[Federal Register Volume 63, Number 242 (Thursday, December 17, 1998)]
[Proposed Rules]
[Pages 69581-69584]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32932]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-106219-98]
RIN 1545-AW32
Acquisition of an S Corporation by a Member of a Consolidated
Group
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations under section
1502. The proposed regulations provide specific rules that apply to the
acquisition of the stock of an S corporation by an affiliated group of
corporations that joins in the filing of a consolidated return. These
rules eliminate the compliance burdens associated with filing a
separate return for the day that an S corporation is acquired by a
consolidated group. Additionally, the proposed regulations clarify that
Sec. 1.1502-76(c) continues to provide rules for the filing of the
separate return for a corporation's items for the period not included
in the consolidated return. This document also provides notice of a
public hearing on these proposed regulations.
DATES: Written comments must be received by March 10, 1999. Outlines of
topics to be discussed at the public hearing scheduled for March 31,
1999, at 10 a.m. must be received by March 17, 1999.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-106219-98), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday through
Friday between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG-
106219-98), Courier s Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit
comments electronically via the Internet by selecting the ``Tax Regs''
option on the IRS Home Page, or by submitting comments directly to the
IRS Internet site at: http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in room 2615, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jeffrey L.
Vogel, (202) 622-7770; concerning submissions, the hearing, and/or to
be placed on the building access list to attend the hearing, LaNita Van
Dyke, (202) 622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) under section 1502 of the Internal Revenue
Code of 1986 (the consolidated return regulations). The amendments
apply to acquisitions by a consolidated group of at least eighty
percent of the stock of an S corporation. When a consolidated group
acquires an S corporation, the interaction of the consolidated return
regulations and the subchapter S rules requires the filing of a
separate return for the day of the acquisition. In most situations,
complying with this requirement results in an unnecessary
administrative burden for taxpayers.
The proposed regulations also clarify the impact of the 1994
revisions to Sec. 1.1502-76(b) (TD 8560, 1994-2 C.B. 200). The 1994
revisions provided taxpayers greater certainty and prevented
inconsistent allocations of items between a separate and a consolidated
return. The proposed regulations clarify that the due date for the
filing of the separate return for the period not included in the
consolidated return continues to be governed by the rules in
Sec. 1.1502-76(c).
Acquisition of an S Corporation
Section 1.1502-76(b)(1)(i) provides that a consolidated return must
include the common parent's items of income, gain, deduction, loss, and
credit for the consolidated return year and each subsidiary's items for
the portion of the year for which the subsidiary is a member. Generally
under Sec. 1.1502-76(b)(1)(ii)(A), a subsidiary becomes a member of the
consolidated group at the end of the day on which its status as a
member changes, and its tax year ends at that time for all Federal
income tax purposes. The subsidiary's items for the period beginning on
the day after it becomes a member of the consolidated group are
generally included in the consolidated return of the group. The
subsidiary's items for the period prior to its becoming a member
generally are included in a separate return.
A small business corporation's selection under section 1362(a) to
be an S corporation terminates under section 1362(d)(2) if it ceases to
be a small business corporation. A small business corporation cannot
have a corporate shareholder. Thus, an S corporation election
terminates when the corporation has another corporation as a
shareholder. The termination is effective on the day the corporation
becomes a shareholder. When the termination of an S corporation
election becomes effective on any day other than the first day of the
taxable year, the taxable year in which the termination occurs is an S
termination year under section 1362(e)(4). The S termination year is
comprised of a short taxable year for which the corporation is an S
corporation (the portion of the S termination year ending on the day
before the terminating event occurs, or S short year) and a short
taxable year for which the corporation is a C corporation (the
remainder of the S termination year, or C short year).
Under section 1362(e)(6)(D), if there is a change in ownership of
50 percent or more of the stock in a corporation during the S
termination year, items of income, gain, loss, deduction, and credit
must be allocated between the S short year and the C short year on the
basis of the corporation's normal method of accounting, as determined
under section 446 (also referred to as a closing of the corporation's
books) as of the close of the S short year, rather than a daily
proration or other method. The S short year and the C short year are
treated as two separate taxable years for most purposes. Separate
returns are required for the S short year and the C short year, and the
due date for the S short year return is the date by which the C short
year return must be filed.
When an S corporation becomes a member of a consolidated group, the
interaction of the consolidated return regulations and the subchapter S
rules results in the corporation having three taxable periods for the
year of the acquisition for which Federal income tax returns are due:
(1) an S short year that ends on the day before the acquisition by the
consolidated group, (2) a C short year consisting solely of the day of
the acquisition, and (3) a short taxable year (included in the
consolidated return) for any items occurring after the day of the
acquisition. Although three separate taxable periods are created when
an S corporation becomes a member of a consolidated group, existing
rules preclude an allocation of items properly attributable to either
the C short year or the consolidated year to the S short
[[Page 69582]]
year, for example, through a daily proration of the items attributable
to the year of the acquisition. Section 1362(e)(6)(D).
The IRS and Treasury have determined that the compliance burdens
associated with filing a separate return for the day that an S
corporation is acquired by a consolidated group are not necessary to
achieve the separate goals of section 1362(e) and the consolidated
return regulations. The proposed regulations will eliminate this
requirement in most situations, while preserving the purpose and effect
of the rules under section 1362(e). These proposed regulations will not
apply, however, if an S corporation becomes a member of a consolidated
group in a qualified stock purchase for which an election under section
338(g) is made. If the common parent of the consolidated group and the
shareholders of the S corporation jointly make a section 338(h)(10)
election, the administrative relief provided by these proposed
regulations is unnecessary because the S corporation election of the
old target corporation does not terminate. See Sec. 1.338(h)(10)-
1(e)(2)(iv).
Under the proposed regulations, an S corporation will become a
member of the consolidated group at the beginning of the day that
includes the acquisition, and its tax year will end for all Federal
income tax purposes at the end of the day preceding the acquisition.
Thus, instead of three short taxable years, the corporation will have
two short taxable years as a result of the acquisition: (1) the period
ending on the day before the S corporation joins the consolidated
group, which will be treated as a taxable year in which the corporation
was an S corporation, and (2) the period during which the corporation
is a member of the consolidated group. The termination of an S
corporation election under section 1362(d)(2) continues to become
effective on the day of the acquisition. However, because the
consolidated return regulations create a separate taxable year for the
corporation, the first day of which is the day on which the S
corporation election terminates, there is no S termination year within
the meaning of section 1362(e)(4). Consequently, section 1362(e)
technically does not apply to the corporation.
Notwithstanding that there is no there is no S termination year,
the proposed regulations provide rules similar to those that would have
applied under section 1362(e). Under the proposed regulations, as under
section 1362(e)(1)(A), the S corporation's short taxable year ends at
the end of the day preceding the date of the acquisition. The Federal
income tax return for the final taxable year of the S corporation will
be due at the earlier of: (1) The date the S corporation return would
have been due if the taxable year of the S corporation did not end or
(2) the date the consolidated group's return for the taxable year that
includes the acquisition is due.
These proposed regulations also preclude the availability of
ratable allocation under Sec. 1.1502-76(b)(2)(ii) and (iii) in order to
achieve the same results that would have obtained if section
1362(e)(6)(D) had applied. Accordingly, if an S corporation joins a
consolidated group and these proposed regulations apply, then items
must be allocated between the two short taxable years that begin and
end with the corporation joining the consolidated group on the basis of
a closing of the books rather than a ratable allocation of the type
that would have been available under section 1362(e)(2) (in the case of
the termination of an S corporation election) or Sec. 1.1502-
76(b)(2)(ii) and (iii) (in the case of a corporation becoming or
ceasing to be a member of a consolidated group).
Due Date for Separate Return
Section 1.1502-76(b) provides guidance regarding the items to be
included in a consolidated return. Items for the portion of a year not
included in the consolidated return must be included in a separate
return.
Section 1.1502-76(b)(1)(ii)(A) provides that a subsidiary becomes
(or ceases to be) a member of the consolidated group at the end of the
day on which its status as a member changes, and its tax year ends at
that time for all Federal income tax purposes. Section 1.1502-
76(b)(2)(i) generally provides that the returns that end and begin with
a subsidiary becoming (or ceasing to be) a member of the consolidated
group are subject to the rules of the Internal Revenue Code applicable
to short periods, as if the subsidiary ceased to exist on becoming a
member (or first existed on becoming a nonmember). Section 1.1502-76(c)
provides rules for the filing of the separate return for the period the
subsidiary was not included in the consolidated group.
The IRS and Treasury are concerned that a broad application of the
provisions of Sec. 1.1502-76(b) could be construed to require an
accelerated filing of the separate return by the fifteenth day of the
third month following the end of the short taxable year that resulted
from the corporation joining or leaving the consolidated group. This
interpretation would, in effect, override the provisions in
Sec. 1.1502-76(c) concerning the due date for the filing of a separate
return.
The IRS and Treasury did not intend to modify the due date for the
separate return for the period not included in the consolidated return
by the changes in Sec. 1.1502-76(b) (as amended by TD 8560). This
proposed regulation clarifies that Sec. 1.1502-76(c) continues to
provide rules for the filing of the separate return.
Proposed Effective Date
The amendments relating to the acquisition of a corporation that,
immediately before becoming a member, had an election under section
1362(a) in effect, are proposed to apply to transactions occurring
after the date final regulations are published in the Federal Register.
The amendments relating to the clarification of the due date for the
separate return for items not included in the return of a consolidated
group are proposed to apply to corporations that became or ceased to be
members of consolidated groups on or after January 1, 1995, the
effective date of the 1994 amendments to Sec. 1.1502-76(b).
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It is hereby certified that
these regulations will not have a significant economic impact on a
substantial number of small entities. This certification is based upon
the fact that the proposed regulations will provide administrative
relief to small entities by removing the administrative burden of
filing a separate one-day return currently required for certain
acquisitions. Therefore, 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 Internal RevenueCode, this notice of
proposed rulemaking will be submitted to the Chief Counsel for Advocacy
of the Small Business Administration for comment on its 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
(a signed original and eight (8) copies) to the IRS. All comments will
be made available for public inspection and copying.
A public hearing has been scheduled for March 31, 1999, at 10 a.m.
in room 2615, Internal Revenue Building,
[[Page 69583]]
1111 Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th Street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the FOR FURTHER INFORMATION
CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments (a signed original and eight (8) copies) by
March 10, 1999. The outline of topics to be discussed and the time to
be devoted to each topic must be received by March 17, 1999.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting information. The principal author of these regulations is
Jeffrey L. Vogel of the Office of the Assistant Chief Counsel
(Corporate), IRS. However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1502-76 also issued under 26 U.S.C. 1502. * * *
Par. 2. Section 1.1362-3 is amended by adding a sentence to the end
of paragraph (a) to read as follows:
Sec. 1.1362-3 Treatment of S termination year.
(a) In general. * * * See, however, Sec. 1.1502-76(b)(1)(ii)(A)(2)
for special rules for an S election that terminates under section
1362(d) immediately before the S corporation becomes a member of a
consolidated group (within the meaning of Sec. 1.1502-1(h)).
* * * * *
Par. 3. Section 1.1502-76 is amended as follows:
1. The text of paragraph (b)(1)(ii)(A) is redesignated as paragraph
(b)(1)(ii)(A)(1).
2. A paragraph heading for newly designated
paragraph(b)(1)(ii)(A)(1) is added.
3. The first sentence of newly designated paragraph(b)(1)(ii)(A)(1)
is revised.
4. Paragraph (b)(1)(ii)(A)(2) is added.
5. Paragraph (b)(2)(v) is redesignated as paragraph(b)(2)(vi).
6. New paragraph (b)(2)(v) is added.
7. Paragraph (b)(5) is redesignated as paragraph (b)(6).
8. Paragraph (b)(4) is redesignated as paragraph (b)(5).
9. New paragraph (b)(4) is added.
10. Newly designated paragraph (b)(5) is amended as follows:
a. The first sentence of paragraph (b)(5), Example 6(b) is revised.
b. The second sentence of paragraph (b)(5), Example 6(c) is
revised.
c. Example 7 is added to paragraph (b)(5).
11. Newly designated paragraph (b)(6)(i) is revised.
The revisions and additions read as follows:
Sec. 1.1502-76 Taxable year of members of group.
* * * * *
(b) * * * (1) * * *
(ii) * * * (A) * * * (1) In general. If a corporation (S), other
than one described in paragraph (b)(1)(ii)(A)(2), becomes or ceases to
be a member during a consolidated return year, it 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. * * *
(2) Special rule for former S corporations. If S becomes a member
in a transaction other than in a qualified stock purchase for which an
election under section 338(g) is made, and immediately before becoming
a member an election under section 1362(a) was in effect, then S will
become a member at the beginning of the day the termination of its S
corporation election is effective. S's tax year ends for all Federal
income tax purposes at the end of the preceding day. This paragraph
(b)(1)(ii)(A)(2) applies to transactions occurring after the date that
final regulations are published in the Federal Register.
* * * * *
(2) * * *
(v) Acquisition of S corporation. If a corporation is acquired in a
transaction to which paragraph (b)(1)(ii)(A)(2) of this section
applies, then paragraphs (b)(2)(ii) and (iii) of this section do not
apply and items of income, gain, loss, deduction, and credit are
assigned to each short taxable year on the basis of the corporation's
normal method of accounting as determined under section 446. This
paragraph (b)(2)(v) applies to transactions occurring after the date
that final regulations are published in the Federal Register.
* * * * *
(4) Determination of due date for separate return. Paragraph (c) of
this section contains rules for the filing of the separate return
referred to in this paragraph (b). In applying paragraph (c) of this
section, the due date for the filing of S's separate return shall also
be determined without regard to the ending of the tax year under
paragraph (b)(1)(ii) of this section or the deemed cessation of its
existence under paragraph (b)(2)(i) of this section.
* * * * *
(5) * * *
Example 6. Allocation of partnership items. * * *
(b) Analysis. Under paragraph (b)(2)(vi)(A) of this section, T
is treated, solely for purposes of determining T's tax year in which
the partnership's items are included, as selling or exchanging its
entire interest in the partnership as of P's sale of T stock. * * *
(c) Controlled partnership. * * * Under paragraph(b)(2)(vi)(B)
of this section, T's distributive share of the partnership items is
treated as T's items for purposes of paragraph (b)(2) of this
section. * * *
Example 7. Acquisition of S corporation. (a) Facts. Z is a small
business corporation for which an election under section 1362(a) was
in effect at all times since Year 1. At all times, Z had only 100
shares of stock outstanding, all of which were owned by individual
A. On July 1 of Year 3, P acquired all of the Z stock. P does not
make an election under section 338(g) with respect to its purchase
of the Z stock.
(b) Analysis. As a result of P's acquisition of the Z stock, Z's
election under section 1362(a) terminates. See sections
1361(b)(1)(B) and 1362(d)(2). Z is required to join in the filing of
the P consolidated return. See Sec. 1.1502-75. Z's tax year ends for
all Federal income tax purposes on June 30 of Year 3. If no
extension of time is sought, Z must file a separate return for the
period from January 1 through June 30 of Year 3 on or before March
15 of Year 4. See paragraph (b)(4) of this section. Z will become a
member of the P consolidated group as of July 1 of Year 3. See
paragraph (b)(1)(ii)(A)(2) of this section. P group's Year 3
consolidated return will include Z's items from July 1 to December
31 of Year 3.
(6) Effective date--(i) General rule. Except as provided in
paragraphs
[[Page 69584]]
(b)(1)(ii)(A)(2) and (b)(2)(v) of this section, this paragraph (b)
applies to corporations becoming or ceasing to be members of
consolidated groups on or after January 1, 1995.
* * * * *
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-32932 Filed 12-16-98; 8:45 am]
BILLING CODE 4830-01-U