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

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[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.

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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