Sec.  1.338-6 and 1.338-7 in 
order to determine the amount realized from each of the sold assets. 
Old target realizes the deemed disposition tax consequences from the 
deemed asset disposition before the close of the disposition date while 
old target is owned by seller.
    (B) Gains and losses--(1) Gains. Except as provided in Sec.  
1.338(h)(10)-1(d)(8) (regarding the installment method), old target 
shall recognize all of the gain realized on the deemed asset 
disposition.
    (2) Losses. Old target shall recognize loss, if any, on the deemed 
sale of each of its assets with respect to the amount of stock sold or 
exchanged in the qualified stock disposition on or before the 
disposition date. Old target shall not recognize loss on the deemed 
sale of each of its assets with respect to the amount of stock 
distributed in the qualified stock disposition on or before the 
disposition date. The amount of loss recognized by old target with 
respect to an asset is the amount of loss realized on the deemed sale 
of the asset multiplied by a fraction (loss recognition fraction). The 
numerator of the loss recognition fraction is the value of the target 
stock, determined on the disposition date, sold or exchanged in the 
qualified stock disposition on or before the disposition date. The 
denominator of the loss recognition fraction is the total value of the 
target stock, determined on the disposition date, disposed of in the 
qualified stock disposition on or before the disposition date. For 
purposes of determining the amount of loss recognized by a subsidiary 
of old target for which a section 336(e) election is made, only the 
fraction of the old target subsidiary stock deemed sold in the deemed 
asset disposition of old target's assets that is equal to the loss 
recognition fraction is considered to have been sold or exchanged. In 
addition, to the extent old target or a subsidiary of old target 
otherwise recognizes losses from the deemed asset disposition, such 
losses may be disallowed under other provisions of the Internal Revenue 
Code or general principles of tax law, in the same manner as if such 
assets were actually sold to an unrelated person.
    (3) Examples. The following examples illustrate this paragraph 
(b)(1)(i)(B).

    Example 1. (i) Facts. Seller owns 98 of the 100 outstanding 
shares of Target common stock, the only class of Target stock 
outstanding. On March 1 of Year 1, Seller sells 30 shares of Target 
stock to A for cash. On April 1 of Year 1, Seller sells 10 shares of 
Target stock to R, a related individual. On July 1 of Year 1, Seller 
distributes 50 shares of target stock to its unrelated shareholders. 
On December 1 of Year 1, Seller sells 5 shares of Target stock to B. 
Seller retains its remaining 3 shares of Target stock. The value of 
the Target stock on July 1 equals $100 per share. A section 336(e) 
election is made.
    (ii) Consequences. Because at least 80 percent of the Target 
stock ((30 + 50 + 5)/100) was disposed of by Seller within the 12-
month disposition period, a qualified stock disposition has 
occurred. July 1 of Year 1, the first date on which there was a 
qualified stock disposition with respect to the Target stock, is the 
disposition date. Old Target recognizes all of its gain on the 
deemed asset disposition. However, only 30 shares of Target stock 
were sold or exchanged in the qualified stock disposition on or 
before the disposition date. Therefore, only a portion of the loss, 
if any, on the deemed sale of each of Target's assets is recognized 
for Federal income tax purposes. The portion of the loss recognized 
is equal to a fraction, the numerator of which is $3,000, the value, 
determined on July 1, the disposition date, of the 30 shares sold by 
Seller in the qualified stock disposition on or before the 
disposition date, and the denominator of which is $8,000, the value 
of the Target stock on July 1, the disposition date, that was 
disposed of in the qualified stock disposition on or before the 
disposition date. Accordingly, only 37.5 percent ($3,000/$8,000) of 
Old Target's loss (if any) with respect to each asset sold in the 
deemed asset disposition is recognized.

    Example 2. (i) Facts. The facts are the same as in Example 1 
with the following additional facts: Target also owns 80 shares of 
Target Subsidiary common stock, the only class of Target Subsidiary 
common stock outstanding, and Seller owns the remaining 20 shares of 
Target Subsidiary stock. Seller, Target, and Target Subsidiary file 
a consolidated Federal income tax return. Also on July 1 of Year 1, 
Seller distributes 15 shares of Target Subsidiary stock to its 
unrelated shareholders and sells 5 shares of Target Subsidiary stock 
to C for cash. The Target Subsidiary stock is worth $10 a share on 
July 1. A section 336(e) election is also made with respect to the 
Target Subsidiary stock.
    (ii) Consequences. The consequences with respect to the Target 
stock are the same as described in Example 1 except that no gain or 
loss is recognized by Target on the deemed sale of its Target 
Subsidiary stock. With respect to Target Subsidiary, because at 
least 80 percent of the Target Subsidiary stock ((80 + 15 +5)/100) 
was disposed of (or deemed disposed of) by members of Seller's 
consolidated group within the 12-month disposition period, a 
qualified stock disposition of Target Subsidiary has occurred. Old 
Target Subsidiary recognizes all of its gain on the deemed asset 
disposition. Notwithstanding that all 80 of Target's shares in 
Target Subsidiary were deemed sold in the deemed asset disposition 
of Target, only 37.5 percent of such shares were deemed sold as a 
result of a sale or exchange of Target stock. Accordingly, in 
determining the amount of loss on each of Target Subsidiary's assets 
that is recognized in the deemed sale of its assets, only 37.5 
percent of the 80 shares of Target Subsidiary deemed sold by Target, 
30 shares, are considered to have been sold or exchanged by Target. 
Therefore, the amount of loss recognized by Target Subsidiary is 
equal to a fraction, the numerator of which is the sum of $300, the 
value, determined on July 1, the disposition date, of the 30 shares 
of Target Subsidiary deemed sold by Target in the

[[Page 49974]]

qualified stock disposition, and $50, the value, determined on July 
1, the disposition date, of the 5 shares of Target Subsidiary stock 
sold by Seller on or before the disposition date, and the 
denominator of which is $1,000, the value of the Target Subsidiary 
stock on July 1, the disposition date, that was disposed of in the 
qualified stock disposition of Target Subsidiary on or before the 
disposition date. Accordingly, only 35 percent (($300 + $50)/
($1,000)) of Old Target Subsidiary's loss (if any) with respect to 
each asset sold in the deemed asset disposition is recognized.

    (C) Tiered targets. In the case of parent-subsidiary chains of 
corporations making section 336(e) elections, the deemed asset 
disposition of a higher-tier subsidiary is considered to precede the 
deemed asset disposition of a lower-tier subsidiary.
    (ii) New target--deemed purchase. New target is treated as 
acquiring all of its assets from an unrelated person in a single 
transaction at the close of the disposition date (but before the deemed 
liquidation) in exchange for an amount equal to the adjusted grossed up 
basis (AGUB) as determined under Sec.  1.336-4. New target shall 
allocate the consideration deemed paid in the transaction in the same 
manner as new target would under Sec. Sec.  1.338-6 and 1.338-7 in 
order to determine the basis in each of the purchased assets. 
Notwithstanding paragraph (b)(1)(iii) of this section (deemed 
liquidation of old target), new target remains liable for the tax 
liabilities of old target (including the tax liability for the deemed 
disposition tax consequences). For example, new target remains liable 
for the tax liabilities of the members of any consolidated group that 
are attributable to taxable years in which those corporations and old 
target joined in the same consolidated return. See Sec.  1.1502-6(a).
    (iii) Old target and seller--deemed liquidation--(A) In general. 
Old target and seller are treated as if, before the close of the 
disposition date, after the deemed asset disposition described in 
paragraph (b)(1)(i)(A) of this section, and while owned by seller, old 
target transferred all of its assets to seller and ceased to exist. The 
transfer from old target to seller is characterized for Federal income 
tax purposes in the same manner as if the parties had actually engaged 
in the transactions deemed to occur because of this se