Guidance Regarding Reporting Income and Deductions of a Corporation That Becomes or Ceases To Be a Member of a Consolidated Group, 12097-12104 [2015-05123]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 80, Number 44 (Friday, March 6, 2015)]
[Proposed Rules]
[Pages 12097-12104]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2015-05123]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-100400-14]
RIN 1545-BM14


Guidance Regarding Reporting Income and Deductions of a 
Corporation That Becomes or Ceases To Be a Member of a Consolidated 
Group

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed amendments to the consolidated 
return regulations. These proposed regulations would revise the rules 
for reporting certain items of income and deduction that are reportable 
on the day a corporation joins or leaves a consolidated group. The 
proposed regulations would affect such corporations and the 
consolidated groups that they join or leave.

DATES: Written or electronic comments and requests for a public hearing 
must be received by June 4, 2015.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-100400-14), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
100400-14), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at https://www.regulations.gov/ (IRS REG-100400-14).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Russell G. Jones, (202) 317-6847; concerning the submission of comments 
or to request a public hearing, Oluwafunmilayo (Funmi) P. Taylor, (202) 
317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

1. Introduction

    This notice of proposed rulemaking contains proposed regulations 
that amend 26 CFR part 1 under section 1502 of the Internal Revenue 
Code (Code). Section 1502 authorizes the Secretary to prescribe 
regulations for corporations that join in filing a consolidated return, 
and it expressly provides that those rules may be different from the 
provisions of chapter 1 of subtitle A of the Code that would apply if 
those corporations filed separate returns. Terms used in the 
consolidated return regulations generally are defined in Sec.  1.1502-
1.
    These proposed regulations provide guidance under Sec.  1.1502-76, 
which prescribes rules for determining the taxable period in which 
items of income, gain, deduction, loss, and credit (tax items) of a 
corporation that joins in filing a consolidated return are included. 
Section 1.1502-76(b) provides, in part, that if a corporation (S) 
becomes or ceases to be a member of a consolidated group during a 
consolidated return year, S must include in the consolidated return its 
tax items for the period during which it is a member. S also must file 
a separate return (including a consolidated return of another group) 
that includes its items for the period during which it is not a member.

2. Prior and Current Regulations

    On September 8, 1966, the IRS and the Treasury Department 
promulgated regulations under Sec.  1.1502-76 in TD 6894, 31 FR 11794 
(1966 regulations). Section 1.1502-76(b) of the 1966 regulations was 
silent regarding the treatment of S's tax items that accrued on the day 
S became or ceased to be a member of a consolidated group (S's change 
in status). Thus, whether S's tax items for the day of S's change in 
status should have been reflected on S's tax return for the short 
period ending with S's change in status, or whether these tax items 
should have been reflected instead on S's tax return for the short 
period beginning after S's change in status, was unclear under the 1966 
regulations.
    On August 15, 1994, the IRS and the Treasury Department published 
final regulations (TD 8560; 59 FR 41666) under Sec.  1.1502-76(b) 
(current regulations) that revised the 1966 regulations to eliminate 
uncertainty regarding the treatment of tax items recognized by S on the 
day of S's change in status. Under the general rule of Sec.  1.1502-
76(b)(1)(ii)(A)(1) of the current regulations (current end of the day 
rule), S is treated for all federal income tax purposes as becoming or 
ceasing to be a member of a consolidated group at the end of the day of 
S's change in status, and S's tax items that are reportable on

[[Page 12098]]

that day generally are included in the tax return for the taxable year 
that ends as a result of S's change in status.
    The notice of proposed rulemaking that proposed the current end of 
the day rule (57 FR 53634, Nov. 12, 1992) (1992 NPRM) indicated that 
the current end of the day rule was intended to provide certainty and 
prevent inconsistent reporting of S's items between the consolidated 
and separate returns. Prior to the 1992 NPRM, some taxpayers had 
inferred (based upon the administrative practice of the IRS) that the 
inclusion in a particular return of a tax item of S incurred on the day 
of S's change in status depended on a factual determination of whether 
the transaction occurred before or after noon on the day of S's change 
in status (the so-called ``lunch rule'').
    There are two exceptions to the current end of the day rule. The 
first exception (in Sec.  1.1502-76(b)(1)(ii)(A)(2)) provides that if a 
corporation is an S corporation (within the meaning of section 
1361(a)(1)) immediately before becoming a member of a consolidated 
group, the corporation becomes a member of the group at the beginning 
of the day the termination of its S corporation election is effective 
(termination date), and its taxable year ends for all federal income 
tax purposes at the end of the preceding day (S corporation exception). 
The S corporation exception was added by TD 8842 (64 FR 61205; Nov. 10, 
1999) to eliminate the need to file a one-day C corporation return for 
the day an S corporation is acquired by a consolidated group. No 
additional rule was necessary with respect to a qualified S corporation 
subsidiary (QSub) of an S corporation that joins a consolidated group. 
See Sec.  1.1361-5(a)(3).
    Added at the same time as the current end of the day rule, the 
second exception (in Sec.  1.1502-76(b)(1)(ii)(B)) provides that if a 
transaction occurs on the day of S's change in status that is properly 
allocable to the portion of S's day after the event resulting in S's 
change in status, S and certain related persons must treat the 
transaction as occurring at the beginning of the following day for all 
federal income tax purposes (current next day rule). The current next 
day rule was added in response to comments to the 1992 NPRM suggesting 
that the current end of the day rule created a ``seller beware'' 
problem with respect to S's tax items arising on the day of S's change 
in status but after the event causing S's change in status. Commenters 
suggested that, for example, if consolidated group A sold the stock of 
S to consolidated group B, and group B caused S to sell one of its 
divisions on the same day it was acquired by group B, the gain from the 
sale of the division would be inappropriately allocable to group A's 
consolidated return. Commenters recommended that final regulations 
adopt rules substantially similar to the current next day rule to 
protect the reasonable expectations of sellers and buyers of S's stock. 
Commenters suggested that a rule providing this type of protection was 
most appropriate with respect to extraordinary items, and some 
commenters suggested that a rule similar to the current next day rule 
should operate unless the seller and buyer of S agreed otherwise.

3. Proposed Regulations

A. Overview
    The IRS and the Treasury Department have determined that changes 
should be made to the regulations under Sec.  1.1502-76(b) due to 
uncertainty regarding the appropriate application of the current next 
day rule. These proposed regulations address this concern as well as 
additional concerns with the current regulations, as summarized in this 
section 3.A. and discussed in greater detail in sections 3.B. through 
3.K. of this preamble.
    To provide certainty, the proposed regulations generally clarify 
the period in which S must report certain tax items by replacing the 
current next day rule with a new exception to the end of the day rule 
(proposed next day rule) that is more narrowly tailored to clearly 
reflect taxable income and prevent certain post-closing actions from 
adversely impacting S's tax return for the period ending on the day of 
S's change in status. The proposed next day rule applies only to 
``extraordinary items'' (as defined in Sec.  1.1502-76(b)(2)(ii)(C) of 
the proposed regulations) that result from transactions that occur on 
the day of S's change in status, but after the event causing the 
change, and that would be taken into account by S on that day. This 
rule requires those extraordinary items to be allocated to S's tax 
return for the period beginning the next day. The proposed next day 
rule is expressly inapplicable to any extraordinary item that arises 
simultaneously with the event that causes S's change in status.
    The proposed regulations further clarify that fees for services 
rendered in connection with S's change in status constitute a 
``compensation-related deduction'' for purposes of Sec.  1.1502-
76(b)(2)(ii)(C)(9) (if payment of the fees would give rise to a 
deduction), and therefore an extraordinary item. The proposed 
regulations also clarify that the anti-avoidance rule in Sec.  1.1502-
76(b)(3) may apply to situations in which a person modifies an existing 
contract or other agreement in anticipation of S's change in status.
    The proposed regulations also add a rule (previous day rule, 
described in section 3.C. of this preamble) to clarify the application 
of the S corporation exception. In addition, the proposed regulations 
limit the scope of the end of the day rule, the next day rule, the S 
corporation exception, and the previous day rule to determining the 
period in which S must report certain tax items and determining the 
treatment of an asset or a tax item for purposes of sections 382(h) and 
1374 (as opposed to applying for all federal income tax purposes).
    Additionally, the proposed regulations provide that short taxable 
years resulting from intercompany transactions to which section 381(a) 
applies (intercompany section 381 transactions) are not taken into 
account in determining the carryover period for a tax item of the 
distributor or transferor member in the intercompany section 381 
transaction or for purposes of section 481(a). Furthermore, the 
proposed regulations provide that the due date for filing S's separate 
return for the taxable year that ends as a result of S becoming a 
member is not accelerated if S ceases to exist in the same consolidated 
return year.
    The proposed regulations make several other conforming and non-
substantive changes to the current regulations as well. Finally, the 
proposed regulations add several examples to illustrate the proposed 
rules.
    The IRS and the Treasury Department note that neither the current 
regulations nor the proposed regulations are intended to supersede 
general rules in the Code and regulations concerning whether an item is 
otherwise includible or deductible.
B. Proposed Next Day Rule
    The current next day rule provides that S and certain related 
persons must treat a transaction as occurring at the beginning of the 
day following S's change in status if the transaction occurs on the day 
of S's change in status and is ``properly allocable'' to the portion of 
that day following S's change in status. The IRS and the Treasury 
Department believe, however, that the standards provided in the current 
next day rule for determining whether a transaction is ``properly 
allocable'' to the portion of S's day after the event resulting in S's 
change in status have

[[Page 12099]]

been inappropriately interpreted by taxpayers. The current next day 
rule provides that a determination of whether a transaction is 
``properly allocable'' to the portion of S's day after the event 
resulting in S's change in status is respected if it is ``reasonable 
and consistently applied by all affected persons.'' In determining 
whether an allocation is ``reasonable,'' certain factors enumerated in 
the current regulations are to be considered, including whether tax 
items arising from the same transaction are allocated inconsistently. 
Some taxpayers have interpreted these rules as providing flexibility in 
reporting tax items that result from transactions occurring on the day 
of S's change in status so that those items can be allocated by 
agreement to the day of, or to the day following, S's change in status. 
The IRS and the Treasury Department view this interpretation of the 
current next day rule as inappropriate because it effectively would 
permit taxpayers to elect the income tax return on which these tax 
items are reported and therefore may not result in an allocation that 
clearly reflects taxable income. This electivity is inconsistent with 
the purpose of Sec.  1.1502-76(b) to clearly reflect the income of S 
and the consolidated group. Further, the IRS and the Treasury 
Department have observed that the current regulations create 
controversy between taxpayers and the IRS as to whether certain of S's 
tax items that become reportable on the day of S's change in status are 
properly allocated to S's tax return for the period ending that day 
rather than to S's tax return for the period beginning the next day.
    The proposed next day rule is intended to eliminate the perceived 
electivity and the source of these controversies. Under the proposed 
regulations, the application of the proposed next day rule is mandatory 
rather than elective--if an extraordinary item results from a 
transaction that occurs on the day of S's change in status, but after 
the event resulting in the change, and if the item would be taken into 
account by S on that day, the transaction resulting in the 
extraordinary item is treated as occurring at the beginning of the 
following day for purposes of determining the period in which S must 
report the item.
    The proposed regulations also provide that the proposed next day 
rule is inapplicable to items that arise simultaneously with the event 
that causes S's change in status. Under the end of the day rule (as 
revised by these proposed regulations), those items are reported on S's 
tax return for the short period ending on the day of S's change in 
status. The proposed regulations are expected to afford taxpayers and 
the IRS greater certainty regarding the period to which S's tax items 
resulting from such a transaction are allocated.
C. Previous Day Rule
    As noted in section 2 of this preamble, the special rule for S 
corporations provides an exception to the end of the day rule if an S 
corporation joins a consolidated group. To avoid creating a one-day C 
corporation tax return for the termination date, the S corporation 
exception provides that S becomes a member of the group at the 
beginning of the termination date, and that S's taxable year ends for 
all federal income tax purposes at the end of the preceding day.
    Although these proposed regulations retain the S corporation 
exception, the proposed regulations add a previous day rule that 
mirrors the principles of the proposed next day rule. Whereas the 
proposed next day rule requires extraordinary items resulting from 
transactions that occur on the day of S's change in status (but after 
the event causing the change) to be allocated to S's tax return for the 
short period that begins the following day, the previous day rule 
requires extraordinary items resulting from transactions that occur on 
the termination date (but before or simultaneously with the event 
causing S's status as an S corporation to terminate) to be allocated to 
S's tax return for the short period that ends on the previous day (that 
is, the day preceding the termination date).
D. Revised Scope of the End of the Day Rule and Related Rules
    Under the current end of the day rule, S becomes or ceases to be a 
member at the end of the day on which its status as a member changes, 
and its tax year ends ``for all federal income tax purposes'' at the 
end of that day. However, applying the end of the day rule for purposes 
other than the reporting of S's tax items could yield results 
inconsistent with other consolidated return rules. For example, under 
Sec. Sec.  1.1502-13 and 1.1502-80(d)(1), if a member contributes 
property subject to a liability in excess of the property's basis to a 
nonmember in exchange for the nonmember's stock, and if the transferee 
becomes a member of the transferor's consolidated group as a result of 
the exchange, the transaction is treated as an intercompany transaction 
and section 357(c) does not apply. However, if the end of the day rule 
applies ``for all federal income tax purposes,'' it may be unclear 
whether the transferee becomes a member ``immediately after the 
transaction,'' whether the transaction is an intercompany transaction, 
and whether section 357(c) could apply to the transaction.
    To eliminate possible confusion arising from application of the 
current end of the day rule and related rules, these proposed 
regulations provide that the end of the day rule, the proposed next day 
rule, the S corporation exception, and the previous day rule apply for 
purposes of determining the period in which S must report its tax 
items, as well as for purposes of sections 382(h) and 1374 (discussed 
in section 3.I. of this preamble).
E. Extraordinary Items
    The proposed next day rule mandatorily applies to extraordinary 
items that result from a transaction that occurs on the day of S's 
change in status but after the event that causes the change. In 
contrast, the previous day rule mandatorily applies to extraordinary 
items that result from a transaction that occurs on the day of S's 
change in status but before or simultaneously with the event that 
causes S's status as an S corporation to terminate.
    One category of extraordinary items, set forth in Sec.  1.1502-
76(b)(2)(ii)(C)(9) of the current regulations, applies to any 
``compensation-related deduction in connection with S's change in 
status.'' The proposed regulations clarify that this category of 
extraordinary items includes (among other items) a deduction for fees 
for services rendered in connection with S's change in status. For 
example, if payment of a fee for the services of a financial adviser is 
contingent upon a successful acquisition of S's stock, to the extent 
the fee gives rise to a deduction, the deduction for the accrual of 
that expense is an extraordinary item, and the deduction is allowable 
only in S's taxable year that ends at the close of the day of the 
change.
    The IRS and the Treasury Department request comments as to whether 
the list of extraordinary items set forth in Sec.  1.1502-
76(b)(2)(ii)(C) should be modified to include any item not currently 
listed or whether any item currently included should be deleted or 
modified. Specifically, the IRS and the Treasury Department are 
considering whether the item in Sec.  1.1502-76(b)(2)(ii)(C)(5) 
(``[a]ny item carried to or from any portion of the original year 
(e.g., a net operating loss carried under section 172), and any section 
481(a)

[[Page 12100]]

adjustment'') should be modified to include ``any section 481(a) 
adjustment or the acceleration thereof,'' and whether the item in Sec.  
1.1502-76(b)(2)(ii)(C)(6) (``[t]he effects of any change in accounting 
method initiated by the filing of the appropriate form after S's change 
in status'') should continue to be included in the list of 
extraordinary items.
    The IRS and the Treasury Department also request comments as to 
whether any extraordinary item should be excluded, in whole or in part, 
from application of the next day rule and the previous day rule. In 
particular, the IRS and the Treasury Department request comments as to 
whether the extraordinary items set forth in Sec.  1.1502-
76(b)(2)(ii)(C)(5) and (6) of the current regulations should be 
excluded, in whole or in part, from application of these rules.
F. Ratable Allocation
    Rather than require S to perform a closing of the books on the day 
of its change in status, the current regulations under Sec.  1.1502-
76(b)(2)(ii) permit S's tax items, other than the extraordinary items, 
to be ratably allocated between S's two short taxable years if certain 
conditions are met. The IRS and the Treasury Department request 
comments as to whether S no longer should be permitted to elect to 
ratably allocate its tax items between the periods ending and beginning 
with S's change in status.
G. Certain Foreign Entities
    Solely for purposes of determining the short taxable year of S to 
which the items of a passthrough entity in which S owns an interest are 
allocated, Sec.  1.1502-76(b)(2)(vi)(A) of the current regulations 
generally provides that S is treated as selling or exchanging its 
entire interest in the entity immediately before S's change in status. 
This rule does not apply to certain foreign corporations the ownership 
of which may give rise to deemed income inclusions under the Code. In 
addition, a deemed income inclusion from a foreign corporation and a 
deferred tax amount from a passive foreign investment company under 
section 1291 are treated as extraordinary items under Sec.  1.1502-
76(b)(2)(ii)(C)(11). The IRS and the Treasury Department request 
comments as to whether such deemed income inclusions or deferred tax 
amounts should continue to be treated as extraordinary items, whether 
rules having similar effects to the rule in Sec.  1.1502-
76(b)(2)(vi)(A) relating to passthrough entities should be adopted for 
controlled foreign corporations and passive foreign investment 
companies in which S owns an interest, and whether any other changes 
should be made to Sec.  1.1502-76(b)(2)(vi) of the current regulations.
H. Anti-Avoidance Rule
    Under Sec.  1.1502-76(b)(3) of the current regulations, if any 
person acts with a principal purpose contrary to the purposes of Sec.  
1.1502-76(b) to substantially reduce the federal income tax liability 
of any person (prohibited purpose), adjustments must be made as 
necessary to carry out the purposes of Sec.  1.1502-76 of the current 
regulations (anti-avoidance rule). The proposed regulations clarify 
that the anti-avoidance rule may apply to situations in which a person 
modifies an existing contract or other agreement in anticipation of S's 
change in status in order to shift an item between the taxable years 
that end and begin as a result of S's change in status if such actions 
are undertaken with a prohibited purpose. The IRS and the Treasury 
Department request comments regarding this proposed amendment to the 
anti-avoidance rule.
I. Coordination With Sections 382(h) and 1374
1. Section 382
    For purposes of section 382, the term recognized built-in loss 
(RBIL) means any loss recognized during the recognition period on the 
disposition of any asset held by the loss corporation immediately 
before the date of the section 382 ownership change (change date), to 
the extent the loss reflects a built-in loss on the change date. 
Section 382(h)(2)(B). The term recognition period means the five-year 
period beginning on the change date. Section 382(h)(7)(A).
    Section 382(h)(1)(B) generally provides that if a loss corporation 
has a net unrealized built-in loss (NUBIL), then any RBIL taken into 
account in a taxable year any portion of which falls in the recognition 
period (recognition period taxable year) is treated as a deduction 
subject to the loss corporation's section 382 limitation as if the RBIL 
were a pre-change loss. The amount of RBILs subject to the section 382 
limitation in any recognition period taxable year is limited, however, 
to the excess of the NUBIL over total RBILs in prior taxable years 
ending in the recognition period. (The amount of such excess is 
referred to in this preamble as the outstanding NUBIL balance.) In 
other words, the amount of the NUBIL limits the amount of RBILs that 
are treated as pre-change losses, and any built-in loss treated as an 
RBIL further reduces the outstanding NUBIL balance.
    In many cases, the event that causes S's change in status for 
purposes of Sec.  1.1502-76(b)(1)(ii) also causes S to undergo an 
ownership change for purposes of section 382. Thus, an item of 
deduction or loss that becomes reportable on the day of S's change in 
status falls within the recognition period beginning that day, even if 
the item is allocated to S's short period ending that day under the end 
of the day rule. As a consequence, an item that should be a pre-change 
loss is treated as an RBIL that reduces the outstanding NUBIL balance. 
For example, assume consolidated group A sells all of S's stock to 
consolidated group B. If on the day of S's change in status (but before 
the event causing the change), S recognizes a loss on the sale of an 
asset, under the end of the day rule the loss is reported on group A's 
consolidated return. However, notwithstanding that the loss may not be 
claimed by group B, the loss may be treated as an RBIL and reduce the 
outstanding NUBIL balance.
    To prevent such an outcome, these proposed regulations provide 
that, for purposes of section 382(h), items includible in the short 
taxable year that ends as a result of S's change in status (including 
items allocated to that taxable year under the end of the day rule) are 
not treated as occurring in the recognition period. Rather, only items 
includible in S's short taxable year that begins as a result of S's 
change in status (including items allocated to that taxable year under 
the proposed next day rule) are treated as occurring in the recognition 
period. Therefore, the beginning of the recognition period for purposes 
of section 382(h) would correspond with the beginning of S's short 
taxable year that begins on the day after S's change in status.
2. Section 1374
    Section 1374 generally imposes a corporate-level tax (section 1374 
tax) on the recognition of gain by an S corporation that formerly was a 
C corporation (or that acquired assets from a C corporation in a 
transferred basis transaction) during a recognition period specified in 
section 1374(d)(7) (section 1374 recognition period), but only to the 
extent of the corporation's net recognized built-in gain (as defined in 
section 1374(d)(2)) for a given taxable year. The section 1374 tax also 
applies to certain tax items attributable to the corporation's C 
corporation taxable years. In addition, regulations under section 
337(d) extend section 1374 treatment to (1) a C corporation's 
conversion to a real estate investment

[[Page 12101]]

trust (REIT), regulated investment company (RIC), and certain tax-
exempt entities, or (2) certain cases in which a REIT, RIC, or tax-
exempt entity acquires assets in a transferred basis transaction from a 
C corporation.
    As with the application of section 382(h), the event that causes 
S's change in status for purposes of Sec.  1.1502-76(b)(1)(ii) may be 
the event that results in S being a corporation that is subject to the 
section 1374 tax. Therefore, it is necessary to determine in which 
return (the group's consolidated return or S's separate return 
beginning the day after S's change in status) S's tax items for the day 
of S's change in status are included. Similarly, if the event that 
causes S's change in status for purposes of Sec.  1.1502-76(b)(1)(ii) 
is the event that results in S ceasing to be a corporation subject to 
the section 1374 tax, it is necessary to determine in which return (the 
group's consolidated return or S's separate return for the period 
ending the day before S's change in status) S's tax items for the day 
of S's change in status are included. The proposed regulations thus 
provide that if S ceases to be a corporation subject to the section 
1374 tax upon becoming a member, or if S elects to be a corporation 
that is subject to the section 1374 tax for its first separate return 
year after ceasing to be a member, S's items of recognized built-in 
gain or loss for purposes of section 1374 will include only the amounts 
reported on S's separate return (including items reported on that 
return under the previous day rule or the next day rule).
J. Intercompany Section 381 Transactions
    Under the current consolidated return regulations, if a member 
distributes or transfers its assets to another corporation that is a 
member immediately after the distribution or transfer in an 
intercompany section 381 transaction, and if the distributor or 
transferor member has a net operating loss carryover or a net capital 
loss carryover, the distributor or transferor member will not be 
treated as having a short taxable year for purposes of determining the 
years to which the loss may be carried. Sections 1.1502-21(b)(3)(iii) 
and 1.1502-22(b)(4).
    These proposed regulations would amend current law by moving these 
rules to Sec.  1.1502-76(b)(2)(i) and making conforming changes to 
Sec. Sec.  1.1502-21(b)(3)(iii) and 1.1502-22(b)(4). In addition, these 
proposed regulations would expand these rules by providing that a short 
taxable year of the distributor or transferor member by reason of an 
intercompany section 381 transaction is not counted as a separate 
taxable year for purposes of determining either the taxable years to 
which any tax attribute of the distributor or transferor member may be 
carried or the taxable years in which an adjustment under section 
481(a) is taken into account. No inference should be drawn from the 
proposed changes to these rules as to whether a short taxable year of a 
member resulting from an intercompany section 381 transaction is 
counted under current law for purposes of determining the years to 
which a tax credit may be carried or in which a section 481 adjustment 
is taken into account.
K. Due Date for Filing Tax Returns
    The proposed regulations also eliminate a provision that could 
cause taxpayers to inadvertently miss a return filing deadline. Under 
Sec.  1.1502-76(b)(4) of the current regulations, if S joins a 
consolidated group, the due date for filing S's separate return is the 
earlier of the due date (with extensions) of the group's return or the 
due date (with extensions) of S's return if S had not joined the group. 
If S goes out of existence during the consolidated return year in which 
S joins a group, its taxable year would end. Under section 6072, the 
due date for S's short period return would be the 15th day of the third 
month (ninth month, with extensions) following the date on which S 
ceases to exist. Accordingly, if S ceases to exist during the same 
consolidated return year in which it becomes a member, the due date for 
S's tax return for the short period that ended as a result of S 
becoming a member could be accelerated. To prevent a taxpayer from 
inadvertently missing a filing date and being subject to potential 
penalties for filing a late return, the proposed regulations provide 
that if S goes out of existence in the same consolidated return year in 
which it becomes a member, the due date for filing S's separate return 
is determined without regard to S's ceasing to exist.
L. Non-Substantive Changes
    In addition to the changes described in this preamble, the proposed 
regulations make several non-substantive changes to the current 
regulations, including moving an example concerning Sec.  1.1502-80(d) 
from the text of Sec.  1.1502-76(b)(1)(ii)(B)(2) of the current 
regulations to Sec.  1.1502-13(c)(7)(ii), Example 3(e).

Effective/Applicability Date

    The amendments to Sec. Sec.  1.1502-21(b)(3)(iii), 1.1502-
22(b)(4)(i), 1.1502-76(b)(2)(i), and 1.1502-76(b)(4) will apply to 
consolidated return years beginning on or after the date these 
regulations are published as final regulations in the Federal Register. 
The other amendments to Sec.  1.1502-76(b) will apply to corporations 
becoming or ceasing to be members of consolidated groups on or after 
the date these regulations are published as final regulations in the 
Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13563. Therefore, a 
regulatory assessment is not required. It is hereby certified that 
these regulations will not have a significant impact on a substantial 
number of small entities. This certification is based on the fact that 
the regulations apply only to transactions involving corporations that 
file consolidated federal income tax returns, and that such 
corporations tend to be larger businesses. Accordingly, a Regulatory 
Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) is not required. Pursuant to section 7805(f) of the Code, 
these regulations will be submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on their impact on 
small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ``Addresses'' 
heading. The IRS and the Treasury Department request comments on all 
aspects of the proposed rules. All comments will be available for 
public inspection and copying. A public hearing may be scheduled if 
requested in writing by any person who timely submits written comments. 
If a public hearing is scheduled, notice of the date, time, and place 
of the hearing will be published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Russell G. 
Jones of the Office of Associate Chief Counsel (Corporate). However, 
other personnel from the IRS and the Treasury Department participated 
in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 12102]]

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *

    Section 1.1361-5 also issued under 26 U.S.C. 1361. * * *
    Section 1.1362-3 also issued under 26 U.S.C. 1362. * * *
    Section 1.1502-13 also issued under 26 U.S.C. 1502. * * *
    Section 1.1502-21 also issued under 26 U.S.C. 1502. * * *
    Section 1.1502-22 also issued under 26 U.S.C. 1502. * * *
    Section 1.1502-28 also issued under 26 U.S.C. 1502. * * *
    Section 1.1502-76 also issued under 26 U.S.C. 382(m) and 26 
U.S.C. 1502. * * *


Sec.  1.1361-5  [Amended]

0
Par. 2. Section 1.1361-5 is amended:
0
1. In paragraph (a)(3), by removing ``Sec.  1.1502-76(b)(1)(ii)(A)(2) 
(relating to a special rule'' and adding ``Sec.  1.1502-76(b)(1)(ii)(B) 
(relating to special rules'' in its place.
0
2. In paragraph (a)(4), Example 4, by removing ``Sec.  1.1502-
76(b)(1)(ii)(A)(2)'' and adding ``Sec.  1.1502-76(b)(1)(ii)(B)(1)'' in 
its place.


Sec.  1.1362-3  [Amended]

0
Par. 3. Section 1.1362-3 is amended in paragraph (a) by removing 
``Sec.  1.1502-76(b)(1)(ii)(A)(2)'' and adding ``Sec.  1.1502-
76(b)(1)(ii)(B)'' in its place.
0
Par. 4. Section 1.1502-13 is amended by adding Example 3(e) to 
paragraph (c)(7)(ii) to read as follows:


Sec.  1.1502-13  Intercompany transactions.

* * * * *
    (c) * * *
    (7) * * *
    (ii) * * *
    Example 3. * * *
    (e) Liability in excess of basis. The facts are the same as in 
paragraph (a) of this Example 3, except that S and B are not members 
of the same consolidated group immediately before S's transfer of 
the land to B, and the land is encumbered with an $80 liability. 
Immediately after the transfer, S and B are members of the same 
consolidated group. Thus, the transfer is an intercompany 
transaction to which section 357(c) does not apply pursuant to Sec.  
1.1502-80(d).
* * * * *
0
Par. 5. Section 1.1502-21 is amended by revising paragraph (b)(3)(iii) 
and adding paragraph (h)(1)(iv) to read as follows:


Sec.  1.1502-21  Net operating losses.

* * * * *
    (b) * * *
    (3) * * *
    (iii) Short years in connection with intercompany transactions to 
which section 381(a) applies. If a member distributes or transfers 
assets in an intercompany transaction to which section 381(a) applies, 
see Sec.  1.1502-76(b)(2)(i).
* * * * *
    (h) * * *
    (1) * * *
    (iv) Paragraph (b)(3)(iii) of this section applies to consolidated 
return years beginning on or after the date these regulations are 
published as final regulations in the Federal Register. For 
transactions occurring before the date these regulations are published 
as final regulations in the Federal Register, see Sec.  1.1502-21(b) as 
contained in 26 CFR part 1, revised as of April 1 preceding the date 
these regulations are published as final regulations in the Federal 
Register.
* * * * *
0
Par. 6. Section 1.1502-22 is amended by:
0
1. Revising paragraph (b)(4)(i).
0
2. Revising the heading of paragraph (h).
0
3. Adding paragraph (h)(1)(iii).
    The revisions and addition read as follows:


Sec.  1.1502-22  Consolidated capital gain and loss.

* * * * *
    (b) * * *
    (4) Special rules--(i) Short years in connection with intercompany 
transactions to which section 381(a) applies. If a member distributes 
or transfers assets in an intercompany transaction to which section 
381(a) applies, see Sec.  1.1502-76(b)(2)(i).
* * * * *
    (h) Effective/applicability date--
    (1) * * *
    (iii) Paragraph (b)(4)(i) of this section applies to consolidated 
return years beginning on or after the date these regulations are 
published as final regulations in the Federal Register. For 
transactions occurring before the date these regulations are published 
as final regulations in the Federal Register, see Sec.  1.1502-22(b) as 
contained in 26 CFR part 1, revised as of April 1 preceding the date 
these regulations are published as final regulations in the Federal 
Register.
* * * * *


Sec.  1.1502-28  [Amended]

0
Par. 7. Section 1.1502-28 is amended in paragraph (b)(11) by removing 
``Sec.  1.1502-76(b)(1)(ii)(B)'' and adding ``Sec.  1.1502-
76(b)(1)(ii)(A)(2)'' in its place.
0
Par. 8. Section 1.1502-76 is amended:
0
1. By adding a sentence at the end of paragraph (b)(1)(i).
0
2. By revising paragraphs (b)(1)(ii)(A) and (B).
0
3. By adding paragraph (b)(1)(ii)(D).
0
4. By adding a sentence at the end of paragraph (b)(2)(i).
0
5. By revising paragraph (b)(2)(ii)(C)(9).
0
6. By removing the last sentence of paragraph (b)(2)(iii).
0
7. By removing the last sentence of paragraph (b)(2)(v).
0
8. In paragraph (b)(2)(vi)(C) by removing ``paragraph (b)(2)(v)'' and 
adding ``paragraph (b)(2)(vi)'' in its place.
0
9. By revising paragraph (b)(3).
0
10. By adding a sentence at the end of paragraph (b)(4).
0
11. By adding Examples 8, 9, and 10 to paragraph (b)(5).
0
12. By revising paragraph (b)(6).
    The revisions and additions read as follows:


Sec.  1.1502-76  Taxable year of members of group.

* * * * *
    (b) * * *
    (1) * * *
    (i) * * * If a corporation (S) becomes or ceases to be a member in 
a stock disposition or purchase for which an election under section 
336(e) or section 338 is made, paragraphs (b)(1)(ii), (b)(2)(ii), and 
(b)(2)(iii) of this section do not apply to the transaction.
    (ii) * * *
    (A) In general--(1) End of the day rule. If S becomes or ceases to 
be a member during a consolidated return year, S's tax year ends, and 
(except as provided in paragraph (b)(1)(ii)(A)(2) or paragraph 
(b)(1)(ii)(B) of this section) for purposes of determining the period 
in which S must report an item of income, gain, deduction, loss, or 
credit, S is treated as becoming or ceasing to be a member at the end 
of the day on which its status as a member changes (end of the day 
rule).
    (2) Next day rule. If an extraordinary item (as defined in 
paragraph (b)(2)(ii)(C) of this section) results from a transaction 
that occurs on the day of S's change in status as a member, but after 
the event resulting in the change, and the item would be taken into 
account by S on that day, the transaction resulting in the 
extraordinary item is treated as occurring at the beginning of the 
following day for purposes of determining the period in which S must 
report the item (next day rule). The next day rule does not apply to 
any extraordinary item that becomes

[[Page 12103]]

includible or deductible simultaneously with the event that causes the 
change in S's status.
    (B) Special rules for former S corporations--(1) Beginning of the 
day rule. If an election under section 1362(a) is in effect for S 
immediately before S becomes a member, S is treated as becoming a 
member at the beginning of the day the termination of its election 
under section 1362(a) is effective (termination date), and S's taxable 
year ends at the end of the day preceding the termination date. See 
Sec.  1.1361-5(a)(3) for the treatment of certain qualified S 
corporation subsidiaries.
    (2) Previous day rule. If an extraordinary item (as defined in 
paragraph (b)(2)(ii)(C) of this section) results from a transaction 
that occurs on the termination date, but before or simultaneously with 
the event resulting in the termination of S's election under section 
1362(a), and the item would be taken into account by S on that day, the 
transaction resulting in the extraordinary item is treated as occurring 
at the end of the previous day for purposes of determining the period 
in which S must report the item (previous day rule). See Sec.  1.1361-
5(a)(3) for the treatment of certain qualified S corporation 
subsidiaries.
* * * * *
    (D) Coordination with sections 382 and 1374. If the day of S's 
change in status is also the date of an ownership change for purposes 
of section 382, the rules and principles of this section apply in 
determining the treatment of any item or asset for purposes of section 
382(h). Accordingly, if the day of S's change in status is also a 
change date, the determination of net unrealized built-in gain or loss 
will reflect the application of both the end of the day rule and the 
next day rule, to the extent each applies. Moreover, items includible 
in the taxable year that ends as a result of S's change in status are 
not treated as occurring in the recognition period described in section 
382(h)(7)(A), and items includible in the taxable year that begins as a 
result of S's change in status are treated as occurring in the 
recognition period. If S ceases to be a corporation subject to the tax 
imposed by section 1374 upon becoming a member of a consolidated group, 
or if S elects to be a corporation that is subject to such tax for its 
first separate return year after ceasing to be a member, S's items of 
recognized built-in gain or loss for purposes of section 1374 will 
include only the amounts reported on S's separate return (including 
items reported on that return under the previous day rule or the next 
day rule).
* * * * *
    (2) * * *
    (i) * * * If a member distributes or transfers assets in an 
intercompany transaction to which section 381(a) applies, a short 
taxable year of the distributor or transferor corporation is not taken 
into account either for purposes of determining the taxable years to 
which any tax attribute of the distributor or transferor corporation 
may be carried or for purposes of determining the taxable years in 
which an adjustment under section 481(a) is taken into account.
    (ii) * * *
    (C) * * *
    (9) Any compensation-related deduction in connection with S's 
change in status (including, for example, a deduction for fees for 
services rendered in connection with S's change in status and for 
bonus, severance, and option cancellation payments made in connection 
with S's change in status);
* * * * *
    (3) Anti-avoidance rule. If any person acts with a principal 
purpose contrary to the purposes of this paragraph (b) to substantially 
reduce the federal income tax liability of any person (including by 
modifying an existing contract or other agreement in anticipation of a 
change in S's status to shift an item between the taxable years that 
end and begin as a result of S's change in status), adjustments must be 
made as necessary to carry out the purposes of this section.
    (4) * * * In addition, if S ceases to exist in the same 
consolidated return year in which S becomes a member, the due date for 
filing S's separate return shall be determined without regard to S's 
ceasing to exist in that year.
    (5) * * *

    Example 8. Allocation of certain amounts that become deductible 
on the day of S's change in status--(a) Facts. P purchases all of 
the stock of S, an accrual-basis, stand-alone C corporation, on June 
30 pursuant to a stock purchase agreement. At the time of the stock 
purchase, S has outstanding nonqualified stock options issued to 
certain employees. The options did not have a readily ascertainable 
fair market value when granted, and the options do not provide for a 
deferral of compensation (as defined in Sec.  1.409A-1(b)). Under 
the option agreements, S is obligated to pay its employees certain 
amounts in cancellation of their stock options upon a change in 
control of S. P's purchase of S's stock causes a change in control 
of S, and S's obligation to make option cancellation payments to its 
employees becomes fixed and determinable upon the closing of the 
stock purchase. Several days after the closing of the stock 
purchase, S pays its employees the amounts required under the option 
agreements.
    (b) Analysis. P's purchase of S's stock causes S to become a 
member of the P group at the end of the day on June 30. Under 
paragraph (b)(2)(ii)(C)(9) of this section, a deduction arising from 
S's liability to pay its employees in cancellation of their stock 
options in connection with S's change in status is an extraordinary 
item that cannot be prorated and must be allocated to June 30. The 
next day rule is inapplicable to this deduction because S's 
liability to pay its employees becomes deductible on the day of S's 
change in status simultaneously with the event that causes S's 
change in status. Consequently, a deduction for the option 
cancellation payments must be reported under the end of the day rule 
on S's tax return for the period ending June 30.
    (c) Success-based fees. The facts are the same as in paragraph 
(a) of this Example 8, except that S also engages a consulting firm 
to provide services in connection with P's purchase of S's stock. 
Under the terms of the engagement letter, S's obligation to pay for 
these services is contingent upon the successful closing of the 
stock purchase. The stock purchase closes successfully, and S's 
obligation to pay its consultants becomes fixed and determinable at 
closing. To the extent S's payment of a success-based fee to its 
consultants is otherwise deductible, this item is an extraordinary 
item that cannot be prorated and must be reported under the end of 
the day rule on S's return for the period ending June 30. (See 
paragraph (b)(2)(ii)(C)(9) of this section.) The next day rule is 
inapplicable to the deduction because S's liability to pay its 
consultants becomes deductible on the day of S's change in status 
simultaneously with the event that causes S's change in status.
    (d) Unwanted assets. The facts are the same as in paragraph (a) 
of this Example 8, except that, after closing on June 30, S sells to 
an unrelated party certain assets used in S's trade or business that 
are not wanted by the P group. Gain or loss on the sale of these 
assets is an extraordinary item that results from a transaction that 
occurs on the day of S's change in status, but after the event 
resulting in the change. Consequently, under the next day rule, the 
gain or loss must be reported on S's tax return for the period 
beginning July 1.
    Example 9. Redemption that causes a change in status--(a) Facts. 
P owns 80 shares of S's only class of outstanding stock, and a 
person whose ownership of S stock is not attributed to P under 
section 302(c) owns the remaining 20 shares. On June 30, S 
distributes land with a basis of $100 and a fair market value of 
$140 to P in redemption of all of P's stock in S.
    (b) Analysis. As a result of the redemption, S ceases to be a 
member of P's consolidated group on June 30. S will recognize $40 of 
gain under section 311(b) on the distribution of the land to P. The 
next day rule is inapplicable because S's gain becomes includible on 
the day of S's change in status simultaneously with the event that 
causes S's change in status. Consequently, S's gain must be reported 
under the end of the day rule in its taxable year ending June 30, 
during which

[[Page 12104]]

S was a member of the P group. Under Sec.  1.1502-32(b)(2)(i), P's 
basis in its S stock is increased to reflect S's $40 gain 
immediately before the redemption of S's stock.
    (c) Partial redemption. The facts are the same as in paragraph 
(a) of this Example 9, except that S distributes the land to P in 
redemption of 20 shares of P's stock in S. Thus, immediately after 
the redemption, P owns 75% (60 shares/80 shares) of S's outstanding 
stock, and S's minority shareholder owns 25% (20 shares/80 shares). 
The redemption does not satisfy the requirements of section 302(b) 
and is treated under section 302(d) as a distribution to which 
section 301 applies. The end of the day rule does not apply for 
purposes of determining whether P and S are members of the same 
consolidated group immediately after the redemption. Because P owns 
only 75% of S's stock immediately after the redemption, the 
distribution is not an intercompany distribution described in Sec.  
1.1502-13(f)(2)(i). Thus, P may not exclude any amount of the 
distribution that is a dividend, and P's basis in S's stock is not 
reduced under Sec.  1.1502-32(b)(2)(iv). P may be entitled to a 
dividends received deduction under section 243(c) (but see section 
1059(e)). For the reasons discussed in paragraph (b) of this Example 
9, S's gain under section 311(b) must be reported under the end of 
the day rule in S's taxable year ending June 30, during which S was 
a member of the P group.
    (d) Distribution of loss property. The facts are the same as in 
paragraph (a) of this Example 9, except that the land distributed by 
S to P has a fair market value of $60 rather than $140. The end of 
the day rule applies for purposes of determining the taxable year in 
which S must take into account its realized loss on the distribution 
of the land. Thus, under the end of the day rule, S's loss on the 
distribution of the land, which occurs simultaneously with S's 
ceasing to be a member, is taken into account in S's taxable year 
that ends as a result of the redemption. However, the end of the day 
rule does not apply for other purposes; for example, the rule does 
not apply in determining whether the transaction is an intercompany 
distribution or in determining the attributes (as defined in Sec.  
1.1502-13(b)(6)) of the loss. Therefore, because S is not a member 
immediately after the distribution, S's loss on the distribution is 
not recognized under section 311(a). Under the end of the day rule, 
the loss is taken into account as a noncapital, nondeductible 
expense on the P group's consolidated return, and under Sec.  
1.1502-32(b)(1)(i), P's basis in its S stock is decreased by $40 
immediately before S leaves the group.
     Example 10. Extraordinary item of S corporation--(a) Facts. On 
July 1, P purchases all the stock of S, an accrual-basis corporation 
with an election in effect under section 1362(a). Prior to the sale, 
S had engaged a consulting firm to find a buyer for S's stock, and 
the consulting firm's fee was contingent upon the successful closing 
of the sale of S's stock.
    (b) Analysis. To the extent S's payment of the success-based fee 
to its consultants is otherwise deductible, this item is an 
extraordinary item (see paragraph (b)(2)(ii)(C)(9) of this section) 
that becomes deductible on July 1 simultaneously with the event that 
terminates S's election as an S corporation. Under paragraph 
(b)(1)(ii)(B)(2) of this section, S's obligation to pay the fee is 
treated as becoming deductible on June 30 under the previous day 
rule.

    (6) Effective/applicability date. Paragraphs (b)(2)(i) and (b)(4) 
of this section apply to consolidated return years beginning on or 
after the date these regulations are published as final regulations in 
the Federal Register. Otherwise, this paragraph (b) applies to 
corporations becoming or ceasing to be members of consolidated groups 
on or after the date these regulations are published as final 
regulations in the Federal Register.
* * * * *

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2015-05123 Filed 3-5-15; 8:45 am]
 BILLING CODE 4830-01-P