Unified Rule for Loss on Subsidiary Stock, 53934-53987 [E8-21006]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 73, Number 181 (Wednesday, September 17, 2008)]
[Rules and Regulations]
[Pages 53934-53987]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-21006]



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Part II





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 602



Unified Rule for Loss on Subsidiary Stock; Final Rule

Federal Register / Vol. 73, No. 181 / Wednesday, September 17, 2008 / 
Rules and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9424]
RIN 1545-BB61


Unified Rule for Loss on Subsidiary Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations under sections 358, 
362(e)(2), and 1502 of the Internal Revenue Code (Code). The 
regulations apply to corporations filing consolidated returns, and 
corporations that enter into certain tax-free reorganizations. The 
regulations provide rules for determining the tax consequences of a 
member's transfer (including by deconsolidation and worthlessness) of 
loss shares of subsidiary stock. In addition, the regulations provide 
that section 362(e)(2) generally does not apply to transactions between 
members of a consolidated group. Finally, the regulations conform or 
clarify various provisions of the consolidated return regulations, 
including those relating to adjustments to subsidiary stock basis.

DATES: Effective Date: These regulations are effective on September 17, 
2008.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.358-6(f)(3), 1.1502-13(l)(1), 1.1502-19(h), 1.1502-21(h)(1)(iii), 
1.1502-30(c), 1.1502-31(h)(1), 1.1502-32(h)(9), 1.1502-33(j)(1), 
1.1502-35(j), 1.1502-36(h), 1.1502-75(l), 1.1502-80(a)(4), 1.1502-
80(h), 1.1502-80(j), 1.1502-91(h)(2), and 1.1502-99(b)(4).

FOR FURTHER INFORMATION CONTACT: Marcie P. Barese at (202) 622-7790, 
Sean P. Duffley at (202) 622-7770, or Theresa Abell at (202) 622-7700 
(none of the numbers are toll-free).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-2096. The collection of information 
in these final regulations is in Sec.  1.1502-36(e)(5). The collection 
of information is necessary to allow a corporation to redetermine basis 
under the basis redetermination rule when it sells all the stock of a 
subsidiary, to modify the application of the attribute reduction rule, 
to apply the Unified Loss Rule retroactively to certain intercompany 
transfers, and to reattribute a section 382 limitation.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number.
    Books or records relating to the 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

    On January 23, 2007, the IRS and Treasury Department issued a 
notice of proposed rulemaking (REG-157711-02, 2007-8 IRB 537, 72 FR 
2964) (January 2007 proposal) that included proposed regulations under 
Sec.  1.1502-36 (Unified Loss Rule). The proposed Unified Loss Rule 
would implement aspects of the repeal of the General Utilities doctrine 
and address the duplication of loss by consolidated groups. The 
proposed Unified Loss Rule consisted of three principal rules that 
would apply when a member (M) transferred a loss share of stock of a 
subsidiary (S): A basis redetermination rule (that would reallocate 
investment adjustments to address both noneconomic and duplicated stock 
loss), a basis reduction rule (that would address noneconomic stock 
loss), and an attribute reduction rule (that would address duplicated 
loss).
    In addition, the January 2007 proposal included proposed 
regulations under Sec.  1.1502-13(e)(4) that would address the 
application of section 362(e)(2) to certain intercompany transactions. 
The January 2007 proposal also included proposed regulations that would 
make various technical and administrative revisions to other provisions 
of the consolidated return regulations and to regulations regarding 
stock basis following certain corporate restructuring transactions.
    No public hearing regarding the proposed regulations was requested 
or held. Written, electronic, and oral comments responding to the 
notice of proposed rulemaking were received. After consideration of all 
the comments, these final regulations generally adopt the rules of the 
proposed regulations other than proposed Sec.  1.1502-13(e)(4) and its 
related provisions. The significant comments and modifications are 
discussed in this preamble.

1. The Unified Loss Rule

A. General Comments
    In general, commentators and practitioners have consistently 
described the provisions of the proposed Unified Loss Rule as reaching 
a fair and reasonable systemic balance. They have generally concurred 
with the major policy decisions reflected in the proposed regulations, 
including the retention of the loss limitation model, the rejection of 
a tracing approach, the application of the rule to built-in income, and 
the systemic prevention of loss duplication. However, commentators and 
practitioners have also consistently raised concerns regarding both the 
complexity of the proposed rules and the anticipated difficulty in 
compiling the data required to implement the proposed rules, especially 
those relating to transfers of stock of subsidiaries that hold stock in 
other subsidiaries.
    The IRS and Treasury Department recognize that the proposed rules 
are complex. However, as recognized by commentators and practitioners, 
the complexity of the rules is a result of the balancing of benefits 
and burdens arising from the presumptions on which the rules are based. 
The IRS and Treasury Department are concerned, therefore, that 
simplifying the proposed rules would adversely impact the fundamental 
fairness the rules are intended to achieve. Nevertheless, careful 
consideration has been given to all simplifying suggestions, and they 
have been incorporated wherever possible.
    The suggestions regarding the general application and operation of 
the rule, and the conclusions reached as to each, are set forth in this 
section A of this preamble. Suggestions relating to individual 
paragraphs of the Unified Loss Rule and to other regulations in the 
January 2007 proposal, including proposed Sec.  1.1502-13(e)(4), and 
the conclusions reached as to each, are set forth in the following 
sections.
i. Order of Application of the Unified Loss Rule and Other Adjustments
    The January 2007 proposal provided that the Unified Loss Rule would 
apply to a transfer of a share of subsidiary stock if, after giving 
effect to all applicable rules of law (other than the Unified Loss 
Rule), the share is a loss share. The provisions of the proposed 
Unified Loss Rule would then apply sequentially to adjust subsidiary 
stock basis and attributes. Any adjustments

[[Page 53935]]

required under the Unified Loss Rule would be given effect immediately 
before the transfer.
    Commentators found the timing rules unclear, particularly as they 
related to the application of other provisions of the consolidated 
return regulations that also purport to apply immediately before a 
transaction. The IRS and Treasury Department have considered this 
comment and agree that there could be some uncertainty in this respect.
    To address this concern, Sec.  1.1502-36(a)(3)(i) of these final 
regulations provides that the Unified Loss Rule applies when a member 
transfers a share of subsidiary stock and, after taking into account 
the effects of all rules of law applicable as of the transfer, even 
those that would not be given effect until after the transfer, the 
share is a loss share. Such effects may be attributable to lower-tier 
dispositions and worthlessness, as well as to the application of the 
Unified Loss Rule. Although the determination of whether a transferred 
share is a loss share is made as of the transfer, the Unified Loss Rule 
as a whole applies, and any adjustments required under the Unified Loss 
Rule are given effect, immediately before the transfer.
    When the Unified Loss Rule applies to a transfer, its individual 
provisions are each applied in order. Thus, as described in Sec.  
1.1502-36(a)(3)(i) of these final regulations, the general rule is that 
paragraph (b) applies first with respect to a transferred loss share 
(or shares). Then, if there is still a transfer of a loss share after 
the application of paragraph (b), paragraph (c) applies to the loss 
share (or shares). Finally, if there is still a transfer of a loss 
share after the application of paragraph (c), paragraph (d) applies 
with respect to that loss share (or shares). Section 1.1502-
36(a)(3)(ii) provides detailed instruction regarding the order in which 
the individual provisions of the Unified Loss Rule apply if there are 
transfers at multiple tiers in the same transaction.
ii. Application of Unified Loss Rule to Nondeconsolidating Transfers
    Several commentators have suggested that the final regulations 
include an election to defer basis recovery in the case of a 
nondeconsolidating transfer. Under such an election, a group could 
avoid applying the Unified Loss Rule to such transfers by shifting the 
basis of a transferred share (to the extent such basis exceeds the 
share's value) to other shares held by members. As a result, the group 
would forego any current loss, but the Unified Loss Rule would continue 
to be applicable to any subsequent transfer of loss shares of stock of 
that subsidiary.
    The IRS and Treasury Department are concerned that such an election 
could cause significant administrative complexity. The IRS and Treasury 
Department are also concerned that such an election could cause 
substantial distortions that could adversely affect the treatment of 
subsequent deconsolidating transfers. For example, a basis shift 
resulting from such an election could significantly increase the 
disconformity amount of the retained shares, potentially causing a 
substantial and inappropriate reduction in the basis of the retained 
shares when they are ultimately transferred. Further, because this 
relief would only address transfers of minority interests, and the IRS 
and Treasury Department believe that such transfers reflect a small 
portion of subsidiary stock dispositions, the IRS and Treasury 
Department do not believe such a rule would give rise to any 
significant relief. Accordingly, this suggestion was not adopted.
    Other suggestions were made that would apply special rules to 
nondeconsolidating transfers. The final regulations generally do not 
adopt special rules for nondeconsolidating transfers. The principal 
reasons are the complexity a dual system would create and the small 
number of transactions expected to be affected by such rules. In 
addition, the IRS and Treasury Department believe that taxpayers will 
typically be able to restructure nondeconsolidating transfers to avoid 
the application of the Unified Loss Rule, for example, by issuing 
subsidiary stock.
iii. Application of Unified Loss Rule to Deferred Recognition Transfers
    The proposed regulations provided that all transfers of loss shares 
of subsidiary stock are immediately subject to the Unified Loss Rule 
when the stock is transferred, even if any loss recognized on the 
transfer would be deferred. The IRS and Treasury Department had 
concluded that the immediate application of the Unified Loss Rule was 
necessary to prevent the significant administrative burden of 
retroactively applying the Unified Loss Rule to members' bases in 
shares of subsidiary stock, and to the subsidiary's attributes, long 
after a stock sale.
    Commentators questioned the need to apply the Unified Loss Rule to 
a transfer in which any loss that would be recognized would be 
deferred, citing as a model Sec.  1.1502-20(a)(3) (deferring the 
application of Sec.  1.1502-20, the Loss Disallowance Rule). 
Commentators also observed that single-entity principles seemed to 
suggest that an intercompany transfer is not an appropriate time to 
apply the Unified Loss Rule, urging that it would be more appropriate 
to apply the Unified Loss Rule to such a transfer when the intercompany 
item is taken into account.
    The IRS and Treasury Department have considered these comments and 
are persuaded that single-entity principles would be furthered, and 
group income would be more clearly reflected, if the application of the 
Unified Loss Rule were coordinated with the intercompany transaction 
provisions in Sec.  1.1502-13. Accordingly, under these final 
regulations, if a member transfers a share of subsidiary stock to 
another member and any gain or loss on the transfer is deferred under 
Sec.  1.1502-13, the Unified Loss Rule applies to the transfer, or to 
any subsequent transfer of that share by a member, when the 
intercompany item is taken into account. At that time, the 
determination of whether the Unified Loss Rule applies and, if so, the 
consequences of its application are made by treating the buying and 
selling members as divisions of a single corporation. The final 
regulations also provide that appropriate adjustments will be made to 
intercompany item(s), any member's basis in the subsidiary's share, 
and/or the subsidiary's attributes in order to further the purposes of 
both the Unified Loss Rule and the intercompany transaction provisions 
in Sec.  1.1502-13.
    Notwithstanding this modification of the treatment of intercompany 
transfers, the IRS and Treasury Department continue to believe that the 
deferral of loss recognized on a sale of subsidiary stock should not, 
in general, defer the application of the Unified Loss Rule. One reason 
is that postponing the application of the Unified Loss Rule in 
transfers that are not intercompany transactions would likely make it 
much more difficult, and in some cases impossible, to obtain the 
information and make the determinations necessary to apply the rule. 
Another reason is that such an approach could require subsequent 
adjustments to attributes outside the consolidated group. Accordingly, 
these final regulations continue to apply the Unified Loss Rule to non-
intercompany transfers of loss shares at the time the stock is 
transferred, even if any loss recognized on the transfer is subject to 
deferral.
    These final regulations modify the definition of the term transfer 
to reflect both the general rule that the deferral of loss does not 
affect the determination of whether stock is transferred and the 
limited exception for intercompany transactions.

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iv. Application of Unified Loss Rule to Liquidations Under Section 332
    The proposed Unified Loss Rule provided that the term transfer 
generally includes transactions in which a member ceases to own 
subsidiary stock. However, the proposed regulations included an 
exception for section 381(a) transactions in which any member acquires 
assets of the subsidiary, provided that no gain or loss is recognized 
by member shareholders with respect to the subsidiary's stock. 
Commentators observed that this exclusion would apply to liquidations 
in which more than one member owns stock of the subsidiary and that, in 
such cases, upper-tier distortions could result because the basis 
redetermination rule would not apply.
    The IRS and Treasury Department agree with this observation and are 
concerned with the potential for distortion and abuse. Accordingly, 
under the final regulations, a disposition of subsidiary stock in a 
liquidation to which section 332 applies is not excepted from the 
definition of a transfer if more than one member owns stock in the 
liquidating subsidiary. However, the final regulations provide that, in 
the case of a multiple-member section 332 liquidation, neither 
paragraph (c) (the basis reduction rule) nor paragraph (d) (the 
attribute reduction rule) will apply to the transfer. Thus, if more 
than one member owns stock in a subsidiary and those members dispose of 
the subsidiary stock in a section 332 liquidation of the subsidiary, 
the transaction is subject to the other provisions of the Unified Loss 
Rule, in particular the basis redetermination rule in Sec.  1.1502-
36(b).
v. Basis in Lower-Tier Stock
    In formulating the proposed Unified Loss Rule, the IRS and Treasury 
Department believed that, by using information that taxpayers were 
otherwise required to create and maintain, the administrative burden on 
taxpayers would be minimal. However, commentators have uniformly 
expressed concern that taxpayers will find it costly and time-
consuming, if not impossible, to obtain the subsidiary stock basis 
information needed to apply many of the provisions of the Unified Loss 
Rule. Particular concern has been expressed regarding the lower-tier 
subsidiary rules in the proposed basis reduction rule (proposed Sec.  
1.1502-36(c)) and the proposed attribute reduction rule (proposed Sec.  
1.1502-36(d)). The reasons cited include the widespread practice of 
determining stock basis only when necessary to determine a person's tax 
liability, complicated intercompany accounting rules that make stock 
basis determinations prone to error, and the frequent inability to 
obtain accurate historical basis information when acquiring companies 
with lower-tier subsidiaries.
    To address this problem, several commentators have suggested 
modifying the proposed rules to apply solely based on the net inside 
attributes of lower-tier subsidiaries (the ``look-through'' approach). 
Those commentators have argued that information regarding inside 
attributes is much more regularly and reliably maintained and available 
than stock basis information.
    The IRS and Treasury Department recognize that adopting a look-
through approach would not only address the problem of inadequate stock 
basis data, it would also significantly simplify the application of the 
rules. However, the IRS and Treasury Department are concerned that a 
look-through approach could produce inappropriate results for groups 
transferring S stock if S holds stock of another subsidiary (S1) and 
S's basis in its S1 stock reflects unrecognized appreciation in S1's 
assets (built-in gain).

    Example. P, the common parent of a consolidated group, transfers 
$100 to S in exchange for S's sole outstanding share of stock. S 
purchases the sole outstanding share of S1 stock for $100 when S1 
holds one asset with a basis of $0 and a value of $100. S earns 
$100, increasing P's basis in S to $200. S1's asset declines in 
value to $0. P sells its S share to X, an unrelated person, for 
$100, recognizing a loss of $100. Under the basis reduction rule as 
proposed, P's basis in S stock is reduced by the lesser of S's 
disconformity amount and S's net positive adjustment. S's 
disconformity amount is $0, the excess of P's $200 basis in the S 
share over S's net inside attribute amount ($200, the sum of S's 
$100 cash and its $100 basis in the S1 share, which is not treated 
as reduced under the tentative reduction rule because there were no 
investment adjustments applied to the basis of the S1 share). 
Accordingly, although S had a $100 net positive adjustment, there is 
no reduction to P's basis in S stock and so P's $100 loss on the S 
stock is allowed. However, because the stock loss is duplicated in 
S's attributes, the attribute reduction rule will apply to eliminate 
S's inside loss.

    If a look-through approach were adopted, however, S's basis in its 
S1 share would be disregarded and S's disconformity amount would be 
$100 (the excess of P's $200 basis in its S share over S's $100 net 
inside attribute amount, computed as the sum of S's $100 cash and S1's 
$0 basis in its asset). As a result, P's basis in its S share would be 
reduced by $100, the lesser of S's $100 disconformity amount and S's 
$100 net positive adjustment. Although S would retain its $100 basis in 
its S1 share, P would recognize no loss on its sale of the S stock. 
Thus, the selling group would have suffered an economic loss but the 
loss would be neither recognized nor allowed. Such a result would be 
contrary to the general rule adopted in the proposed regulations, that 
stock basis is not presumed noneconomic to the extent there is no 
disconformity amount or no net positive adjustment amount.
    The IRS and Treasury Department recognize that, under the proposed 
regulations, a very different result follows where it is S1, not S, 
that earns the $100. In that case, the proposed regulation would treat 
S's basis in the S1 stock as tentatively reduced by $100 (the lesser of 
S1's $100 disconformity amount and S1's net positive adjustment). As a 
result, S would have a disconformity amount of $100 and P's basis in 
its S share would be reduced by $100 (the lesser of S's $100 
disconformity amount and S's $100 net positive adjustment). But the IRS 
and Treasury Department believe this result is appropriate because S1's 
disconformity amount evidences that S1 has at least $100 of built-in 
gain. Further, S1 has a net positive adjustment that evidences the 
recognition of that built-in gain. Thus, in this case, the facts 
indicate that S1's income is attributable to the recognition of built-
in gain and that, as a result, M's loss on the share of S stock should 
be treated as noneconomic.
    The IRS and Treasury Department recognize that this approach could 
lead to situations in which the location of an item is manipulated to 
produce inappropriate results, but believe there are adequate 
protections against such manipulation. See, for example, section 482 
and the various anti-abuse provisions of the consolidated return 
regulations, including these final regulations.
    For all these reasons, the IRS and Treasury Department continue to 
believe that including lower-tier stock basis in determinations made 
under the Unified Loss Rule more fully safeguards taxpayers' interests 
and generally produces more appropriate results.
    Several commentators argued that an elective look-through rule 
would address the concerns inherent in a mandatory look-through rule, 
as well as the concerns regarding the availability of stock basis 
information and the complexity of the proposed rules.
    The IRS and Treasury Department agree that an elective approach 
would mitigate the concerns presented by a mandatory look-through rule, 
but believe that an elective approach would

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not provide the desired simplification. The reason is that the decision 
will affect computations under both the basis reduction rule and the 
attribute reduction rule, and what may be taxpayer favorable for one 
rule may be taxpayer unfavorable for the other rule. Thus, the benefit 
(or burden) of ignoring lower-tier stock basis for the basis reduction 
rule will need to be weighed against any benefit (or burden) of 
ignoring lower-tier stock basis for the attribute reduction rule.
    The IRS and Treasury Department acknowledge that, in order to 
simplify compliance, some taxpayers might elect a look-through approach 
without making detailed alternative computations. However, the IRS and 
Treasury Department believe that, given the consequences of such an 
election, the vast majority of taxpayers will compute their tax 
treatment both with and without a look-through approach before deciding 
whether to make such an election. Thus, in the vast majority of cases, 
there would be little or no simplification from an elective look-
through approach, and one of the major goals of such a rule would not 
be achieved.
    Moreover, the IRS and Treasury Department believe that taxpayers 
making both computations will then universally choose the method that 
produces better results. While taxpayers are free to arrange their 
affairs so as to legitimately minimize their taxes, a system that will 
always operate to the disadvantage of one party or the other (in this 
case, the government) is not properly balanced.
    Accordingly, the IRS and Treasury Department believe that a 
mandatory look-through approach would produce inappropriate results in 
certain cases, and that an elective look-through approach would fail to 
achieve a significant amount of simplification and would significantly 
diminish the balance and fairness of the regulations. The final Unified 
Loss Rule therefore does not adopt any form of the look-through 
approach.
    Still, the IRS and Treasury Department recognize that determining 
lower-tier subsidiary stock basis may be difficult for the reasons 
previously noted. Further, although the need to determine lower-tier 
subsidiary stock basis is not particular to these regulations, the 
Unified Loss Rule arguably increases both the frequency and 
significance of these determinations. Accordingly, the IRS and Treasury 
Department are considering various proposals that would mitigate these 
difficulties on a system-wide basis.
    One alternative under consideration is a conforming basis election. 
Under this election, consolidated groups could determine members' bases 
in shares of subsidiary stock by treating the basis in each share owned 
by a member as being equal to the share's proportionate interest in the 
subsidiary's net inside attributes. If such an election were made, the 
determination would presumably be effective for all Federal income tax 
purposes. Further, because the determination of subsidiary stock basis 
is not a concern that is unique to the Unified Loss Rule, consideration 
is being given to allowing the election with respect to all 
subsidiaries, with no restrictions on consistency or the time for 
making elections. However, the IRS and Treasury Department are not 
certain that such a rule would materially simplify the determination of 
basis because taxpayers are likely to conclude that they must determine 
stock basis in judging whether to make the election. Further, the IRS 
and Treasury Department are concerned about the collateral consequences 
of such a rule.
    Accordingly, the IRS and Treasury Department are requesting 
comments regarding whether such an election would assist taxpayers and 
whether it would in fact provide any simplification. Additionally, 
comments are requested regarding what collateral consequences, if any, 
such an election should or would have, and whether such consequences 
are appropriate. The issues include, for example, whether such an 
election would be an appropriate means of eliminating excess loss 
accounts, whether it could potentially produce inappropriate cross-
chain basis shifts, or whether it could inappropriately facilitate the 
acceleration of losses.
    The IRS and Treasury Department also request comments regarding any 
other method for addressing this issue.
vi. Items Taken Into Account in Determining the Net Inside Attribute 
Amount
    As a result of various questions and comments received, the IRS and 
Treasury Department have reconsidered the inclusion of credits in the 
determination of the net inside attribute amount. Commentators have 
correctly observed that, at least with respect to credits held at the 
time of a taxable acquisition of subsidiary stock, credits are 
economically similar to other valuable attributes and it would be 
appropriate to take such credits into account in determining the 
disconformity amount. However, the proper treatment of other credits 
(that is, credits accruing after the subsidiary stock was acquired) in 
determining the disconformity amount, and of any credits (whenever 
accruing) in determining loss duplication, is less clear. Presumably, 
however, any such methodology would need to be tracing-based, and would 
therefore be expected to present the significant administrative 
concerns described in the preamble to the January 2007 proposal. 
Ultimately, no viable presumptive methodology was identified for 
determining the proper inclusion of credits, and so no change is made 
in the final Unified Loss Rule regarding the treatment of credits.
vii. Adjustments for Section 362(e)(2) Transactions
    As discussed in Section 3 of this preamble, the IRS and Treasury 
Department have concluded that section 362(e)(2) should generally not 
apply to intercompany transactions. However, section 362(e)(2) will 
apply to transactions occurring prior to September 17, 2008 if the 
taxpayer does not elect to apply the rule in the final regulations. In 
such cases, distortions will result and, thus, adjustments will need to 
be made. The IRS and Treasury Department are also concerned that there 
are other provisions that could create distortions. Accordingly, the 
final regulations retain the rule in proposed Sec.  1.1502-36(e)(2) 
that provided for adjustments to offset the effects of basis reductions 
required by section 362(e)(2) with respect to intercompany 
transactions, and the rule that provided for appropriate adjustments in 
cases raising similar issues. However, under the final regulations, 
taxpayers may make appropriate adjustments without a determination from 
the Commissioner.
viii. Effective/Applicability Date Issues
    As proposed, the Unified Loss Rule would have been applicable for 
all transfers on or after the date the regulations were published as 
final. Several practitioners observed that the proposed effective date 
caused problems for taxpayers attempting to negotiate transactions 
because they could not be certain what set of regulations would be in 
effect when their transactions were completed. Accordingly, 
commentators and practitioners requested that the regulations include a 
transition rule that would exclude transfers effected on or after the 
date the final regulations are published, if such transfers were made 
pursuant to a binding agreement in place before the publication date.
    The IRS and Treasury Department recognized the difficulty created 
by the proposed effective date and, in Notice 2008-9, 2008-3 IRB 277 
(regarding the Internal Revenue Bulletin generally, see

[[Page 53938]]

Sec.  601.601(d)(2)(ii)(b)), announced that the final regulations would 
include a transition rule for transfers between unrelated parties if 
made pursuant to an agreement that is binding before the date that 
final regulations are published and at all times thereafter. Further, 
Notice 2008-9 stated that the IRS and Treasury Department expect that 
the rule would incorporate the provisions of section 267(b) in 
determining whether persons are related for this purpose. Accordingly, 
as stated in Notice 2008-9, the final Unified Loss Rule applies to 
transfers on or after September 17, 2008, unless the transfer is made 
pursuant to a binding agreement between unrelated parties that was in 
effect before September 17, 2008 and at all times thereafter. The final 
regulations provide that the term related party has the same meaning as 
in section 267(b).
    One comment was also received suggesting that the final regulations 
include an election to apply their provisions retroactively. The IRS 
and Treasury Department considered this suggestion but are concerned 
that adopting such an approach would disrupt taxpayers' otherwise 
closed transactions and thereby exacerbate the problems caused by the 
uncertainty and instability in this area over these past years. 
Accordingly, the final Unified Loss Rule does not include an election 
to apply its provisions retroactively.
B. Section 1.1502-36(b): Basis Redetermination Rule
    Commentators generally recognize and concur with the need for a 
rule that reallocates investment adjustments to address the problems 
created when shares of stock are held with disparate bases. As 
illustrated in Sections B.3, B.4, and E of the preamble to the January 
2007 proposal, the allocation of investment adjustments under Sec.  
1.1502-32 can create a noneconomic stock loss on an individual share 
that would be eliminated under Sec.  1.1502-36(c). Similarly, the 
allocation of investment adjustments under Sec.  1.1502-32 can fail to 
eliminate a duplicated loss on an individual share. In both cases, 
however, the allocation creates no net loss if all the shares are taken 
into account. The basis redetermination rule in Sec.  1.1502-36(b) is 
designed to address these issues.
    Commentators have expressed concern, however, with both the 
availability of the investment adjustment data required to implement 
the rule and the complexity of the application of the rule.
    The IRS and Treasury Department recognize that the information may 
be difficult and costly to produce. However, unlike lower-tier 
subsidiary stock basis information, the information required to 
implement the basis redetermination rule (specifically, the investment 
adjustment history of the stock of the subsidiary that is being 
transferred) is generally information obtained from the group's own tax 
returns and other records. Groups are therefore, as a general matter, 
not dependent on other taxpayers for this information.
    Furthermore, the IRS and Treasury Department expect that this rule 
will apply to only a small number of transactions due to the exception 
for transactions in which members transfer all of their S stock to one 
or more nonmembers in a fully taxable transaction. Accordingly, it is 
anticipated that, in most transactions, taxpayers will not be required 
to redetermine basis. Moreover, in those situations in which it does 
apply, it accomplishes important objectives for both taxpayers and the 
government.
    Some commentators suggested allowing a member to be treated as 
having an averaged basis in its shares of S stock if S has only one 
class of stock outstanding and the member holds all of the S stock. The 
commentators argue that such an election could significantly reduce the 
number of taxpayers required to apply the basis redetermination rule. 
While that might be true, such basis averaging could result in 
additional complexities and distortions. For example, if a portion of 
the shares were previously transferred in an intercompany transaction 
and the bases in all of the subsidiary's shares were averaged, it might 
be difficult to determine the extent to which particular shares reflect 
the prior intercompany transaction. Further, averaging the basis in the 
subsidiary's shares could alter the application of section 267 and 
section 311.
    For all these reasons, the final Unified Loss Rule retains the 
basis redetermination rule without the suggested modifications.
    The final regulations do, however, modify the basis redetermination 
rule to omit the reallocation of positive investment adjustments 
applied to preferred shares under Sec.  1.1502-32. The reason is that 
Sec.  1.1502-32 allocates positive adjustments to preferred shares 
solely to account for the right to receive distributions. Thus, the 
positive Sec.  1.1502-32 adjustments allocated to preferred shares, 
like the adjustments for distributions (which were not reallocated 
under the proposed Unified Loss Rule), are based on economic changes in 
the shareholder's investment. As a result, they should have no 
correlation to unrecognized loss reflected in the bases of the shares 
and so should not be subject to this rule. The final regulations do, 
however, continue to permit the reallocation of both positive and 
negative adjustments from common to preferred shares in order to reduce 
or eliminate any loss on transferred preferred shares and any gain on 
either transferred or nontransferred preferred shares. The IRS and 
Treasury Department believe such reallocations are necessary and 
appropriate to address any reflection of unrecognized gain or loss in 
preferred shares attributable, for example, to contributions of assets 
in exchanged for preferred stock.
i. Exceptions to Basis Redetermination Rule
    The proposed basis redetermination rule contained two exceptions to 
its application, the ``no potential for redetermination'' exception and 
the ``disposition of entire interest'' exception.
    The proposed ``no potential for redetermination'' exception 
provided that basis redetermination is not required if redetermination 
would not change any member's basis in S stock. Some commentators found 
this exception confusing; others suggested that it offered no 
simplification because it would be necessary to apply the basis 
redetermination rule to determine whether the exception was available. 
Other commentators thought that it provided a useful safe harbor. The 
IRS and Treasury Department have concluded that the rule should be 
retained, but that it should be revised to state its scope and effect 
more clearly. Accordingly, under the final regulations, the basis 
redetermination rule does not apply if members' bases in shares of S 
common stock are equal (that is, there is no disparity) and members' 
bases in shares of S preferred stock reflect no gain or loss. The 
reason is that, under these circumstances, the only effect that a 
reallocation of investment adjustments could have would be an increase, 
not a decrease, in basis disparity.
    The proposed ``disposition of entire interest'' exception provided 
that basis redetermination is not required if, within the group's 
taxable year in which the transfer occurs, all of the shares of S stock 
held by members are transferred to a nonmember in a one or more fully 
taxable transactions. This rule differed from the basis reduction 
netting rule in proposed Sec.  1.1502-36(c)(7) and the net stock loss 
definition in proposed Sec.  1.1502-36(d)(3)(ii), which only netted 
among shares transferred in the same

[[Page 53939]]

transaction. Commentators observed that this difference presents a 
potential for distortion and abuse if items are taken into account by S 
between transfers. While this problem exists to a certain extent if a 
transaction is comprised of steps that are not executed simultaneously, 
the problem may be significantly exacerbated by a rule that allowed 
netting among all transactions within a year. Moreover, because the 
netting rule in the basis reduction rule is intended, in part, to 
protect taxpayers when the basis redetermination rule is not applied, 
the IRS and Treasury Department believe that the application of these 
rules should be coextensive. Accordingly, the final regulations provide 
that this exception only applies if members dispose of their entire 
interest in S stock to one or more nonmembers, if all members' shares 
of S stock become worthless, or if all members' shares of S stock are 
either worthless or disposed of to one or more nonmembers, in one fully 
taxable transaction.
    Commentators also inquired whether the ``disposition of entire 
interest'' exception was mandatory, that is, whether the basis 
redetermination rule could be applied even if a group disposed of its 
entire interest in a transaction that qualifies for the exception. The 
IRS and Treasury Department recognize that taxpayers might choose to 
apply the basis redetermination rule in such cases in order to reduce 
gain or avoid the Unified Loss Rule with respect to upper-tier shares. 
The IRS and Treasury Department do not believe that doing so would be 
inappropriate, as the premise of the basis redetermination rule is that 
reallocations made under the rule are appropriate allocations. However, 
because the IRS and Treasury Department believe that taxpayers will 
most often not want to apply the basis redetermination rule, the final 
regulations generally provide that basis is not redetermined when the 
exception applies, but include an election to apply the basis 
redetermination rule in such cases.
ii. Manner in Which Investment Adjustments Are Reallocated
    Some commentators observed that the proposed rules were vague 
regarding the manner in which reallocations were to be made. The IRS 
and Treasury Department generally agree with this observation, but had 
concluded that the rule would work best if taxpayers were given 
considerable flexibility in determining how to make specific 
reallocations. In recognition of the fact that such an approach would 
allow differing interpretations, section F.2 of the preamble to the 
January 2007 proposal stated that the IRS would respect any reasonable 
method or formula employed in applying the basis redetermination rule.
    The IRS and Treasury Department continue to believe that the rule 
should be as flexible as possible. However, in response to these 
comments, the specific provisions of the final basis redetermination 
rule provide some additional guidance (discussed more fully in the next 
section). But the rule is still intended to be flexible in its 
application and, therefore, the final regulations explicitly provide 
that the reallocation of an investment adjustment may be made using any 
reasonable method or formula that is consistent with the basis 
redetermination rule and furthers the purposes of the Unified Loss 
Rule. Thus, like the proposed regulations, the final regulations 
contemplate that more than one result may be reasonable in any specific 
case.
iii. Decreasing Disparity in Basis of Members' Shares
    The general operating rules of the proposed basis redetermination 
rule provided that reallocations are made in a manner that reduces the 
extent to which there is disparity in members' bases in S stock. The 
IRS and Treasury Department have received various questions regarding 
the scope of this rule. Some practitioners read the rule to completely 
eliminate the loss on transferred shares even if overall disparity were 
increased. One practitioner suggested that the general rule, in 
referring only to the manner of redetermination, did not clearly 
restrict the amount of redetermination that would otherwise be required 
under the rules.
    To address these concerns, each of the specific allocation 
provisions in the final regulations includes a statement regarding the 
manner and extent to which allocations are to be made under the 
provision. In addition, the operating rules generally provide that the 
overall application of the rule must reduce disparity among members' 
bases in preferred shares of subsidiary stock (as provided in the 
applicable reallocation provisions) and among members' bases in common 
shares of subsidiary stock, to the greatest extent possible.
C. Section 1.1502-36(c): Basis Reduction Rule
    In general, commentators found the general structure of the basis 
reduction rule and its components (limiting basis reduction to the 
lesser of the share's disconformity amount and net positive adjustment) 
to be a reasonable approach to addressing the issue of noneconomic 
loss. The principal concern expressed was the anticipated difficulty 
with respect to gathering the information necessary to implement the 
lower-tier subsidiary rules. Nevertheless, commentators uniformly 
agreed that basis adjustments from lower-tier subsidiaries must be 
taken into account in order to identify and address noneconomic stock 
loss.
    The principal suggestion for addressing the lack of readily 
accessible and reliable information on lower-tier stock basis was to 
adopt a look-through approach, as discussed in section 1.A.v. of this 
preamble. For the reasons set forth in that section of this preamble, 
the final regulations do not adopt this approach. However, as noted, 
the IRS and Treasury Department continue to request and consider 
comments on mechanisms for alleviating the difficulty in determining 
lower-tier subsidiary stock basis.
    Commentators and practitioners did suggest a number of other 
modifications to the basis reduction rule. Those suggestions and the 
decisions reached are discussed in the following sections.
i. Treatment of Intercompany Debt
    Several commentators suggested revising the net positive adjustment 
amount to exclude items related to intercompany debt. The rationale for 
this suggestion was that, in general, the nature of such amounts makes 
them more like to capital transactions than the recognition of built-in 
gain or loss. Thus it is argued that these amounts should be treated 
like contributions and distributions, which are not included in the net 
positive adjustment amount.
    The IRS and Treasury Department recognize that, in certain 
circumstances, intercompany debt has some inherent similarity to 
capital contributions and distributions, at least with respect to the 
principal amounts of such obligations. However, the IRS and Treasury 
Department also recognize that there are circumstances in which 
unrecognized appreciation in intercompany debt can be reflected in 
stock basis. For example, if a subsidiary receives cash in exchange for 
newly issued stock when it holds an intercompany obligation, the basis 
of the newly issued shares will reflect a portion of any unrecognized 
appreciation in the obligation. Because the consequences of having that 
unrecognized appreciation reflected in stock basis are no different 
from the consequences of any other built-in gain, the regulations would 
have to provide a system to identify and monitor those

[[Page 53940]]

amounts. Such a system would need to rely on a tracing-based 
methodology, which the IRS and Treasury Department have rejected for 
the reasons articulated in the preamble to the January 2007 proposal. 
Accordingly, the IRS and Treasury Department have concluded that no 
special rules would be adopted for items related to intercompany debt.
ii. Disconformity Amount: Net Inside Attributes
    In the proposed regulations, the term net inside attributes was 
defined as the excess of the sum of S's loss carryovers, deferred 
deductions, and asset basis over S's liabilities. Although different 
rules applied to determine basis in lower-tier subsidiary stock, the 
terms otherwise had the same meaning for purposes of both the basis 
reduction and attribute reduction rules.
    The proposed regulations defined the term loss carryover to mean 
any net operating or capital loss carryover attributable to S that is 
or, under the principles of Sec.  1.1502-21 would be, carried to S's 
first taxable year, if any, following the year of the transfer. Thus, 
if a buyer were to waive a loss carryover under Sec.  1.1502-32(b)(4), 
the loss would not be carried to S's first taxable year after the 
transfer, and so it would be excluded from the computation of net 
inside attributes.
    Practitioners agree that this definition is appropriate for 
purposes of measuring loss duplication, as it prevents attributes that 
cannot be duplicated from being taken into account in computing S's 
attribute reduction amount. However, one commentator observed that this 
definition seemed inappropriate for purposes of measuring S's 
disconformity amount.
    The IRS and Treasury Department have considered this comment and 
agree that the definition is inappropriate for computing S's 
disconformity amount. As discussed in the January 2007 preamble, the 
disconformity amount was incorporated in the basis reduction rule in 
order to limit basis reduction to the net amount of a subsidiary's 
built-in gain. The IRS and Treasury Department believed that, by 
limiting basis reduction to the amount of net built-in gain, the basis 
reduction rule would not reduce stock basis by an amount that could not 
be attributed to the recognition of built-in gain.
    However, by adopting a definition of loss carryovers that required 
such losses to be carried to a separate return year, the rule allowed a 
waiver of a loss carryover under Sec.  1.1502-32(b)(4) to reduce the 
amount of a subsidiary's loss carryovers and, as a result, the 
subsidiary's net inside attributes. That, in turn, caused an increase 
in the subsidiary's disconformity amount. But, as the commentator 
observed, any disconformity created by the waiver of a loss carryover 
would be unrelated to the existence of built-in gain. Thus, this 
definition of loss carryovers undermined the protection otherwise 
afforded by the use of the disconformity amount as a limit on basis 
reduction.
    In addition, other commentators found the proposed rule unclear in 
its reference to losses that would be carried to a separate return 
year.
    To address these concerns, the final regulations provide that the 
term loss carryovers means those losses that are attributable to the 
subsidiary, including any losses that would be apportioned to the 
subsidiary under the principles of Sec.  1.1502-21(b)(2) if the 
subsidiary had a separate return year. However, because a waiver under 
Sec.  1.1502-32(b)(4) does affect the extent to which a loss can be 
duplicated, the final regulations provide that, solely for purposes of 
applying the attribute reduction rule, a subsidiary's loss carryovers 
(and therefore its net inside attributes) do not include the amount of 
any losses waived under Sec.  1.1502-32(b)(4).
D. Section 1.1502-36(d): The Attribute Reduction Rule
    As discussed in the preamble to the January 2007 proposal, the loss 
duplication component of the Unified Loss Rule addresses loss 
duplication systemically in order to clearly reflect the income of both 
the group and its members, including former members. The IRS and 
Treasury Department view this rule as a necessary and appropriate 
complement to Sec.  1.1502-32 because, together they work to eliminate 
the duplication of a group item once the group enjoys the benefit of 
the item, without regard to which of the duplicative items is 
recognized and allowed first. The IRS and Treasury Department also view 
this rule as a necessary and appropriate complement to the basis 
reduction rule because it eliminates S's unrecognized built-in loss to 
the extent it prevented the identification of S's recognized built-in 
gain (and thus prevented the reduction of noneconomic stock basis, and 
noneconomic stock loss). See sections C.3 and C.4.v of the preamble to 
the January 2007 proposal for a discussion of the interaction between 
unrecognized built-in loss and recognized built-in gain.
    Commentators generally agreed with the IRS and Treasury Department 
on the need for, and appropriateness of, the systemic approach to loss 
duplication. However, like the basis redetermination and basis 
reduction rules, the attribute reduction rule received considerable 
commentary regarding the issues of data availability and computational 
complexity. Commentators and practitioners made several suggestions for 
technical revisions to the proposed regulations. The IRS and Treasury 
Department have considered the suggestions received as well as other 
revisions to the proposed attribute reduction rule. The suggestions and 
conclusions are discussed in the following sections.
i. Lower-Tier Subsidiary Rules
    In general, commentators and practitioners recognize that the rules 
for measuring and eliminating loss duplication must take into account 
both the basis in lower-tier subsidiary stock and the attributes of 
lower-tier subsidiaries in order to be most effective. Nevertheless, as 
already noted, commentators expressed much concern regarding the 
administrability of the proposed lower-tier subsidiary rules. Their 
principal suggestion for addressing this concern was the adoption of a 
look-through approach that would address loss duplication only by 
taking lower-tier attributes into account.
    The IRS and Treasury Department considered a look-through approach 
when drafting the January 2007 proposal, but were concerned that such 
an approach would not adequately address loss duplication. The 
principal reason for this concern was that loss duplication can reside 
in the basis of lower-tier subsidiary stock and in the attributes of 
that lower-tier subsidiary and, moreover, that it can reside in those 
locations in differing amounts. Therefore, a rule that measures loss 
duplication solely by reference to lower-tier attributes, or solely by 
reference to lower-tier stock basis, would permit potentially 
significant amounts of loss duplication to avoid reduction. To avoid 
this problem, the IRS and Treasury Department concluded that the loss 
duplication regulations must measure loss duplication by reference to 
both.
    The IRS and Treasury Department recognized, however, that when 
duplication is not uniformly reflected in stock basis and attributes, 
this approach could cause an over-reduction in lower-tier attributes 
(when loss duplication resides primarily in lower-tier stock basis) or 
in lower-tier stock basis (when loss duplication resides primarily in 
lower-tier attributes). To prevent the former result, the conforming 
limitation on lower-tier attribute reduction limits the application of 
tiered-down attribute reduction (generally permitting a lower-

[[Page 53941]]

tier subsidiary's attributes to be reduced only to the extent necessary 
to conform them to members' bases in that subsidiary's stock, as 
reduced under this rule). To prevent the latter result, the basis 
restoration rule reverses reductions to lower-tier stock basis made by 
the Unified Loss Rule (generally to the extent necessary to conform 
members' bases in the subsidiary's stock to the subsidiary's net inside 
attributes, as reduced under this rule).
    Thus, these rules work together to protect the government's 
interests (by addressing the entire potential for loss duplication) and 
taxpayers' interests (by preventing the over-reduction of either lower-
tier stock basis or lower-tier attributes). Accordingly, the IRS and 
Treasury Department continue to believe these rules are essential to 
the balance and fundamental fairness of the Unified Loss Rule.
    Nevertheless, the IRS and Treasury Department recognize that the 
conforming limitation and basis restoration rules can add considerable 
complexity to the application of the Unified Loss Rule. To address this 
concern, commentators have suggested that one or the other of these 
rules could be omitted to simplify the proposed rule. The IRS and 
Treasury Department are concerned, however, that eliminating either of 
these rules would considerably undermine the overall fairness of the 
regulation. But the IRS and Treasury Department are persuaded that, if 
a taxpayer determines that the expected benefit of applying these rules 
is outweighed by the additional complexity, then that taxpayer should 
be permitted to choose not to apply these rules.
    Accordingly, these final regulations continue to measure the 
potential for loss duplication by taking both stock basis and 
attributes into account and continue to safeguard against over-
reduction of either inside attributes or stock basis by applying both 
the conforming limitation and the basis restoration rules. However, 
under the final regulations, taxpayers are permitted to elect not to 
apply the conforming limitation or the basis restoration rule if they 
decide the protection afforded by either or both of those rules does 
not outweigh the burden of applying them.
ii. Attribute Reduction Amount Below Five Percent of Value
    Although the fundamental structure of the attribute reduction rule 
has been retained, the IRS and Treasury Department have determined that 
it is appropriate to provide an exception to the application of the 
attribute reduction rule if the attribute reduction amount (that is, 
the duplicated loss) is small relative to the size of the transaction. 
This decision reflects a balancing of the need to eliminate duplicated 
loss and the administrative burden of applying the attribute reduction 
rule. Accordingly, under these final regulations, taxpayers must still 
compute their attribute reduction amount, but if the total attribute 
reduction amount is less than five percent of the aggregate value of 
the subsidiary shares that are transferred by members in the 
transaction, the attribute reduction rule does not apply to the 
transfer.
    However, the IRS and Treasury Department also recognize that, in 
certain circumstances, a taxpayer may prefer to have the attribute 
reduction rule apply. For example, a group may want to apply the rule 
in order to reattribute a subsidiary's attributes. Accordingly, the 
final regulations allow taxpayers to elect to apply the attribute 
reduction rule notwithstanding that their total attribute reduction 
amount is less than five percent of the aggregate value of the 
transferred shares. If this election is made, the attribute reduction 
rule will apply with respect to the entire attribute reduction amount 
determined in the transaction, and thus applies with respect to all 
members transferring shares, and all shares transferred, in the 
transaction.
iii. Ordering of Reduction of Recognized Losses
    Commentators generally agreed with the decision to reduce 
recognized losses (net operating loss (NOL) carryovers, capital loss 
carryovers, and deferred deductions, identified as Category A, Category 
B, and Category C attributes, respectively) before reducing asset 
basis, since the former items represent actual, identified losses. The 
proposed regulations provided that the attribute reduction amount would 
be first applied to reduce NOL carryovers (from oldest to newest), then 
capital loss carryovers (from oldest to newest), and then deferred 
deductions (proportionately). However, several commentators questioned 
the need for a mandatory order in which these attributes would be 
reduced. These commentators observed that, because loss duplication is 
a mathematical determination under the Unified Loss Rule, and because 
it is difficult (if not impossible) to know which attributes are 
economically duplicative of a stock loss, the reduction of any item in 
those categories should be equally appropriate and effective.
    The IRS and Treasury Department have reconsidered this issue and 
agree with the commentators. Accordingly, the final regulations provide 
that if the attribute reduction amount is less than the total 
attributes in Category A, Category B, and Category C, the taxpayer may 
specify the allocation of S's attribute reduction amount among the 
attributes in those categories.
    The final regulations do, however, prescribe a default allocation 
for the reduction of such attributes that is used to the extent the 
taxpayer does not specify an allocation. This default allocation 
differs from the order provided in the proposed rule in that capital 
loss carryovers (not NOLs) are reduced first. This modification was 
made in response to a commentator's suggestion, based on the 
observation that capital loss carryovers have a significantly shorter 
expiration period and are therefore more likely than NOLs to expire 
unused. Accordingly, except to the extent a taxpayer elects to specify 
an allocation, the final regulations first reduce capital loss 
carryovers (oldest to newest), then NOL carryovers (oldest to newest), 
and then deferred deductions (proportionately). This change in the 
order of reduction is intended to minimize the possibility that the 
attribute reduction rule will reduce attributes in an amount greater 
than the amount that would ultimately be available for duplicative use.
    The final regulations continue to provide that, regardless of the 
order in which attributes in these categories are reduced, they are 
reduced in full before any reduction is made to asset basis.
iv. Methodology for Reduction of Asset Basis
    Several commentators have suggested simplifying modifications to 
the manner in which asset basis is reduced under the attribute 
reduction rule. One is the elimination of the proposed Category D 
attributes (unrecognized losses on publicly traded property). This 
category was included in the proposed rule because the IRS and Treasury 
Department recognized that these amounts represent a readily 
identifiable loss that could be eliminated before the presumptive 
reduction of the bases of other assets. This approach prevented the 
attribute reduction rule from creating or increasing gain in publicly 
traded assets. However, commentators viewed this rule as increasing the 
complexity of an already complex analysis while providing only a 
marginal benefit.
    The IRS and Treasury Department are persuaded that this extra 
complexity might not be warranted in this context

[[Page 53942]]

and that the elimination of this rule would not materially affect the 
balance otherwise reached by the Unified Loss Rule. Accordingly, the 
final regulations include publicly traded property in the general asset 
basis category (now designated Category D).
    Another suggestion made by commentators was to apply the attribute 
reduction amount remaining after reducing Category A, Category B, and 
Category C attributes to reduce asset basis in the reverse order of the 
residual method of allocating consideration paid or received in a 
transaction under section 1060.
    The IRS and Treasury Department have concluded that this approach 
is readily administrable and reflects an appropriate balancing of 
presumptions regarding the location of duplicated loss. An important 
consideration is that such a rule reduces basis in purchased goodwill 
and going concern value before basis in other assets, and the IRS and 
Treasury Department are persuaded that duplicated loss is generally 
more likely to be reflected in the bases of such assets. Therefore, the 
elimination of the basis in those assets first seems particularly 
appropriate. Further, the IRS and Treasury Department believe that this 
approach would generally be more administrable than the proposed pro 
rata reduction of asset basis.
    Accordingly, these final regulations adopt this suggestion and 
generally provide that the attribute reduction amount is applied to 
reduce the basis of assets in the asset classes specified in Sec.  
1.338-6(b) other than Class I (cash and general deposit accounts, other 
than certificates of deposit held in depository institutions), but in 
the reverse order from the order specified in that section. Thus, under 
this reverse residual method, any attribute reduction amount applied to 
reduce asset basis is generally applied first to reduce any basis of 
assets in Class VII (proportionately, based on basis instead of value, 
until all such basis is eliminated). Any remaining attribute reduction 
amount is then applied in the same manner to reduce the basis of assets 
in each succeeding lower asset class, other than Class I.
    Notwithstanding the general adoption of this allocation methodology 
for Category D attributes, these final regulations provide that the 
portion of the attribute reduction amount that is not applied to 
attributes in Category A, Category B, and Category C, is first 
allocated between S's basis in any stock of lower-tier subsidiaries 
(treating all S's shares of any one lower-tier subsidiary as a deemed 
single share) and the subsidiary's other assets (treating the non-stock 
Category D assets as one asset). The allocation is made in proportion 
to S's deemed basis in each single share of lower-tier subsidiary stock 
and S's basis in the non-stock Category D asset (S's aggregate basis in 
all of its Category D assets other than subsidiary stock). Only the 
portion of the attribute reduction amount not allocated to lower-tier 
subsidiary stock is applied under the reverse residual method. This 
initial allocation between lower-tier subsidiary stock and other assets 
is necessary to ensure that, to the extent the attribute reduction 
amount reflects items attributable to a lower-tier subsidiary's stock 
basis or attributes, the attribute reduction amount is properly 
directed and applied to those items.
v. Suspension of Excess Attribute Reduction Amount
    Several commentators and practitioners questioned the need to 
suspend attribute reduction amounts in excess of reducible attributes 
and apply those suspended amounts to reduce or eliminate attributes 
otherwise arising when all or part of the liability is paid or 
otherwise satisfied, whether by S or another person. The IRS and 
Treasury Department proposed this rule because the mathematical 
operation of the formula for computing the attribute reduction amount 
results in such an excess only if there is a liability or similar item 
that has reduced economic value but that