Elimination of Circular Adjustments to Basis; Absorption of Losses, 33211-33222 [2015-13982]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 80, Number 112 (Thursday, June 11, 2015)]
[Proposed Rules]
[Pages 33211-33222]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-13982]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-101652-10]
RIN 1545-BJ29


Elimination of Circular Adjustments to Basis; Absorption of 
Losses

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 amendments would revise the rules concerning 
the use of a consolidated group's losses in a consolidated return year 
in which stock of a subsidiary is disposed of. The regulations would 
affect corporations filing consolidated returns.

DATES: Written or electronic comments, and a request for a public 
hearing, must be received by September 9, 2015.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-101652-10), Room 
5205, Internal Revenue Service, PO 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-
101652-10), 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-101652-10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Robert M. Rhyne, (202) 317-6848; concerning submissions of comments or 
to request a public hearing, Oluwafunmilayo (Funmi) Taylor, (202) 317-
6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

1. Introduction

    This document contains proposed amendments to 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 consolidated returns to reflect clearly the income tax 
liability of the group and to prevent avoidance of such tax liability, 
and provides that these rules may be different from the provisions of 
chapter 1 of subtitle A of the Code that would apply if the 
corporations filed separate returns. Terms used in the consolidated 
return regulations generally are defined in Sec.  1.1502-1.
    These proposed regulations would provide guidance regarding the 
absorption of members' losses in a consolidated return year, and 
provide guidance to eliminate the ``circular basis problem'' in a 
broader class of transactions than under current law.
    This document also contains proposed conforming amendments to 26 
CFR part 301 under section 6402. Section 6402 authorizes the Secretary 
to make credits and refunds. The proposed regulations would amend Sec.  
301.6402-7(g) (relating to claims for refunds and application for 
tentative carryback adjustments involving consolidated groups that 
include financial institutions) by revising the definition of separate 
net operating loss of a member in light of the proposed amendments to 
Sec.  1.1502-21 (relating to the determination and treatment of 
consolidated and separate net operating losses, carrybacks, and 
carryovers).

2. Allocation and Absorption of Members' Losses

    In general, the consolidated taxable income (CTI) or consolidated 
net operating loss (CNOL) of a consolidated group is the sum of each 
member's separately computed taxable income or loss (computed pursuant 
to Sec.  1.1502-12) and certain items of income and deduction that are 
computed on a consolidated basis pursuant to Sec.  1.1502-11.
    Section 1.1502-21(b)(2)(i) (relating to carryovers and carrybacks 
of CNOLs to separate return years) provides generally that if a group 
has a CNOL and a portion of the CNOL would be carried to a

[[Page 33212]]

member's separate return year, the CNOL must be apportioned between the 
group and the member (or members) with the separate return year(s) in 
accordance with the amount of the CNOL attributable to those member(s). 
For this purpose, Sec.  1.1502-21(b)(2)(iv) employs a fraction to 
determine the percentage amount of the CNOL attributable to a member. 
The numerator of the fraction is the separate net operating loss of the 
member for the consolidated return year, and the denominator is the sum 
of the separate net operating losses of all members for that year. For 
this purpose, the separate net operating loss of a member is determined 
by computing the CNOL, taking into account only the member's items of 
income, gain, deduction, and loss. Although the current consolidated 
return regulations provide rules for apportioning a CNOL among members 
when a member's loss may be carried to a separate return year, the 
regulations do not expressly adopt the fraction-based methodology of 
Sec.  1.1502-21(b)(2)(iv) for computing the amount of each member's 
absorbed loss that is used to offset the income of members with 
positive separate taxable income or net capital gain for the 
consolidated return year in which the loss is recognized.
    Furthermore, although the method provided for apportioning a CNOL 
under current law generally yields appropriate results, the 
apportionment may produce anomalies if capital gains are present. For 
example, assume a stand-alone corporation, P, acquires the stock of 
corporation S, and P and S file a consolidated return for the first 
taxable year of P ending after the acquisition. For the consolidated 
return year, P generates $100 of capital gain and incurs $100 of 
deductible expenses. S incurs a $100 capital loss. Thus, the group has 
a $100 CNOL. Under current law, the percentage of the CNOL attributable 
to each member is determined by its relative separate net operating 
loss, taking into account only its items. The CNOL that the group would 
have if only P's items were taken into account is zero ($100 of capital 
gain offset by $100 of deductible expenses). If only S's items were 
taken into account the group would have a consolidated net capital 
loss, but the CNOL would also be zero. Accordingly, because neither P 
nor S has a separate net operating loss, the allocation of the group's 
$100 CNOL is not clear.
    Both to provide an absorption rule for apportioning ordinary and 
capital losses incurred in the same consolidated return year, and to 
address the CNOL apportionment issue, the proposed regulations would 
amend the current regulations in the following two ways. First, the 
proposed regulations add a new paragraph (e) to Sec.  1.1502-11 to 
clarify that the absorption of members' losses to offset income of 
other members in the consolidated return year is made on a pro rata 
basis, consistent with the pro rata absorption of losses from taxable 
years ending on the same date that are carried back or forward under 
the rules of Sec. Sec.  1.1502-21(b) and 1.1502-22(b) (relating to net 
capital loss carrybacks and carryovers). Second, to address 
apportionment anomalies that may arise if capital gains are present, 
the proposed regulations would provide that the separate net operating 
loss of a member, solely for apportionment purposes, is its loss 
determined without regard to capital gains (or losses) or amounts 
treated as capital gains. Thus, in the example in the preceding 
paragraph, P would be allocated the entire $100 CNOL. Excluding capital 
gains and losses from the computation is consistent with excluding 
capital gains and losses in determining a member's separate taxable 
income under Sec.  1.1502-12, and taking capital gains and losses into 
account on a group, rather than a separate member, basis. A conforming 
amendment is made to Sec.  301.6402-7(g)(2)(ii) (relating to refunds to 
certain statutory or court-appointed fiduciaries of an insolvent 
financial institution), which contains a similar allocation rule.

3. Circular Adjustments to Basis

A. The Circular Basis Problem and Current Regulations
    To prevent the income, gain, deduction, or loss of a subsidiary 
from being reflected more than once in a consolidated group's income, 
the consolidated return regulations adjust an owning member's basis in 
a subsidiary's stock to reflect those items. As a group takes into 
account a subsidiary's items of income or gain, an owning member's 
basis in the subsidiary's stock increases. Likewise, as a group absorbs 
a subsidiary's deductions or losses, an owning member's basis in the 
subsidiary's stock decreases. These adjustments take place under what 
is generally referred to as the investment adjustment system. See Sec.  
1.1502-32.
    If a group absorbs a portion of a subsidiary's loss in the same 
consolidated return year in which an owning member disposes of that 
subsidiary's stock, the owning member's basis in the subsidiary's stock 
is reduced immediately before the disposition. Consequently, the amount 
of the owning member's gain or loss on the disposition may be affected. 
Any change in the amount of gain or loss resulting from the disposition 
may in turn affect the amount of the subsidiary's loss that the group 
absorbs. Any further absorption of the subsidiary's loss triggers 
further adjustments to the basis in the subsidiary's stock. These 
iterative computations, which may completely eliminate the benefit of 
the disposed of member's losses, are referred to as the circular basis 
problem.
    For example, assume P owns all the stock of S, and the group has a 
$100 consolidated net capital loss carryover, all of which is 
attributable to S. On December 31, P sells all of S's stock to a 
nonmember at a $10 gain. Absent the current rules in Sec.  1.1502-
11(b), P's $10 capital gain on the sale of S's stock would be offset by 
$10 of the consolidated net capital loss carryover (all of which is 
attributable to S). The use of the loss would cause P's basis in S's 
stock to be reduced by $10 (immediately before the sale), causing P to 
recognize $20 of gain on the sale of S's stock. Similarly, that $20 
gain would be offset by $20 of S's consolidated net capital loss 
carryover, and so on, until the entire consolidated net capital loss 
carryover was depleted. At the end of these iterative calculations, the 
group would still report $10 of consolidated net capital gain. The 
current regulations prevent this result.
    The Treasury Department and the IRS have considered a variety of 
approaches to the circular basis problem since the introduction of the 
investment adjustment system in 1966. The options considered, and 
either rejected or adopted in regulations to date, appear to have been 
motivated by differing views concerning the scope and severity of the 
circular basis problem. The circumstances in which the consolidated 
return regulations have provided relief to date have been limited to 
preventing the disposed of subsidiary's loss absorption from affecting 
the gain or loss recognized on the sale of that subsidiary. This is the 
case notwithstanding that many commentators have criticized the scope 
of relief as being too narrow, and have maintained that relief should 
be extended to, for example, the sales of brother-sister subsidiaries 
within the same consolidated return year.
    Regulations promulgated in 1966 provided no relief from the 
circular basis problem, even though some relief was initially proposed. 
Section 1.1502-11(b), published in 1972, provided some relief from the 
circular basis problem, and those regulations were revised in

[[Page 33213]]

1994 into their current form (the circular basis rules).
    To resolve the circular basis problem, the circular basis rules 
require that a tentative computation of CTI be made without taking into 
account any gain or loss on the disposition of a subsidiary's stock. 
The amount of the subsidiary's losses that would be absorbed under the 
tentative computation becomes a limitation on that subsidiary's losses 
that may be absorbed in the consolidated return year of disposition or 
as a carryback to a prior year. The limitation is intended to eliminate 
the circular basis adjustments to the subsidiary's stock and thus 
prevent iterative computations.
    For example, assume a consolidated group consists of P, the common 
parent, and S, its wholly owned subsidiary, and neither P nor S had 
income or gain in a prior year. At the beginning of the consolidated 
return year, P has a $500 basis in S's stock. P sells S's stock for 
$520 at the end of the year. For the year, P has $30 of ordinary income 
(determined without taking into account P's gain or loss on the 
disposition of S's stock) and S has $80 of ordinary loss. To determine 
the limitation on the amount of S's loss that the group may use during 
the consolidated return year or as a carryback to a prior year, CTI is 
tentatively determined without taking into account P's gain or loss on 
the disposition of S's stock. Accordingly, the use of S's loss in the 
consolidated return year of disposition is limited to $30. The group is 
tentatively treated as having a CNOL of $50 (P's $30 of income minus 
S's $80 loss). The absorption of $30 of S's loss reduces P's basis in 
S's stock to $470, and results in $50 [$520--($500-$30)] of gain to P 
on the disposition. Thus, iterative computations are avoided.
    Nevertheless, the circular basis rules do not prevent iterative 
computations in all cases--not even all cases in which the stock of a 
single subsidiary with a loss is disposed of. For example, if a member 
other than the disposed of subsidiary also has a loss, and the sum of 
the losses of the disposed subsidiary and the other member exceeds the 
income of the group (without regard to gain on the disposed 
subsidiary's stock) a tentative computation applying a pro rata rule 
for absorption establishes a limitation on the use of the disposed of 
subsidiary's loss. That amount will be used to reduce the owning 
member's basis in the subsidiary's stock and determine the gain or loss 
on the stock disposition. If the stock disposition results in gain, 
that gain will be taken into account in an actual computation of CTI. 
If the sum of the other member's loss and the disposed of subsidiary's 
limited loss still exceeds the income and gain of other members, the 
pro rata absorption rule will be applied again. That computation will 
result in a lower amount for the absorption of the disposed of 
subsidiary's loss, which will be different than the amount by which the 
owning member's stock basis was reduced. Accordingly, iterative 
computations would be required.
    To illustrate, assume a consolidated group consists of P, the 
common parent, and its wholly owned subsidiaries, S1 and S2. At the 
beginning of the consolidated return year, P has a $500 basis in S1's 
stock. P sells all of its S1 stock for $500 at the end of the year. For 
the year, P has a $60 capital gain (determined without taking into 
account P's gain or loss on the disposition of S1's stock), S1 has a 
$40 net capital loss and S2 has an $80 net capital loss. To determine 
the limitation on the amount of S1's capital loss that the group may 
use during the consolidated return year, CTI is tentatively determined 
without taking into account gain or loss on the disposition of S1's 
stock, but with regard to S2's net capital loss. Because S2 has an $80 
net capital loss in addition to S1's $40 net capital loss, $40 of S2's 
loss [$60 x ($80/$120)] and $20 of S1's loss [$60 x ($40/$120)] will be 
used (assuming pro rata absorption of losses as described in section 2 
of the Explanation of Provisions of this preamble). Accordingly, the 
group's use of S1's loss is limited to $20. Thus, P's basis in S1's 
stock is reduced by $20 before P disposes of the stock. Therefore, P is 
assumed to recognize $20 [$500-($500-$20)] of gain on the disposition 
of its S1 stock, which leaves P with a total capital gain for the year 
of $80. Again, because S2 has an $80 loss in addition to S1's $20 
usable loss, a pro rata portion of each subsidiary's losses will be 
absorbed in computing the P group's CTI. Assuming pro rata absorption 
of losses, P's $80 capital gain is offset with $16 of S1's capital loss 
[$80 x ($20/$100)]. This amount, however, is less than the $20 amount 
determined in the tentative computation by which P's basis in S1's 
stock was reduced. Thus, iterative computations would be required.
    In considering the circular basis problem, the Treasury Department 
and the IRS have become aware that taxpayers have taken a broad range 
of approaches in cases in which the circular basis problem persists. 
Some taxpayers may undertake many iterative computations while, under 
similar facts, others will undertake few. Some commentators have 
suggested using simultaneous equations. That method can produce 
appropriate results in the simplest fact patterns, but becomes highly 
complex if both ordinary income and capital gains are present, or if 
the stock of more than one subsidiary is sold.
    One approach that the Treasury Department and IRS considered but 
did not adopt in these proposed regulations was to disallow the 
absorption of any losses of a subsidiary in the year of disposition. 
Such a rule would have an adverse impact on any consolidated group with 
ordinary income that otherwise would be offset by the subsidiary's 
losses. Furthermore, a blanket prohibition on the use of a subsidiary's 
losses would be inappropriately harsh if a subsidiary's stock was sold 
at a loss and the unified loss rules required a stock basis reduction 
that was greater than the amount of S's loss. In such a case, the use 
of S's loss to offset income of other members allowed under current law 
reduces CTI, but the basis reduction that results from the absorption 
of the loss has no net effect on the owning member's basis in the 
subsidiary's stock. Prohibiting the use of the disposed of subsidiary's 
losses would simply increase the group's CTI.
    The Treasury Department and IRS also considered but did not adopt 
an approach similar to the current rules that would compute a tentative 
amount of S's losses, and then require a reduction to P's basis in S's 
stock, regardless of whether S's losses were actually absorbed. This 
approach could lead to non-economic consequences when another 
subsidiary's losses are actually absorbed instead of S's according to 
the general rules of the Code and regulations, but S's losses are 
nonetheless treated as absorbed for purposes of reducing P's basis in 
S's stock.
    A third approach that the Treasury Department and IRS considered 
but did not adopt was to turn-off the investment adjustment rules for 
losses of a subsidiary used in the year of disposition. Such an 
approach would allow a double deduction and undermine a bedrock 
principle of consolidated returns as articulated by the Supreme Court 
in Charles Ilfeld Co. v. Hernandez, 292 U.S. 62 (1934).
B. Proposed Circular Basis Rules
i. In General
    The proposed regulations would provide relief and certainty to 
cases in which the circular basis problem persists, yet adhere to 
underlying consolidated return concepts without undue complexity. To 
prevent iterative

[[Page 33214]]

computations for a consolidated return year in which the stock of one 
or more subsidiaries is disposed of, these proposed regulations require 
a group to first determine the amount of each disposed subsidiary's 
loss that will be absorbed by computing CTI without regard to gain or 
loss on the disposition of the stock of any subsidiary (the absorbed 
amount). Once the amount of a subsidiary's absorbed loss is determined 
under that computation, the absorbed amount for each disposed of 
subsidiary is not redetermined. Determining each disposed of 
subsidiary's absorbed amount establishes an immutable number that will 
also be the amount of reduction to the basis of S's stock taken into 
account in computing the owning member's gain or loss on the 
disposition of S's stock. After the absorbed amount is determined, the 
owning member's basis of the S stock is adjusted under Sec.  1.1502-32 
(and Sec.  1.1502-36 as relevant). The actual computation of CTI can 
then be made, taking into account losses of each disposed of subsidiary 
equal to that amount. In some cases, however, applying the generally 
applicable rules of the Code and regulations would result in less than 
all of a disposed of subsidiary's absorbed amount being used.
    For example, assume S has an ordinary loss of $100 and P has 
capital gain net income of $100 (unrelated to its disposition of S 
stock), then S's absorbed amount would be determined to be $100. If 
after taking into account S's $100 absorbed amount P would have a $100 
capital loss on a sale of S's stock, P's capital loss on its S stock 
would offset P's $100 capital gain, and S's ordinary loss would not be 
used in that year and would become a CNOL carryover (assuming no 
ability to carry back the loss). If an amount of S's losses equal to 
its absorbed amount were not used, P's basis in its S stock would not 
be reduced by the absorbed amount, and the amount of P's loss on S's 
stock would be changed.
    The proposed regulations prevent such a result by providing for an 
alternative four-step computation of CTI if, applying the general 
ordering rules of the Code and regulations, less than all of a disposed 
of subsidiary's absorbed amount would be used. See Examples 5, 6, 7, 8 
and 9 of Sec.  1.1502-11(b)(2)(vi) as proposed herein.
    Under the first step, any income, gain, or loss on any share of 
subsidiary stock is excluded from the computation of CTI and the group 
uses losses of each disposed of subsidiary equal in both amount and 
character and from the same taxable years as those used in the 
computation of its absorbed amount. Thus, by excluding any income, 
gain, or loss on a stock disposition, and by giving priority to the 
losses of all disposed of subsidiaries, the proposed regulations would 
solve the circularity problem.
    Under the second step, a disposing member offsets its gain on 
subsidiary stock with its losses on subsidiary stock (determined after 
applying Sec.  1.1502-36 (b) and (c), and so much of Sec.  1.1502-36(d) 
as is necessary to give effect to an election actually made under Sec.  
1.1502-36(d)(6)). If the disposing member has net income or gain on the 
subsidiary stock, and if the disposing member also has a loss of the 
same character (determined without regard to the stock net income or 
gain), the disposing member's loss is used to offset the net income or 
gain on the subsidiary stock to the extent of such income or gain. Any 
remaining net income or gain is added to the group's remaining income 
or gain as determined under the first step. Giving priority to S's 
losses ahead of other members' losses and excluding gain or loss on 
subsidiary stock are departures from the general rules that require a 
member to net its income and gain with its own losses before those 
amounts are combined in a consolidated computation. These departures 
may distort the amount of absorbed losses of a disposing member 
relative to the absorbed losses of other members. Thus, in order to put 
losses of a disposing member (unrelated to its loss on a stock 
disposition) on a par with losses of other members, the proposed 
regulations allow P's losses to offset the group's income before other 
members, but only to the extent of the gain (or income) on the disposed 
of subsidiary's stock.
    Under the third step if, after the application of the second step 
of the alternative computation, the group has remaining income or gain 
and a disposing member has a net loss on subsidiary stock (determined 
after applying Sec.  1.1502-36 (b) and (c), and so much of Sec.  
1.1502-36(d) as is necessary to give effect to an election actually 
made under Sec.  1.1502-36(d)(6)), that income or gain is then offset 
by the loss on the disposition of subsidiary stock, subject to 
generally applicable rules of the Code and regulations. The amount of 
the offset, however, is limited to the lesser of the total remaining 
ordinary income or capital gain of the group (determined after the 
application of the second step) or the amount of the disposing member's 
ordinary income or capital gain (determined without regard to the stock 
loss).
    Finally, under the fourth step, if the group has remaining income 
or gain, the unused losses of all members are applied on a pro rata 
basis.
    The Treasury Department and the IRS recognize that the special 
rules in these proposed regulations may in certain cases alter the 
general rule under section 1211(a) that allows the deduction of losses 
from the sale or exchange of capital assets to the extent of capital 
gains. However, giving priority to the absorption of a disposed 
subsidiary's losses will prevent the need for iterative computations.
    The Treasury Department and the IRS also recognize that the 
proposed regulations may increase the number of cases in which the 
general ordering rules for the absorption of members' losses will be 
altered and may in certain cases result in more gain (or less loss) on 
the sale of a subsidiary's stock than under current law. However, the 
Treasury Department and the IRS believe that the benefits derived from 
the certainty that the proposed rules achieve generally outweigh the 
potential detriments of these deviations from the general rules. 
Comments are requested on whether there are alternative approaches that 
would both eliminate the circular basis problem and preserve the 
general rule for the absorption of capital and ordinary losses.
ii. Higher-Tier Subsidiaries
    Under Sec.  1.1502-11(b)(4)(ii) of the current regulations, if S is 
a higher-tier subsidiary of another subsidiary (T), the use of T's 
losses is subject to the circular basis rules upon a disposition of S's 
stock, but only if 100 percent of T's items of income, gain, deduction, 
and loss would be reflected in the basis of S's stock in the hands of 
the owning member (100-percent requirement). If another member of S's 
consolidated group or a nonmember owns any stock of either S or T, the 
circular basis rules do not apply.
    These proposed regulations would remove the 100-percent 
requirement. Thus, if any stock of a higher-tier subsidiary is disposed 
of, the absorption of losses of a lower-tier subsidiary is subject to 
the proposed circular basis rules by treating the lower-tier subsidiary 
as if its stock had been disposed of. The Treasury Department and the 
IRS request comments regarding whether, and under what circumstances, 
the 100-percent requirement should be retained.
C. Other Provisions
    Ordinary income and deductions are generally taken into account on 
a separate company basis before the

[[Page 33215]]

computation of CTI occurs. A member's separate taxable income under 
Sec.  1.1502-12 is computed in accordance with the provisions of the 
Code subject to certain modifications. These modifications generally 
relate to items that are determined on a consolidated basis (for 
example, the use of capital losses and the limitation on charitable 
contribution deductions). Although gain or loss on the disposition of a 
subsidiary's stock is usually capital, a worthless stock deduction 
could be ordinary if the conditions of section 165(g)(3) are satisfied. 
In addition, a gain on the disposition of such stock can be ordinary if 
the recapture rules of section 1017(d) apply. Under these proposed 
regulations, gain and loss on the disposition of subsidiary stock are 
disregarded in determining the subsidiary's absorbed amount, and in an 
alternative computation of CTI. Consequently, if stock of a subsidiary 
is disposed of, these proposed regulations may require a departure from 
the general rules for the computation of an owning member's separate 
taxable income. The Treasury Department and the IRS believe that this 
departure from the general rules is necessary to avoid iterative 
computations and request comments as to whether an alternative 
methodology would be preferable.
    These proposed regulations clarify the interaction of the Unified 
Loss Rule of Sec.  1.1502-36 with the circular basis rules. Adjustments 
under Sec.  1.1502-36 (b), (c), and (d)(6) (if an election is made to 
reattribute losses or reduce stock basis) will affect the computation 
of CTI. Therefore, these proposed regulations contain guidance as to 
the point in the computation that those adjustments are made.
    The proposed regulations also contain a rule to prevent iterative 
computations in determining the amount of deductions that are 
determined by reference to or are limited by the group's CTI, for 
example, the consolidated charitable contributions deduction under 
Sec.  1.1502-24 and a member's percentage depletion deduction with 
respect to oil or gas property for independent producers and royalty 
owners under Sec.  1.1502-44. The amount of those deductions is taken 
into account in determining the group's CTI and may affect the 
computation of a disposed of subsidiary's absorbed amount. The absorbed 
amount will reduce the stock basis and affect the amount of gain or 
loss on the disposition of the subsidiary's stock, which will change 
the amount of CTI, and thus the amount of the group's deduction. To 
prevent these iterative computations, the proposed regulations provide 
that the amount of those deductions is determined without regard to 
gain or loss on the disposition of a subsidiary's stock.
    As a result of the later addition of Sec.  1.1502-11(c), current 
Sec.  1.1502-11(b) does not apply if a member realizes discharge of 
indebtedness income that is excluded from gross income under section 
108(a). The rules applicable in that case, contained in paragraph (c) 
of Sec.  1.1502-11, are generally not addressed by these proposed 
regulations, but to the extent that paragraph (c) uses the absorbed 
amount described in Sec.  1.1502-11(b)(2) as a starting point, the 
computation will be affected. Comments are requested regarding 
appropriate additional changes to Sec.  1.1502-11(c).
    Finally, the proposed regulations include modifications to 
Sec. Sec.  1.1502-11(a), 1.1502-12, 1.1502-22(a), and 1.1502-24 of the 
current regulations and removal of Sec. Sec.  1.1502-21A, 1.1502-22A 
and 1.1502-23A. These modifications are not changes to current 
substantive law; they are intended solely to update the regulations to 
reflect certain statutory changes and remove cross-references to 
outdated regulatory provisions.

Proposed Effective Date

    These regulations are proposed to be effective for consolidated 
return years beginning 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. These proposed regulations would 
not impose a collection of information on small entities. Further, 
under the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby 
certified that these proposed regulations would not have a significant 
economic impact on a substantial number of small entities. This 
certification is based on the fact that these proposed regulations 
would primarily affect members of consolidated groups that tend to be 
large corporations. Accordingly, a regulatory flexibility analysis is 
not required. Pursuant to section 7805(f) of the Code, this notice of 
proposed rulemaking has been submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original with 
eight (8) copies) or electronic comments that are submitted timely to 
the IRS. The Treasury Department and the IRS request comments on all 
aspects of the proposed regulations.
    All comments will be available for public inspection and copying at 
www.regulations.gov or upon request. A public hearing may be scheduled 
if requested by any person that timely submits comments. If a public 
hearing is scheduled, notice of the date, time, and place for the 
public hearing will be published in the Federal Register.

Drafting Information

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

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recording keeping requirements.

26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recording requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as 
follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry for Sec.  1.1502-24 to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
* * * * *
    Section 1.1502-24 also issued under 26 U.S.C. 1502.
* * * * *
0
Par. 2. Section 1.1502-11 is amended by:
0
1. Revising paragraphs (a) introductory text, (a)(2), (a)(3), and 
(a)(4).
0
2. Removing and reserving paragraph (a)(6).
0
3. Revising paragraphs (b), (c)(2)(i), and (c)(2)(ii).
0
4. Removing in paragraph (c)(2)(vi) the phrase ``unlimited deductions 
and losses that are absorbed'' and adding

[[Page 33216]]

``S's absorbed amount of losses'' in its place.
0
5. Revising paragraph (c)(4).
0
6. Revising the heading of paragraph (c)(7) and adding a sentence at 
the end of the paragraph.
0
7. Adding paragraph (e).
    The revisions and additions read as follows:


Sec.  1.1502-11  Consolidated taxable income.

    (a) In general. The consolidated taxable income (CTI) for a 
consolidated return year shall be determined by taking into account--
* * * * *
    (2) Any consolidated net operating loss (CNOL) deduction (see Sec.  
1.1502-21 for the computation of the CNOL deduction);
    (3) Any consolidated capital gain net income (see Sec.  1.1502-22 
for the computation of the consolidated capital gain net income);
    (4) Any consolidated section 1231 net loss (see Sec.  1.1502-23 for 
the computation of the consolidated section 1231 net loss);
* * * * *
    (6) [Reserved]
* * * * *
    (b) Elimination of circular basis adjustments if there is no 
excluded COD income--(1) In general. If a member (P) disposes of a 
share of stock of one or more subsidiaries (S), this paragraph (b) 
applies to determine the amount of S's losses that will be used in the 
consolidated return year of disposition and in a carryback year. The 
purpose of these rules is to prevent P's income, gain, deduction, or 
loss from the disposition of a share of S's stock from affecting the 
amount of S's deductions and losses that are absorbed. A change to the 
amount of S's absorbed losses would affect P's basis in S's stock under 
Sec.  1.1502-32, which in turn affects P's gain or loss on the 
disposition of S's stock. For purposes of this section, P is treated as 
disposing of a share of a subsidiary's stock if any event described in 
Sec.  1.1502-19(c) occurs or, if for any reason, a member recognizes 
gain or loss (including an excess loss account included in income) with 
respect to the share. However, to the extent income, gain, deduction, 
or loss from a disposition of a share of S's stock is deferred under 
any rule of law (for example, Sec.  1.1502-13 and section 267(f)), the 
taxable year in which the deferred amount is taken into account is 
treated as the taxable year of disposition. This paragraph (b) does not 
apply if any member realizes discharge of indebtedness income that is 
excluded from gross income under section 108(a) during the consolidated 
return year of the disposition. If a member realizes such income, see 
paragraph (c) of this section. For purposes of this section, S's 
ordinary loss means its separate net operating loss (as defined in 
Sec.  1.1502-21(b)(2)(iv)(B)). Solely for purposes of this section, any 
reference to a member's capital gain includes amounts treated as 
capital gain. Furthermore, for those purposes, a member's capital loss 
means a consolidated net capital loss determined by reference to only 
that member's capital gain and capital loss items.
    (2) Deductions and losses of disposed subsidiaries--(i) 
Determination of absorbed amounts. If P disposes of a share of S's 
stock in a transaction to which this paragraph (b) applies, the extent 
to which S's ordinary loss and capital loss (including losses carried 
over from a prior year) that are absorbed in the consolidated return 
year of the disposition or in a prior year as a carryback (the absorbed 
amount) is determined under this paragraph (b)(2). S's absorbed amount 
is the amount that would be absorbed in a computation of the group's 
consolidated taxable income (CTI) for the consolidated return year of 
the disposition (and any taxable year to which losses may be carried 
back) without taking into account any member's income, gain, deduction, 
or loss from the disposition of any share of any subsidiary's stock in 
that year. S's absorbed amount is determined after first applying other 
applicable limitations and ordering rules (for example, limitations 
imposed by section 382(a) and Sec.  1.1502-21 and the ordering rules of 
section 382(l)(2)) to S's deductions and losses. Any election that the 
group makes on its actual return for the consolidated return year (for 
example, an election to relinquish a carryback under Sec.  1.1502-
21(b)(3)) must be used in this computation. Once S's absorbed amount is 
determined, that amount is not redetermined. Except as provided in 
paragraph (b)(2)(iii)(B)(1) of this section, the amount determined 
under this paragraph (b)(2)(i) fixes only the amount of S's losses that 
will be absorbed. Thus, under paragraph (b)(2)(iii)(A) of this section, 
the character of the losses that are absorbed in the actual computation 
of the group's CTI for the year (or as a carryback to a prior year) may 
not be the same as the character of the losses that are absorbed in 
determining the absorbed amount. However, if the alternative 
computation of paragraph (b)(2)(iii)(B)(1) of this section is required, 
the character of the absorbed amount as determined under this paragraph 
(b)(2)(i) is retained.
    (ii) Stock basis reduction and gain or loss on disposition. After 
the determination of S's absorbed amount, P reduces its basis in S's 
stock under the investment adjustment rules of Sec.  1.1502-32(b)(2) by 
the absorbed amount. If any share is a loss share, P then adjusts its 
basis in S's stock by applying paragraphs (b) and (c) of Sec.  1.1502-
36, and, if an election is actually made under Sec.  1.1502-36(d)(6), 
by applying Sec.  1.1502-36(d) to the extent necessary to give effect 
to the election. P then computes its gain or loss on the disposed of 
shares after taking into account those adjustments.
    (iii) Actual computation of CTI--(A) In general. The group's CTI 
and any carryback of a portion of a CNOL are determined under 
applicable provisions of the Internal Revenue Code (Code) and 
regulations, taking into account gain or loss on any subsidiary's 
stock, and taking into account losses of disposed of subsidiaries equal 
to each such subsidiary's absorbed amount.
    (B) Alternative computation. If the computation of the group's CTI 
under paragraph (b)(2)(iii)(A) of this section would result in an 
absorption of less than all of any disposed of subsidiary's absorbed 
amount, then the group's CTI is computed by applying the following 
steps, rather than the computation under that paragraph:
    (1) First, losses of each disposed of subsidiary equal in both 
amount and character and from the same taxable years as losses used in 
the computation of its absorbed amount under paragraph (b)(2)(i) of 
this section offset income and gain of other members without taking 
into account any gain or loss on any share of subsidiary stock and 
without regard to net losses of other members.
    (2) Second, a disposing member offsets its gain on subsidiary stock 
with its losses on subsidiary stock of the same character. For this 
purpose, a loss on subsidiary stock is determined after applying Sec.  
1.1502-36 (b) and (c), and so much of Sec.  1.1502-36(d) as is 
necessary to give effect to an election actually made under Sec.  
1.1502-36(d)(6). If the disposing member has net income or gain on 
subsidiary stock, and if the member also has a loss of the same 
character (determined without regard to the net income, gain, deduction 
or loss on subsidiary stock), the loss offsets that net income or gain 
and any remaining income or gain is added to the amount determined 
after the application of paragraph (b)(2)(ii)(B)(1) of this section. 
For example, if P has a net capital loss on portfolio stock, that net 
loss is not taken into account in applying paragraph (b)(2)(iii)(B)(1). 
However, under this paragraph (b)(2)(iii)(B)(2),

[[Page 33217]]

that net capital loss is absorbed to the extent of that member's net 
capital gain on subsidiary stock.
    (3) Third, if, after the application of paragraph (b)(2)(iii)(B)(2) 
of this section, the group has remaining income or gain and a disposing 
member has a net loss on subsidiary stock (determined after applying 
Sec.  1.1502-36(b) and (c), and so much of Sec.  1.1502-36(d) as is 
necessary to give effect to an election actually made under Sec.  
1.1502-36(d)(6)), that remaining income or gain is then offset by a 
loss on the disposition of subsidiary stock, subject to the applicable 
rules of the Code and regulations. The amount of the offset, however, 
is limited to the lesser of the total remaining ordinary income or 
capital gain of the group (determined after the application of 
paragraph (b)(2)(iii)(B)(2) of this section), or the amount of the 
disposing member's ordinary income or capital gain of the same 
character (determined without regard to the stock loss). If the 
preceding sentence applies to more than one disposing member, and the 
sum of the amounts determined under that sentence exceeds the group's 
remaining ordinary or capital gain, the amounts offset capital gain or 
ordinary income on a pro rata basis under the principles of paragraph 
(e) of this section.
    (4) Fourth, if, after application of paragraph (b)(2)(iii)(B)(3) of 
this section, the group has remaining ordinary income or capital gain, 
those amounts are offset by the unused losses of all members on a pro 
rata basis under paragraph (e) of this section.
    (C) Priority of rules. The computation of CTI under this paragraph 
(b)(2)(iii) applies notwithstanding other rules for the absorption of a 
portion of a member's current year loss, such as paragraphs (a) and (e) 
of this section, Sec. Sec.  1.1502-12 and 1.1502-22(a), and the 
absorption of a member's portion of a CNOL or consolidated net capital 
loss carryover from a prior year under Sec. Sec.  1.1502-21(b) and 
1.1502-22(b), respectively. For example, in some circumstances, an 
ordinary loss of a disposed of subsidiary may offset capital gain of 
another member notwithstanding that under general rules a capital loss 
of another member would be allowed to the extent of capital gains 
before an ordinary loss is taken into account. Similarly, an ordinary 
loss with respect to a subsidiary's stock, which would generally offset 
ordinary income of the owning member and be included in determining 
that member's separate taxable income, may become a loss carryover if 
use of that loss would cause less than all of a disposed of 
subsidiary's absorbed amount to be used.
    (D) Deductions determined by reference to CTI. In the case of any 
deduction of any member that is determined by reference to or limited 
by the amount of CTI (for example, a charitable contribution deduction 
under Sec.  1.1502-24(c) and a percentage depletion deduction under 
Sec.  1.1502-44(b)), the amount of the deduction is determined without 
regard to any gain or loss on subsidiary stock.
    (iv) Losses not absorbed. To the extent S's losses in the 
consolidated return year of the disposition of its stock do not offset 
income or gain by reason of the rules of this paragraph (b), S ceases 
to be a member, and S's losses are not reattributed under Sec.  1.1502-
36(d)(6), the losses are carried over to its separate return years (if 
any) under the applicable principles of the Code and regulations 
thereunder. Those losses are not taken into account in determining the 
percentage of CNOL or consolidated net capital loss attributable to 
members under Sec.  1.1502-21(b)(2)(iv) or Sec.  1.1502-22(b)(3), 
respectively. If S remains a member, its unused losses are included in 
the CNOL or consolidated net capital loss carryovers and are subject to 
the allocation rules of those sections.
    (v) Disposition of stock of a higher-tier subsidiary. If a 
subsidiary (T) is a lower-tier subsidiary (as described in Sec.  
1.1502-36(f)(4)) of a higher-tier subsidiary (S), and S's stock is 
disposed of during a consolidated return year, T's losses are subject 
to this paragraph (b) as if T's stock had been disposed of. Thus, T's 
absorbed amount is determined by disregarding any gain or loss (for 
example, an excess loss account taken into account under Sec.  1.1502-
19(b)) on a deemed disposition of T's stock as provided under this 
paragraph (b), as well as any gain or loss on the disposition of a 
share of any other subsidiary's stock.
    (vi) Examples. For purposes of the examples in this paragraph 
(b)(2)(vi), unless otherwise stated, P is the common parent of a 
calendar-year consolidated group and owns all of the only class of 
stock of subsidiaries S, S1, S2, M, M1, and M2 for the entire year; S, 
S1, S2, M, M1, M2, and T own no stock of lower-tier subsidiaries; all 
persons use the accrual method of accounting; the facts set forth the 
only corporate activity; all transactions are between unrelated 
persons; tax liabilities are disregarded; and Sec.  1.1502-36 will not 
cause P to adjust its basis in S's stock immediately before a 
disposition. The rules of this paragraph (b)(2) are illustrated by the 
following examples:

    Example 1. Absorption of disposed of subsidiary's losses. (i) 
Facts. P has a $500 basis in S's stock. P sells S's stock for $520 
at the close of Year 1. For Year 1, P has ordinary income of $30 
(determined without taking into account P's gain or loss from the 
disposition of S's stock) and S an $80 ordinary loss.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its losses under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's taxable 
income is computed without taking into account P's gain or loss from 
the disposition of S's stock. The P group is treated as having a 
CNOL of $50 (P's $30 of income minus S's $80 separate net operating 
loss). Accordingly, S's absorbed amount determined under paragraph 
(b)(2)(i) of this section is $30.
    (iii) Loss absorption and basis reduction. Under paragraph 
(b)(2)(ii) of this section, P's basis in S's stock is reduced by S's 
$30 absorbed amount from $500 to $470 immediately before the 
disposition. Consequently, P recognizes a $50 gain from the sale of 
S's stock, and the P group has CTI of $50 for Year 1 (P's $30 of 
ordinary income plus its $50 of gain from the sale of S's stock, 
minus $30 of S's ordinary loss equal to its absorbed amount). In 
addition, S's $50 of unabsorbed loss is carried to S's first 
separate return year.
    Example 2. Carrybacks and carryovers. (i) Facts. For Year 1, the 
P group has CTI of $30 (all of which is attributable to P) and a 
consolidated net capital loss of $100 ($50 attributable to P and $50 
to S), which cannot be carried back. At the beginning of Year 2, P 
has a $300 basis in S's stock. P sells S's stock for $280 at the 
close of Year 2. For Year 2, P has ordinary income of $30, and a $20 
capital gain (determined without taking into account the 
consolidated net capital loss carryover from Year 1 or P's gain or 
loss from the disposition of S's stock), and S has a $100 ordinary 
loss.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its losses under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's taxable 
income for Year 2 is computed without taking into account P's gain 
or loss from the disposition of S's stock. Under section 
1212(a)(1)(B), P's $20 capital gain for Year 2 would be offset by 
$20 of the group's consolidated capital loss carryover from Year 1 
($10 attributable to P and $10 attributable to S). P's $30 of 
ordinary income in Year 2 would be offset by $30 of S's $100 
ordinary loss in that year. P's $30 of ordinary income in Year 1 
would be offset by a $30 CNOL carryback from Year 2, all of which is 
attributable to S. Accordingly, S's absorbed amount under paragraph 
(b)(2)(i) of this section is $70 ($10 of S's portion of the 
consolidated capital loss carryover from Year 1 plus $60 of S's loss 
from Year 2).
    (iii) Loss absorption and basis reduction. Under paragraph 
(b)(2)(ii) of this section, P's basis in S's stock is reduced by S's 
$70 absorbed amount from $300 to $230, immediately before the 
disposition, resulting in $50 of capital gain to P from the sale of 
S's stock for $280 in Year 2. Thus, for Year 2 P will have $70 of 
capital gain ($50 from

[[Page 33218]]

the stock sale plus $20 from its other capital gain for that year), 
which will be offset by $70 of the consolidated capital loss 
carryover from Year 1, $35 of which is attributable to P and $35 of 
which is attributable to S. Another $30 of S's ordinary loss offsets 
P's $30 of ordinary income in Year 2. An amount of S's ordinary loss 
equal to its remaining $5 absorbed amount may be carried back to 
Year 1 to offset $5 of the group's CTI in that year. P will have a 
$15 ($50-$35) capital loss carryover from Year 1, and S will carry 
over a $15 ($50-$35) capital loss from Year 1 and a $65 ($100-$35) 
NOL to its first separate return year.
    Example 3. Chain of subsidiaries. (i) Facts. P has a $500 basis 
in the stock of S and S has a $500 basis in the stock of T, its 
wholly owned subsidiary. P sells all of its S stock for $520 at the 
close of Year 1. For Year 1, P has ordinary income of $30, S has no 
income or loss, and T has an $80 ordinary loss.
    (ii) Determination of absorbed amount, basis reduction, and loss 
absorption. Under Sec.  1.1502-19(c)(1)(ii), T's stock is treated as 
disposed of when it becomes a nonmember, and its losses are subject 
to paragraph (b) of this section. Thus, T's absorbed amount is 
determined by taking into account P's $30 of ordinary income but 
without taking into account any gain or loss on P's disposition of 
S's stock. Accordingly, T's absorbed amount determined under 
paragraph (b)(2)(i) of this section is $30. Under paragraph 
(b)(2)(ii) of this section, S's basis in T's stock is reduced by 
$30, from $500 to $470. Furthermore, under Sec.  1.1502-
32(a)(3)(iii), P's basis in S's stock is reduced by $30, from $500 
to $470, immediately before the sale. Consequently, P recognizes a 
$50 gain from the sale of S's stock ($520-$470), and T will have a 
$50 ($80--$30) NOL carryover to its first separate return year.
    (iii) Excess loss account in lower-tier stock. The facts are the 
same as in paragraph (i) of this Example 3, except that S has a $10 
excess loss account (ELA) in T's stock (rather than a $500 basis). 
Under paragraph (b)(1) of this section, T's stock is treated as 
disposed of and its absorbed amount is determined under paragraph 
(b)(2)(i) of this section. Thus, T's absorbed amount is determined 
by taking into account P's $30 of ordinary income but without taking 
into account P's gain or loss on the disposition of S's stock and 
S's inclusion of its ELA with respect to T's stock under Sec.  
1.1502-19(b)(1). Accordingly, T's absorbed amount determined under 
paragraph (b)(2)(i) of this section is $30. Under paragraph 
(b)(2)(ii) of this section, S's ELA in its T stock is increased by 
$30, from $10 to $40, immediately before the disposition of T's 
stock. Under Sec.  1.1502-19(b), the ELA is included in S's income. 
Moreover, under Sec.  1.1502-32(b)(2), P's basis in S's stock is 
increased immediately before the sale by a net $10 (S's $40 
inclusion of T's ELA under Sec.  1.1502-19(b) minus T's $30 absorbed 
loss that tiers up under Sec.  1.1502-32(a)(3)(iii)) from $500 to 
$510. Thus, P recognizes $10 of gain on the sale of S's stock ($520-
$510), and S takes into account $40 of gain from the inclusion of 
its ELA in T's stock. T will have a $50 ($80-$30) NOL carryover to 
its first separate return year.
    Example 4. Sale of S's stock and S remains in the group. (i) 
Facts. For Year 1, the P group has CTI of $100 (all of which is 
attributable to P). At the beginning of Year 2, P has a $40 basis in 
each of the 10 shares of S's stock. P sells 2 shares of S's stock 
for $85 each at the close of Year 2. For Year 2, P has an $80 
ordinary loss (determined without taking into account P's gain or 
loss from the sale of S's stock), and S has an $80 ordinary loss.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its losses under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's CTI for Year 
2 is computed without taking into account P's gain or loss from the 
sale of S's stock. Thus, the group would have a $160 CNOL for Year 
2, $100 of which is carried back to Year 1 ($50 attributable to S 
and $50 attributable to P) and offsets $100 of CTI in that year. 
Accordingly, S's absorbed amount determined under paragraph 
(b)(2)(i) of this section is $50.
    (iii) Loss absorption and basis reduction. Under paragraph 
(b)(2)(ii) of this section, P's basis in all of S's stock is reduced 
by $50. Each of P's 10 shares of S stock is reduced by $5 from $40 
to $35. Consequently, on the sale of each of the 2 shares of S's 
stock, P recognizes a $50 gain ($85-$35). The losses available to 
offset the $100 gain on the sale of S's 2 shares consist of P's $80 
ordinary loss and $50 of S's ordinary loss equal its absorbed 
amount. Under paragraph (e) of this section, P's and S's losses are 
absorbed on a pro rata basis. Therefore, the group absorbs 
approximately $62 ($100 x 80/80 + 50) of P's ordinary loss from Year 
2, and approximately $38 ($100 x 50/80 + 50) of S's ordinary loss in 
that year. P's remaining $18 ($80-$62) of ordinary loss in Year 2 
and S's remaining $12 ($50-$38) of ordinary loss equal to its 
remaining absorbed amount may be carried back to Year 1 to offset 
$30 of the $100 of CTI in that year. For Year 2, the P group has $30 
remaining of its CNOL (all of which is attributable to S) which is 
carried to the P group's Year 3 consolidated return year.
    (iv) Lower-tier subsidiary. The facts are the same as in 
paragraph (i) of this Example 4, except that S has no income or loss 
for Year 2, but S's wholly owned subsidiary, T, has an $80 ordinary 
loss. Under paragraph (b)(2)(v) of this section, T's loss is subject 
to paragraph (b) of this section as if T's stock had been disposed 
of. To determine T's absorbed amount, and the effect of the 
absorption of its losses under Sec.  1.1502-32 on S's basis in its T 
stock and P's basis in its S stock, the group's taxable income is 
computed without taking into account P's gain or loss from the sale 
of S's stock. Of the group's $160 CNOL for Year 2, $100 is carried 
back to Year 1 ($50 attributable to P and $50 attributable to T) and 
offsets $100 of CTI in that year. Accordingly, T's absorbed amount 
determined under paragraph (b)(2)(i) of this section is $50. Under 
paragraph (b)(2)(ii) of this section, S's basis in T's stock is 
reduced by $50. Under Sec.  1.1502-32(a)(3)(iii), the $50 reduction 
to S's basis in T's stock tiers up and reduces P's basis in its 10 
shares of S stock by $50. Consequently, P's basis in each of the 10 
shares of S stock will be decreased by $5 from $40 to $35. On the 
sale of each of the 2 shares of S's stock, P recognizes a $50 gain 
($85-$35). Under the actual computation, the group has P's $80 
ordinary loss and $50 of T's $80 ordinary loss (limited by its 
absorbed amount) available to offset P's $100 gain on the sale of 
S's stock. Under paragraph (e) of this section, P's gain is offset 
on a pro rata basis by approximately $62 ($100 x 80/($80 + $50)) of 
P's ordinary loss in Year 2, and approximately $38 ($100 x ($50/($80 
+ $50)) of T's ordinary loss in that year. P's remaining $18 of 
ordinary loss in Year 2 and $12 of T's ordinary loss equal to its 
remaining absorbed amount may be carried back to Year 1 to offset 
$30 of the $100 of CTI in that year. For Year 2, the P group has $30 
remaining of its CNOL (all of which is attributable to T) which is 
carried to the P group's Year 3 consolidated return year.
    Example 5. Alternative Computation. (i) Facts. At the beginning 
of Year 1, P has a $200 basis in S's stock. P sells all of its S 
stock for $100 at the close of Year 1. For Year 1, P has $10 capital 
gain on portfolio stock. In addition to S, P has two other 
subsidiaries, M1 and M2. M1 has capital gain of $50; M2 has a 
capital loss of $30, and S has a capital loss of $60.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amounts and the effect of the absorption of its loss under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's taxable 
income is computed without taking into account P's gain or loss from 
the disposition of S's stock. Under that computation, S's capital 
loss would offset $40 ($60 x $60/$90) of the group's $60 of capital 
gain. Accordingly, S's absorbed amount is $40.
    (iii) Basis reduction. Under paragraph (b)(2)(ii) of this 
section, S's $40 absorbed amount reduces P's basis in S's stock by 
$40 from $200 to $160. On the sale of S's stock, P recognizes a 
capital loss of $60 ($100 - $160).
    (iv) Computation of CTI under generally applicable rules. In the 
actual computation under paragraph (b)(2)(iii)(A) of this section, P 
is treated as having a $50 capital loss ($60 capital loss on the 
sale of S's stock plus $10 capital gain). Therefore, the only 
capital gain in the actual computation is M1's $50. There is a total 
of $120 of capital loss in the computation: S's $40 of capital loss 
(equal to its absorbed amount), as well as P's $50 and M2's $30 
capital losses. M1's $50 of capital gain would be offset on a pro 
rata basis by approximately $16.50 of S's loss ($50 x $40/$120), 
approximately $21.00 ($50 x $50/$120) of P's $50 capital loss, and 
$12.50 ($50 x $30/$120) of M2's capital loss. Because less than all 
of S's absorbed amount of $40 would be used, the group's CTI is 
determined under the alternative computation of paragraph 
(b)(2)(iii)(B) of this section.
    (v) Alternative computation of CTI. Under paragraph 
(b)(2)(iii)(B)(1) of this section, S's $40 capital loss (the amount 
and character of S's absorbed amount) first offsets $40 of the $60 
of capital gain (determined without taking into account any gain or 
loss on P's sale of S stock and without regard to M2's capital loss 
of $30) generated by other members. Accordingly, $20 of capital gain 
(P's $10 capital gain determined without regard to its loss on S's 
stock plus M1's $50

[[Page 33219]]

capital gain minus S's $40 absorbed amount) remains. Because P has 
no net stock gain, paragraph (b)(2)(iii)(B)(2) of this section is 
inapplicable. Under paragraph (b)(2)(iii)(B)(3) of this section, $10 
(the amount of P's capital loss on S's stock limited by the amount 
of its income included in the computation under paragraph (b)(2)(i) 
of this section) of P's capital loss offsets the group's $20 
remaining capital gain. Under paragraph (b)(2)(iii)(B)(4) of this 
section, capital losses of members other than S offset the group's 
remaining $10 of capital gain on a pro rata basis. Therefore, the 
group will use $3.75 of M2's $30 capital loss ($10 x $30/$80) and 
$6.25 of P's $50 remaining capital loss ($10 x $50/$80). The group 
will have a $70 consolidated net capital loss carryover to Year 2 
($43.75 attributable to P and $26.25 attributable to M2). Paragraphs 
(b), (c), and (d)(6) of Sec.  1.1502-36 will not cause P to adjust 
its basis in S's stock immediately before P's sale of the S stock. 
However, S's $20 unabsorbed capital loss that may be carried to its 
first separate return year may be reduced under the attribute 
reduction rule of Sec.  1.1502-36(d)(2).
    Example 6. Loss disposition. (i) Facts. For Year 1, the P group 
has a consolidated net capital loss of $100, all of which is 
attributable to S, and P and M have no income or loss. At the 
beginning of Year 2, P has a $300 basis in S's stock. P sells all of 
S's stock for $100 at the close of Year 2. For Year 2, P and S have 
no income or loss (determined without taking into account P's gain 
or loss from the disposition of S's stock) and the group has 
consolidated capital gain net income of $100 attributable solely to 
M.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its losses under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's taxable 
income for Year 2 is computed without taking into account P's gain 
or loss from the disposition of S's stock. The $100 consolidated net 
capital loss carryover from Year 1 attributable to S offsets the 
group's $100 of consolidated capital gain net income in Year 2. 
Accordingly, S's absorbed amount determined under paragraph 
(b)(2)(i) of this section is $100.
    (iii) Loss absorption and basis reduction. Under paragraph 
(b)(2)(ii) of this section, P's basis in S's stock is reduced from 
$300 to $200 immediately before the disposition. Consequently, P 
recognizes a $100 capital loss on the sale of S's stock. In an 
actual computation of CTI, P's $100 capital loss on S's stock in 
Year 2 would offset M's $100 capital gain in Year 2 before the 
consolidated capital loss carryover from Year 1 and, as a result, 
S's $100 absorbed amount would not be used. Because less than all of 
S's absorbed amount of $100 would be used, the group's CTI is 
determined under the alternative computation of paragraph 
(b)(2)(iii)(B) of this section.
    (iv) Alternative Computation of CTI. Under paragraph 
(b)(2)(iii)(B)(1) of section, S's $100 consolidated net capital loss 
carryover from Year 1 first offsets M's $100 of capital gain in Year 
2. Because P has no net stock gain to be added to the computation, 
the amount under paragraph (b)(2)(iii)(B)(2) of this section is 
zero. Because there is no remaining income to offset, paragraphs 
(b)(2)(iii)(B)(3) and (b)(2)(iii)(B)(4) of this section are 
inapplicable. Therefore, P's $100 loss on S's stock becomes a 
consolidated net capital loss carryover to the group's Year 3 
consolidated return year.
    Example 7. Netting of Disposing Member's Gains and Losses. (i) 
Facts. At the beginning of Year 1, P has a $120 basis in S's stock. 
P sells all of S's stock for $80 at the close of Year 1. In 
addition, P has $60 capital loss on the sale of portfolio stock. S 
has a capital loss of $180. M1 has a capital gain of $100 and M2 has 
a capital loss of $120.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its loss under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's taxable 
income is computed without taking into account P's gain or loss from 
the disposition of S's stock. Under that computation, S's capital 
loss would offset $50 ($100 x $180/($180 + $120 + $60)) of M1's $100 
capital gain. Accordingly, S's absorbed amount is $50.
    (iii) Basis reduction and computation of CTI under generally 
applicable rules. Under paragraph (b)(2)(ii) of this section, P's 
basis in S's stock is reduced by $50 from $120 to $70 immediately 
before the sale. Consequently, P recognizes a $10 capital gain on 
the sale of S's stock. In an actual computation of CTI, P's $10 
capital gain on the sale of S's stock would be offset by $10 of P's 
$60 capital loss. M1's $100 capital gain would be offset by $22.73 
($100 x $50/($50 + $120 + $50)) of P's $50 of net capital loss, 
$54.54 ($100 x $120/$220) of M2's $120 capital loss and $22.73 ($100 
x $50/$220) of S's $50 capital loss. Because less than all of S's 
absorbed amount of $50 would be used, the group's CTI is determined 
under the alternative computation of paragraph (b)(2)(iii)(B) of 
this section.
    (iv) Alternative computation of CTI. Under paragraph 
(b)(2)(iii)(B)(1) of this section, $50 of S's capital loss (the 
amount and character of S's absorbed amount) first offsets $50 of 
the $100 capital gain (determined without taking into account any 
gain or loss on P's sale of S stock and without regard to P's and 
M2's capital losses). Therefore, after the absorption of S's loss 
equal to its absorbed amount, there is $50 of remaining capital 
gain. P will have a $10 capital gain on the sale of S's stock, a $60 
capital loss on portfolio stock, and M2 will have a $120 capital 
loss. Under paragraph (b)(2)(iii)(B)(2) of this section, $10 of P's 
$60 loss on portfolio stock offsets its $10 gain on S's stock before 
M2's $120 capital loss is taken into account. No member has a net 
loss on subsidiary stock, and therefore paragraph (b)(2)(iii)(B)(3) 
of this section does not apply. Under paragraph (b)(2)(iii)(B)(4) of 
this section, the remaining capital gain of $50 after the 
application of paragraph (b)(2)(iii)(B)(3) is offset pro rata by 
$14.70 ($50 x $50/($50 + $120)) of P's capital loss and $35.30 ($50 
x $120/$170) of M2's capital loss. P's unused capital loss of $35.30 
and M2's unused capital loss of $84.70 become a $120 consolidated 
net capital loss carryover to the group's Year 2 consolidated return 
year.
    Example 8. Character of Absorbed Amount. (i) Facts. At the 
beginning of Year 1, P has a $550 basis in S's stock. P sells all of 
S's stock for $50 at the close of Year 1. In addition, P has a 
capital gain of $200 (without regard to gain or loss on the sale of 
S's stock). S has an ordinary loss of $50 and M has an ordinary loss 
of $25.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its losses under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's taxable 
income is computed without taking into account P's gain or loss from 
the disposition of S's stock. Under that computation, S's $50 
ordinary loss and M's $25 ordinary loss offset $75 of P's $200 
capital gain. Accordingly, S's absorbed amount determined under 
paragraph (b)(2)(i) of this section is $50.
    (iii) Basis reduction and computation of CTI under generally 
applicable rules. Under paragraph (b)(2)(ii) of this section, P's 
basis in S's stock is reduced by $50 from $550 to $500 immediately 
before the sale. Consequently, P recognizes a $450 capital loss on 
the sale of S's stock. In an actual computation of CTI, $200 of P's 
$450 capital loss on its sale of S's stock would offset its $200 
capital gain and none of S's absorbed amount would be used. Because 
less than all of S's absorbed amount of $50 would be used, the 
group's CTI is determined under the alternative computation of 
paragraph (b)(2)(iii)(B) of this section.
    (iv) Alternative computation of CTI. Under paragraph 
(b)(2)(iii)(B)(1) of this section, S's $50 ordinary loss first 
offsets $50 of P's $200 capital gain. Therefore, after the 
absorption of S's loss equal to its absorbed amount, the group will 
have $150 ($200 - $50) of remaining capital gain. Because P has no 
net stock gain to be added to the computation, paragraph 
(b)(2)(iii)(B)(2) of this section is inapplicable. Under paragraph 
(b)(2)(iii)(B)(3) of this section, $150 of P's $450 loss on S's 
stock (the lesser of P's $200 capital gain or the group's $150 
remaining capital gain) offsets the group's remaining $150 of 
capital gain. Because there is no more income in the group for M's 
loss to offset, the amount under paragraph (b)(2)(iii)(B)(4) of this 
section is zero. Therefore, P's remaining unused capital loss on S's 
stock of $300 and M's $25 ordinary loss become carryovers to the 
group's Year 2 consolidated return year.
    Example 9. Worthless Stock Loss. (i) Facts. At the beginning of 
Year 1, P has a $120 basis in S's stock. For Year 1, P has $100 of 
ordinary income (determined without taking into account P's gain or 
loss on the disposition of S's stock) and S generates an $80 
ordinary loss. At the close of Year 1, S issues stock to its 
creditors in a bankruptcy proceeding, and P's stock in S is 
canceled. The aggregate of S's historic gross receipts meets the 
requirements of section 165(g)(3)(B), which allows P to claim an 
ordinary loss with respect to S's stock.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption under Sec.  1.1502-32(b)(2) 
on P's basis in S's stock, the group's CTI is computed without 
taking into account P's gain or loss from the disposition of S's 
stock. Under that computation, S's $80 ordinary loss would offset 
$80 of P's $100 of ordinary income. Accordingly, S's absorbed amount

[[Page 33220]]

under paragraph (b)(2)(i) of this section is $80.
    (iii) Basis reduction and computation of CTI under generally 
applicable rules. Under paragraph (b)(2)(ii) of this section, S's 
$80 absorbed amount reduces P's basis in S's stock from $120 to $40. 
Therefore, P's worthless stock deduction with respect to S's stock 
is $40. In an actual computation of CTI, P's separate taxable income 
under Sec.  1.1502-12 would be determined by offsetting P's $100 of 
ordinary income with its $40 worthless stock deduction with respect 
to S's stock, leaving $60 of ordinary income that would be offset by 
S's ordinary loss. However, that computation would result in the 
absorption of only $60 of S's losses. Because less than all of S's 
absorbed amount of $80 would be used, the group's CTI is determined 
under the alternative computation of paragraph (b)(2)(iii)(B) of 
this section.
    (iv) Alternative computation of CTI. Under paragraph 
(b)(2)(iii)(B)(1) of this section, S's $80 ordinary loss first 
offsets $80 of P's $100 of ordinary income. Therefore, after the 
absorption of S's loss equal to its absorbed amount, the group will 
have $20 of remaining ordinary income. Because P has no net stock 
gain to be added to the computation, the amount under paragraph 
(b)(2)(iii)(B)(2) of this section is zero. Under paragraph 
(b)(2)(iii)(B)(3) of this section, the group uses $20 of P's $40 
ordinary loss on S's stock to offset the remaining $20 income of the 
group. Because there remains no more income in the group, the amount 
under paragraph (b)(2)(iii)(B)(4) of this section is zero. P's 
remaining $20 ordinary loss becomes a CNOL carryover to the group's 
Year 2 consolidated return year.
    Example 10. Charitable Contributions. (i) Facts. At the 
beginning of Year 1, P has a $1,000 basis in S's stock. P sells all 
of its S stock for $900 at the close of Year 1. For Year 1, P has 
$1,000 of ordinary income (determined without taking into account 
P's gain or loss on the disposition of S's stock). For Year 1, S 
makes a $100 charitable contribution and incurs $200 of ordinary and 
necessary business expenses that are deductible under section 
162(a). In addition, P has a subsidiary M, which also makes a $100 
charitable contribution.
    (ii) Determination of S's portion of consolidated charitable 
contributions deduction. Under Sec.  1.1502-24(a), a group's 
consolidated charitable contributions deduction is limited to ten 
percent of its adjusted consolidated taxable income as defined in 
Sec.  1.1502-24(c). Under paragraph (b)(2)(iii)(D) of this section, 
S's portion of the group's consolidated charitable contributions 
deduction is determined by computing the group's taxable income 
without regard to P's gain or loss on S's stock. Thus, for purposes 
of determining the consolidated charitable contributions deduction 
for Year 1, the group's CTI would be $800 (P's $1,000 of income 
minus S's $200 of section 162 expenses). Accordingly, the 
consolidated charitable contributions deduction for Year 1 is 
limited to $80 ($800 x 10%), $40 attributable to S and $40 
attributable to M. Accordingly, S's ordinary loss for Year 1 is $240 
($200 + $40).
    (iii) Determination of absorbed amount. To determine S's 
absorbed amount and the effect of the absorption of its losses under 
Sec.  1.1502-32(b)(2) on P's basis in S's stock, the group's CTI is 
computed without taking into account P's gain or loss from the 
disposition of S's stock. S's $240 ordinary loss offsets $240 of P's 
$1,000 of ordinary income. Accordingly, S's absorbed amount is $240.
    (iv) Loss absorption and basis reduction. Under paragraph 
(b)(2)(ii) of this section, S's $240 absorbed amount reduces P's 
basis in S's stock from $1,000 to $760. On the sale of S's stock, P 
recognizes capital gain of $140 ($900 - $760). P's ordinary income 
is offset by $240 of S's ordinary loss and $40 of M's portion of the 
group's consolidated charitable contributions deduction, resulting 
in CTI of $860 ($1,000 + $140 - $280). Of the group's excess 
charitable contributions of $120, $60 will be apportioned to S and 
carried to its first separate return year. The remaining $60 of 
excess consolidated charitable contributions is the group's 
consolidated charitable contribution carryover under Sec.  1.1502-
24(b).
    Example 11. Application of Unified Loss Rule. (i) Facts. In Year 
1, P purchases the sole share of S's stock for $500. At the time of 
the purchase, S owns Land with a basis of $420. During Year 1, P 
incurs a $100 ordinary loss and S earns $100 in rental income, which 
increases P's basis in S's stock to $600. For Year 2, P has ordinary 
income of $30 (determined without taking into account P's gain or 
loss from the disposition of S's stock) and S incurs an ordinary 
loss of $80. At the close of Year 2, S has $20 of cash in addition 
to Land. In addition to S, P has another subsidiary M, which has an 
ordinary loss of $40 for Year 2. At the close of Year 2, when the 
value of Land has declined, P sells the sole share of S's stock for 
$480. No election is made under Sec.  1.1502-36(d)(6) to reduce P's 
basis in S's stock or reattribute S's attributes to P.
    (ii) Determination of absorbed amount. To determine S's absorbed 
amount and the effect of the absorption of its losses under Sec.  
1.1502-32(b)(2) on P's basis in S's stock, the group's CTI is 
computed without taking into account P's gain or loss from the 
disposition of S's stock. Under paragraph (e)(1) of this section, 
P's $30 of ordinary income would be offset by $10 ($30 x $40/$120) 
of M's ordinary loss for Year 2 and $20 ($30 x $80/$120) of S's 
ordinary loss for Year 2. Accordingly, S's absorbed amount 
determined under paragraph (b)(2)(i) of this section is $20.
    (iii) Loss absorption and basis reduction. Under paragraph 
(b)(2)(ii) of this section, S's $20 absorbed amount reduces P's 
basis in S's stock from $600 (P's $500 purchase price plus the $100 
positive adjustment in Year 1) to $580. After taking into account 
the effects of all applicable rules of law, including paragraph 
(b)(2)(ii) of this section, P would recognize a $100 ($480 - $580) 
loss on the sale of S's stock. Thus, P's sale of the S share is a 
transfer of a loss share and therefore subject to Sec.  1.1502-36. 
Under Sec.  1.1502-36(b)(1)(ii), P's basis in its sole share of S's 
stock is not subject to redetermination. Under Sec.  1.1502-36(c), 
P's basis in the S share ($580) is reduced, but not below value, by 
the lesser of the share's net positive adjustment and disconformity 
amount. The share's net positive adjustment is the greater of zero 
and the sum of all investment adjustments (as defined in Sec.  
1.1502-36(b)(1)(iii)) applied to the basis of the share. The net 
positive adjustment applied to the basis of the share is $80, S's 
$100 income for Year 1 and its $20 absorbed amount for Year 2. The 
share's disconformity amount is the excess, if any, of its basis 
($580) over its allocable portion of S's net inside attribute 
amount. S's net inside attribute amount of $500 is the sum of S's 
$20 cash, S's basis in Land of $420, and S's $60 loss carryover ($80 
- $20). Thus, the share's disconformity amount is $80 ($580 - $500). 
The lesser of the net positive adjustment ($80) and the share's 
disconformity amount ($80) is $80. Accordingly, under Sec.  1.1502-
36(c), P's basis in S's share is reduced by $80 from $580 to $500, 
and after taking into account the adjustments under paragraphs (b) 
and (c) of Sec.  1.1502-36, the transferred S share is still a loss 
share ($480 sale price minus $500 basis).
    (iv) Computation of CTI. In an actual computation of CTI, P's 
$30 of ordinary income would be offset on a pro rata basis by $20 
($30 x $40/$60) of M's ordinary loss and $10 ($30 x $20/$60) of S's 
ordinary loss. Because less than all of S's absorbed amount of $20 
would be used, the group's CTI is determined under the alternative 
computation of paragraph (b)(2)(iii)(B) of this section. Under 
paragraph (b)(2)(iii)(B)(1) of this section, the computation of CTI 
is made by first computing the group's taxable income without taking 
into account P's loss on the disposition of S's stock and using only 
S's loss equal to its $20 absorbed amount. Accordingly, the group's 
$30 of ordinary income is reduced by $20 of S's ordinary loss, 
leaving $10 of remaining ordinary income. Because P has no net stock 
gain to be added to the computation, paragraph (b)(2)(iii)(B)(2) of 
this section is inapplicable. Under paragraph (b)(2)(iii)(B)(3) of 
this section, the group's remaining $10 of ordinary income is offset 
by a loss on the disposition of subsidiary stock, subject to 
applicable principles of the Code and regulations. The group's 
remaining $10 of income may not be offset by P's capital loss on the 
sale of S's stock, because P has no income of the same character on 
its loss on S's stock. Under paragraph (b)(2)(iii)(B)(4) of this 
section, the group's remaining $10 of ordinary income is offset by 
$10 of M's ordinary loss. M's $30 unabsorbed loss is carried over as 
a CNOL and P's remaining $20 capital loss from the sale of S's stock 
is carried over as a consolidated net capital loss to the group's 
Year 3 consolidated return year. S's $60 unused loss would be 
carried over to its separate return year subject to Sec.  1.1502-
36(d). Under Sec.  1.1502-36(d)(2), S's attributes are reduced by 
S's attribute reduction amount. Under Sec.  1.1502-36(d)(3), S's 
attribute reduction amount is the lesser of the net stock loss and 
S's aggregate inside loss. The net stock loss is $20, the excess of 
the $500 basis of the transferred share over the $480 value of the 
transferred share. S's aggregate inside loss is $20, the excess of 
its $500 net inside attribute amount over the $480 value of the S 
share. Therefore, the attribute reduction amount is $20, the lesser

[[Page 33221]]

of the $20 net stock loss and the $20 aggregate inside loss. 
Accordingly, S's $20 attribute reduction amount is applied to reduce 
from $60 to $40 the amount of S's NOL carryover to its separate 
return year.
    (v) Election to reduce stock basis. The facts are the same as in 
paragraph (i) of this Example 11 except that P elects under Sec.  
1.1502-36(d)(6)(i)(B) to reattribute S's losses to the full extent 
of the attribute reduction amount ($20). Accordingly, P is treated 
as succeeding to $20 of S's losses as if acquired in a transaction 
described in section 381(a) (see Sec.  1.1502-36(d)(6)(i)(B) and 
(iv)(A)) and, as a result, P's basis in the S share is reduced from 
$500 to $480. After giving effect to the election, P will have no 
loss on S's stock, the group will have a $50 CNOL carryover to Year 
3 ($30 attributable to M and $20 attributable to P), and S will have 
a $40 NOL carryover to its separate return year.

    (3) Effective/applicability date. This paragraph (b) applies to 
dispositions of subsidiary stock occurring in consolidated return years 
beginning on or after the date these regulations are published as final 
regulations in the Federal Register.
    (c) * * *
    (2) * * *
    (i) Limitation on deductions and losses to offset income or gain. 
First, the determination of the extent to which S's deductions and 
losses for the consolidated return year of the disposition (and its 
deductions and losses carried over from prior years) may offset income 
and gain is made pursuant to paragraph (b)(2) of this section.
    (ii) Tentative adjustment of stock basis. Second, Sec.  1.1502-32 
is tentatively applied to adjust the basis of the S stock to reflect 
the amount of S's income and gain included, and S's absorbed amount of 
losses, in the computation of consolidated taxable income or loss for 
the year of disposition (and any prior years) that is made pursuant to 
paragraph (b)(2) of this section, but not to reflect the realization of 
excluded COD income and the reduction of attributes in respect thereof.
* * * * *
    (4) Definition of lower-tier corporation. For purposes of this 
paragraph (c), lower-tier corporation means a lower-tier subsidiary 
described in Sec.  1.1502-36(f)(4).
* * * * *
    (7) Effective/applicability date. * * * However, paragraphs (c)(2) 
and (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.
* * * * *
    (e) Absorption rule--(1) Pro rata absorption of ordinary losses. If 
the group has a CNOL for a consolidated return year, the amount of each 
member's separate net operating loss, as defined in Sec.  1.1502-
21(b)(2)(iv)(B)(1), for the year that offsets the income or gain of 
other members is determined on a pro rata basis under the principles of 
Sec.  1.1502-21(b)(2)(iv). For example, if, for the consolidated return 
year, P and S1 have a separate net operating loss of $60 and $30, 
respectively, and S2 (the only other member of the P group) has $21 of 
income, $14 of P's net operating loss and $7 of S1's net operating loss 
offset S2's $21 of income and are absorbed in the year.
    (2) Pro-rata absorption of capital losses. If the group has a 
consolidated net capital loss for a consolidated return year and any 
member has capital gain net income for the year (taking into account 
only its capital gains and losses), the amount of each member's capital 
loss (as defined in paragraph (b)(1) of this section) that offsets the 
sum of the capital gain net income of other members (computed 
separately for each member) is determined on a pro rata basis under the 
principles of Sec.  1.1502-21(b)(2)(iv). For purposes of this paragraph 
(e)(2), the character of each member's gains and losses is first 
determined on a consolidated basis. See Sec. Sec.  1.1502-22 and 
1.1502-23.
    (3) Effective/applicability date. This paragraph (e) applies to 
consolidated return years beginning on or after the date these 
regulations are published as final regulations in the Federal Register.
0
Par. 3. Section 1.1502-12 is amended by:
0
1. Revising paragraphs (b) and (e).
0
2. Removing and reserving paragraph (m).
    The revisions read as follows:


Sec.  1.1502-12  Separate taxable income.

* * * * *
    (b) Any deduction that is disallowed under Sec.  1.1502-15 shall be 
taken into account as provided in that section;
* * * * *
    (e) If a member disposes of a share of a subsidiary's stock, the 
member's deduction or loss (if any) on the stock that will be used in 
the consolidated return year of the disposition and as a carryback to 
prior years is computed in accordance with Sec.  1.1502-11(b) or (c), 
as appropriate.
* * * * *
    (m) [Reserved]
* * * * *
0
Par. 4. Section 1.1502-21 is amended by:
0
1. Revising paragraph (b)(2)(iv)(B).
0
2. Adding paragraphs (b)(3)(vi) and (h)(1)(iv).
    The revision and additions read as follows:


Sec.  1.1502-21  Net operating losses.

* * * * *
    (b) * * *
    (2) * * *
    (iv) * * *
    (B) Percentage of CNOL attributable to a member--(1) In general. 
Except as provided in paragraph (b)(2)(iv)(B)(2) of this section, the 
percentage of the CNOL attributable to a member shall equal the 
separate net operating loss of the member for the consolidated return 
year divided by the sum of the separate net operating losses of all 
members having such losses for that year. For this purpose, the 
separate net operating loss of a member is determined by computing the 
CNOL by reference to only the member's items of income, gain, 
deduction, and loss (excluding capital gains and amounts treated as 
capital gains), including the member's losses and deductions actually 
absorbed by the group in the consolidated return year (whether or not 
absorbed by the member).
    (2) Recomputed percentage. If, for any reason, a member's portion 
of a CNOL is absorbed or reduced on a non pro rata basis (for example, 
under Sec. Sec.  1.1502-11(b) or (c), 1.1502-28, 1.1502-36(d), or as 
the result of a carryback to a separate return year), the percentage of 
the CNOL attributable to each member is recomputed. In addition, if a 
member with a separate net operating loss ceases to be a member, the 
percentage of the CNOL attributable to each remaining member is 
recomputed under paragraph (b)(2)(iv)(B)(1) of this section. The 
recomputed percentage of the CNOL attributable to each member shall 
equal the remaining CNOL attributable to the member at the time of the 
recomputation divided by the sum of the remaining CNOL attributable to 
all of the remaining members at the time of the recomputation.
* * * * *
    (3) * * *
    (vi) Amount of subsidiary's absorbed deductions and losses if 
subsidiary's stock is disposed of. For special rules regarding the 
amount of a subsidiary's deductions and losses that is absorbed if a 
member disposes of a share of the subsidiary's stock, see Sec.  1.1502-
11(b) and (c).
* * * * *
    (h) * * *
    (1) * * *
    (iv) Paragraphs (b)(2)(iv)(B) and (b)(3)(vi) of this section apply 
to consolidated return years beginning on or after the date these 
regulations are

[[Page 33222]]

published as final regulations in the Federal Register.
* * * * *


Sec.  1.1502-21A  [Removed]

0
Par. 5. Section 1.1502-21A is removed.
0
Par. 6. Section 1.1502-22 is amended by:
0
1. Revising paragraphs (a)(2) and (3).
0
2. Adding paragraph (a)(4).
    The revisions and addition read as follows:


Sec.  1.1502-22  Consolidated capital gain and loss.

* * * * *
    (a) * * *
    (2) The consolidated net section 1231 gain for the year (determined 
under Sec.  1.1502-23);
    (3) The net capital loss carryovers or carrybacks to the year; and
    (4) Applying the ordering rules of Sec.  1.1502-11(b) if stock of a 
subsidiary is disposed of.
* * * * *


Sec.  1.1502-22A  [Removed]

0
Par. 7. Section 1.1502-22A is removed.


Sec.  1.1502-23A  [Removed]

0
Par. 8. Section 1.1502-23A is removed.


Sec.  1.1502-24  [Amended]

0
Par. 9. Section 1.1502-24 is amended by:
0
1. Removing the words ``Five percent'' in paragraph (a)(2) and adding 
``The percentage limitation on the total charitable contribution 
deduction provided in section 170(b)(2)(A)'' in its place.
0
2. Removing ``section 242,'' and ``Sec.  1.1502-25,'' in paragraph (c).

PART 301--PROCEDURE AND ADMINISTRATION

0
Par. 10. The authority citation for part 301 is amended by revising the 
entry for Sec.  301.6402-7 to read in part as follows:

    Authority: 26 U.S.C. 7805.
* * * * *
Section 301.6402-7 also issued under 26 U.S.C. 6402(k).
* * * * *
0
Par. 11. Section 301.6402-7 is amended by revising the last sentence of 
paragraph (g)(2)(ii) and paragraph (l) to read as follows:


Sec.  301.6402-7  Claims for refund and applications for tentative 
carryback adjustments involving consolidated groups that include 
insolvent financial institutions.

* * * * *
    (g) * * *
    (2) * * *
    (ii) * * * For this purpose, the separate net operating loss of a 
member is determined by computing the consolidated net operating loss 
by reference to only the member's items of income, gain, deduction, and 
loss (excluding capital gains and amounts treated as capital gains), 
including the member's losses and deductions actually absorbed by the 
group in the consolidated return year (whether or not absorbed by the 
member).
* * * * *
    (l) Effective/applicability dates. This section applies to refunds 
and tentative carryback adjustments paid after December 30, 1991. 
However, the last sentence of paragraph (g)(2)(ii) of this section 
applies to separate net operating losses of members incurred in 
consolidated return years beginning on or after the date these 
regulations are published as final regulations in the Federal Register.

John M. Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2015-13982 Filed 6-10-15; 8:45 am]
 BILLING CODE 4830-01-P