Guidance Regarding Deferred Discharge of Indebtedness Income of Corporations and Deferred Original Issue Discount Deductions, 49394-49407 [2010-20060]

Download as PDF 49394 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations for 2012 is the lesser of: $23.35 ($31 of OID that accrues on the new debt instrument in 2012 less $7.75 of this OID that is allowed as a deduction to A in 2012) or $9.75 (the excess of $75 (ABC partnership’s deferred COD income of $150 less A’s share of ABC partnership’s deferred COD income that is included in A’s income for 2012 of $75) over $65.25 (the aggregate amount of OID that accrued in previous taxable years of $87 less the aggregate amount of such OID that has been allowed as a deduction by A in 2012 of $21.75)). Thus, of the $31 of OID that accrues in 2012, $9.75 is deferred under section 108(i). erowe on DSK5CLS3C1PROD with RULES (3) Effect of an election under section 108(i) on recapture amounts under section 465(e)—(i) In general. To the extent that a decrease in a partner’s or shareholder’s amount at risk (as defined in section 465) in an activity as a result of a reacquisition of an applicable debt instrument would cause a partner with a deferred amount or a shareholder with a share of the S corporation’s deferred COD income to have income under section 465(e) in the taxable year of the reacquisition, such decrease (not to exceed the partner’s deferred amount or the shareholder’s share of the S corporation’s deferred COD income with respect to that applicable debt instrument) (deferred section 465 amount) shall not be taken into account for purposes of determining the partner’s or shareholder’s amount at risk in an activity under section 465 as of the close of the taxable year of the reacquisition. A partner’s or shareholder’s deferred section 465 amount is treated as a decrease in the partner’s or shareholder’s amount at risk in an activity at the same time, and to the extent remaining in same amount, as the partner recognizes its deferred amount or the S corporation shareholder recognizes its share of the S corporation’s deferred COD income. (ii) Example. The following example illustrates the rules in paragraph (d)(3) of this section: Example. (i) PRS is a calendar-year partnership with two equal partners, individuals A and B. PRS is engaged in an activity described in section 465(c) (Activity). PRS has a $500 recourse applicable debt instrument outstanding. Each partner’s amount at risk on January 1, 2009 is $50. On June 1, 2009, the creditor agrees to cancel the $500 indebtedness. PRS realizes $500 of COD income as a result of the reacquisition. The partners’ share of the liabilities of PRS decreases by $500 under section 752(b), and each partner’s amount at risk is decreased by $250. Other than the $500 of COD income, PRS’s income and expenses for 2009 are equal. PRS makes an election under section 108(i) to defer $200 of the $500 COD income realized in connection with the reacquisition. PRS allocates the $500 of COD income equally between its partners, A and B. A and B each have a COD income amount of $250 VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 with respect to the applicable debt instrument. PRS determines that, for both partners A and B, $100 of the $250 COD income amount is the deferred amount, and $150 is the included amount. Beginning in each taxable year 2014 through 2018, A and B each include $20 of the deferred amount in gross income. (ii) Under paragraph (d)(3)(i) of this section, $50 of the $250 decrease in A’s and B’s amount at risk in Activity is the deferred section 465 amount for each of A and B and is not taken into account for purposes of determining A’s and B’s amount at risk in Activity at the close of 2009. In taxable year 2014, A’s and B’s amount at risk in Activity is decreased by $20 (deferred section 465 amount that equals the deferred amount included in A’s and B’s gross income in 2014). In taxable year 2015, A’s and B’s amount at risk in Activity is decreased by $20 for the deferred section 465 amount that equals the deferred amount included in A’s and B’s gross income in 2015. In taxable year 2016, A’s and B’s amount at risk in Activity is decreased by $10 (the remaining amount of the deferred section 465 amount). (e) Election procedures and reporting requirements—(1) Partnerships—(i) In general. A partnership makes an election under section 108(i) by following procedures outlined in guidance and applicable forms and instructions issued by the Commissioner. An electing partnership (or its successor) must provide to its partners certain information as required by guidance and applicable forms and instructions issued by the Commissioner. (ii) Tiered pass-through entities. A partnership that is a direct or indirect partner of an electing partnership (or its successor) or a related partnership or an S corporation partner must provide to its partners or shareholders, as the case may be, certain information as required by guidance and applicable forms and instructions issued by the Commissioner. (iii) Related partnerships. A related partnership must provide to its partners certain information as required by guidance and applicable forms and instructions issued by the Commissioner. (2) S corporations—(i) In general. An S corporation makes an election under section 108(i) by following procedures outlined in guidance and applicable forms and instructions issued by the Commissioner. An electing S corporation (or its successor) must provide to its shareholders certain information as required by guidance and applicable forms and instructions issued by the Commissioner. (ii) Related S corporations. A related S corporation must provide to its shareholders certain information as required by guidance and applicable PO 00000 Frm 00044 Fmt 4700 Sfmt 4700 forms and instructions issued by the Commissioner. (f) Effective/applicability date. For the applicability dates of this section, see § 1.108(i)–0T(b). (g) Expiration date. This section expires on August 9, 2013. PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT Par. 3. The authority citation for part 602 continues to read as follows: ■ Authority: 26 U.S.C. 7805. Par. 4. In § 602.101, paragraph (b) is amended by adding the following entry in numerical order to the table to read as follows: ■ § 602.101 * OMB Control numbers. * * (b) * * * * * CFR part or section where identified and described * * * 1.108(i)–2T ........................... * * * Current OMB control No. * * 1545–2147 * * Steven T. Miller, Deputy Commissioner for Services and Enforcement. Approved: August 6, 2010. Michael F. Mundaca, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2010–20058 Filed 8–11–10; 11:15 am] BILLING CODE 4830–01–P DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602 [TD 9497] RIN 1545–BI97 Guidance Regarding Deferred Discharge of Indebtedness Income of Corporations and Deferred Original Issue Discount Deductions Internal Revenue Service (IRS), Treasury. ACTION: Temporary regulations. AGENCY: This document contains temporary regulations under section 108(i) of the Internal Revenue Code (Code). These regulations primarily affect C corporations regarding the acceleration of deferred discharge of indebtedness (COD) income (deferred COD income) and deferred original SUMMARY: E:\FR\FM\13AUR1.SGM 13AUR1 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations issue discount (OID) deductions (deferred OID deductions) under section 108(i)(5)(D), and the calculation of earnings and profits as a result of an election under section 108(i). In addition, these regulations provide rules applicable to all taxpayers regarding deferred OID deductions under section 108(i) as a result of a reacquisition of an applicable debt instrument by an issuer or related party. The text of these temporary regulations also serves as the text of proposed regulations (REG– 142800–09) set forth in the notice of proposed rulemaking on this subject in the Proposed Rules section in this issue of the Federal Register. DATES: Effective Dates: These regulations are effective on August 11, 2010. Applicability Dates: For dates of applicability, see § 1.108(i)–0T(b). FOR FURTHER INFORMATION CONTACT: Concerning the acceleration rules for deferred COD income and deferred OID deductions, and the rules for earnings and profits, Robert M. Rhyne (202) 622– 7790; concerning the rules for deferred OID deductions, Rubin B. Ranat (202) 622–7530 (not toll-free numbers). SUPPLEMENTARY INFORMATION: erowe on DSK5CLS3C1PROD with RULES Paperwork Reduction Act These temporary regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 1545–2147. Responses to this collection of information are required in order for a member of a consolidated group to make the election described in § 1.108(i)–1T(b)(3). 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. For further information concerning this collection of information, and where to submit comments on the collection of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the crossreferencing notice of proposed rulemaking on this subject in the Proposed Rules section in this issue of the Federal Register. Books or records relating to a collection of information must be retained as long as their contents may become material in the administration VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 of any internal revenue law. See 26 U.S.C. 6001. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background Under section 61(a)(12), a taxpayer includes in gross income any discharge of indebtedness (COD income) if the taxpayer’s obligation to repay its indebtedness is discharged in whole or in part. Section 108 provides special rules for the treatment of COD income in certain cases. Section 108(i) was added to the Code by section 1231 of the American Recovery and Reinvestment Tax Act of 2009 (Pub. L. 111–5, 123 Stat. 338), enacted on February 17, 2009. Section 108(i)(1) provides an election for deferral of the inclusion of COD income (deferred COD income) arising in connection with the reacquisition after December 31, 2008, and before January 1, 2011, of an applicable debt instrument. If a taxpayer makes the election, the deferred COD income generally is includible in gross income ratably over a 5-taxable-year period, beginning with the taxpayer’s fourth or fifth taxable year following the taxable year of the reacquisition (inclusion period). If, as part of a reacquisition to which section 108(i)(1) applies, a debt instrument is issued (or is treated as issued) for the applicable debt instrument and there is any OID with respect to the newly issued debt instrument, then the deduction for all or a portion of the OID may be deferred (deferred OID deductions) under section 108(i)(2). (See the discussion of section 108(i)(2) later in this preamble.) An applicable debt instrument means any debt instrument (within the meaning of section 1275(a)(1)) issued by a C corporation, or any other person in connection with the conduct of a trade or business by such a person. Section 108(i)(3). Section 108(i)(4)(A) defines a reacquisition as any acquisition of the debt instrument by the debtor which issued (or is otherwise the obligor under) the debt instrument, or by a person related to the debtor within the meaning of section 108(e)(4). An acquisition includes acquisitions for cash or other property, for another debt instrument, for corporate stock or a partnership interest, or as a contribution of the debt instrument to capital. The term also includes the complete forgiveness of the indebtedness by the holder of the debt instrument. Section 108(i)(4)(B). Section 108(i)(5)(D) requires a taxpayer to accelerate the inclusion of any remaining items of deferred COD income or deferred (and otherwise PO 00000 Frm 00045 Fmt 4700 Sfmt 4700 49395 allowable) OID deduction (deferred items) under certain circumstances, including the death of the taxpayer, the liquidation or sale of substantially all the assets of the taxpayer (including in a title 11 or similar case), the cessation of business by the taxpayer, or similar circumstances. Section 108(i)(7) authorizes the Secretary to issue guidance necessary or appropriate for purposes of applying section 108(i), including extending the application of the rules of section 108(i)(5)(D) to other appropriate circumstances. On August 17, 2009, the IRS and Treasury Department issued Rev. Proc. 2009–37, 2009–36 IRB 309, providing procedures for taxpayers to make a section 108(i) election, and requiring the annual reporting of additional information. See § 601.601(d)(2)(ii)(b). The revenue procedure also announced the intention to issue additional guidance, and that the additional guidance may be retroactive. Explanation of Provisions I. Mandatory Acceleration Events for Deferred COD Income The IRS and Treasury Department believe that the deferral rules of section 108(i) generally are intended to facilitate debt workouts and to alleviate taxpayer liquidity concerns by deferring the tax liability associated with COD income. These taxpayer-favorable deferral rules are tempered, however, by section 108(i)(5)(D), which operates to accelerate the inclusion of a taxpayer’s remaining deferred COD income in the case of the death of the taxpayer, the liquidation or sale of substantially all the assets of the taxpayer (including in a title 11 or similar case), the cessation of business by the taxpayer or similar circumstances (acceleration events). A common trait of these enumerated acceleration events is that they involve situations where collection of the tax liability associated with a taxpayer’s deferred COD income may be hindered, either because the taxpayer has ceased to exist or because the taxpayer has disposed of the business to which the COD income relates. Section 108(i) poses unique concerns regarding collectability of the incipient tax liability associated with deferred COD income. In other contexts in which gain or income is deferred, the deferral is generally associated with a particular asset or its replacement. For example, gain on the sale of an asset under the installment method of accounting is deferred until payments are received under the installment obligation, or until the taxpayer disposes of the installment obligation. Collectability of E:\FR\FM\13AUR1.SGM 13AUR1 erowe on DSK5CLS3C1PROD with RULES 49396 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations the tax liability associated with the deferred gain is preserved in that context because the taxpayer has either the installment obligation or the proceeds therefrom. Section 108(i) deferral, in contrast, is not linked to a particular asset or a particular replacement asset. In the absence of acceleration events, the government’s ability to ensure appropriate inclusion of the deferred COD income and the collectability of the associated tax liability would be jeopardized. The enumerated acceleration events apply, however, to a broad range of taxpayers, including individuals and passthrough entities as well as corporations. Applied literally, the statutory rules would require acceleration in circumstances, such as certain corporate nonrecognition transactions, that do not pose particular concerns regarding collectability. For example, the statute treats a sale of substantially all the assets of the taxpayer as an acceleration event. If construed broadly, any asset disposition involving the transfer of substantially all of the assets of a corporation that made a section 108(i) election (for example, a reorganization exchange described in section 368(a)(1)(C)) would constitute an acceleration event. However, commentators noted that it did not seem consistent with the purposes of section 108(i) to require the acceleration of an electing corporation’s deferred items in the case of a transaction to which section 381(a) applies. As discussed further in this preamble, the IRS and Treasury Department generally agree. The rules provided in these temporary regulations with respect to a C corporation with deferred COD income by reason of a section 108(i) election (electing corporation) are intended to focus more precisely on the underlying purpose of section 108(i)(5)(D) to ensure that the government’s ability to collect the tax liability associated with the deferred COD income is not impaired. Thus, with respect to electing corporations, the rules provided in these regulations generally reflect a narrower interpretation of the statutory acceleration events. In addition, however, the nature of the corporate entity introduces concerns not present for other types of taxpayers. In particular, a corporation can dissipate its assets (for example, by distributions to its shareholders) without harming the economic interests of its shareholders. As a result, there may be a greater incentive for the owners of a corporation to make the corporation judgment-proof with respect to its tax liability. This is illustrated by the intermediary transactions described in VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 Notice 2008–111, 2008–2 CB 1299. The IRS and Treasury Department believe that the acceleration rules should be tailored to foreclose such opportunities. Accordingly, while these temporary regulations do not require acceleration in every instance enumerated in the statute, they provide instead for acceleration in a limited number of circumstances in which corporations have impaired their ability to pay their incipient tax liability. This approach is broadly consistent with the approach advanced by commentators who suggested, for example, that a transfer of a corporation’s business assets for stock in a section 351 exchange should not be an acceleration event, despite the literal language of section 108(i)(5)(D). Specifically, these temporary regulations generally provide that an electing corporation will accelerate deferred COD income under section 108(i)(5)(D) if the electing corporation (i) changes its tax status, (ii) ceases its corporate existence in a transaction to which section 381(a) does not apply, or (iii) engages in a transaction that impairs its ability to pay the tax liability associated with its deferred COD income (the net value acceleration rule). Under these temporary regulations, the foregoing three rules are the only events that accelerate an electing corporation’s deferred COD income. In addition to these temporary regulations, however, the rules under § 1.108(i)–2T apply to C corporations that are direct or indirect partners of a partnership. The acceleration rules provided in these temporary regulations generally are different from the rules for passthrough entities. For example, a sale of substantially all of the assets of a passthrough entity is an acceleration event for an S corporation while that transaction, standing alone, is not an acceleration event for an electing corporation. The IRS and Treasury Department believe that it is appropriate to provide different acceleration rules for passthrough entities and electing corporations because the statute requires the debt instrument of a passthrough entity to be issued in connection with a trade or business. Accordingly, consistent with the trade or business requirement, it is appropriate to accelerate the deferred COD income of a passthrough entity if the entity sells substantially all of its assets. A. Net Value Acceleration Rule Under the net value acceleration rule, an electing corporation generally is required to accelerate all of its remaining deferred COD income if it engages in an impairment transaction, PO 00000 Frm 00046 Fmt 4700 Sfmt 4700 and immediately after the transaction, the value of its assets fails to satisfy a minimum threshold (as further described herein). In general, impairment transactions are volitional transactions that reduce an electing corporation’s asset base. As provided in these regulations, impairment transactions are any transactions, however effected, that impair an electing corporation’s ability to pay the amount of Federal income tax liability on its deferred COD income and include, for example, distributions (including section 381(a) transactions), redemptions, below market sales, and donations, and the incurrence of additional indebtedness without a corresponding increase in asset value. However, value-for-value sales or exchanges (including, for example, an exchange to which section 351 or section 721 applies) are not impairment transactions. The IRS and Treasury Department believe that the receipt of replacement assets in these cases adequately protects the government’s interests and ensures continued collectability of any incipient tax liability. Under this rule, an electing corporation’s investments and expenditures in pursuance of its good faith business judgment are not impairment transactions, merely because, for example, acquired assets are riskier or less liquid than the electing corporation’s previous assets. In addition, mere declines in the market value of an electing corporation’s assets are not impairment transactions. Although the decline may impair an electing corporation’s ability to pay its tax liability, a different rule would require continuous valuations and is contrary to the transactional approach taken in the statute and these regulations, and the realization requirement generally. Under the net value acceleration rule, an electing corporation generally is required to accelerate its remaining deferred COD income if immediately after an impairment transaction, the gross value of the corporation’s assets (gross asset value) is less than one hundred and ten percent of the sum of its total liabilities and the tax on the net amount of its deferred items (the net value floor). Solely for purposes of computing the net value floor, the tax on the net amount of the electing corporation’s deferred items is determined by applying the highest rate of tax specified in section 11(b) for the taxable year (even though the corporation’s actual tax rate for the taxable year may differ). The net value acceleration rule has a mitigating provision that allows an E:\FR\FM\13AUR1.SGM 13AUR1 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations erowe on DSK5CLS3C1PROD with RULES electing corporation to avoid accelerated inclusion of its deferred COD income if value is restored to the corporation by the due date of the electing corporation’s tax return (including extensions). In general, the amount required to be restored is the lesser of: (i) The amount of value that was removed (net of amounts previously restored under this rule) from the electing corporation in one or more impairment transactions; or (ii) the amount by which the electing corporation’s net value floor exceeds its gross asset value. For example, assume an electing corporation incurs $50 of indebtedness, distributes the $50 of proceeds to its shareholder, and immediately after the distribution, the electing corporation’s gross asset value is $25 below the net value floor. The electing corporation may avoid application of the net value acceleration rule if, as a result of a transaction, assets with a value of $25 are restored to the corporation before the due date of its tax return (including extensions) for the taxable year that includes the distribution. For purposes of this provision, the value that must be restored is determined at the time of the impairment transaction, and is determined upon a net value basis (for example, additional borrowings by an electing corporation do not restore value). The IRS and Treasury Department believe that the net value acceleration rule is an appropriate interpretation of section 108(i) because, consistent with the purpose of facilitating workouts, the rule allows electing corporations the flexibility to realign business operations through strategic acquisitions and dispositions within the objective standard of the net value floor. Although the net value acceleration rule contains a valuation component, a valuation will be required only if an electing corporation engages in an impairment transaction. Moreover, the IRS and Treasury Department believe that the net value acceleration rule is a more objective rule than requiring corporations to determine the amount of business assets that would have to be retained simply to preserve the deferral benefit of section 108(i). 1. Consolidated Groups In the case of consolidated groups, the determination of whether an electing corporation that is a member of a consolidated group (electing member) has engaged in an impairment transaction is made on a group-wide basis. Thus, an electing member is treated as engaging in an impairment transaction if any member’s transaction VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 impairs the group’s ability to pay the tax liability associated with the group’s deferred COD income. See § 1.1502–6. Accordingly, intercompany transactions are not impairment transactions. Similarly, the net value acceleration rule is applied by reference to the gross asset value of all members (excluding stock of members whether or not the stock is described in section 1504(a)(4)), the liabilities of all members, and the tax on all members’ deferred items. For example, assume P is the common parent of the P–S consolidated group, S has a section 108(i) election in effect, and S makes a $100 distribution to P, which, on a separate entity basis, would reduce S’s gross asset value below the net value floor. S’s intercompany distribution to P is not an impairment transaction. However, if P makes a $100 distribution to its shareholder, P’s distribution, subject to an exception described in section I.A.2 of this preamble, is an impairment transaction, and the net value acceleration rule is applied by reference to the assets, liabilities, and deferred items of the P– S group. Special rules are provided when an electing member that previously engaged in an impairment transaction on a separate entity basis leaves a consolidated group. If the electing member ceases to be a member of a consolidated group, the cessation is treated as an impairment transaction and the net value acceleration rule is applied on a separate entity basis (by reference to the assets, liabilities, and deferred items of the electing member only) immediately after it ceases to be a member. If the electing member’s gross asset value is less than the net value floor, then the electing member’s remaining deferred COD income must be taken into account immediately before the electing member ceases to be a member (unless value is restored). In the case of an electing member that becomes a member of another consolidated group, the cessation is treated as an impairment transaction and the net value acceleration rule is applied by reference to the assets, liabilities, and deferred items of the members of the acquiring group immediately after the transaction. If the gross asset value of the acquiring group is less than its net value floor, the electing member’s remaining deferred COD income is taken into account immediately before the electing member ceases to be a member of the former group. If accelerated inclusion is not required, the common parent of the acquiring group succeeds to the PO 00000 Frm 00047 Fmt 4700 Sfmt 4700 49397 reporting requirements of section 108(i) with respect to the electing member. 2. Exception for Distributions and Charitable Contributions Consistent With Historical Practice—In General The IRS and Treasury Department believe it is appropriate to allow an electing corporation to continue to make distributions to the extent the distributions are consistent with its historical practice. Accordingly, these distributions are not treated as impairment transactions (and are not taken into account as a reduction in gross asset value when applying the net value acceleration rule to any impairment transaction). For this purpose, distributions are consistent with an electing corporation’s historical practice to the extent the distributions are described in section 301(c) and the amount of these distributions, in the aggregate, for the applicable taxable year (applicable distribution amount) does not exceed the annual average amount of section 301(c) distributions over the preceding three taxable years (average distribution amount). Any excess of the applicable distribution amount over the average distribution amount is treated as an impairment transaction and is taken into account when applying the net value acceleration rule. For purposes of this rule, appropriate adjustments must be made to take into account any issuances or redemptions of stock, or similar transactions, occurring during a relevant taxable year. In addition, if the electing corporation has a short taxable year for the year of the distribution or for any of the years relied upon in computing the average distribution amount, the applicable distribution amount and the average distribution amount are determined on an annualized basis. If an electing corporation has been in existence for less than three years, the average distribution amount is computed by substituting the period during which the electing corporation has been in existence for the three preceding taxable years. The regulations also provide similar rules that exclude from impairment transaction status an electing corporation’s charitable contributions (within the meaning of section 170(c)) that are consistent with its historical practice. 3. Special Rules for Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs) In the case of a RIC or REIT, any distributions with respect to stock that are treated as a dividend under section 852 or 857 are not treated as impairment transactions (and are not taken into E:\FR\FM\13AUR1.SGM 13AUR1 49398 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations account as a reduction in gross asset value when applying the net value acceleration rule to any impairment transaction). In addition, any redemption of a redeemable security, as defined in 15 U.S.C. section 80a– 2(a)(32), by a RIC in the ordinary course of business is not treated as an impairment transaction (and is not taken into account as a reduction in gross asset value when applying the net value acceleration rule to any impairment transaction). B. Other Mandatory Acceleration Events erowe on DSK5CLS3C1PROD with RULES 1. Changes in Tax Status To preserve the government’s ability to collect the incipient tax liability associated with a C corporation’s deferred COD income, these regulations provide that an electing corporation must take into account its remaining deferred COD income immediately before a change in its tax status. An example of such a change includes a C corporation that becomes a tax-exempt entity, or a C corporation that begins operating as a cooperative. Other changes in tax status are more fully described herein. If a C corporation elects to be treated as an S corporation, the S corporation is subject to tax on its net recognized builtin gains during the recognition period. Section 1374(a). Although an item of income, such as deferred COD income, can constitute recognized built-in gain, recognition of the gain for any taxable year may be limited under § 1.1374–2. Accordingly, if an electing corporation elects to be treated as an S corporation, the S corporation would not pay tax on its deferred COD income to the extent that the S corporation’s COD income and other recognized built-in gains exceed the limitation. The IRS and Treasury Department have determined that permanent exclusion of a corporate tax liability associated with a section 108(i) election is inconsistent with congressional intent to provide for deferral of corporate tax liability with respect to COD income. Accordingly, these temporary regulations provide that if an electing corporation elects to become an S corporation, the C corporation must take into account its deferred COD income immediately before the S corporation election is effective. Similarly, these temporary regulations provide that an electing corporation that elects to be treated as a RIC or REIT must take into account its remaining deferred COD income immediately before the election is effective. VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 2. Cessation of Existence b. Inbound Section 381(a) Transactions Section 108(i)(5)(D) provides that in the case of the cessation of business by a taxpayer, deferred items must be taken into account in the taxable year of the cessation. Consistent with this provision, in general, these temporary regulations provide that an electing corporation must accelerate its remaining deferred COD income in the taxable year that the corporation ceases to exist. As noted in section I of the preamble, commentators suggested that continued deferral of an electing corporation’s COD income is appropriate if the corporation ceases to exist in a reorganization or liquidation to which section 381(a) applies. The IRS and Treasury Department agree that, in these transactions, the policies that support nonrecognition for corporations also support continued deferral of COD income. In addition, an exception for these transactions affords corporations maximum flexibility in structuring transactions as asset reorganizations or stock reorganizations to meet business exigencies. Therefore, these temporary regulations generally provide that if the assets of the electing corporation are acquired in a transaction to which section 381(a) applies (the section 381 exception), the electing corporation’s deferred COD income is not accelerated. In such a case, the acquiring corporation succeeds to the electing corporation’s remaining deferred COD income, and becomes subject to section 108(i), including all of its reporting requirements. However, these temporary regulations limit the applicability of the section 381 exception in certain circumstances, some of which are described herein. Moreover, a section 381(a) transaction may still constitute an impairment transaction. (See Example 3 of § 1.108(i)–1T(c)). As more fully described in section III, in general, deferred COD income increases the earnings and profits of an electing corporation, including a foreign electing corporation, in the year the debt is discharged. Accordingly, if the assets of a foreign electing corporation are acquired by a domestic corporation in a transaction to which section 381(a) applies, the increase in earnings and profits is taken into account in computing the foreign corporation’s all earnings and profits amount and therefore, may be subject to U.S. taxation as a deemed dividend pursuant to § 1.367(b)–3(b)(3). To prevent the deferred COD income from being subject to U.S. tax a second time when the deferred COD income is includible in the domestic acquirer’s gross income, these temporary regulations provide that a foreign electing corporation takes into account its remaining deferred COD income immediately before the transaction if, as a result of the transaction, one or more exchanging shareholders include in income as a deemed dividend the all earnings and profits amount with respect to stock in the foreign electing corporation pursuant to § 1.367(b)–3(b)(3). a. Outbound Section 381(a) Transactions If the assets of a domestic electing corporation are acquired by a foreign corporation in a transaction to which section 381(a) applies, the electing corporation’s deferred COD income may not be subject to U.S. tax when it is includible in the foreign acquirer’s gross income. Accordingly, to ensure that the COD income is appropriately taxed, these temporary regulations provide that the electing corporation takes into account its remaining deferred COD income immediately before the transaction. PO 00000 Frm 00048 Fmt 4700 Sfmt 4700 c. Acquisition of Assets of an Electing Corporation by a RIC or REIT or by an S Corporation To ensure that the corporate tax liability associated with deferred COD income is appropriately preserved, these temporary regulations provide that if the assets of an electing corporation are acquired by a RIC or REIT in a transaction that is subject to § 1.337(d)– 7 and section 381(a) (a conversion transaction), the electing corporation takes into account its remaining deferred COD income immediately before the conversion transaction. Similarly, if the assets of an electing C corporation are acquired by an S corporation in a transaction to which sections 1374(d)(8) and section 381(a) apply, the electing C corporation takes into account its remaining deferred COD income immediately before the transaction. C. Title 11 (or Similar Case) Under section 108(i)(5)(D), if an electing corporation ceases to do business, liquidates or sells substantially all of its assets in a proceeding under title 11 (or a similar case), the corporation’s deferred items are taken into account the day before the petition is filed. The IRS and Treasury Department believe that the acceleration rules (outlined in section I) are E:\FR\FM\13AUR1.SGM 13AUR1 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations sufficient to protect the collectability of tax relating to deferred COD income. Accordingly, no special acceleration rules for an electing corporation in a title 11 or similar case are provided. erowe on DSK5CLS3C1PROD with RULES II. Elective Acceleration for Electing Members of a Consolidated Group These temporary regulations provide an elective provision under which an electing member of a consolidated group (other than the common parent) may at any time accelerate in full (and not in part) the inclusion of its remaining deferred COD income with respect to all applicable debt instruments. Elective acceleration within a consolidated group is consistent with other consolidated return provisions that mitigate the double taxation of income or gain. III. Earnings and Profits In Rev. Proc. 2009–37, the IRS and Treasury Department announced its intention to issue regulations regarding the computation of a corporation’s earnings and profits in connection with an election under section 108(i). See § 601.601(d)(2)(ii)(b). Consistent with the revenue procedure, these temporary regulations provide that deferred COD income generally increases earnings and profits in the taxable year that it is realized, and deferred OID deductions generally decrease earnings and profits in the taxable year or years in which the deductions would be allowed without regard to the deferral rules of section 108(i). Although § 1.312–6(a) generally states that adjustments to earnings and profits are dependent upon the method of accounting properly employed in computing taxable income (or net income, as the case may be), the IRS and Treasury Department believe this principle should not apply in the case of an electing corporation. Section 312(n)(5) provides that in the case of any installment sale, earnings and profits shall be computed as if the corporation did not use the installment sale method. Some commentators have suggested that because the deferral of COD income under section 108(i) is analogous to the deferral of gain from an installment sale, a rule consistent with section 312(n)(5) should apply for purposes of determining the timing of adjustments to earnings and profits with respect to deferred items under section 108(i). The IRS and Treasury Department agree that the policies underlying section 312(n) inform the treatment of deferred COD income under section 108(i). The legislative history to section 312(n)(5) focuses on the fact that a VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 taxpayer may realize cash or its equivalent under the installment method in the year of the sale, but is not required to take income into account until later years. S. Rep. No. 98–169, at 198–99 (1984). As in the case of an installment sale, an electing corporation realizes economic income in the year of discharge. Even though the electing corporation is not required to recognize income until later years, its dividend paying capacity is enhanced immediately, not during the inclusion period, or at the time the deferred COD income may be accelerated into income. These temporary regulations also provide certain exceptions to current year adjustments to earnings and profits. In the case of RICs and REITs, deferred COD income increases earnings and profits in the taxable year or years in which the deferred COD income is includible in gross income and not in the year that the deferred COD income is realized, and deferred OID deductions decrease earnings and profits in the taxable year or years that the deferred OID deductions are deductible. This rule is intended to ensure that a RIC or REIT has sufficient earnings and profits to claim a dividends paid deduction in the taxable year that the deferred COD income is included in taxable income. In addition, for purposes of calculating alternative minimum taxable income, deferred items increase or decrease, as the case may be, adjusted current earnings under section 56(g)(4) in the taxable year or years that the item is includible or deductible. IV. Deferred OID Deductions Section 108(i)(2) generally provides that if, as part of a reacquisition to which section 108(i)(1) applies, a debt instrument is issued (or is treated as issued under section 108(e)(4)) for the applicable debt instrument being reacquired and there is any OID with respect to the debt instrument, no deduction otherwise allowable is allowed for the portion of the OID that accrues before the inclusion period and that does not exceed the COD income with respect to the applicable debt instrument being reacquired. The aggregate amount of deferred OID deductions is allowed ratably over the inclusion period. If the amount of OID accruing before the inclusion period exceeds the deferred COD income with respect to the applicable debt instrument being reacquired, the deductions are disallowed in the order in which the OID is accrued. Under section 108(i)(2)(B), if a debt instrument is issued by an issuer and the proceeds of the debt instrument are used directly or indirectly by the issuer PO 00000 Frm 00049 Fmt 4700 Sfmt 4700 49399 to reacquire an applicable debt instrument of the issuer, then the debt instrument is treated as issued for the applicable debt instrument being reacquired. If only a portion of the proceeds of the debt instrument are used directly or indirectly to reacquire the applicable debt instrument, then the rules in section 108(i)(2)(A) apply to the portion of any OID on the debt instrument that is equal to the portion of the proceeds used to reacquire the applicable debt instrument. A. Application of § 1.1502–13(g)(5) The intercompany obligation rules of § 1.1502–13(g) operate to minimize the effect on consolidated taxable income of items of income, gain, deduction, or loss arising from intercompany debt. These rules generally match the amount, timing, and character of the creditor and debtor member’s items, and ensure that future items similarly correspond. Thus, for example, assume that S holds a B note with an adjusted issue price and basis of $100 and a fair market value of $70, and that S sells the B note to a nonmember for $70. Under § 1.1502– 13(g)(3), B is deemed, immediately before the sale to X, to satisfy the note for its fair market value of $70, resulting in $30 of COD income for B and $30 of loss for S (which is treated as ordinary loss under the attribute redetermination rule of § 1.1502–13(c)(4)(i)). Because the debtor’s COD income matches the creditor’s ordinary loss, in cases where the intercompany obligation becomes a non-intercompany obligation (and in intragroup transactions), there is no benefit to the group to elect deferral of COD income under section 108(i). However, for those transactions in which a non-intercompany obligation becomes an intercompany obligation (as described in § 1.1502–13(g)(5)), the timing and attributes of the debtor and creditor member’s items from the deemed satisfaction are determined on a separate entity basis. In such cases, the elective deferral rules of section 108(i) may be beneficial. Accordingly, these temporary regulations limit the application of section 108(i) by providing that in the case of an intercompany obligation (as defined in § 1.1502–13(g)(2)(ii)), the term applicable debt instrument includes only a debt instrument for which COD income is realized upon the debt instrument’s deemed satisfaction under § 1.1502–13(g)(5). B. Deemed Debt-for-Debt Exchanges Pursuant to the regulatory authority in section 108(i)(7), the temporary regulations provide that, for purposes of section 108(i)(2) (relating to deferred E:\FR\FM\13AUR1.SGM 13AUR1 49400 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations erowe on DSK5CLS3C1PROD with RULES OID deductions that arise in certain debt-for-debt exchanges involving the reacquisition of an applicable debt instrument), if the proceeds of any debt instrument are used directly or indirectly by the issuer or a person related to the issuer (within the meaning of section 108(i)(5)(A)) to reacquire an applicable debt instrument, the debt instrument shall be treated as issued for the applicable debt instrument being reacquired. Therefore, section 108(i)(2) may apply, for example, to a debt instrument issued by a corporation for cash in which some or all of the proceeds are used directly or indirectly by the corporation’s related subsidiary in the reacquisition of the subsidiary’s applicable debt instrument. The rule in the temporary regulations is intended to prevent related parties from avoiding the rules for deferred OID deductions. C. Directly or Indirectly In response to comments received by the IRS and Treasury Department, the temporary regulations provide principles similar to those of § 1.279– 3(b) for purposes of determining when the proceeds of a debt instrument will be treated as having been used ‘‘directly or indirectly’’ to reacquire an applicable debt instrument. Generally, whether the proceeds from an issuance of a debt instrument are used directly or indirectly by the issuer of the debt instrument or a person related to the issuer to reacquire an applicable debt instrument will depend upon all of the facts and circumstances surrounding the issuance and the reacquisition. The proceeds of an issuance of a debt instrument will be treated as being used indirectly to reacquire an applicable debt instrument if: (i) At the time of the issuance of the debt instrument, the issuer of the debt instrument anticipated that an applicable debt instrument of the issuer or a person related to the issuer would be reacquired by the issuer, and the debt instrument would not have been issued if the issuer had not so anticipated such reacquisition; (ii) at the time of the issuance of the debt instrument, the issuer of the debt instrument or a person related to the issuer anticipated that an applicable debt instrument would be reacquired by a related person and the related person receives cash or property that it would not have received unless the reacquisition had been so anticipated; or (iii) at the time of the reacquisition, the issuer or a person related to the issuer foresaw or reasonably should have foreseen that it would be required to issue a debt instrument, which it would not have otherwise been required to issue if the reacquisition had not VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 occurred, in order to meet its future economic needs. D. Proportional Rule for Accruals of OID If a portion of the proceeds of a debt instrument with OID are used directly or indirectly to reacquire an applicable debt instrument, then the temporary regulations provide that the amount of the issuer’s deferred OID deductions generally is equal to the product of the amount of OID that accrues in the taxable year under section 1272 or section 1275 (and the regulations under those sections), whichever section is applicable, and a fraction, the numerator of which is the portion of the total proceeds of the debt instrument used directly or indirectly to reacquire the applicable debt instrument and the denominator of which is the total proceeds of the debt instrument. However, if the total amount of OID that accrues before the inclusion period is greater than the total amount of deferred COD income under section 108(i), then the OID deductions are disallowed in the order in which the OID is accrued, subject to the total amount of deferred COD income. E. Acceleration Events for Deferred OID Deductions The temporary regulations provide rules for the acceleration of deferred OID deductions by an issuer that is a C corporation (C corporation issuer). The IRS and Treasury Department believe that it is appropriate to accelerate deferred OID deductions with respect to a debt instrument when the corresponding deferred COD income is taken into account. Accordingly, these temporary regulations provide that all or a portion of a C corporation issuer’s deferred OID deductions with respect to a debt instrument are taken into account to the extent that an electing entity or its owners include all or a portion of the deferred COD income to which the C corporation issuer’s deferred OID deductions relate. These temporary regulations also include special rules to accelerate a C corporation issuer’s remaining deferred OID deductions even though the deferred COD income to which it relates continues to be deferred. Under these rules, a C corporation issuer takes into account all of its remaining deferred OID deductions if the issuer (i) changes its tax status, or (ii) ceases to exist in a transaction to which section 381(a) does not apply, taking into account the application of § 1.1502–34. See § 1.1502–80(g). With respect to all taxpayers with deferred OID deductions, the temporary regulations also provide that any PO 00000 Frm 00050 Fmt 4700 Sfmt 4700 remaining deferred OID deductions are not accelerated solely by reason of the retirement of any debt instrument subject to section 108(i)(2). V. Effective/Applicability Dates In general, the rules regarding deferred COD income and the calculation of earnings and profits apply to reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. In addition, the rules regarding deferred OID deductions generally apply to debt instruments issued after December 31, 2008 in connection with the reacquisition of an applicable debt instrument. However, the rules with respect to the acceleration of deferred COD income and deferred OID deductions apply prospectively to acceleration events occurring on or after August 11, 2010. Electing corporations and C corporation issuers are given the option to apply these rules to all acceleration events occurring prior to August 11, 2010 by taking a return position consistent with these provisions. In the case of a consolidated group, this option is available only if the acceleration rules are applied to all acceleration events with respect to all members of the group. In addition, certain transitional rules are provided in order to allow electing corporations the ability to use provisions in the acceleration rules that are time sensitive. To the extent an electing corporation or C corporation issuer does not apply these acceleration rules to acceleration events occurring prior to August 11, 2010, then all deferred items are subject to the rules of section 108(i)(5)(D)(i). Comments The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in the Proposed Rules section in this issue of the Federal Register. Please see the ‘‘Comments and Requests for a Public Hearing’’ section of the notice of proposed rulemaking for the procedures to follow in submitting comments on the proposed regulations on this subject. Special Analyses It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the cross-referenced notice of proposed rulemaking published in E:\FR\FM\13AUR1.SGM 13AUR1 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations the Proposed Rules section in this issue of the Federal Register. Pursuant to section 7805(f) of the Code, these regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business. Section 108(i) applies to the reacquisition of an applicable debt instrument during the brief election period, January 1, 2009 through December 31, 2010. These temporary regulations provide necessary guidance regarding the application of this new section 108(i) in order for corporations to timely file their tax returns. For this reason, it has been determined pursuant to 5 U.S.C. 553(b)(3)(B), that prior notice and public procedure are impracticable and contrary to the public interest. For the same reason, it has been determined pursuant to 5 U.S.C. 553(d)(3) that good cause exists for not delaying the effective date of these temporary regulations. Drafting Information The principal authors of these regulations are Robert M. Rhyne and Rubin B. Ranat of the Office of Associate Chief Counsel (Corporate). Other personnel from the IRS and Treasury Department participated in their development. List of Subjects 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. 26 CFR Part 602 Reporting and recordkeeping requirements. Amendments to the Regulations Accordingly, 26 CFR parts 1 and 602 are amended as follows: ■ PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding the entry for § 1.108(i)–0T, § 1.108(i)–1T, and § 1.108(i)–3T, to read, in part, as follows: ■ erowe on DSK5CLS3C1PROD with RULES Authority: 26 U.S.C. 7805 * * * Section 1.108(i)–0T also issued under 26 U.S.C. 108(i)(7) and 1502. * * * Section 1.108(i)–1T also issued under 26 U.S.C. 108(i)(7) and 1502. * * * Section 1.108(i)–3T also issued under 26 U.S.C. 108(i)(7) and 1502. * * * Par. 2. Section 1.108(i)–0T is added to read as follows: ■ § 1.108(i)–0T Definitions (temporary). (a) Definitions. For purposes of regulations under section 108(i)— VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 (1) Acquisition. An acquisition, with respect to any applicable debt instrument, includes an acquisition of the debt instrument for cash or other property, the exchange of the debt instrument for another debt instrument (including an exchange resulting from a modification of the debt instrument), the exchange of the debt instrument for corporate stock or a partnership interest, the contribution of the debt instrument to capital, the complete forgiveness of the indebtedness by the holder of the debt instrument, and a direct or an indirect acquisition within the meaning of § 1.108–2; (2) Applicable debt instrument. An applicable debt instrument is a debt instrument that was issued by a C corporation or any other person in connection with the conduct of a trade or business by such person. In the case of an intercompany obligation (as defined in § 1.1502–13(g)(2)(ii)), applicable debt instrument includes only an instrument for which COD income is realized upon the instrument’s deemed satisfaction under § 1.1502–13(g)(5); (3) C corporation issuer. C corporation issuer means a C corporation that issues a debt instrument with any deferred OID deduction; (4) C corporation partner. A C corporation partner is a C corporation that is a direct or indirect partner of an electing partnership or a related partnership; (5) COD income. COD income means income from the discharge of indebtedness, as determined under sections 61(a)(12) and 108(a) and the regulations under those sections; (6) COD income amount. A COD income amount is a partner’s distributive share of COD income with respect to an applicable debt instrument of an electing partnership; (7) Debt instrument. Debt instrument means a bond, debenture, note, certificate, or any other instrument or contractual arrangement constituting indebtedness (within the meaning of section 1275(a)(1)); (8) Deferral period. For a reacquisition that occurs in 2009, deferral period means the taxable year of the reacquisition and the four taxable years following such taxable year. For a reacquisition that occurs in 2010, deferral period means the taxable year of the reacquisition and the three taxable years following such taxable year; (9) Deferred amount. A deferred amount is the portion of a partner’s COD income amount with respect to an applicable debt instrument that is deferred under section 108(i); PO 00000 Frm 00051 Fmt 4700 Sfmt 4700 49401 (10) Deferred COD income. Deferred COD income means COD income that is deferred under section 108(i); (11) Deferred item. A deferred item is any item of deferred COD income or deferred OID deduction that has not been previously taken into account under section 108(i); (12) Deferred OID deduction. A deferred OID deduction means an otherwise allowable deduction for OID that is deferred under section 108(i)(2) with respect to a debt instrument issued (or treated as issued under section 108(e)(4)) in a debt-for-debt exchange described in section 108(i)(2)(A) or a deemed debt-for-debt exchange described in § 1.108(i)–3T(a); (13) Deferred section 465 amount. A deferred section 465 amount is described in paragraph (d)(3) of § 1.108(i)–2T; (14) Deferred section 752 amount. A deferred section 752 amount is described in paragraph (b)(3) of § 1.108(i)–2T; (15) Direct partner. A direct partner is a person that owns a direct interest in a partnership; (16) Electing corporation. An electing corporation is a C corporation with deferred COD income by reason of a section 108(i) election; (17) Electing entity. An electing entity is an entity that is a taxpayer that makes an election under section 108(i); (18) Electing member. An electing member is an electing corporation that is a member of an affiliated group that files a consolidated return; (19) Electing partnership. An electing partnership is a partnership that makes an election under section 108(i); (20) Electing S corporation. An electing S corporation is an S corporation that makes an election under section 108(i); (21) Included amount. An included amount is the portion of a partner’s COD income amount with respect to an applicable debt instrument that is not deferred under section 108(i) and is included in the partner’s distributive share of partnership income for the taxable year of the partnership in which the reacquisition occurs; (22) Inclusion period. The inclusion period is the five taxable years following the last taxable year of the deferral period; (23) Indirect partner. An indirect partner is a person that owns an interest in a partnership through an S corporation and/or one or more partnerships; (24) Issuing entity. An issuing entity is any entity that is— (i) A related partnership; (ii) A related S corporation; E:\FR\FM\13AUR1.SGM 13AUR1 erowe on DSK5CLS3C1PROD with RULES 49402 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations (iii) An electing partnership that issues a debt instrument (or is treated as issuing a debt instrument under section 108(e)(4)) in a debt-for-debt exchange described in section 108(i)(2)(A) or a deemed debt-for-debt exchange described in § 1.108(i)–3T(a); or (iv) An electing S corporation that issues a debt instrument (or is treated as issuing a debt instrument under section 108(e)(4)) in a debt-for-debt exchange described in section 108(i)(2)(A) or a deemed debt-for-debt exchange described in § 1.108(i)–3T(a); (25) OID. OID means original issue discount, as determined under sections 1271 through 1275 (and the regulations under those sections). If the amount of OID with respect to a debt instrument is less than a de minimis amount as determined under § 1.1273–1(d), the OID is treated as zero for purposes of section 108(i)(2); (26) Reacquisition. A reacquisition, with respect to any applicable debt instrument, is any event occurring after December 31, 2008 and before January 1, 2011, that causes COD income with respect to such applicable debt instrument, including any acquisition of the debt instrument by the debtor that issued (or is otherwise the obligor under) the debt instrument or a person related to such debtor (within the meaning of section 108(i)(5)(A)); (27) Related partnership. A related partnership is a partnership that is related to the electing entity (within the meaning of section 108(i)(5)(A)) and that issues a debt instrument in a debt-fordebt exchange described in section 108(i)(2)(A) or a deemed debt-for-debt exchange described in § 1.108(i)–3T(a); (28) Related S corporation. A related S corporation is an S corporation that is related to the electing entity (within the meaning of section 108(i)(5)(A)) and that issues a debt instrument in a debt-fordebt exchange described in section 108(i)(2)(A) or a deemed debt-for-debt exchange described in § 1.108(i)–3T(a); (29) Separate interest. A separate interest is a direct interest in an electing partnership or in a partnership or S corporation that is a direct or indirect partner of an electing partnership; (30) S corporation partner. An S corporation partner is an S corporation that is a direct or indirect partner of an electing partnership or a related partnership. (b) Effective/Applicability dates—(1) In general. This section, § 1.108(i)–2T, and, except as provided in paragraph (b)(2) of this section, § 1.108(i)–1T apply to reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. In addition, § 1.108(i)–3T applies to debt VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 instruments issued after December 31, 2008, in connection with reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. (2) Acceleration events—(i) In general. Section 1.108(i)–1T(b) (acceleration rules) generally applies to acceleration events occurring on or after August 11, 2010 However, an electing corporation or C corporation issuer may apply the acceleration rules to all acceleration events occurring prior to August 11, 2010 by taking a return position consistent with these provisions beginning with the first acceleration event occurring prior to August 11, 2010. Also, in the case of a consolidated group, if the common parent of the consolidated group applies the acceleration rules on behalf of one member of the consolidated group, then the common parent must apply the acceleration rules to all acceleration events with respect to all members of the group. If the electing corporation, common parent (under the preceding sentence), or C corporation issuer, as the case may be, does not apply the acceleration rules to all acceleration events occurring prior to August 11, 2010, then it is, with respect to all deferred items, subject to the rules of section 108(i)(5)(D)(i). (3) Transitional rules—(i) Net value acceleration rule and corrective action to restore net value rule. If an electing corporation applies the acceleration rules of § 1.108(i)–1T(b) to all acceleration events occurring prior to August 11, 2010 and the due date of its tax return (including extensions) for the taxable year of the mandatory acceleration event occurs prior to August 11, 2010, then for purposes of the net value acceleration rule described in § 1.108(i)–1T(b)(2)(iii), an electing corporation may restore value by the fifteenth day of the ninth month following August 11, 2010. (ii) Elective acceleration. If an electing member cannot timely file an election under § 1.108(i)–1T(b)(3) to accelerate its remaining deferred COD income by the due date of the electing member’s tax return (including extensions) which occurs prior to August 11, 2010, then an amended return must be filed with the required information statement by the fifteenth day of the ninth month following August 11, 2010. Par. 3. Section 1.108(i)–1T is added to read as follows: ■ PO 00000 Frm 00052 Fmt 4700 Sfmt 4700 § 1.108(i)–1T Deferred discharge of indebtedness income and deferred original issue discount deductions of C corporations (temporary). (a) Overview. Section 108(i)(1) provides an election for the deferral of COD income arising in connection with the reacquisition of an applicable debt instrument. An electing corporation generally includes deferred COD income ratably over the inclusion period. Paragraph (b) of this section provides rules for the mandatory acceleration of an electing corporation’s remaining deferred COD income, the mandatory acceleration of a C corporation issuer’s deferred OID deductions, and for the elective acceleration of an electing member’s (other than the common parent’s) remaining deferred COD income. Paragraph (c) of this section provides examples illustrating the application of the mandatory and elective acceleration rules. Paragraph (d) of this section provides rules for the computation of an electing corporation’s earnings and profits. Paragraph (e) of this section refers to the effective/ applicability dates. (b) Acceleration events—(1) Deferred COD income. Except as otherwise provided in paragraphs (b)(2) and (3) of this section, and § 1.108(i)–2T(b)(6) (in the case of a corporate partner), an electing corporation’s deferred COD income is taken into account ratably over the inclusion period. (2) Mandatory acceleration events. An electing corporation takes into account all of its remaining deferred COD income, including its share of an electing partnership’s deferred COD income, immediately before the occurrence of any one of the events described in this paragraph (b)(2) (mandatory acceleration events). (i) Changes in tax status. The electing corporation changes its tax status. For purposes of the preceding sentence, an electing corporation is treated as changing its tax status if it becomes one of the following entities: (A) A tax-exempt entity as defined in § 1.337(d)–4(c)(2). (B) An S corporation as defined in section 1361(a)(1). (C) A qualified subchapter S subsidiary as defined in section 1361(b)(3)(B). (D) An entity operating on a cooperative basis within the meaning of section 1381. (E) A regulated investment company (RIC) as defined in section 851 or a real estate investment trust (REIT) as defined in section 856. (F) A qualified REIT subsidiary as defined in section 856(i), but only if the qualified REIT subsidiary was not a E:\FR\FM\13AUR1.SGM 13AUR1 erowe on DSK5CLS3C1PROD with RULES Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations REIT immediately before it became a qualified REIT subsidiary. (ii) Cessation of corporate existence— (A) In general. The electing corporation ceases to exist for Federal income tax purposes. (B) Exception for section 381(a) transactions—(1) In general. The electing corporation is not treated as ceasing to exist and is not required to take into account its remaining deferred COD income solely because its assets are acquired in a transaction to which section 381(a) applies. In such a case, the acquiring corporation succeeds to the electing corporation’s remaining deferred COD income and becomes subject to section 108(i) and the regulations thereunder, including all reporting requirements, as if the acquiring corporation were the electing corporation. A transaction is not treated as one to which section 381(a) applies for purposes of this paragraph (b)(2)(ii)(B) in any one of the following circumstances: (i) The acquisition of the assets of an electing corporation by an S corporation, if the acquisition is described in section 1374(d)(8). (ii) The acquisition of the assets of an electing corporation by a RIC or REIT, if the acquisition is described in § 1.337(d)–7(a)(2)(ii). (iii) The acquisition of the assets of a domestic electing corporation by a foreign corporation. (iv) The acquisition of the assets of a foreign electing corporation by a domestic corporation, if as a result of the transaction, one or more exchanging shareholders include in income as a deemed dividend all the earnings and profits amount with respect to stock in the foreign electing corporation pursuant to § 1.367(b)–3(b)(3). (v) The acquisition of the assets of an electing corporation by a tax-exempt entity as defined in § 1.337(d)–4(c)(2). (vi) The acquisition of the assets of an electing corporation by an entity operating on a cooperative basis within the meaning of section 1381. (2) Special rules for consolidated groups—(i) Liquidations. For purposes of paragraph (b)(2)(ii)(B) of this section, the acquisition of assets by distributee members of a consolidated group upon the liquidation of an electing corporation is not treated as a transaction to which section 381(a) applies, unless immediately prior to the liquidation, one of the distributee members owns stock in the electing corporation meeting the requirements of section 1504(a)(2) (without regard to § 1.1502–34). See § 1.1502–80(g). (ii) Taxable years. In the case of an intercompany transaction to which VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 section 381(a) applies, the transaction does not cause the transferor or distributor to have a short taxable year for purposes of determining the taxable year of the deferral and inclusion period. (iii) Net value acceleration rule—(A) In general. The electing corporation engages in an impairment transaction and, immediately after the transaction, the gross value of the electing corporation’s assets (gross asset value) is less than one hundred and ten percent of the sum of its total liabilities and the tax on the net amount of its deferred items (the net value floor) (the net value acceleration rule). Impairment transactions are any transactions, however effected, that impair an electing corporation’s ability to pay the amount of Federal income tax liability on its deferred COD income and include, for example, distributions (including section 381(a) transactions), redemptions, below-market sales, charitable contributions, and the incurrence of additional indebtedness without a corresponding increase in asset value. Value-for-value sales or exchanges (for example, an exchange to which section 351 or section 721 applies), or mere declines in the market value of the electing corporation’s assets are not impairment transactions. In addition, an electing corporation’s investments and expenditures in pursuance of its good faith business judgment are not impairment transactions. For purposes of determining an electing corporation’s gross asset value, the amount of any distribution that is not treated as an impairment transaction under paragraph (b)(2)(iii)(D) of this section (distribution consistent with historical practice) or under paragraph (b)(2)(iii)(E) of this section (special rules for RICs and REITs) is treated as an asset of the electing corporation. Solely for purposes of computing the amount of the net value floor, the tax on the deferred items is determined by applying the highest rate of tax specified in section 11(b) for the taxable year. (B) Transactions integrated. Any transaction that occurs before the reacquisition of an applicable debt instrument, but that occurs pursuant to the same plan as the reacquisition, is taken into account in determining whether the gross asset value of the electing corporation is less than the net value floor. (C) Corrective action to restore net value. An electing corporation is not required to take into account its deferred COD income under the net value acceleration rule of paragraph (b)(2)(iii)(A) of this section if, before the PO 00000 Frm 00053 Fmt 4700 Sfmt 4700 49403 due date of the electing corporation’s return (including extensions), value is restored in a transaction in an amount equal to the lesser of— (1) The amount of value that was removed from the electing corporation in one or more impairment transactions (net of amounts previously restored under this paragraph (b)(2)(iii)(C)); or (2) The amount by which the electing corporation’s net value floor exceeds its gross asset value. For purposes of this paragraph (b)(2)(iii)(C), for example, assume an electing corporation incurs $50 of debt, distributes the $50 of proceeds to its shareholder, and immediately after the distribution, the electing corporation’s gross asset value is below the net value floor by $25. The electing corporation may avoid the inclusion of its remaining deferred COD income if value of at least $25 is restored to it before the due date of the electing corporation’s tax return (including extensions) for the taxable year that includes the distribution. The value that must be restored is determined at the time of the impairment transaction on a net value basis (for example, additional borrowings by an electing corporation do not restore value). (D) Exceptions for distributions and charitable contributions that are consistent with historical practice. An electing corporation’s distributions are not treated as impairment transactions (and are not taken into account as a reduction of the electing corporation’s gross asset value when applying the net value acceleration rule to any impairment transaction), to the extent that the distributions are described in section 301(c) and the amount of these distributions, in the aggregate, for the applicable taxable year (applicable distribution amount) does not exceed the annual average amount of section 301(c) distributions over the preceding three taxable years (average distribution amount). If an electing corporation’s applicable distribution amount exceeds its average distribution amount (excess amount), then the amount of the impairment transaction equals the excess amount. Appropriate adjustments must be made to take into account any issuances or redemptions of stock, or similar transactions, occurring during the year of distribution or any of the three preceding years. If the electing corporation has a short taxable year for the year of the distribution or for any of the three preceding years, the amounts are determined on an annualized basis. If an electing corporation has been in existence for less than three years, the period during which the electing corporation has been in existence is E:\FR\FM\13AUR1.SGM 13AUR1 erowe on DSK5CLS3C1PROD with RULES 49404 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations substituted for the three preceding taxable years. For purposes of determining an electing corporation’s average distribution amount, the electing corporation does not take into account the distribution history of a distributor or transferor in a transaction to which section 381(a) applies (other than a transaction described in section 368(a)(1)(F)). Rules similar to those prescribed in this paragraph (b)(2)(iii)(D) also apply to an electing corporation’s charitable contributions (within the meaning of section 170(c)) that are consistent with its historical practice. (E) Special rules for RICs and REITs— (1) Distributions. Notwithstanding paragraph (b)(2)(iii)(D) of this section, in the case of a RIC or REIT, any distribution with respect to stock that is treated as a dividend under section 852 or 857 is not treated as an impairment transaction (and is not taken into account as a reduction in gross asset value when applying the net value acceleration rule to any impairment transaction). (2) Redemptions by RICs. Any redemption of a redeemable security, as defined in 15 U.S.C. section 80a– 2(a)(32), by a RIC in the ordinary course of business is not treated as an impairment transaction (and is not taken into account as a reduction in gross asset value when applying the net value acceleration rule to any impairment transaction). (F) Special rules for consolidated groups—(1) Impairment transactions and net value acceleration rule. In the case of an electing member, the determination of whether the member has engaged in an impairment transaction is made on a group-wide basis. An electing member is treated as engaging in an impairment transaction if any member’s transaction impairs the group’s ability to pay the tax liability associated with all electing members’ deferred COD income. Accordingly, intercompany transactions are not impairment transactions. Similarly, the net value acceleration rule is applied by reference to the gross asset value of all members (excluding stock of members whether or not described in section 1504(a)(4)), the liabilities of all members, and the tax on all members’ deferred items. For example, assume P is the common parent of the P–S consolidated group, S has a section 108(i) election in effect, and S makes a $100 distribution to P which, on a separate entity basis, would reduce S’s gross asset value below the net value floor. S’s intercompany distribution to P is not an impairment transaction. However, if P makes a $100 distribution VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 to its shareholder, P’s distribution is an impairment transaction (unless the distribution is consistent with its historical practice under paragraph (b)(2)(iii)(D) of this section), and the net value acceleration rule is applied by reference to the assets, liabilities, and deferred items of the P–S group. (2) Departing member. If an electing member that previously engaged in one or more impairment transactions on a separate entity basis ceases to be a member of a consolidated group (departing member), the cessation is treated as an impairment transaction and the net value acceleration rule under paragraph (b)(2)(iii)(A) of this section is applied to the departing member on a separate entity basis immediately after ceasing to be a member (and taking into account the impairment transaction(s) that occurred on a separate entity basis). If the departing member’s gross asset value is below the net value floor, the departing member’s remaining deferred COD income is taken into account immediately before the departing member ceases to be a member (unless value is restored under paragraph (b)(2)(iii)(C) of this section). If the departing member’s deferred COD income is not accelerated, the departing member is subject to the reporting requirements of section 108(i) on a separate entity basis. If the departing member becomes a member of another consolidated group, the cessation is treated as an impairment transaction and the net value acceleration rule under paragraph (b)(2)(iii)(A) of this section is applied by reference to the assets, liabilities, and the tax on deferred items of the members of the acquiring group immediately after the transaction. If the acquiring group’s gross asset value is below the net value floor, the departing member’s remaining deferred COD income is taken into account immediately before the departing member ceases to be a member (unless value is restored under paragraph (b)(2)(iii)(C) of this section). If the departing member’s remaining deferred COD income is not accelerated, the common parent of the acquiring group succeeds to the reporting requirements of section 108(i) with respect to the departing member. (3) Elective acceleration for certain consolidated group members—(i) In general. An electing member (other than the common parent) of a consolidated group may elect at any time to accelerate in full (and not in part) the inclusion of its remaining deferred COD income with respect to all applicable debt instruments by filing a statement described in paragraph (b)(3)(ii) of this PO 00000 Frm 00054 Fmt 4700 Sfmt 4700 section. Once made, an election to accelerate deferred COD income under this paragraph (b)(3) is irrevocable. (ii) Time and manner for making election—(A) In general. The election to accelerate the inclusion of an electing member’s remaining deferred COD income with respect to all applicable debt instruments is made on a statement attached to a timely filed tax return (including extensions) for the year in which the deferred COD income is taken into account. The election is made by the common parent on behalf of the electing member. See § 1.1502–77(a). (B) Additional information. The statement must include— (1) Label. A label entitled ‘‘SECTION 1.108(i)–1T ELECTION AND INFORMATION STATEMENT BY [INSERT NAME AND EMPLOYER IDENTIFICATION NUMBER OF THE ELECTING MEMBER]’’; and (2) Required information. An identification of each applicable debt instrument to which an election under this paragraph (b)(3) applies and the corresponding amount of— (i) Deferred COD income that is accelerated under this paragraph (b)(3); and (ii) Deferred OID deductions that are accelerated under paragraph (b)(4) of this section. (4) Deferred OID deductions—(i) In general. Except as otherwise provided in paragraph (b)(4)(ii) of this section and § 1.108(i)–2T(b)(6) (in the case of a C corporation partner), a C corporation issuer’s deferred OID deductions are taken into account ratably over the inclusion period. (ii) OID acceleration events. A C corporation issuer takes into account all of its remaining deferred OID deductions with respect to a debt instrument immediately before the occurrence of any one of the events described in this paragraph (b)(4)(ii). (A) Inclusion of deferred COD income. An electing entity or its owners take into account all of the remaining deferred COD income to which the C corporation issuer’s deferred OID deductions relate. If, under § 1.108(i)– 2T(b) or (c), an electing entity or its owners take into account only a portion of the deferred COD income to which the deferred OID deductions relate, then the C corporation issuer takes into account a proportionate amount of the remaining deferred OID deductions. (B) Changes in tax status. The C corporation issuer changes its tax status within the meaning of paragraph (b)(2)(i) of this section. (C) Cessation of corporate existence— (1) In general. The C corporation issuer E:\FR\FM\13AUR1.SGM 13AUR1 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations erowe on DSK5CLS3C1PROD with RULES ceases to exist for Federal income tax purposes. (2) Exception for section 381(a) transactions—(i) In general. A C corporation issuer is not treated as ceasing to exist and does not take into account its remaining deferred OID deductions in a transaction to which section 381(a) applies, taking into account the application of § 1.1502–34, as appropriate. See § 1.1502–80(g). This exception does not apply to a transaction which is not treated as one to which section 381(a) applies under paragraph (b)(2)(iii)(B)(1) of this section. (ii) Taxable years. In the case of an intercompany transaction to which section 381(a) applies, the transaction does not cause the transferor or distributor to have a short taxable year for purposes of determining the taxable year of the deferral and inclusion period. (c) Examples. The application of this section is illustrated by the following examples. Unless otherwise stated, P, S, S1, and X are domestic C corporations, and each files a separate return on a calendar year basis: Example 1. Net value acceleration rule. (i) Facts. On January 1, 2009, S reacquires its own note and realizes $400 of COD income. Pursuant to an election under section 108(i), S defers recognition of the entire $400 of COD income. Therefore, absent a mandatory acceleration event, S will take into account $80 of its deferred COD income in each year of the inclusion period. On December 31, 2010, S makes a $25 distribution to its sole shareholder, P, and this is the only distribution made by S in the past four years. Immediately following the distribution, S’s gross asset value is $100, S has no liabilities, and the Federal income tax on S’s $400 of deferred COD income is $140. Accordingly, S’s net value floor is $154 (110% × $140). (ii) Analysis. Under paragraph (b)(2)(iii)(A) of this section, S’s distribution is an impairment transaction. Immediately following the distribution, S’s gross asset value of $100 is less than the net value floor of $154. Accordingly, under the net value acceleration rule of paragraph (b)(2)(iii)(A) of this section, S takes into account its $400 of deferred COD income immediately before the distribution. (iii) Corrective action to restore value. The facts are the same as in paragraph (i) of this Example 1, except that P contributes assets with a value of $25 to S before the due date of S’s 2010 return (including extensions). Because P restores $25 of value to S (the lesser of the amount of value removed in the distribution ($25) or the amount by which S’s net value floor exceeds its gross asset value ($54)), under paragraph (b)(2)(iii)(C) of this section, S does not take into account its $400 of deferred COD income. Example 2. Distributions consistent with historical practice. (i) Facts. P, a publicly traded corporation, makes a valid section 108(i) election with respect to COD income VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 realized in 2009. On December 31, 2009, P distributes $25 million on its 5 million shares of common stock outstanding. As of January 1, 2006, P has 10 million shares of common stock outstanding, and on March 31, 2006, P distributes $10 million on those 10 million shares. On September 15, 2006, P effects a 2:1 reverse stock split, and on December 31, 2006, P distributes $10 million on its 5 million shares of common stock outstanding. In each of 2007 and 2008, P distributes $5 million on its 5 million shares of common stock outstanding. All of the distributions are described in section 301(c). (ii) Amount of impairment transaction. Under paragraph (b)(2)(iii)(D) of this section, P’s 2009 distributions are not treated as impairment transactions (and are not taken into account as a reduction of P’s gross asset value when applying the net value acceleration rule to any impairment transaction), to the extent that the aggregate amount distributed in 2009 (the applicable distribution amount) does not exceed the annual average amount of distributions (the average distribution amount) over the preceding three taxable years. Accordingly, P’s applicable distribution amount for 2009 is $25 million, and its average distribution amount is $10 million ($20 million (2006) plus $5 million (2007) plus $5 million (2008) divided by 3). The reverse stock split in 2006 is not a transaction requiring an adjustment to the determination of the average distribution amount. Because P’s applicable distribution amount of $25 million exceeds its average distribution amount of $10 million, under paragraph (b)(2)(iii)(D) of this section, the amount of P’s 2009 distribution that is treated as an impairment transaction is $15 million. The balance of the 2009 distribution, $10 million, is not treated as an impairment transaction (and is not taken into account as a reduction in P’s gross asset value when applying the net value acceleration rule to any impairment transaction). (iii) Distribution history. The facts are the same as in paragraph (i) of this Example 2, except that in 2010, P merges into X in a transaction to which section 381(a) applies, with X succeeding to P’s deferred COD income, and X makes a distribution to its shareholders. For purposes of determining whether X’s distribution is consistent with its historical practice, the average distribution amount is determined solely with respect to X’s distribution history. Example 3. Cessation of corporate existence. (i) Transaction to which section 381(a) applies. P owns all of the stock of S. In 2009, S reacquires its own note and elects to defer recognition of its $400 of COD income under section 108(i). On December 31, 2010, S liquidates into P in a transaction that qualifies under section 332. Under paragraph (b)(2) of this section, S must take into account all of its remaining deferred COD income upon the occurrence of any one of the mandatory acceleration events. Although S ceases its corporate existence as a result of the liquidation, S is not required to take into account its remaining deferred COD income under the exception in paragraph (b)(2)(ii)(B) of this section because its assets are acquired in a transaction to PO 00000 Frm 00055 Fmt 4700 Sfmt 4700 49405 which section 381(a) applies. However, under paragraph (b)(2)(iii)(A) of this section, S’s distribution to P is an impairment transaction and the net value acceleration rule is applied with respect to the assets, liabilities, and deferred items of P (S’s successor) immediately following the distribution. If S’s deferred COD income is not taken into account under the net value acceleration rule of (b)(2)(iii) of this section, P succeeds to S’s remaining deferred COD income and to S’s reporting requirements as if P were the electing corporation. (ii) Debt-laden distributee. The facts are the same as in paragraph (i) of this Example 3, except that in the liquidation, S distributes $100 of assets to P, a holding company whose only asset is its stock in S. Assume that immediately following the distribution, P’s gross asset value is $100, P has $60 of liabilities, and the Federal income tax on the $400 of deferred COD income is $140. Under paragraph (b)(2) of this section, S must take into account all of its remaining deferred COD income upon the occurrence of any one of the mandatory acceleration events. Although S ceases its corporate existence as a result of the liquidation, S is not required to take into account its remaining deferred COD income under the exception in paragraph (b)(2)(ii)(B) of this section because its assets are acquired in a transaction to which section 381(a) applies. However, under paragraph (b)(2)(iii)(A) of this section, S’s distribution to X is an impairment transaction and the net value acceleration rule is applied with respect to the assets, liabilities, and deferred items of P (S’s successor). Immediately following the distribution, P’s gross asset value of $100 is less than the net value floor of $220 [110% × ($60 + $140)]. Accordingly, under the net value acceleration rule of paragraph (b)(2)(iii)(A) of this section, S is required to take into account its $400 of deferred COD income immediately before the distribution, unless value is restored to P pursuant to (b)(2)(iii)(C) of this section. (iii) Foreign acquirer. The facts are the same as in paragraph (i) of this Example 3, except that P is a foreign corporation. Although S’s assets are acquired in a transaction to which section 381(a) applies, under paragraph (b)(2)(ii)(B)(1)(iii) of this section, the exception to accelerated inclusion does not apply and S takes into account its remaining deferred COD income immediately before the liquidation. See also section 367(e)(2) and the regulations thereunder. (iv) Section 338 transaction. P, the common parent of a consolidated group (P group), owns all the stock of S1, one of the members of the P group. In 2009, S1 reacquires its own indebtedness and realizes $30 of COD income. Pursuant to an election under section 108(i), S1 defers recognition of the entire $30 of COD income. In 2010, P sells all the stock of S1 to X, an unrelated corporation, for $300, and P and X make a timely section 338(h)(10) election with respect to the sale. Under paragraph (b)(2)(ii)(A) of this section, an electing corporation takes into account its remaining deferred COD income when it ceases its existence for Federal income tax purposes E:\FR\FM\13AUR1.SGM 13AUR1 49406 Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations unless the exception in paragraph (b)(2)(ii)(B) of this section applies. Pursuant to section 338(h)(10) and the regulations, S1 is treated as transferring all of its assets to an unrelated person in exchange for consideration that includes the discharge of its liabilities. This deemed value-for-value exchange is not an impairment transaction. Following the deemed sale, while S1 is still a member of the P group, S1 is treated as distributing all of its assets to P and as ceasing its existence. Under these facts, the distribution of all of S1’s assets constitutes a deemed liquidation, and is a transaction to which sections 332 and 381(a) apply. Although S1 ceases its corporate existence as a result of the liquidation, S1 is not required to take into account its remaining deferred COD income under the exception in paragraph (b)(2)(ii)(B) of this section because its assets are acquired in a transaction to which section 381(a) applies. P succeeds to S1’s remaining deferred COD income and to S1’s reporting requirements as if P were the electing corporation. Under paragraph (b)(2)(iii)(F)(1) of this section, the intercompany distribution from S1 to P is not an impairment transaction. erowe on DSK5CLS3C1PROD with RULES (d) Earnings and profits—(1) In general. Deferred COD income increases earnings and profits in the taxable year that it is realized and not in the taxable year or years that the deferred COD income is includible in gross income. Deferred OID deductions decrease earnings and profits in the taxable year or years in which the deduction would be allowed without regard to section 108(i). (2) Exceptions—(i) RICs and REITs. Notwithstanding paragraph (d)(1) of this section, deferred COD income increases earnings and profits of a RIC or REIT in the taxable year or years in which the deferred COD income is includible in gross income and not in the year that the deferred COD income is realized. Deferred OID deductions decrease earnings and profits of a RIC or REIT in the taxable year or years that the deferred OID deductions are deductible. (ii) Alternative minimum tax. For purposes of calculating alternative minimum taxable income, any items of deferred COD income or deferred OID deduction increase or decrease, respectively, adjusted current earnings under section 56(g)(4) in the taxable year or years that the item is includible or deductible. (e) Effective/applicability dates. For effective/applicability dates, see § 1.108(i)–0T(b). (f) Expiration date. This section expires August 9, 2013. Par. 4. Section 1.108(i)–3T is added to read as follows: ■ § 1.108(i)–3T Rules for the deduction of OID (temporary). (a) Deemed debt-for-debt exchanges— (1) In general. For purposes of section VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 108(i)(2) (relating to deferred OID deductions that arise in certain debt-fordebt exchanges involving the reacquisition of an applicable debt instrument), if the proceeds of any debt instrument are used directly or indirectly by the issuer or a person related to the issuer (within the meaning of section 108(i)(5)(A)) to reacquire an applicable debt instrument, the debt instrument shall be treated as issued for the applicable debt instrument being reacquired. Therefore, section 108(i)(2) may apply, for example, to a debt instrument issued by a corporation for cash in which some or all of the proceeds are used directly or indirectly by the corporation’s related subsidiary in the reacquisition of the subsidiary’s applicable debt instrument. (2) Directly or indirectly. Whether the proceeds of an issuance of a debt instrument are used directly or indirectly to reacquire an applicable debt instrument depends upon all of the facts and circumstances surrounding the issuance and the reacquisition. The proceeds of an issuance of a debt instrument will be treated as being used indirectly to reacquire an applicable debt instrument if— (i) At the time of the issuance of the debt instrument, the issuer of the debt instrument anticipated that an applicable debt instrument of the issuer or a person related to the issuer would be reacquired by the issuer, and the debt instrument would not have been issued if the issuer had not so anticipated such reacquisition; (ii) At the time of the issuance of the debt instrument, the issuer of the debt instrument or a person related to the issuer anticipated that an applicable debt instrument would be reacquired by a related person and the related person receives cash or property that it would not have received unless the reacquisition had been so anticipated; or (iii) At the time of the reacquisition, the issuer or a person related to the issuer foresaw or reasonably should have foreseen that the issuer or a person related to the issuer would be required to issue a debt instrument, which it would not have otherwise been required to issue if the reacquisition had not occurred, in order to meet its future economic needs. (b) Proportional rule for accruals of OID. For purposes of section 108(i)(2), if only a portion of the proceeds from the issuance of a debt instrument are used directly or indirectly to reacquire an applicable debt instrument, the rules of section 108(i)(2)(A) will apply to the portion of OID on the debt instrument that is equal to the portion of the proceeds from such instrument used to PO 00000 Frm 00056 Fmt 4700 Sfmt 4700 reacquire the outstanding applicable debt instrument. Except as provided in the last sentence of section 108(i)(2)(A), the amount of deferred OID deduction that is subject to section 108(i)(2)(A) for a taxable year is equal to the product of the amount of OID that accrues in the taxable year under section 1272 or section 1275 (and the regulations under those sections), whichever section is applicable, and a fraction, the numerator of which is the portion of the total proceeds from the issuance of the debt instrument used directly or indirectly to reacquire the applicable debt instrument and the denominator of which is the total proceeds from the issuance of the debt instrument. (c) No acceleration—(1) Retirement. Retirement of a debt instrument subject to section 108(i)(2) does not accelerate deferred OID deductions. (2) Cross-reference. See § 1.108(i)–1T and § 1.108(i)–2T for rules relating to the acceleration of deferred OID deductions. (d) Examples. The application of this section is illustrated by the following examples. Unless otherwise stated, all taxpayers in the following examples are calendar-year taxpayers, and P and S each file separate returns: Example 1. (i) Facts. P, a domestic corporation, owns all of the stock of S, a domestic corporation. S has a debt instrument outstanding that has an adjusted issue price of $100,000. On January 1, 2010, P issues for $160,000 a four-year debt instrument that has an issue price of $160,000 and a stated redemption price at maturity of $200,000, resulting in $40,000 of OID. In P’s discussion with potential lenders/ holders, and as described in offering materials provided to potential lenders/ holders, P disclosed that it planned to use all or a portion of the proceeds from the issuance of the debt instrument to reacquire outstanding debt of P and its affiliates. Following the issuance, P makes a $70,000 capital contribution to S. S then reacquires its debt instrument from X, a person not related to S within the meaning of section 108(i)(5)(A), for $70,000. At the time of the reacquisition, the adjusted issue price of S’s debt instrument is $100,000. Under § 1.61– 12(c), S realizes $30,000 of COD income. S makes a section 108(i) election for the $30,000 of COD income. (ii) Analysis. Under the facts, at the time of P’s issuance of its $160,000 debt instrument, P anticipated that the loan proceeds would be used to reacquire the debt of S, and P’s debt instrument would not have been issued for an amount greater than $90,000 if P had not anticipated that S would use the proceeds to reacquire its debt. Pursuant to paragraph (a) of this section, the proceeds from P’s issuance of its debt instrument are treated as being used indirectly to reacquire S’s applicable debt instrument. Therefore, section 108(i)(2)(B) applies to P’s debt instrument and P’s OID E:\FR\FM\13AUR1.SGM 13AUR1 erowe on DSK5CLS3C1PROD with RULES Federal Register / Vol. 75, No. 156 / Friday, August 13, 2010 / Rules and Regulations deductions on its debt instrument are subject to deferral under section 108(i)(2)(A). However, because only a portion of the proceeds from P’s debt instrument are used by S to reacquire its applicable debt instrument, only a portion of P’s total OID deductions will be deferred under section 108(i)(2)(A). See section 108(i)(2)(B). Accordingly, a maximum of $17,500 ($40,000 × $70,000/$160,000) of P’s $40,000 total OID deductions is subject to deferral under section 108(i)(2)(A). Under paragraph (b) of this section, the amount of P’s deferred OID deduction each taxable year under section 108(i)(2)(A) is equal to the product of the amount of OID that accrues in the taxable year under section 1272 for the debt instrument and a fraction ($70,000/ $160,000). As a result, P’s deferred OID deductions are the following amounts: $4,015.99 for 2010 ($ 9,179.40 × $70,000/ $160,000); $4,246.39 for 2011 ($9,706.04 × $70,000/$160,000); $4,490.01 for 2012 ($10,262.88 × $70,000/$160,000); and $4,747.61 for 2013 ($10,851.68 × $70,000/ $160,000). Example 2. (i) Facts. The facts are the same as in Example 1, except that S makes a section 108(i) election for only $10,000 of the $30,000 of COD income. (ii) Analysis. The maximum amount of P’s deferred OID deductions under section 108(i)(2)(A) is $10,000 rather than $17,500 because S made a section 108(i) election for only $10,000 of the $30,000 of COD income. Under section 108(i)(2)(A), because the amount of OID that accrues prior to 2014 attributable to the portion of the debt instrument issued to indirectly reacquire S’s applicable debt instrument under paragraph (b) of this section ($17,500) exceeds the amount of deferred COD income under section 108(i) ($10,000), P’s deferred OID deductions are the following amounts: $4,015.99 for 2010; $4,246.39 for 2011; $1,737.62 for 2012; and $0 for 2013. Example 3. (i) Facts. The facts are the same as in Example 1, except that P pays $200,000 in cash to the lenders/holders on December 31, 2012, to retire the debt instrument. P did not directly or indirectly obtain the funds to retire the debt instrument from the issuance of another debt instrument with OID. (ii) Analysis. Under paragraph (c)(1) of this section, the retirement of P’s debt instrument is not an acceleration event for the deferred OID deductions of $4,015.99 for 2010, $4,246.39 for 2011, and $4,490.01 for 2012. Except as provided in § 1.108(i)–1T(b)(4), these amounts will be taken into account during the inclusion period. P, however, paid a repurchase premium of $10,851.68 in 2012 ($200,000 minus the adjusted issue price of $189,148.32) to retire the debt instrument. If otherwise allowable, P may deduct this amount in 2012 under § 1.163–7(c). (e) Effective/applicability dates. For effective/applicability dates, see § 1.108(i)–0T(b). (f) Expiration date. This section expires August 9, 2013. VerDate Mar<15>2010 15:00 Aug 12, 2010 Jkt 220001 49407 NW., Washington, DC 20005, 202–326– 4024. (TTY/TDD users may call the Federal relay service toll-free at 1–800– 877–8339 and ask to be connected to ■ Par. 5.The authority citation for part 202–326–4024.) 602 continues to read as follows: SUPPLEMENTARY INFORMATION: PBGC’s regulations prescribe actuarial Authority: 26 U.S.C. 7805. assumptions—including interest ■ Par. 6. In § 602.101, paragraph (b) is assumptions—for valuing and paying amended by adding the following entry plan benefits of terminating singlein numerical order to the table to read employer plans covered by title IV of as follows: the Employee Retirement Income Security Act of 1974. The interest § 602.101 OMB Control numbers. assumptions are intended to reflect * * * * * current conditions in the financial and (b) * * * annuity markets. These interest assumptions are found CFR part or section where Current OMB in two PBGC regulations: The regulation identified and described control No. on Benefits Payable in Terminated Single-Employer Plans (29 CFR part 4022) and the regulation on Allocation * * * * * 1.108(i)–1T ........................... 1545–2147 of Assets in Single-Employer Plans (29 CFR part 4044). Assumptions under the * * * * * asset allocation regulation are updated quarterly; assumptions under the benefit * * * * * payments regulation are updated monthly. This final rule updates only Steven T. Miller, the assumptions under the benefit Deputy Commissioner for Services and payments regulation. Enforcement. Two sets of interest assumptions are Approved: August 6, 2010. prescribed under the benefit payments Michael Mundaca, regulation: (1) A set for PBGC to use to Assistant Secretary of the Treasury (Tax determine whether a benefit is payable Policy). as a lump sum and to determine lump[FR Doc. 2010–20060 Filed 8–11–10; 11:15 am] sum amounts to be paid by PBGC (found BILLING CODE 4830–01–P in Appendix B to Part 4022), and (2) a set for private-sector pension practitioners to refer to if they wish to use lump-sum interest rates determined PENSION BENEFIT GUARANTY using PBGC’s historical methodology CORPORATION (found in Appendix C to Part 4022). 29 CFR Part 4022 This amendment (1) adds to Appendix B to Part 4022 the interest Benefits Payable in Terminated Single- assumptions for PBGC to use for its own Employer Plans; Interest Assumptions lump-sum payments in plans with for Valuing and Paying Benefits valuation dates during September 2010, and (2) adds to Appendix C to Part 4022 AGENCY: Pension Benefit Guaranty the interest assumptions for privateCorporation. sector pension practitioners to refer to if ACTION: Final rule. they wish to use lump-sum interest rates determined using PBGC’s historical SUMMARY: Pension Benefit Guaranty methodology for valuation dates during Corporation’s regulation on Benefits Payable in Terminated Single-Employer September 2010. The interest assumptions that PBGC Plans prescribes interest assumptions will use for its own lump-sum payments for valuing and paying certain benefits (set forth in Appendix B to Part 4022) under terminating single-employer will be 2.25 percent for the period plans. This final rule amends the benefit during which a benefit is in pay status payments regulation to adopt interest and 4.00 percent during any years assumptions for plans with valuation preceding the benefit’s placement in pay dates in September 2010. Interest status. In comparison with the interest assumptions are also published on assumptions in effect for August 2010, PBGC’s Web site (http://www.pbgc.gov). these interest assumptions are DATES: Effective September 1, 2010. unchanged. For private-sector FOR FURTHER INFORMATION CONTACT: payments, the interest assumptions (set Catherine B. Klion, Manager, Regulatory forth in Appendix C to part 4022) will and Policy Division, Legislative and be the same as those used by PBGC for Regulatory Department, Pension Benefit determining and paying lump sums (set Guaranty Corporation, 1200 K Street, forth in Appendix B to Part 4022). PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT PO 00000 Frm 00057 Fmt 4700 Sfmt 4700 E:\FR\FM\13AUR1.SGM 13AUR1

Agencies

[Federal Register Volume 75, Number 156 (Friday, August 13, 2010)]
[Rules and Regulations]
[Pages 49394-49407]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-20060]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9497]
RIN 1545-BI97


Guidance Regarding Deferred Discharge of Indebtedness Income of 
Corporations and Deferred Original Issue Discount Deductions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains temporary regulations under section 
108(i) of the Internal Revenue Code (Code). These regulations primarily 
affect C corporations regarding the acceleration of deferred discharge 
of indebtedness (COD) income (deferred COD income) and deferred 
original

[[Page 49395]]

issue discount (OID) deductions (deferred OID deductions) under section 
108(i)(5)(D), and the calculation of earnings and profits as a result 
of an election under section 108(i). In addition, these regulations 
provide rules applicable to all taxpayers regarding deferred OID 
deductions under section 108(i) as a result of a reacquisition of an 
applicable debt instrument by an issuer or related party. The text of 
these temporary regulations also serves as the text of proposed 
regulations (REG-142800-09) set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules section in this issue 
of the Federal Register.

DATES: Effective Dates: These regulations are effective on August 11, 
2010.
    Applicability Dates: For dates of applicability, see Sec.  
1.108(i)-0T(b).

FOR FURTHER INFORMATION CONTACT: Concerning the acceleration rules for 
deferred COD income and deferred OID deductions, and the rules for 
earnings and profits, Robert M. Rhyne (202) 622-7790; concerning the 
rules for deferred OID deductions, Rubin B. Ranat (202) 622-7530 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collection of information contained 
in these regulations has been reviewed and, pending receipt and 
evaluation of public comments, approved by the Office of Management and 
Budget under control number 1545-2147. Responses to this collection of 
information are required in order for a member of a consolidated group 
to make the election described in Sec.  1.108(i)-1T(b)(3).
    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.
    For further information concerning this collection of information, 
and where to submit comments on the collection of information and the 
accuracy of the estimated burden, and suggestions for reducing this 
burden, please refer to the preamble to the cross-referencing notice of 
proposed rulemaking on this subject in the Proposed Rules section in 
this issue of the Federal Register.
    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. See 26 U.S.C. 6001. 
Generally, tax returns and tax return information are confidential, as 
required by 26 U.S.C. 6103.

Background

    Under section 61(a)(12), a taxpayer includes in gross income any 
discharge of indebtedness (COD income) if the taxpayer's obligation to 
repay its indebtedness is discharged in whole or in part. Section 108 
provides special rules for the treatment of COD income in certain 
cases.
    Section 108(i) was added to the Code by section 1231 of the 
American Recovery and Reinvestment Tax Act of 2009 (Pub. L. 111-5, 123 
Stat. 338), enacted on February 17, 2009. Section 108(i)(1) provides an 
election for deferral of the inclusion of COD income (deferred COD 
income) arising in connection with the reacquisition after December 31, 
2008, and before January 1, 2011, of an applicable debt instrument. If 
a taxpayer makes the election, the deferred COD income generally is 
includible in gross income ratably over a 5-taxable-year period, 
beginning with the taxpayer's fourth or fifth taxable year following 
the taxable year of the reacquisition (inclusion period). If, as part 
of a reacquisition to which section 108(i)(1) applies, a debt 
instrument is issued (or is treated as issued) for the applicable debt 
instrument and there is any OID with respect to the newly issued debt 
instrument, then the deduction for all or a portion of the OID may be 
deferred (deferred OID deductions) under section 108(i)(2). (See the 
discussion of section 108(i)(2) later in this preamble.)
    An applicable debt instrument means any debt instrument (within the 
meaning of section 1275(a)(1)) issued by a C corporation, or any other 
person in connection with the conduct of a trade or business by such a 
person. Section 108(i)(3). Section 108(i)(4)(A) defines a reacquisition 
as any acquisition of the debt instrument by the debtor which issued 
(or is otherwise the obligor under) the debt instrument, or by a person 
related to the debtor within the meaning of section 108(e)(4). An 
acquisition includes acquisitions for cash or other property, for 
another debt instrument, for corporate stock or a partnership interest, 
or as a contribution of the debt instrument to capital. The term also 
includes the complete forgiveness of the indebtedness by the holder of 
the debt instrument. Section 108(i)(4)(B).
    Section 108(i)(5)(D) requires a taxpayer to accelerate the 
inclusion of any remaining items of deferred COD income or deferred 
(and otherwise allowable) OID deduction (deferred items) under certain 
circumstances, including the death of the taxpayer, the liquidation or 
sale of substantially all the assets of the taxpayer (including in a 
title 11 or similar case), the cessation of business by the taxpayer, 
or similar circumstances. Section 108(i)(7) authorizes the Secretary to 
issue guidance necessary or appropriate for purposes of applying 
section 108(i), including extending the application of the rules of 
section 108(i)(5)(D) to other appropriate circumstances.
    On August 17, 2009, the IRS and Treasury Department issued Rev. 
Proc. 2009-37, 2009-36 IRB 309, providing procedures for taxpayers to 
make a section 108(i) election, and requiring the annual reporting of 
additional information. See Sec.  601.601(d)(2)(ii)(b). The revenue 
procedure also announced the intention to issue additional guidance, 
and that the additional guidance may be retroactive.

Explanation of Provisions

I. Mandatory Acceleration Events for Deferred COD Income

    The IRS and Treasury Department believe that the deferral rules of 
section 108(i) generally are intended to facilitate debt workouts and 
to alleviate taxpayer liquidity concerns by deferring the tax liability 
associated with COD income. These taxpayer-favorable deferral rules are 
tempered, however, by section 108(i)(5)(D), which operates to 
accelerate the inclusion of a taxpayer's remaining deferred COD income 
in the case of the death of the taxpayer, the liquidation or sale of 
substantially all the assets of the taxpayer (including in a title 11 
or similar case), the cessation of business by the taxpayer or similar 
circumstances (acceleration events).
    A common trait of these enumerated acceleration events is that they 
involve situations where collection of the tax liability associated 
with a taxpayer's deferred COD income may be hindered, either because 
the taxpayer has ceased to exist or because the taxpayer has disposed 
of the business to which the COD income relates. Section 108(i) poses 
unique concerns regarding collectability of the incipient tax liability 
associated with deferred COD income. In other contexts in which gain or 
income is deferred, the deferral is generally associated with a 
particular asset or its replacement. For example, gain on the sale of 
an asset under the installment method of accounting is deferred until 
payments are received under the installment obligation, or until the 
taxpayer disposes of the installment obligation. Collectability of

[[Page 49396]]

the tax liability associated with the deferred gain is preserved in 
that context because the taxpayer has either the installment obligation 
or the proceeds therefrom. Section 108(i) deferral, in contrast, is not 
linked to a particular asset or a particular replacement asset. In the 
absence of acceleration events, the government's ability to ensure 
appropriate inclusion of the deferred COD income and the collectability 
of the associated tax liability would be jeopardized.
    The enumerated acceleration events apply, however, to a broad range 
of taxpayers, including individuals and passthrough entities as well as 
corporations. Applied literally, the statutory rules would require 
acceleration in circumstances, such as certain corporate nonrecognition 
transactions, that do not pose particular concerns regarding 
collectability. For example, the statute treats a sale of substantially 
all the assets of the taxpayer as an acceleration event. If construed 
broadly, any asset disposition involving the transfer of substantially 
all of the assets of a corporation that made a section 108(i) election 
(for example, a reorganization exchange described in section 
368(a)(1)(C)) would constitute an acceleration event. However, 
commentators noted that it did not seem consistent with the purposes of 
section 108(i) to require the acceleration of an electing corporation's 
deferred items in the case of a transaction to which section 381(a) 
applies. As discussed further in this preamble, the IRS and Treasury 
Department generally agree.
    The rules provided in these temporary regulations with respect to a 
C corporation with deferred COD income by reason of a section 108(i) 
election (electing corporation) are intended to focus more precisely on 
the underlying purpose of section 108(i)(5)(D) to ensure that the 
government's ability to collect the tax liability associated with the 
deferred COD income is not impaired. Thus, with respect to electing 
corporations, the rules provided in these regulations generally reflect 
a narrower interpretation of the statutory acceleration events.
    In addition, however, the nature of the corporate entity introduces 
concerns not present for other types of taxpayers. In particular, a 
corporation can dissipate its assets (for example, by distributions to 
its shareholders) without harming the economic interests of its 
shareholders. As a result, there may be a greater incentive for the 
owners of a corporation to make the corporation judgment-proof with 
respect to its tax liability. This is illustrated by the intermediary 
transactions described in Notice 2008-111, 2008-2 CB 1299. The IRS and 
Treasury Department believe that the acceleration rules should be 
tailored to foreclose such opportunities.
    Accordingly, while these temporary regulations do not require 
acceleration in every instance enumerated in the statute, they provide 
instead for acceleration in a limited number of circumstances in which 
corporations have impaired their ability to pay their incipient tax 
liability. This approach is broadly consistent with the approach 
advanced by commentators who suggested, for example, that a transfer of 
a corporation's business assets for stock in a section 351 exchange 
should not be an acceleration event, despite the literal language of 
section 108(i)(5)(D).
    Specifically, these temporary regulations generally provide that an 
electing corporation will accelerate deferred COD income under section 
108(i)(5)(D) if the electing corporation (i) changes its tax status, 
(ii) ceases its corporate existence in a transaction to which section 
381(a) does not apply, or (iii) engages in a transaction that impairs 
its ability to pay the tax liability associated with its deferred COD 
income (the net value acceleration rule). Under these temporary 
regulations, the foregoing three rules are the only events that 
accelerate an electing corporation's deferred COD income. In addition 
to these temporary regulations, however, the rules under Sec.  
1.108(i)-2T apply to C corporations that are direct or indirect 
partners of a partnership.
    The acceleration rules provided in these temporary regulations 
generally are different from the rules for passthrough entities. For 
example, a sale of substantially all of the assets of a passthrough 
entity is an acceleration event for an S corporation while that 
transaction, standing alone, is not an acceleration event for an 
electing corporation. The IRS and Treasury Department believe that it 
is appropriate to provide different acceleration rules for passthrough 
entities and electing corporations because the statute requires the 
debt instrument of a passthrough entity to be issued in connection with 
a trade or business. Accordingly, consistent with the trade or business 
requirement, it is appropriate to accelerate the deferred COD income of 
a passthrough entity if the entity sells substantially all of its 
assets.

A. Net Value Acceleration Rule

    Under the net value acceleration rule, an electing corporation 
generally is required to accelerate all of its remaining deferred COD 
income if it engages in an impairment transaction, and immediately 
after the transaction, the value of its assets fails to satisfy a 
minimum threshold (as further described herein). In general, impairment 
transactions are volitional transactions that reduce an electing 
corporation's asset base.
    As provided in these regulations, impairment transactions are any 
transactions, however effected, that impair an electing corporation's 
ability to pay the amount of Federal income tax liability on its 
deferred COD income and include, for example, distributions (including 
section 381(a) transactions), redemptions, below market sales, and 
donations, and the incurrence of additional indebtedness without a 
corresponding increase in asset value. However, value-for-value sales 
or exchanges (including, for example, an exchange to which section 351 
or section 721 applies) are not impairment transactions. The IRS and 
Treasury Department believe that the receipt of replacement assets in 
these cases adequately protects the government's interests and ensures 
continued collectability of any incipient tax liability. Under this 
rule, an electing corporation's investments and expenditures in 
pursuance of its good faith business judgment are not impairment 
transactions, merely because, for example, acquired assets are riskier 
or less liquid than the electing corporation's previous assets. In 
addition, mere declines in the market value of an electing 
corporation's assets are not impairment transactions. Although the 
decline may impair an electing corporation's ability to pay its tax 
liability, a different rule would require continuous valuations and is 
contrary to the transactional approach taken in the statute and these 
regulations, and the realization requirement generally.
    Under the net value acceleration rule, an electing corporation 
generally is required to accelerate its remaining deferred COD income 
if immediately after an impairment transaction, the gross value of the 
corporation's assets (gross asset value) is less than one hundred and 
ten percent of the sum of its total liabilities and the tax on the net 
amount of its deferred items (the net value floor). Solely for purposes 
of computing the net value floor, the tax on the net amount of the 
electing corporation's deferred items is determined by applying the 
highest rate of tax specified in section 11(b) for the taxable year 
(even though the corporation's actual tax rate for the taxable year may 
differ).
    The net value acceleration rule has a mitigating provision that 
allows an

[[Page 49397]]

electing corporation to avoid accelerated inclusion of its deferred COD 
income if value is restored to the corporation by the due date of the 
electing corporation's tax return (including extensions). In general, 
the amount required to be restored is the lesser of: (i) The amount of 
value that was removed (net of amounts previously restored under this 
rule) from the electing corporation in one or more impairment 
transactions; or (ii) the amount by which the electing corporation's 
net value floor exceeds its gross asset value. For example, assume an 
electing corporation incurs $50 of indebtedness, distributes the $50 of 
proceeds to its shareholder, and immediately after the distribution, 
the electing corporation's gross asset value is $25 below the net value 
floor. The electing corporation may avoid application of the net value 
acceleration rule if, as a result of a transaction, assets with a value 
of $25 are restored to the corporation before the due date of its tax 
return (including extensions) for the taxable year that includes the 
distribution. For purposes of this provision, the value that must be 
restored is determined at the time of the impairment transaction, and 
is determined upon a net value basis (for example, additional 
borrowings by an electing corporation do not restore value).
    The IRS and Treasury Department believe that the net value 
acceleration rule is an appropriate interpretation of section 108(i) 
because, consistent with the purpose of facilitating workouts, the rule 
allows electing corporations the flexibility to realign business 
operations through strategic acquisitions and dispositions within the 
objective standard of the net value floor. Although the net value 
acceleration rule contains a valuation component, a valuation will be 
required only if an electing corporation engages in an impairment 
transaction. Moreover, the IRS and Treasury Department believe that the 
net value acceleration rule is a more objective rule than requiring 
corporations to determine the amount of business assets that would have 
to be retained simply to preserve the deferral benefit of section 
108(i).
1. Consolidated Groups
    In the case of consolidated groups, the determination of whether an 
electing corporation that is a member of a consolidated group (electing 
member) has engaged in an impairment transaction is made on a group-
wide basis. Thus, an electing member is treated as engaging in an 
impairment transaction if any member's transaction impairs the group's 
ability to pay the tax liability associated with the group's deferred 
COD income. See Sec.  1.1502-6. Accordingly, intercompany transactions 
are not impairment transactions. Similarly, the net value acceleration 
rule is applied by reference to the gross asset value of all members 
(excluding stock of members whether or not the stock is described in 
section 1504(a)(4)), the liabilities of all members, and the tax on all 
members' deferred items. For example, assume P is the common parent of 
the P-S consolidated group, S has a section 108(i) election in effect, 
and S makes a $100 distribution to P, which, on a separate entity 
basis, would reduce S's gross asset value below the net value floor. 
S's intercompany distribution to P is not an impairment transaction. 
However, if P makes a $100 distribution to its shareholder, P's 
distribution, subject to an exception described in section I.A.2 of 
this preamble, is an impairment transaction, and the net value 
acceleration rule is applied by reference to the assets, liabilities, 
and deferred items of the P-S group.
    Special rules are provided when an electing member that previously 
engaged in an impairment transaction on a separate entity basis leaves 
a consolidated group. If the electing member ceases to be a member of a 
consolidated group, the cessation is treated as an impairment 
transaction and the net value acceleration rule is applied on a 
separate entity basis (by reference to the assets, liabilities, and 
deferred items of the electing member only) immediately after it ceases 
to be a member. If the electing member's gross asset value is less than 
the net value floor, then the electing member's remaining deferred COD 
income must be taken into account immediately before the electing 
member ceases to be a member (unless value is restored). In the case of 
an electing member that becomes a member of another consolidated group, 
the cessation is treated as an impairment transaction and the net value 
acceleration rule is applied by reference to the assets, liabilities, 
and deferred items of the members of the acquiring group immediately 
after the transaction. If the gross asset value of the acquiring group 
is less than its net value floor, the electing member's remaining 
deferred COD income is taken into account immediately before the 
electing member ceases to be a member of the former group. If 
accelerated inclusion is not required, the common parent of the 
acquiring group succeeds to the reporting requirements of section 
108(i) with respect to the electing member.
2. Exception for Distributions and Charitable Contributions Consistent 
With Historical Practice--In General
    The IRS and Treasury Department believe it is appropriate to allow 
an electing corporation to continue to make distributions to the extent 
the distributions are consistent with its historical practice. 
Accordingly, these distributions are not treated as impairment 
transactions (and are not taken into account as a reduction in gross 
asset value when applying the net value acceleration rule to any 
impairment transaction). For this purpose, distributions are consistent 
with an electing corporation's historical practice to the extent the 
distributions are described in section 301(c) and the amount of these 
distributions, in the aggregate, for the applicable taxable year 
(applicable distribution amount) does not exceed the annual average 
amount of section 301(c) distributions over the preceding three taxable 
years (average distribution amount). Any excess of the applicable 
distribution amount over the average distribution amount is treated as 
an impairment transaction and is taken into account when applying the 
net value acceleration rule. For purposes of this rule, appropriate 
adjustments must be made to take into account any issuances or 
redemptions of stock, or similar transactions, occurring during a 
relevant taxable year. In addition, if the electing corporation has a 
short taxable year for the year of the distribution or for any of the 
years relied upon in computing the average distribution amount, the 
applicable distribution amount and the average distribution amount are 
determined on an annualized basis. If an electing corporation has been 
in existence for less than three years, the average distribution amount 
is computed by substituting the period during which the electing 
corporation has been in existence for the three preceding taxable 
years. The regulations also provide similar rules that exclude from 
impairment transaction status an electing corporation's charitable 
contributions (within the meaning of section 170(c)) that are 
consistent with its historical practice.
3. Special Rules for Regulated Investment Companies (RICs) and Real 
Estate Investment Trusts (REITs)
    In the case of a RIC or REIT, any distributions with respect to 
stock that are treated as a dividend under section 852 or 857 are not 
treated as impairment transactions (and are not taken into

[[Page 49398]]

account as a reduction in gross asset value when applying the net value 
acceleration rule to any impairment transaction). In addition, any 
redemption of a redeemable security, as defined in 15 U.S.C. section 
80a-2(a)(32), by a RIC in the ordinary course of business is not 
treated as an impairment transaction (and is not taken into account as 
a reduction in gross asset value when applying the net value 
acceleration rule to any impairment transaction).

B. Other Mandatory Acceleration Events

1. Changes in Tax Status
    To preserve the government's ability to collect the incipient tax 
liability associated with a C corporation's deferred COD income, these 
regulations provide that an electing corporation must take into account 
its remaining deferred COD income immediately before a change in its 
tax status. An example of such a change includes a C corporation that 
becomes a tax-exempt entity, or a C corporation that begins operating 
as a cooperative. Other changes in tax status are more fully described 
herein.
    If a C corporation elects to be treated as an S corporation, the S 
corporation is subject to tax on its net recognized built-in gains 
during the recognition period. Section 1374(a). Although an item of 
income, such as deferred COD income, can constitute recognized built-in 
gain, recognition of the gain for any taxable year may be limited under 
Sec.  1.1374-2. Accordingly, if an electing corporation elects to be 
treated as an S corporation, the S corporation would not pay tax on its 
deferred COD income to the extent that the S corporation's COD income 
and other recognized built-in gains exceed the limitation.
    The IRS and Treasury Department have determined that permanent 
exclusion of a corporate tax liability associated with a section 108(i) 
election is inconsistent with congressional intent to provide for 
deferral of corporate tax liability with respect to COD income. 
Accordingly, these temporary regulations provide that if an electing 
corporation elects to become an S corporation, the C corporation must 
take into account its deferred COD income immediately before the S 
corporation election is effective.
    Similarly, these temporary regulations provide that an electing 
corporation that elects to be treated as a RIC or REIT must take into 
account its remaining deferred COD income immediately before the 
election is effective.
2. Cessation of Existence
    Section 108(i)(5)(D) provides that in the case of the cessation of 
business by a taxpayer, deferred items must be taken into account in 
the taxable year of the cessation. Consistent with this provision, in 
general, these temporary regulations provide that an electing 
corporation must accelerate its remaining deferred COD income in the 
taxable year that the corporation ceases to exist.
    As noted in section I of the preamble, commentators suggested that 
continued deferral of an electing corporation's COD income is 
appropriate if the corporation ceases to exist in a reorganization or 
liquidation to which section 381(a) applies. The IRS and Treasury 
Department agree that, in these transactions, the policies that support 
nonrecognition for corporations also support continued deferral of COD 
income. In addition, an exception for these transactions affords 
corporations maximum flexibility in structuring transactions as asset 
reorganizations or stock reorganizations to meet business exigencies.
    Therefore, these temporary regulations generally provide that if 
the assets of the electing corporation are acquired in a transaction to 
which section 381(a) applies (the section 381 exception), the electing 
corporation's deferred COD income is not accelerated. In such a case, 
the acquiring corporation succeeds to the electing corporation's 
remaining deferred COD income, and becomes subject to section 108(i), 
including all of its reporting requirements. However, these temporary 
regulations limit the applicability of the section 381 exception in 
certain circumstances, some of which are described herein. Moreover, a 
section 381(a) transaction may still constitute an impairment 
transaction. (See Example 3 of Sec.  1.108(i)-1T(c)).
a. Outbound Section 381(a) Transactions
    If the assets of a domestic electing corporation are acquired by a 
foreign corporation in a transaction to which section 381(a) applies, 
the electing corporation's deferred COD income may not be subject to 
U.S. tax when it is includible in the foreign acquirer's gross income. 
Accordingly, to ensure that the COD income is appropriately taxed, 
these temporary regulations provide that the electing corporation takes 
into account its remaining deferred COD income immediately before the 
transaction.
b. Inbound Section 381(a) Transactions
    As more fully described in section III, in general, deferred COD 
income increases the earnings and profits of an electing corporation, 
including a foreign electing corporation, in the year the debt is 
discharged. Accordingly, if the assets of a foreign electing 
corporation are acquired by a domestic corporation in a transaction to 
which section 381(a) applies, the increase in earnings and profits is 
taken into account in computing the foreign corporation's all earnings 
and profits amount and therefore, may be subject to U.S. taxation as a 
deemed dividend pursuant to Sec.  1.367(b)-3(b)(3). To prevent the 
deferred COD income from being subject to U.S. tax a second time when 
the deferred COD income is includible in the domestic acquirer's gross 
income, these temporary regulations provide that a foreign electing 
corporation takes into account its remaining deferred COD income 
immediately before the transaction if, as a result of the transaction, 
one or more exchanging shareholders include in income as a deemed 
dividend the all earnings and profits amount with respect to stock in 
the foreign electing corporation pursuant to Sec.  1.367(b)-3(b)(3).
c. Acquisition of Assets of an Electing Corporation by a RIC or REIT or 
by an S Corporation
    To ensure that the corporate tax liability associated with deferred 
COD income is appropriately preserved, these temporary regulations 
provide that if the assets of an electing corporation are acquired by a 
RIC or REIT in a transaction that is subject to Sec.  1.337(d)-7 and 
section 381(a) (a conversion transaction), the electing corporation 
takes into account its remaining deferred COD income immediately before 
the conversion transaction. Similarly, if the assets of an electing C 
corporation are acquired by an S corporation in a transaction to which 
sections 1374(d)(8) and section 381(a) apply, the electing C 
corporation takes into account its remaining deferred COD income 
immediately before the transaction.

C. Title 11 (or Similar Case)

    Under section 108(i)(5)(D), if an electing corporation ceases to do 
business, liquidates or sells substantially all of its assets in a 
proceeding under title 11 (or a similar case), the corporation's 
deferred items are taken into account the day before the petition is 
filed. The IRS and Treasury Department believe that the acceleration 
rules (outlined in section I) are

[[Page 49399]]

sufficient to protect the collectability of tax relating to deferred 
COD income. Accordingly, no special acceleration rules for an electing 
corporation in a title 11 or similar case are provided.

II. Elective Acceleration for Electing Members of a Consolidated Group

    These temporary regulations provide an elective provision under 
which an electing member of a consolidated group (other than the common 
parent) may at any time accelerate in full (and not in part) the 
inclusion of its remaining deferred COD income with respect to all 
applicable debt instruments. Elective acceleration within a 
consolidated group is consistent with other consolidated return 
provisions that mitigate the double taxation of income or gain.

III. Earnings and Profits

    In Rev. Proc. 2009-37, the IRS and Treasury Department announced 
its intention to issue regulations regarding the computation of a 
corporation's earnings and profits in connection with an election under 
section 108(i). See Sec.  601.601(d)(2)(ii)(b). Consistent with the 
revenue procedure, these temporary regulations provide that deferred 
COD income generally increases earnings and profits in the taxable year 
that it is realized, and deferred OID deductions generally decrease 
earnings and profits in the taxable year or years in which the 
deductions would be allowed without regard to the deferral rules of 
section 108(i).
    Although Sec.  1.312-6(a) generally states that adjustments to 
earnings and profits are dependent upon the method of accounting 
properly employed in computing taxable income (or net income, as the 
case may be), the IRS and Treasury Department believe this principle 
should not apply in the case of an electing corporation.
    Section 312(n)(5) provides that in the case of any installment 
sale, earnings and profits shall be computed as if the corporation did 
not use the installment sale method. Some commentators have suggested 
that because the deferral of COD income under section 108(i) is 
analogous to the deferral of gain from an installment sale, a rule 
consistent with section 312(n)(5) should apply for purposes of 
determining the timing of adjustments to earnings and profits with 
respect to deferred items under section 108(i). The IRS and Treasury 
Department agree that the policies underlying section 312(n) inform the 
treatment of deferred COD income under section 108(i).
    The legislative history to section 312(n)(5) focuses on the fact 
that a taxpayer may realize cash or its equivalent under the 
installment method in the year of the sale, but is not required to take 
income into account until later years. S. Rep. No. 98-169, at 198-99 
(1984). As in the case of an installment sale, an electing corporation 
realizes economic income in the year of discharge. Even though the 
electing corporation is not required to recognize income until later 
years, its dividend paying capacity is enhanced immediately, not during 
the inclusion period, or at the time the deferred COD income may be 
accelerated into income.
    These temporary regulations also provide certain exceptions to 
current year adjustments to earnings and profits. In the case of RICs 
and REITs, deferred COD income increases earnings and profits in the 
taxable year or years in which the deferred COD income is includible in 
gross income and not in the year that the deferred COD income is 
realized, and deferred OID deductions decrease earnings and profits in 
the taxable year or years that the deferred OID deductions are 
deductible. This rule is intended to ensure that a RIC or REIT has 
sufficient earnings and profits to claim a dividends paid deduction in 
the taxable year that the deferred COD income is included in taxable 
income. In addition, for purposes of calculating alternative minimum 
taxable income, deferred items increase or decrease, as the case may 
be, adjusted current earnings under section 56(g)(4) in the taxable 
year or years that the item is includible or deductible.

IV. Deferred OID Deductions

    Section 108(i)(2) generally provides that if, as part of a 
reacquisition to which section 108(i)(1) applies, a debt instrument is 
issued (or is treated as issued under section 108(e)(4)) for the 
applicable debt instrument being reacquired and there is any OID with 
respect to the debt instrument, no deduction otherwise allowable is 
allowed for the portion of the OID that accrues before the inclusion 
period and that does not exceed the COD income with respect to the 
applicable debt instrument being reacquired. The aggregate amount of 
deferred OID deductions is allowed ratably over the inclusion period. 
If the amount of OID accruing before the inclusion period exceeds the 
deferred COD income with respect to the applicable debt instrument 
being reacquired, the deductions are disallowed in the order in which 
the OID is accrued.
    Under section 108(i)(2)(B), if a debt instrument is issued by an 
issuer and the proceeds of the debt instrument are used directly or 
indirectly by the issuer to reacquire an applicable debt instrument of 
the issuer, then the debt instrument is treated as issued for the 
applicable debt instrument being reacquired. If only a portion of the 
proceeds of the debt instrument are used directly or indirectly to 
reacquire the applicable debt instrument, then the rules in section 
108(i)(2)(A) apply to the portion of any OID on the debt instrument 
that is equal to the portion of the proceeds used to reacquire the 
applicable debt instrument.

A. Application of Sec.  1.1502-13(g)(5)

    The intercompany obligation rules of Sec.  1.1502-13(g) operate to 
minimize the effect on consolidated taxable income of items of income, 
gain, deduction, or loss arising from intercompany debt. These rules 
generally match the amount, timing, and character of the creditor and 
debtor member's items, and ensure that future items similarly 
correspond. Thus, for example, assume that S holds a B note with an 
adjusted issue price and basis of $100 and a fair market value of $70, 
and that S sells the B note to a nonmember for $70. Under Sec.  1.1502-
13(g)(3), B is deemed, immediately before the sale to X, to satisfy the 
note for its fair market value of $70, resulting in $30 of COD income 
for B and $30 of loss for S (which is treated as ordinary loss under 
the attribute redetermination rule of Sec.  1.1502-13(c)(4)(i)). 
Because the debtor's COD income matches the creditor's ordinary loss, 
in cases where the intercompany obligation becomes a non-intercompany 
obligation (and in intragroup transactions), there is no benefit to the 
group to elect deferral of COD income under section 108(i).
    However, for those transactions in which a non-intercompany 
obligation becomes an intercompany obligation (as described in Sec.  
1.1502-13(g)(5)), the timing and attributes of the debtor and creditor 
member's items from the deemed satisfaction are determined on a 
separate entity basis. In such cases, the elective deferral rules of 
section 108(i) may be beneficial. Accordingly, these temporary 
regulations limit the application of section 108(i) by providing that 
in the case of an intercompany obligation (as defined in Sec.  1.1502-
13(g)(2)(ii)), the term applicable debt instrument includes only a debt 
instrument for which COD income is realized upon the debt instrument's 
deemed satisfaction under Sec.  1.1502-13(g)(5).

B. Deemed Debt-for-Debt Exchanges

    Pursuant to the regulatory authority in section 108(i)(7), the 
temporary regulations provide that, for purposes of section 108(i)(2) 
(relating to deferred

[[Page 49400]]

OID deductions that arise in certain debt-for-debt exchanges involving 
the reacquisition of an applicable debt instrument), if the proceeds of 
any debt instrument are used directly or indirectly by the issuer or a 
person related to the issuer (within the meaning of section 
108(i)(5)(A)) to reacquire an applicable debt instrument, the debt 
instrument shall be treated as issued for the applicable debt 
instrument being reacquired. Therefore, section 108(i)(2) may apply, 
for example, to a debt instrument issued by a corporation for cash in 
which some or all of the proceeds are used directly or indirectly by 
the corporation's related subsidiary in the reacquisition of the 
subsidiary's applicable debt instrument. The rule in the temporary 
regulations is intended to prevent related parties from avoiding the 
rules for deferred OID deductions.

C. Directly or Indirectly

    In response to comments received by the IRS and Treasury 
Department, the temporary regulations provide principles similar to 
those of Sec.  1.279-3(b) for purposes of determining when the proceeds 
of a debt instrument will be treated as having been used ``directly or 
indirectly'' to reacquire an applicable debt instrument. Generally, 
whether the proceeds from an issuance of a debt instrument are used 
directly or indirectly by the issuer of the debt instrument or a person 
related to the issuer to reacquire an applicable debt instrument will 
depend upon all of the facts and circumstances surrounding the issuance 
and the reacquisition. The proceeds of an issuance of a debt instrument 
will be treated as being used indirectly to reacquire an applicable 
debt instrument if: (i) At the time of the issuance of the debt 
instrument, the issuer of the debt instrument anticipated that an 
applicable debt instrument of the issuer or a person related to the 
issuer would be reacquired by the issuer, and the debt instrument would 
not have been issued if the issuer had not so anticipated such 
reacquisition; (ii) at the time of the issuance of the debt instrument, 
the issuer of the debt instrument or a person related to the issuer 
anticipated that an applicable debt instrument would be reacquired by a 
related person and the related person receives cash or property that it 
would not have received unless the reacquisition had been so 
anticipated; or (iii) at the time of the reacquisition, the issuer or a 
person related to the issuer foresaw or reasonably should have foreseen 
that it would be required to issue a debt instrument, which it would 
not have otherwise been required to issue if the reacquisition had not 
occurred, in order to meet its future economic needs.

D. Proportional Rule for Accruals of OID

    If a portion of the proceeds of a debt instrument with OID are used 
directly or indirectly to reacquire an applicable debt instrument, then 
the temporary regulations provide that the amount of the issuer's 
deferred OID deductions generally is equal to the product of the amount 
of OID that accrues in the taxable year under section 1272 or section 
1275 (and the regulations under those sections), whichever section is 
applicable, and a fraction, the numerator of which is the portion of 
the total proceeds of the debt instrument used directly or indirectly 
to reacquire the applicable debt instrument and the denominator of 
which is the total proceeds of the debt instrument. However, if the 
total amount of OID that accrues before the inclusion period is greater 
than the total amount of deferred COD income under section 108(i), then 
the OID deductions are disallowed in the order in which the OID is 
accrued, subject to the total amount of deferred COD income.

E. Acceleration Events for Deferred OID Deductions

    The temporary regulations provide rules for the acceleration of 
deferred OID deductions by an issuer that is a C corporation (C 
corporation issuer). The IRS and Treasury Department believe that it is 
appropriate to accelerate deferred OID deductions with respect to a 
debt instrument when the corresponding deferred COD income is taken 
into account. Accordingly, these temporary regulations provide that all 
or a portion of a C corporation issuer's deferred OID deductions with 
respect to a debt instrument are taken into account to the extent that 
an electing entity or its owners include all or a portion of the 
deferred COD income to which the C corporation issuer's deferred OID 
deductions relate.
    These temporary regulations also include special rules to 
accelerate a C corporation issuer's remaining deferred OID deductions 
even though the deferred COD income to which it relates continues to be 
deferred. Under these rules, a C corporation issuer takes into account 
all of its remaining deferred OID deductions if the issuer (i) changes 
its tax status, or (ii) ceases to exist in a transaction to which 
section 381(a) does not apply, taking into account the application of 
Sec.  1.1502-34. See Sec.  1.1502-80(g).
    With respect to all taxpayers with deferred OID deductions, the 
temporary regulations also provide that any remaining deferred OID 
deductions are not accelerated solely by reason of the retirement of 
any debt instrument subject to section 108(i)(2).

V. Effective/Applicability Dates

    In general, the rules regarding deferred COD income and the 
calculation of earnings and profits apply to reacquisitions of 
applicable debt instruments in taxable years ending after December 31, 
2008. In addition, the rules regarding deferred OID deductions 
generally apply to debt instruments issued after December 31, 2008 in 
connection with the reacquisition of an applicable debt instrument.
    However, the rules with respect to the acceleration of deferred COD 
income and deferred OID deductions apply prospectively to acceleration 
events occurring on or after August 11, 2010. Electing corporations and 
C corporation issuers are given the option to apply these rules to all 
acceleration events occurring prior to August 11, 2010 by taking a 
return position consistent with these provisions. In the case of a 
consolidated group, this option is available only if the acceleration 
rules are applied to all acceleration events with respect to all 
members of the group. In addition, certain transitional rules are 
provided in order to allow electing corporations the ability to use 
provisions in the acceleration rules that are time sensitive.
    To the extent an electing corporation or C corporation issuer does 
not apply these acceleration rules to acceleration events occurring 
prior to August 11, 2010, then all deferred items are subject to the 
rules of section 108(i)(5)(D)(i).

Comments

    The text of these temporary regulations also serves as the text of 
the proposed regulations set forth in the notice of proposed rulemaking 
on this subject in the Proposed Rules section in this issue of the 
Federal Register. Please see the ``Comments and Requests for a Public 
Hearing'' section of the notice of proposed rulemaking for the 
procedures to follow in submitting comments on the proposed regulations 
on this subject.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. For applicability 
of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the 
Special Analyses section of the preamble to the cross-referenced notice 
of proposed rulemaking published in

[[Page 49401]]

the Proposed Rules section in this issue of the Federal Register. 
Pursuant to section 7805(f) of the Code, these regulations will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.
    Section 108(i) applies to the reacquisition of an applicable debt 
instrument during the brief election period, January 1, 2009 through 
December 31, 2010. These temporary regulations provide necessary 
guidance regarding the application of this new section 108(i) in order 
for corporations to timely file their tax returns. For this reason, it 
has been determined pursuant to 5 U.S.C. 553(b)(3)(B), that prior 
notice and public procedure are impracticable and contrary to the 
public interest. For the same reason, it has been determined pursuant 
to 5 U.S.C. 553(d)(3) that good cause exists for not delaying the 
effective date of these temporary regulations.

Drafting Information

    The principal authors of these regulations are Robert M. Rhyne and 
Rubin B. Ranat of the Office of Associate Chief Counsel (Corporate). 
Other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding the 
entry for Sec.  1.108(i)-0T, Sec.  1.108(i)-1T, and Sec.  1.108(i)-3T, 
to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.108(i)-0T also issued under 26 U.S.C. 108(i)(7) and 
1502. * * *
    Section 1.108(i)-1T also issued under 26 U.S.C. 108(i)(7) and 
1502. * * *
    Section 1.108(i)-3T also issued under 26 U.S.C. 108(i)(7) and 
1502. * * *


0
Par. 2. Section 1.108(i)-0T is added to read as follows:


Sec.  1.108(i)-0T  Definitions (temporary).

    (a) Definitions. For purposes of regulations under section 108(i)--
    (1) Acquisition. An acquisition, with respect to any applicable 
debt instrument, includes an acquisition of the debt instrument for 
cash or other property, the exchange of the debt instrument for another 
debt instrument (including an exchange resulting from a modification of 
the debt instrument), the exchange of the debt instrument for corporate 
stock or a partnership interest, the contribution of the debt 
instrument to capital, the complete forgiveness of the indebtedness by 
the holder of the debt instrument, and a direct or an indirect 
acquisition within the meaning of Sec.  1.108-2;
    (2) Applicable debt instrument. An applicable debt instrument is a 
debt instrument that was issued by a C corporation or any other person 
in connection with the conduct of a trade or business by such person. 
In the case of an intercompany obligation (as defined in Sec.  1.1502-
13(g)(2)(ii)), applicable debt instrument includes only an instrument 
for which COD income is realized upon the instrument's deemed 
satisfaction under Sec.  1.1502-13(g)(5);
    (3) C corporation issuer. C corporation issuer means a C 
corporation that issues a debt instrument with any deferred OID 
deduction;
    (4) C corporation partner. A C corporation partner is a C 
corporation that is a direct or indirect partner of an electing 
partnership or a related partnership;
    (5) COD income. COD income means income from the discharge of 
indebtedness, as determined under sections 61(a)(12) and 108(a) and the 
regulations under those sections;
    (6) COD income amount. A COD income amount is a partner's 
distributive share of COD income with respect to an applicable debt 
instrument of an electing partnership;
    (7) Debt instrument. Debt instrument means a bond, debenture, note, 
certificate, or any other instrument or contractual arrangement 
constituting indebtedness (within the meaning of section 1275(a)(1));
    (8) Deferral period. For a reacquisition that occurs in 2009, 
deferral period means the taxable year of the reacquisition and the 
four taxable years following such taxable year. For a reacquisition 
that occurs in 2010, deferral period means the taxable year of the 
reacquisition and the three taxable years following such taxable year;
    (9) Deferred amount. A deferred amount is the portion of a 
partner's COD income amount with respect to an applicable debt 
instrument that is deferred under section 108(i);
    (10) Deferred COD income. Deferred COD income means COD income that 
is deferred under section 108(i);
    (11) Deferred item. A deferred item is any item of deferred COD 
income or deferred OID deduction that has not been previously taken 
into account under section 108(i);
    (12) Deferred OID deduction. A deferred OID deduction means an 
otherwise allowable deduction for OID that is deferred under section 
108(i)(2) with respect to a debt instrument issued (or treated as 
issued under section 108(e)(4)) in a debt-for-debt exchange described 
in section 108(i)(2)(A) or a deemed debt-for-debt exchange described in 
Sec.  1.108(i)-3T(a);
    (13) Deferred section 465 amount. A deferred section 465 amount is 
described in paragraph (d)(3) of Sec.  1.108(i)-2T;
    (14) Deferred section 752 amount. A deferred section 752 amount is 
described in paragraph (b)(3) of Sec.  1.108(i)-2T;
    (15) Direct partner. A direct partner is a person that owns a 
direct interest in a partnership;
    (16) Electing corporation. An electing corporation is a C 
corporation with deferred COD income by reason of a section 108(i) 
election;
    (17) Electing entity. An electing entity is an entity that is a 
taxpayer that makes an election under section 108(i);
    (18) Electing member. An electing member is an electing corporation 
that is a member of an affiliated group that files a consolidated 
return;
    (19) Electing partnership. An electing partnership is a partnership 
that makes an election under section 108(i);
    (20) Electing S corporation. An electing S corporation is an S 
corporation that makes an election under section 108(i);
    (21) Included amount. An included amount is the portion of a 
partner's COD income amount with respect to an applicable debt 
instrument that is not deferred under section 108(i) and is included in 
the partner's distributive share of partnership income for the taxable 
year of the partnership in which the reacquisition occurs;
    (22) Inclusion period. The inclusion period is the five taxable 
years following the last taxable year of the deferral period;
    (23) Indirect partner. An indirect partner is a person that owns an 
interest in a partnership through an S corporation and/or one or more 
partnerships;
    (24) Issuing entity. An issuing entity is any entity that is--
    (i) A related partnership;
    (ii) A related S corporation;

[[Page 49402]]

    (iii) An electing partnership that issues a debt instrument (or is 
treated as issuing a debt instrument under section 108(e)(4)) in a 
debt-for-debt exchange described in section 108(i)(2)(A) or a deemed 
debt-for-debt exchange described in Sec.  1.108(i)-3T(a); or
    (iv) An electing S corporation that issues a debt instrument (or is 
treated as issuing a debt instrument under section 108(e)(4)) in a 
debt-for-debt exchange described in section 108(i)(2)(A) or a deemed 
debt-for-debt exchange described in Sec.  1.108(i)-3T(a);
    (25) OID. OID means original issue discount, as determined under 
sections 1271 through 1275 (and the regulations under those sections). 
If the amount of OID with respect to a debt instrument is less than a 
de minimis amount as determined under Sec.  1.1273-1(d), the OID is 
treated as zero for purposes of section 108(i)(2);
    (26) Reacquisition. A reacquisition, with respect to any applicable 
debt instrument, is any event occurring after December 31, 2008 and 
before January 1, 2011, that causes COD income with respect to such 
applicable debt instrument, including any acquisition of the debt 
instrument by the debtor that issued (or is otherwise the obligor 
under) the debt instrument or a person related to such debtor (within 
the meaning of section 108(i)(5)(A));
    (27) Related partnership. A related partnership is a partnership 
that is related to the electing entity (within the meaning of section 
108(i)(5)(A)) and that issues a debt instrument in a debt-for-debt 
exchange described in section 108(i)(2)(A) or a deemed debt-for-debt 
exchange described in Sec.  1.108(i)-3T(a);
    (28) Related S corporation. A related S corporation is an S 
corporation that is related to the electing entity (within the meaning 
of section 108(i)(5)(A)) and that issues a debt instrument in a debt-
for-debt exchange described in section 108(i)(2)(A) or a deemed debt-
for-debt exchange described in Sec.  1.108(i)-3T(a);
    (29) Separate interest. A separate interest is a direct interest in 
an electing partnership or in a partnership or S corporation that is a 
direct or indirect partner of an electing partnership;
    (30) S corporation partner. An S corporation partner is an S 
corporation that is a direct or indirect partner of an electing 
partnership or a related partnership.
    (b) Effective/Applicability dates--(1) In general. This section, 
Sec.  1.108(i)-2T, and, except as provided in paragraph (b)(2) of this 
section, Sec.  1.108(i)-1T apply to reacquisitions of applicable debt 
instruments in taxable years ending after December 31, 2008. In 
addition, Sec.  1.108(i)-3T applies to debt instruments issued after 
December 31, 2008, in connection with reacquisitions of applicable debt 
instruments in taxable years ending after December 31, 2008.
    (2) Acceleration events--(i) In general. Section 1.108(i)-1T(b) 
(acceleration rules) generally applies to acceleration events occurring 
on or after August 11, 2010 However, an electing corporation or C 
corporation issuer may apply the acceleration rules to all acceleration 
events occurring prior to August 11, 2010 by taking a return position 
consistent with these provisions beginning with the first acceleration 
event occurring prior to August 11, 2010. Also, in the case of a 
consolidated group, if the common parent of the consolidated group 
applies the acceleration rules on behalf of one member of the 
consolidated group, then the common parent must apply the acceleration 
rules to all acceleration events with respect to all members of the 
group. If the electing corporation, common parent (under the preceding 
sentence), or C corporation issuer, as the case may be, does not apply 
the acceleration rules to all acceleration events occurring prior to 
August 11, 2010, then it is, with respect to all deferred items, 
subject to the rules of section 108(i)(5)(D)(i).
    (3) Transitional rules--(i) Net value acceleration rule and 
corrective action to restore net value rule. If an electing corporation 
applies the acceleration rules of Sec.  1.108(i)-1T(b) to all 
acceleration events occurring prior to August 11, 2010 and the due date 
of its tax return (including extensions) for the taxable year of the 
mandatory acceleration event occurs prior to August 11, 2010, then for 
purposes of the net value acceleration rule described in Sec.  
1.108(i)-1T(b)(2)(iii), an electing corporation may restore value by 
the fifteenth day of the ninth month following August 11, 2010.
    (ii) Elective acceleration. If an electing member cannot timely 
file an election under Sec.  1.108(i)-1T(b)(3) to accelerate its 
remaining deferred COD income by the due date of the electing member's 
tax return (including extensions) which occurs prior to August 11, 
2010, then an amended return must be filed with the required 
information statement by the fifteenth day of the ninth month following 
August 11, 2010.

0
Par. 3. Section 1.108(i)-1T is added to read as follows:


Sec.  1.108(i)-1T  Deferred discharge of indebtedness income and 
deferred original issue discount deductions of C corporations 
(temporary).

    (a) Overview. Section 108(i)(1) provides an election for the 
deferral of COD income arising in connection with the reacquisition of 
an applicable debt instrument. An electing corporation generally 
includes deferred COD income ratably over the inclusion period. 
Paragraph (b) of this section provides rules for the mandatory 
acceleration of an electing corporation's remaining deferred COD 
income, the mandatory acceleration of a C corporation issuer's deferred 
OID deductions, and for the elective acceleration of an electing 
member's (other than the common parent's) remaining deferred COD 
income. Paragraph (c) of this section provides examples illustrating 
the application of the mandatory and elective acceleration rules. 
Paragraph (d) of this section provides rules for the computation of an 
electing corporation's earnings and profits. Paragraph (e) of this 
section refers to the effective/applicability dates.
    (b) Acceleration events--(1) Deferred COD income. Except as 
otherwise provided in paragraphs (b)(2) and (3) of this section, and 
Sec.  1.108(i)-2T(b)(6) (in the case of a corporate partner), an 
electing corporation's deferred COD income is taken into account 
ratably over the inclusion period.
    (2) Mandatory acceleration events. An electing corporation takes 
into account all of its remaining deferred COD income, including its 
share of an electing partnership's deferred COD income, immediately 
before the occurrence of any one of the events described in this 
paragraph (b)(2) (mandatory acceleration events).
    (i) Changes in tax status. The electing corporation changes its tax 
status. For purposes of the preceding sentence, an electing corporation 
is treated as changing its tax status if it becomes one of the 
following entities:
    (A) A tax-exempt entity as defined in Sec.  1.337(d)-4(c)(2).
    (B) An S corporation as defined in section 1361(a)(1).
    (C) A qualified subchapter S subsidiary as defined in section 
1361(b)(3)(B).
    (D) An entity operating on a cooperative basis within the meaning 
of section 1381.
    (E) A regulated investment company (RIC) as defined in section 851 
or a real estate investment trust (REIT) as defined in section 856.
    (F) A qualified REIT subsidiary as defined in section 856(i), but 
only if the qualified REIT subsidiary was not a

[[Page 49403]]

REIT immediately before it became a qualified REIT subsidiary.
    (ii) Cessation of corporate existence--(A) In general. The electing 
corporation ceases to exist for Federal income tax purposes.
    (B) Exception for section 381(a) transactions--(1) In general. The 
electing corporation is not treated as ceasing to exist and is not 
required to take into account its remaining deferred COD income solely 
because its assets are acquired in a transaction to which section 
381(a) applies. In such a case, the acquiring corporation succeeds to 
the electing corporation's remaining deferred COD income and becomes 
subject to section 108(i) and the regulations thereunder, including all 
reporting requirements, as if the acquiring corporation were the 
electing corporation. A transaction is not treated as one to which 
section 381(a) applies for purposes of this paragraph (b)(2)(ii)(B) in 
any one of the following circumstances:
    (i) The acquisition of the assets of an electing corporation by an 
S corporation, if the acquisition is described in section 1374(d)(8).
    (ii) The acquisition of the assets of an electing corporation by a 
RIC or REIT, if the acquisition is described in Sec.  1.337(d)-
7(a)(2)(ii).
    (iii) The acquisition of the assets of a domestic electing 
corporation by a foreign corporation.
    (iv) The acquisition of the assets of a foreign electing 
corporation by a domestic corporation, if as a result of the 
transaction, one or more exchanging shareholders include in income as a 
deemed dividend all the earnings and profits amount with respect to 
stock in the foreign electing corporation pursuant to Sec.  1.367(b)-
3(b)(3).
    (v) The acquisition of the assets of an electing corporation by a 
tax-exempt entity as defined in Sec.  1.337(d)-4(c)(2).
    (vi) The acquisition of the assets of an electing corporation by an 
entity operating on a cooperative basis within the meaning of section 
1381.
    (2) Special rules for consolidated groups--(i) Liquidations. For 
purposes of paragraph (b)(2)(ii)(B) of this section, the acquisition of 
assets by distributee members of a consolidated group upon the 
liquidation of an electing corporation is not treated as a transaction 
to which section 381(a) applies, unless immediately prior to the 
liquidation, one of the distributee members owns stock in the electing 
corporation meeting the requirements of section 1504(a)(2) (without 
regard to Sec.  1.1502-34). See Sec.  1.1502-80(g).
    (ii) Taxable years. In the case of an intercompany transaction to 
which section 381(a) applies, the transaction does not cause the 
transferor or distributor to have a short taxable year for purposes of 
determining the taxable year of the deferral and inclusion period.
    (iii) Net value acceleration rule--(A) In general. The electing 
corporation engages in an impairment transaction and, immediately after 
the transaction, the gross value of the electing corporation's assets 
(gross asset value) is less than one hundred and ten percent of the sum 
of its total liabilities and the tax on the net amount of its deferred 
items (the net value floor) (the net value acceleration rule). 
Impairment transactions are any transactions, however effected, that 
impair an electing corporation's ability to pay the amount of Federal 
income tax liability on its deferred COD income and include, for 
example, distributions (including section 381(a) transactions), 
redemptions, below-market sales, charitable contributions, and the 
incurrence of additional indebtedness without a corresponding increase 
in asset value. Value-for-value sales or exchanges (for example, an 
exchange to which section 351 or section 721 applies), or mere declines 
in the market value of the electing corporation's assets are not 
impairment transactions. In addition, an electing corporation's 
investments and expenditures in pursuance of its good faith business 
judgment are not impairment transactions. For purposes of determining 
an electing corporation's gross asset value, the amount of any 
distribution that is not treated as an impairment transaction under 
paragraph (b)(2)(iii)(D) of this section (distribution consistent with 
historical practice) or under paragraph (b)(2)(iii)(E) of this section 
(special rules for RICs and REITs) is treated as an asset of the 
electing corporation. Solely for purposes of computing the amount of 
the net value floor, the tax on the deferred items is determined by 
applying th