Part I. Rulings — Internal Revenue Bulletin 2008-11

Section 25.—Interest on Certain Home Mortgages

A revenue procedure provides guidance with respect to the United States and area median gross income figures that are to be used by issuers of qualified mortgage bonds, as defined in § 143(a) of the Internal Revenue Code, and issuers of mortgage credit certificates, as defined in § 25(c), in computing the housing cost/income ratio described in § 143(f)(5). See Rev. Proc. 2008-19, page 594.

Section 61.—Gross Income Defined

26 CFR 1.61–21: Taxation of fringe benefits.

Fringe benefits aircraft valuation for- mula. The Standard Industry Fare Level

Period During Which the Flight Is Taken

(SIFL) cents-per-mile rates and terminal charge in effect for the first half of 2008 are set forth for purposes of determining the value of noncommercial flights on employer-provided aircraft under section 1.61–21(g) of the regulations.

Rev. Rul. 2008–14

For purposes of the taxation of fringe benefits under section 61 of the Internal Revenue Code, section 1.61–21(g) of the Income Tax Regulations provides a rule for valuing noncommercial flights on employer-provided aircraft. Section 1.61–21(g)(5) provides an aircraft valuation formula to determine the value of such flights. The value of a flight is determined

Terminal Charge

under the base aircraft valuation formula (also known as the Standard Industry Fare Level formula or SIFL) by multiplying the SIFL cents-per-mile rates applicable for the period during which the flight was taken by the appropriate aircraft multiple provided in section 1.61–21(g)(7) and then adding the applicable terminal charge. The SIFL cents-per-mile rates in the formula and the terminal charge are calculated by the Department of Transportation and are reviewed semi-annually.

The following chart sets forth the terminal charge and SIFL mileage rates:

SIFL Mileage Rates

1/1/08 - 6/30/08 $39.86 Up to 500 miles = $.2180 per mile

501-1500 miles = $.1662 per mile

Over 1500 miles = $.1598 per mile

Section 338.—Certain Stock Purchases Treated as Asset Acquisitions

26 CFR 1.338–11: Effect on section 338 election on insurance company targets.

T.D. 9377

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602

Application of Section 338 to Insurance Companies

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

SUMMARY: This document contains final regulations under section 197 of the

DRAFTING INFORMATION

The principal author of this revenue ruling is Kathleen Edmondson of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt/Government Entities). For further information regarding this revenue ruling, contact Ms. Edmondson at (202) 622–0047 (not a toll-free call).

Section 103.—Interest on State and Local Bonds

Section 143.—Mortgage Revenue Bonds: Qualified Mortgage Bond and Qualified Veterans’ Mortgage Bond

2008–11 I.R.B. 578 March 17, 2008

Treasury decision also revises cross-references where appropriate to reflect the removal of temporary regulations and their replacement with final regulations and corrects two obvious errors, one a mathematical error in the last sentence of §1.381(c)(22)–1(b)(7)(v), Example 3, the other an error in the captioning of §1.338(i)–1(c)(2)(ii)(B).

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that the collection of information requirement in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that these regulations do not have a substantial economic impact because they merely provide guidance about the operation of the tax law in the context of acquisitions of insurance companies and businesses. Moreover, they are expected to apply predominantly to transactions involving larger businesses. In addition, the collection of information requirement merely requires a taxpayer to prepare a written representation that contains minimal information relating to the making of an election. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Under section 7805(f) of the Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of the final regulations is William T. Sullivan, Office of Chief Counsel (Financial Institutions and Products). However, other personnel from the IRS and the Treasury Department participated in the development of these regulations.

- - - -

Adoption of Amendments to the Regulations

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

Internal Revenue Code (Code) that apply to a section 197 intangible resulting from an assumption reinsurance transaction, and under section 338 that apply to reserve increases after a deemed asset sale. The final regulations also provide guidance with respect to existing section 846(e) elections to use historical loss payment patterns. The final regulations apply to insurance companies.

DATES: Effective Date: These regulations are effective on January 23, 2008.

Applicability Date: For date of applicability of these regulations, see §1.197–2(g)(5)(ii)(E), §1.338–11(d)(7) and §1.846–4(b).

FOR FURTHER INFORMATION CONTACT: William T. Sullivan (202) 622–7052 or Donald J. Drees, Jr. (202) 622–3970 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545–1990. The collection of information in these final regulations is in §1.338–11(e)(2). This information is required by the IRS to allow an insurance company to choose to cease using its historical loss payment pattern, and instead use industry-wide factors, to discount unpaid losses.

An agency may not conduct or sponsor, and the person is not required to respond to a collection of information unless the collection of information displays a valid control number.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax information are confidential, as required by 26 U.S.C. 6103.

Background and Explanation of Provisions :

On March 8, 2002, the IRS and the Treasury Department published a notice

of proposed rulemaking REG–118861–00, 2002–1 C.B. 651, in the Federal Register (67 FR 10640) (2002–1 Cumulative Bulletin (C.B.) 651) (the 2002 proposed regulations) that set forth rules applying to taxable acquisitions and dispositions of insurance businesses, including those that are deemed to occur when an election under section 338 of the Code is made. (See §601.601(d)(2)(ii)( b )). The C.B. is made available by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. Written comments were received in response to the 2002 proposed regulations, and a public hearing was held. After consideration of all the comments, the IRS and the Treasury Department published final regulations in the Federal Register on April 10, 2006, (T.D. 9257, 2006–1 C.B. 821) (71 FR 17990), as corrected in the Federal Register (T.D. 9257) (71 FR 26826) to remove an error that might have proven to be misleading.

T.D. 9257 also contains temporary regulations under sections 197, 338, and 846, which serve as the basis for a cross-reference notice of proposed rulemaking published in the Federal Register (REG–146384–05, 2006–1 C.B. 843) (71 FR 18053) with respect to issues that were the subject of comments on the 2002 proposed regulations. Specifically, §1.197–2T(g)(5)(ii) provides guidance with regard to the interplay between section 197(f)(5) (concerning the treatment of certain reinsurance transactions) and section 848 (requiring the capitalization of certain policy acquisition expenses); §1.338–11T(d) addresses reserve increases after a deemed asset sale that results from a section 338 election; and §1.338–11T(e) provides guidance on the effect of a section 338 election on an insurance company’s election under section 846(e) to use its historical loss payment pattern to discount certain unpaid losses.

Although the 2002 proposed regulations generated a number of comments which are discussed in detail in the preamble to T.D. 9257, no new comments were received with respect to the temporary regulations that served as a cross-reference notice of proposed rulemaking in 2006. Accordingly, this Treasury decision adopts the proposed regulations without substantive change and removes the corresponding temporary regulations. This

March 17, 2008 579 2008–11 I.R.B.

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by removing the entries for §§1.197–2T, 1.338–1T, and 1.338–11T to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.197–0 is amended by:

Revising the introductory text and the entries for §1.197–2(g)(5)(ii).
Removing the entries for §1.197–2T. The revisions read as follows:

§1.197–0 Table of contents .

This section lists the headings that appear in §1.197–2.

§1.197–2 Amortization of goodwill and certain other intangibles.

- - - (g) - - (5) - - (ii) Determination of adjusted basis of amortizable section 197 intangible resulting from an assumption reinsurance transaction.

(A) In general. (B) Amount paid or incurred by acquirer (reinsurer) under the assumption reinsurance transaction.

( 1 ) In general. ( 2 ) Required capitalization amount. ( 3 ) General deductions allocable to the assumption reinsurance transaction.

( 4 ) Treatment of a capitalization shortfall allocable to the reinsurance agreement.

( i ) In general. ( ii ) Treatment of additional capitalized amounts as the result of an election under §1.848–2(g)(8).

( 5 ) Cross references and special rules. (D) Examples. (E) Effective/applicability date.

- - - Par. 3. Section 1.197–2(g)(5)(ii) is revised to read as follows:

§1.197–2 Amortization of goodwill and certain other intangibles .

- - - (g) - - (5) - -

(ii) Determination of adjusted basis of amortizable section 197 intangible result- ing from an assumption reinsurance trans- action —(A) In general . Section 197(f)(5) determines the basis of an amortizable section 197 intangible for insurance or annuity contracts acquired in an assumption reinsurance transaction. The basis of such intangible is the excess, if any, of—

( 1 ) The amount paid or incurred by the acquirer (reinsurer) under the assumption reinsurance transaction; over

( 2 ) The amount, if any, required to be capitalized under section 848 in connection with such transaction.

(B) Amount paid or incurred by ac- quirer (reinsurer) under the assumption reinsurance transaction . The amount paid or incurred by the acquirer (reinsurer) under the assumption reinsurance transaction is—

( 1 ) In a deemed asset sale resulting from an election under section 338, the amount of the adjusted grossed-up basis (AGUB) allocable thereto (see §§1.338–6 and 1.338–11(b)(2));

( 2 ) In an applicable asset acquisition within the meaning of section 1060, the amount of the consideration allocable thereto (see §§1.338–6, 1.338–11(b)(2), and 1.1060–1(c)(5)); and

( 3 ) In any other transaction, the excess of the increase in the reinsurer’s tax reserves resulting from the transaction (computed in accordance with sections 807, 832(b)(4)(B), and 846) over the value of the net assets received from the ceding company in the transaction.

(C) Amount required to be capitalized under section 848 in connection with the transaction —( 1 ) In general . The amount required to be capitalized under section 848 for specified insurance contracts (as defined in section 848(e)) acquired in an assumption reinsurance transaction is the lesser of—

( i ) The reinsurer’s required capitalization amount for the assumption reinsurance transaction; or

( ii ) The reinsurer’s general deductions (as defined in section 848(c)(2)) allocable to the transaction.

( 2 ) Required capitalization amount . The reinsurer determines the required capitalization amount for an assumption reinsurance transaction by multiplying the net positive or net negative consideration for the transaction by the applicable

percentage set forth in section 848(c)(1) for the category of specified insurance contracts acquired in the transaction. See §1.848–2(g)(5). If more than one category of specified insurance contracts is acquired in an assumption reinsurance transaction, the required capitalization amount for each category is determined as if the transfer of the contracts in that category were made under a separate assumption reinsurance transaction. See §1.848–2(f)(7).

( 3 ) General deductions allocable to the assumption reinsurance transaction . The reinsurer determines the general deductions allocable to the assumption reinsurance transaction in accordance with the procedure set forth in §1.848–2(g)(6). Accordingly, the reinsurer must allocate its general deductions to the amount required under section 848(c)(1) on specified insurance contracts that the reinsurer has issued directly before determining the general deductions allocable to the assumption reinsurance transaction. For purposes of allocating its general deductions under §1.848–2(g)(6), the reinsurer includes premiums received on the acquired specified insurance contracts after the assumption reinsurance transaction in determining the amount required under section 848(c)(1) on specified insurance contracts that the reinsurer has issued directly. If the reinsurer has entered into multiple reinsurance agreements during the taxable year, the reinsurer determines the general deductions allocable to each reinsurance agreement (including the assumption reinsurance transaction) by allocating the general deductions allocable to reinsurance agreements under §1.848–2(g)(6) to each reinsurance agreement with a positive required capitalization amount.

( 4 ) Treatment of a capitalization short- fall allocable to the reinsurance agree- ment —( i ) In general . The reinsurer determines any capitalization shortfall allocable to the assumption reinsurance transaction in the manner provided in §§1.848–2(g)(4) and 1.848–2(g)(7). If the reinsurer has a capitalization shortfall allocable to the assumption reinsurance transaction, the ceding company must reduce the net negative consideration (as determined under §1.848–2(f)(2)) for the transaction by the amount described in §1.848–2(g)(3) unless the parties make the election provided in §1.848–2(g)(8) to determine the amounts capitalized under section 848 in

2008–11 I.R.B. 580 March 17, 2008

connection with the transaction without regard to the general deductions limitation of section 848(c)(2).

( ii ) Treatment of additional capitalized amounts as the result of an election under §1.848–2(g)(8) . The additional amounts capitalized by the reinsurer as the result of the election under §1.848–2(g)(8) reduce the adjusted basis of any amortizable section 197 intangible with respect to specified insurance contracts acquired in the assumption reinsurance transaction. If the additional capitalized amounts exceed the adjusted basis of the amortizable section 197 intangible, the reinsurer must reduce its deductions under section 805 or section 832 by the amount of such excess. The additional capitalized amounts are treated as specified policy acquisition expenses attributable to the premiums and other consideration on the assumption reinsurance transaction and are deducted ratably over a 120-month period as provided under section 848(a)(2).

( 5 ) Cross references and special rules . In general, for rules applicable to the determination of specified policy acquisition expenses, net premiums, and net consideration, see section 848(c) and (d), and §1.848–2(a) and (f). However, the following special rules apply for purposes of this paragraph (g)(5)(ii)(C)—

( i ) The amount required to be capitalized under section 848 in connection with the assumption reinsurance transaction cannot be less than zero;

( ii ) For purposes of determining the company’s general deductions under section 848(c)(2) for the taxable year of the assumption reinsurance transaction, the reinsurer takes into account a tentative amortization deduction under section 197(a) as if the entire amount paid or incurred by the reinsurer for the specified insurance contracts were allocated to an amortizable section 197 intangible with respect to insurance contracts acquired in an assumption reinsurance transaction; and

( iii ) Any reduction of specified policy acquisition expenses pursuant to an election under §1.848–2(i)(4) (relating to an assumption reinsurance transaction with an insolvent insurance company) is disregarded.

(D) Examples . The following examples illustrate the principles of this paragraph (g)(5)(ii):

Example 1 . (i) Facts . On January 15, 2006, P acquires all of the stock of T, an insurance company, in a qualified stock purchase and makes a section 338 election for T. T issues individual life insurance contracts which are specified insurance contracts as defined in section 848(e)(1). P and new T are calendar year taxpayers. Under §§1.338–6 and 1.338–11(b)(2), the amount of AGUB allocated to old T’s individual life insurance contracts is $300,000. On the acquisition date, the tax reserves for old T’s individual life insurance contracts are $2,000,000. After the acquisition date, new T receives $1,000,000 of net premiums with respect to new and renewal individual life insurance contracts and incurs $100,000 of general deductions under section 848(c)(2) through December 31, 2006. New T engages in no other reinsurance transactions other than the assumption reinsurance transaction treated as occurring by reason of the section 338 election.

(ii) Analysis . The transfer of insurance contracts and the assumption of related liabilities deemed to occur by reason of the election under section 338 is treated as an assumption reinsurance transaction. New T determines the adjusted basis under section 197(f)(5) for the life insurance contracts acquired in the assumption reinsurance transaction as follows. The amount paid or incurred for the individual life insurance contracts is $300,000. To determine the amount required to be capitalized under section 848 in connection with the assumption reinsurance transaction, new T compares the required capitalization amount for the assumption reinsurance transaction with the general deductions allocable to the transaction. The required capitalization amount for the assumption reinsurance transaction is $130,900, which is determined by multiplying the $1,700,000 net positive consideration for the transaction ($2,000,000 reinsurance premium less $300,000 ceding commission) by the applicable percentage under section 848(c)(1) for the acquired individual life insurance contracts (7.7 percent). To determine its general deductions, new T takes into account a tentative amortization deduction under section 197(a) as if the entire amount paid or incurred for old T’s individual life insurance contracts ($300,000) were allocable to an amortizable section 197 intangible with respect to insurance contracts acquired in the assumption reinsurance transaction. Accordingly, for the year of the assumption reinsurance transaction, new T is treated as having general deductions under section 848(c)(2) of $120,000 ($100,000 + $300,000/15). Under §1.848–2(g)(6), these general deductions are first allocated to the $77,000 capitalization requirement for new T’s directly written business ($1,000,000 x .077). Thus, $43,000 ($120,000 $77,000) of the general deductions are allocable to the assumption reinsurance transaction. Because the general deductions allocable to the assumption reinsurance transaction ($43,000) are less than the required capitalization amount for the transaction ($130,900), new T has a capitalization shortfall of $87,900 ($130,900 - $43,000) with regard to the transaction. Under §1.848–2(g), this capitalization shortfall would cause old T to reduce the net negative consideration taken into account with respect to the assumption reinsurance transaction by $1,141,558 ($87,900 ÷ .077) unless the parties make the election under §1.848–2(g)(8) to capitalize specified policy acquisition expenses in connection with the

assumption reinsurance transaction without regard to the general deductions limitation. If the parties make the election, the amount capitalized by new T under section 848 in connection with the assumption reinsurance transaction would be $130,900. The $130,900 capitalized by new T under section 848 would reduce new T’s adjusted basis of the amortizable section 197 intangible with respect to the specified insurance contracts acquired in the assumption reinsurance transaction. Accordingly, new T would have an adjusted basis under section 197(f)(5) with respect to the individual life insurance contracts acquired from old T of $169,100 ($300,000

$130,900). New T’s actual amortization deduction under section 197(a) with respect to the amortizable section 197 intangible for insurance contracts acquired in the assumption reinsurance transaction would be $11,273 ($169,100 ÷15).

Example 2 . (i) Facts . The facts are the same as Example 1, except that T only issues accident and health insurance contracts that are qualified long-term care contracts under section 7702B. Under section 7702B(a)(5), T’s qualified long-term care insurance contracts are treated as guaranteed renewable accident and health insurance contracts, and, therefore, are considered specified insurance contracts under section 848(e)(1). Under §§1.338–6 and 1.338–11(b)(2), the amount of AGUB allocable to T’s qualified long-term care insurance contracts is $250,000. The amount of T’s tax reserves for the qualified long-term care contracts on the acquisition date is $7,750,000. Following the acquisition, new T receives net premiums of $500,000 with respect to qualified long-term care contracts and incurs general deductions of $75,000 through December 31, 2006.

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AGUB that is subsequently taken into account. Thus, AGUB is increased by the amount of the additional premium included in new target’s gross income. See §§1.338–5(b)(2)(ii) and 1.338–7. Old target has no deduction under this paragraph (d) and makes no adjustments under §§1.338–4(b)(2)(ii) and 1.338–7.

(2) Exceptions . New target is not treated as receiving additional premium under paragraph (d)(1) of this section if—

(i) It is under state receivership as of the close of the taxable year for which the increase in reserves occurs; or

(ii) It is required by section 807(f) to spread the reserve increase over the 10 succeeding taxable years.

(3) Amount of additional premium —(i) In general . The additional premium taken into account under this paragraph (d) is an amount equal to the sum of the positive amounts described in paragraphs (d)(3)(ii) and (d)(3)(iii) of this section. However, the additional premium cannot exceed the limitation described in paragraph (d)(4) of this section.

(ii) Increases in unpaid loss reserves . The positive amount with respect to unpaid loss reserves is computed using the formula A/B x (C - [D + E]) where—

(A) A equals old target’s discounted unpaid losses (determined under section 846) included in AGUB under paragraph 11(b)(1) of this section; (B) B equals old target’s undiscounted unpaid losses (determined under section 846(b)(1)) as of the close of the acquisition date;

(C) C equals new target’s undiscounted unpaid losses (determined under section 846(b)(1)) at the end of the taxable year that are attributable to losses incurred by old target on or before the acquisition date;

(D) D (which may be a negative number) equals old target’s undiscounted unpaid losses as of the close of the acquisition date, reduced by the cumulative amount of losses, loss adjustment expenses, and reinsurance premiums paid by new target through the end of the taxable year for losses incurred by old target on or before the acquisition date; and

(E) E equals the amount obtained by dividing the cumulative amount of reserve increases taken into account under this paragraph (d) in prior taxable years by A/B.

business ($500,000 x .077). Thus, $53,167 ($91,667

$38,500) of general deductions are allocable to the assumption reinsurance transaction. Because the general deductions allocable to the assumption reinsurance transaction ($53,167) are less than the required capitalization amount for the transaction ($577,500), new T has a capitalization shortfall of $524,333 ($577,500 - $53,167) with regard to the transaction. Under §1.848–2(g), this capitalization shortfall would cause old T to reduce the net negative consideration taken into account with respect to the assumption reinsurance transaction by $6,809,519 ($524,333 ÷ .077) unless the parties make the election under §1.848–2(g)(8) to capitalize specified policy acquisition expenses in connection with the assumption reinsurance transaction without regard to the general deductions limitation. If the parties make the election, the amount capitalized by new T under section 848 in connection with the assumption reinsurance transaction would increase from $53,167 to $577,500. Pursuant to paragraph (g)(5)(ii)(C)( 4 ) of this section, the additional $524,333 ($577,500
$53,167) capitalized by new T under section 848 would reduce new T’s adjusted basis of the amortizable section 197 intangible with respect to the insurance contracts acquired in the assumption reinsurance transaction. Accordingly, new T’s adjusted basis of the section 197 intangible with regard to the insurance contracts is reduced from $196,833 ($250,000 - $53,167) to $0. Because the additional $524,333 capitalized pursuant to the §1.848–2(g)(8) election exceeds the $196,833 adjusted basis of the section 197 intangible before the reduction, new T is required to reduce its deductions under section 805 by the $327,500 ($524,333 - $196,833).

(E) Effective/applicability date . This section applies to acquisitions and dispositions of insurance contracts on or after April 10, 2006.

§1.197–2T [Removed]

Par. 4. Section 1.197–2T is removed. Par. 5. Section 1.338–0 is amended by revising the entries for §1.338–11(d) and (e) to read as follows:

§1.338–0 Outline of topics .

§1.338–11 Effect of section 338 election on insurance company targets .

- - - (d) Reserve increases by new target after the deemed asset sale.

(1) In general. (2) Exceptions. (3) Amount of additional premium. (i) In general. (ii) Increases in unpaid loss reserves. (iii) Increases in other reserves. (4) Limitation on additional premium.

(5) Treatment of additional premium under section 848.

(6) Examples. (7) Effective/applicability date. (i) In general. (ii) Application to pre-effective date increases to reserves.

(e) Effect of section 338 election on section 846(e) election.

(1) In general. (2) Revocation of existing section 846(e) election.

- - - Par. 6. Section 1.338–1 is amended by adding paragraph (b)(2)(vii) to read as follows:

§1.338–1 General principles; status of old target and new target.

- - - (b) - - (2) - - (vii) Section 846(e) (relating to an election to use an insurance company’s historical loss payment pattern).

§1.338–1T [Removed]

Par. 7. Section 1.338–1T is removed. Par. 8. Section 1.338–11 is amended by revising paragraphs (d) and (e) to read as follows:

§1.338–11 Effect of section 338 election on insurance company targets .

- - - (d) Reserve increases by new target after the deemed asset sale —(1) In gen- eral . If in new target’s first taxable year or any subsequent year, new target increases its reserves for any acquired contracts, new target is treated as receiving an additional premium, which is computed under paragraph (d)(3) of this section, in the assumption reinsurance transaction described in paragraph (c)(1) of this section. New target includes the additional premium in gross income for the taxable year in which new target increases its reserves for acquired contracts. New target’s increase in reserves for the insurance contracts acquired in the deemed asset sale is a liability of new target not originally taken into account in determining

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(iii) Increases in other reserves . The positive amount with respect to reserves other than discounted unpaid loss reserves is the net increase of those reserves due to changes in estimate, methodology, or other assumptions used to compute the reserves (including the adoption by new target of a methodology or assumptions different from those used by old target).

(4) Limitation on additional premium . The additional premium taken into account by new target under paragraph (d)(1) of this section is limited to the excess, if any, of—

(i) The fair market value of old target’s assets acquired by new target in the deemed asset sale (other than Class VI and Class VII assets); over

(ii) The AGUB allocated to those assets (including increases in AGUB allocated to those assets as the result of reserve increases by new target in prior taxable years).

(5) Treatment of additional premium under section 848 . If a portion of the positive amounts described in paragraphs (d)(3)(ii) and (iii) of this section are attributable to an increase in reserves for specified insurance contracts (as defined in section 848(e)), new target takes an allocable portion of the additional premium in determining its specified policy acquisition expenses under section 848(c) for the taxable year of the reserve increase.

(6) Examples . The following examples illustrate this paragraph (d):

Example 1 . (i) Facts . On January 1, 2006, P purchases all of the stock of T, a non-life insurance company, for $120 and makes a section 338 election for T. On the acquisition date, old T has total reserve liabilities under state law of $725, consisting of undiscounted unpaid losses of $625 and unearned premiums of $100. Old T’s tax reserves on the acquisition date are $580, which consist of discounted unpaid losses (as defined in section 846) of $500 and unearned premiums (as computed under section 832(b)(4)(B)) of $80. Old T has Class I through Class V assets with a fair market value of $800. Old T also has a Class VI asset with a fair market value of $75, consisting of the future profit stream of certain insurance contracts. During 2006, new T makes loss and loss adjustment expense payments of $200 with respect to the unpaid losses incurred by old T before the acquisition date. As of December 31, 2006, new T reports undiscounted unpaid losses of $475 attributable to losses incurred before the acquisition date. The related amount of discounted unpaid losses (as defined in section 846) for those losses is $390.

(ii) Computation and allocation of AGUB . Under §1.338–5 and paragraph (b)(1) of this section, as of the acquisition date, AGUB is $700, reflecting the sum of the amount paid for old T’s stock ($120) and

the tax reserves assumed by new T in the transaction ($580). The fair market value of old T’s Class I through V assets is $800, whereas the AGUB available for such assets under §1.338–6 is $700. There is no AGUB available for old T’s Class VI assets, even though such assets have a fair market value of $75 on the acquisition date.

(iii) Adjustments for increases in reserves for un- paid losses . Under paragraph (d) of this section, new T must determine whether there are any amounts by which it increased its unpaid loss reserves that will be treated as an additional premium and an increase in AGUB. New T applies the formula of paragraph (d)(3) of this section, where A equals $500, B equals $625, C equals $475, D equals $425 ($625 - $200), and E equals $0. Under this formula, new T is treated as having increased its reserves for discounted unpaid losses attributable to losses incurred by old T by $40 ($500/$625 x ($475 -[$425+0]). The limitation under paragraph (d)(5) of this section based on the difference between the fair market value of old T’s Class I through Class V assets and the AGUB allocated to such assets is $100. Accordingly, new T includes an additional premium of $40 in gross income for 2006, and increases the AGUB allocated to old T’s Class I through Class V assets to reflect this additional premium.

Example 2 . (i) Facts . Assume the same facts as in Example 1 . Further assume that during 2007 new T deducts total loss and loss expense payments of $375 with respect to losses incurred by old T before the acquisition date. On December 31, 2007, new T reports undiscounted unpaid losses of $150 with respect to losses incurred before the acquisition date. The related amount of discounted unpaid losses (as defined in section 846) for those unpaid losses is $125.

(ii) Analysis . New T must determine whether any amounts by which it increased its unpaid losses during 2007 will be treated as an additional premium in paragraph (d)(3) of this section. New T applies the formula under paragraph (d)(3) of this section, where A equals $500, B equals $625, C equals $150, D equals $50 ($625 - $575), and E equals $50 ($40 divided by .8). In paragraph (d)(3) of this section, new T is treated as increasing its reserves for discounted unpaid losses by $40 during 2007 with respect to losses incurred by old T ($500/$625 x ($150 - [$50 + $50]). New T determines the limitation of paragraph (d)(5) of this section by comparing the $800 fair market value of the Class I through V assets on the acquisition date to the $740 AGUB allocated to such assets (which includes the $40 addition to AGUB included during 2006). Thus, new T recognizes $40 of additional premium as a result of the increase in reserves during 2007, and adjusts the AGUB allocable to the Class I through V assets acquired from old T to reflect such additional premium.

Example 3 . (i) Facts . The facts are the same as Example 2, except that on January 1, 2008, new T reinsures the outstanding liability with respect to losses incurred by old T before the acquisition date through a portfolio reinsurance transaction with R, another non-life insurance company. R agrees to assume any remaining liability relating to losses incurred by old T before the acquisition date in exchange for a reinsurance premium of $200. Accordingly, as of December 31, 2008, new T reports no undiscounted unpaid losses with respect to losses incurred by old T before the acquisition date.

(ii) Analysis . New T must determine whether any amount by which it increased its unpaid loss reserves will be treated as an additional premium under paragraph (d) of this section. New T applies the formula of paragraph (d)(3) of this section, where A equals $500, B equals $625, C equals $0, and D equals -$150 ($625 - ($575 + $200), and E equals $100 ($80 divided by .8). Thus, new T is treated as having increased its discounted unpaid losses by $40 in 2008 with respect to losses incurred by old T before the acquisition date ($500/$625 x (0 - [-$150 + $100]). New T includes this positive amount in gross income, subject to the limitation of paragraph (d)(4) of this section. The limitation of paragraph (d)(4) of this section equals $20, which is computed by comparing the $800 fair market value of the Class I through V assets acquired from old T with the $780 AGUB allocated to such assets (which includes the $40 addition to AGUB in 2006 and the $40 addition to AGUB in 2007). Thus, New T includes $20 in additional premium, and increases the AGUB allocated to the Class I through V assets acquired from old T by $20. As a result of these adjustments, the limitation under paragraph (d)(4) of this section is reduced to zero.

(7) Effective/applicability date —(i) In general . This section applies to increases to reserves made by new target after a deemed asset sale occurring on or after April 10, 2006.

(ii) Application to pre-effective date increases to reserves . If either new target makes an election under §1.338(i)–1(c)(2) or old target makes an election under §1.338(i)–1(c)(3) to apply the rules of this section, in whole, to a qualified stock purchase occurring before April 10, 2006, then the rules contained in this section shall apply in whole to the qualified stock purchase.

(e) Effect of section 338 election on sec- tion 846(e) election —(1) In general . New target and old target are treated as the same corporation for purposes of an election by old target to use its historical loss payment pattern under section 846(e). See §1.338–1(b)(2)(vii). Therefore, if old target has a section 846(e) election in effect on the acquisition date, new target will continue to use the historical loss payment pattern of old target to discount unpaid losses incurred in accident years covered by the election, unless new target elects to revoke the section 846(e) election. In addition, new target may consider old target’s historical loss payment pattern when determining whether to make the section 846(e) election for a determination year that includes or is subsequent to the acquisition date.

(2) Revocation of existing section 846(e) election . New target may revoke

March 17, 2008 583 2008–11 I.R.B.

old target’s section 846(e) election to use its historical loss payment pattern to discount unpaid losses. If new target elects to revoke old target’s section 846(e) election, new target will use the industry-wide patterns determined by the Secretary to discount unpaid losses incurred in accident years beginning on or after the acquisition date through the subsequent determination year. New target may revoke old target’s section 846(e) election by attaching a statement to new target’s original tax return for its first taxable year.

§1.338–11T [Removed]

Par. 9. Section 1.338–11T is removed. Par. 10. Section 1.338(i)–1 is amended by:

Revising the section heading to read as set forth below.
Redesignating paragraph (c)(2)(ii)( b ) as paragraph (c)(2)(ii)(B).

The revisions read as follows:

§1.381(i)–1 Effective/applicability date .

- - - Par. 11. Section 1.381(c)(22)– 1(b)(7)(v) is amended by revising the last sentence of Example 3 to read as follows:

§1.381(c)(22)–1 Successor life insurance company .

- - - (b) - - (7) - - (v) - - Example 3 . - * * In that case, in the taxable year of the indemnity reinsurance transaction, S takes into account as ordinary income the portion of the old T’s accounts ($1) that old T or S has not previously taken into account as income.

§1.846–0 [Amended]

Par. 12. Section 1.846–0 is amended by removing the entries for §§1.846–2T and 1.846–4T.

Par. 13. Section 1.846–2(d) is revised to read as follows:

§1.846–2 Election by taxpayer to use its own historical loss payment pattern .

- - - (d) Effect of section 338 election on section 846(e) election . For rules regarding qualified stock purchase occurring on or after April 10, 2006, see §§1.338–1(b)(2)(vii) and 1.338–11(e).

Par. 14. Section 1.846–4 is amended by revising the section heading and paragraph (b) to read as follows:

§1.846–4 Effective/applicability date .

- - - (b) Section 338 election . Section 1.846–2(d) applies to section 846(e) elections made with regard to a qualified stock purchase made on or after April 10, 2006.

Par. 15. For each entry in the “Section” column remove the phrase in the “Remove” column and add the phrase in the “Add” column in its place.

Section	Remove	Add
§1.338(i)–1(c)(2)(i)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(2)(i)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(2)(ii)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(2)(ii)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(2)(ii)(B) (First sentence)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(2)(ii)(B) (First sentence)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(2)(ii)(B) (Second sentence)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(2)(ii)(B) (Second sentence)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(3)(i)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(3)(i)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(3)(ii)	§§1.338–11 and1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(3)(ii)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(3)(ii)(B) (First sentence)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.338(i)–1(c)(3)(ii)(B) (First sentence)	1.197–2T(g)(5)(ii),
§1.338(i)–1(c)(3)(ii)(B) (Second sentence)	§§1.338–11 and 1.338–11T(d)	§1.338–11

2008–11 I.R.B. 584 March 17, 2008

Section	Remove	Add
§1.338(i)–1(c)(3)(ii)(B) (Second sentence)	1.197–2T(g)(5)(ii),
§1.1060–1(a)(2)(i)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.1060–1(a)(2)(i)	1.197–2T(g)(5)(ii),
§1.1060–1(a)(2)(ii)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.1060–1(a)(2)(ii)	1.197–2T(g)(5)(ii),
§1.1060–1(a)(2)(ii)(B)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.1060–1(a)(2)(ii)(B)	1.197–2T(g)(5)(ii),
§1.1060–1(a)(2)(iii)	§§1.338–11T(d) and 1.338–11T(d)	§1.338–11(d)
§1.1060–1(a)(2)(iii)	1.197–2T(g)(5)(ii),
§1.1060–1(a)(2)(iii)(B)	§§1.338–11 and 1.338–11T(d)	§1.338–11
§1.1060–1(a)(2)(iii)(B)	1.197–2T(g)(5)(ii),

§602.101 OMB Control numbers.

- - - (b) - *

Current OMB control No.

PART 602 - OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 16. The authority citation for part 602 continues to read as follows:

CFR part or section where Identified and described

Authority: 26 U.S.C. 7805. Par. 17. In §602.101, paragraph (b) is amended by removing the entry for §1.338–11T from the table and adding an entry to the table in numerical order to read as follows:

1.338–11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1545–1990

shareholder’s pro rata share of the S corporation’s losses and deductions for the taxable year in which the property is contributed?

FACTS

Individual A is the sole shareholder of S Corporation X . At the beginning of X ’s 2007 taxable year, A has a basis of $50x in the X stock. During 2007, X makes a charitable contribution of unencumbered real property, with an adjusted basis of $100x and a fair market value of $190x, in a transaction that qualifies under § 170(c). The charitable contribution is not subject to the limitations of § 170(e)(1). In 2007, X has §1363 taxable income of $30x and a long-term capital loss of $25x.

LAW

Section 170(a) allows as a deduction any charitable contribution (as defined in § 170(c)) the payment of which is made

Linda Stiff, Deputy Commissioner for Services and Enforcement.

Approved January 9, 2008.

Eric Solomon, Assistant Secretary of the

Treasury (Tax Policy).

(Filed by the Office of the Federal Register on January 22, 2008, 8:45 a.m., and published in the issue of the Federal Register for January 23, 2008, 73 F.R. 3868)

Section 1366.—Pass-Thru of Items to Shareholders

26 CFR 1.1366–2: Limitations on deduction of pass- through items of an S corporation to its shareholders. (Also § 1367; 1.1367–1.)

S corporations; charitable contribu- tions. This ruling provides guidance for S corporations that made charitable contributions of appreciated property during a taxable year beginning after December 31,

2005 and before January 1, 2008. The ruling provides that the amount of the charitable deduction the shareholder may claim may not exceed the sum of (i) the shareholder’s pro rata share of the fair market value of the contributed property over the shareholder’s pro rata share of the contributed property’s adjusted tax basis, and (ii) the amount of the Code section 1366(d) loss limitation amount that is allocable to the contributed property’s basis under regulations section 1.1366–2(a)(4).

Rev. Rul. 2008–16

ISSUE

If an S corporation makes a charitable contribution of appreciated property in a taxable year beginning after December 31, 2005, and before January 1, 2008, what is the amount of the charitable contribution deduction that a shareholder may claim in circumstances where § 1366(d) of the Internal Revenue Code (Code) limits the

March 17, 2008 585 2008–11 I.R.B.

271, provides the following illustration of § 1203:

Thus, for example, assume an S corporation with one individual shareholder makes a charitable contribution of stock with a basis of $200 and a fair market value of $500. The shareholder will be treated as having made a $500 charitable contribution (or a lesser amount if the special rules of section 170(e) apply), and will reduce the basis of the S corporation stock by $200. ( Footnote 306: This example assumes that basis of the S corporation stock (before reduction) is at least $200.) Section 3(b) of the Tax Technical Corrections Act of 2007 (Technical Corrections Act), P.L. 172, 121 Stat. 2473 (2007), added § 1366(d)(4), which concerns the application of the basis limitation rule of § 1366(d)(1) to charitable contributions of appreciated property by S corporations. Generally, under § 1366(d)(1), the amount of losses and deductions which a shareholder of an S corporation may take into account in any taxable year is limited to the shareholder’s adjusted basis in his stock and indebtedness of the corporation. Section 1366(d)(4) provides that, in the case of a charitable contribution of property, § 1366(d)(1) shall not apply to the extent of the excess (if any) of (A) the shareholder’s pro rata share of such contribution, over (B) the shareholder’s pro rata share of the adjusted basis of such property. Thus, the basis limitation rule of § 1366(d)(1) does not apply to the amount of deductible appreciation in the contributed property. See Description of the Tax Technical Corrections Act of 2007, JCX–119–07, pages 2–3. The Pension Act amendment to § 1367(a)(2) and the Technical Corrections Act amendment to § 1366(d) apply to charitable contributions made by S corporations in taxable years beginning after December 31, 2005, and before January 1, 2008. Charitable contributions made by S corporations in taxable years beginning after December 31, 2007, barring any statutory change, are subject to the law in existence prior to these amendments. The IRS and Treasury Department are considering issuing guidance on the treatment of charitable contributions made by S corporations in taxable years beginning after December 31, 2007.

during the taxable year. The deduction allowable by § 170(a) is subject to the limitations of § 170(b).

Section 1.170A–1(c)(1) of the Income Tax Regulations provides that if a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution reduced as provided in § 170(e)(1) and § 1.170A–4(a), or § 170(e)(3) and § 1.170A–4A(c).

Section 1363(b)(2) provides that the taxable income of an S corporation shall be computed in the same manner as in the case of an individual, except that the deductions referred to in § 703(a)(2), including the deduction for charitable contributions provided in § 170, shall not be allowed to the corporation.

Section 1366(a)(1)(A) provides that, in determining the tax of a shareholder, there shall be taken into account the shareholder’s pro rata share of the corporation’s items of income, loss, deduction, or credit the separate treatment of which could affect the liability for tax of any shareholder. Section 1366(a)(1) provides further that the items referred to in § 1366(a)(1)(A) include amounts described in § 702(a)(4). Section 702(a)(4) refers to charitable contributions (as defined in § 170(c)).

Section 1366(a)(1)(B) provides that, in determining the tax of a shareholder, there shall be taken into account the shareholder’s pro rata share of any nonseparately computed income or loss.

Section 1366(d)(1) provides that the aggregate amount of losses and deductions taken into account by a shareholder under § 1366(a) for any taxable year shall not exceed the sum of (A) the adjusted basis of the shareholder’s stock in the S corporation, and (B) the shareholder’s adjusted basis of any indebtedness of the S corporation to the shareholder.

Section 1366(d)(2)(A) generally provides that any loss or deduction which is disallowed for any taxable year by reason of § 1366(d)(1) shall be treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder.

Section 1.1366–1(a)(2)(i) and (iii) provides that each S corporation shareholder must take into account separately the shareholder’s pro rata share of the S corporation’s gains and losses from sales or exchanges of capital assets and the corporation’s charitable contributions.

Section 1.1366–1(a)(3) provides that each shareholder must take into account separately the shareholder’s pro rata share of the nonseparately computed income or loss of the S corporation.

Section 1.1366–1(b)(1) provides, in part, that the character of any item of income, loss, deduction, or credit described in § 1366(a)(1)(A) or (B) is determined for the S corporation and retains that character in the hands of the shareholder.

Section 1.1366–2(a)(4) generally provides that if a shareholder’s pro rata share of the aggregate amount of losses and deductions exceeds the sum of the adjusted basis of the shareholder’s stock in the corporation and the adjusted basis of any indebtedness of the corporation to the shareholder, then the limitation on losses and deductions under § 1366(d)(1) must be allocated among the shareholder’s pro rata share of each loss or deduction. The amount of the limitation allocated to any loss or deduction is an amount that bears the same ratio to the amount of the limitation as the loss or deduction bears to the total of the losses and deductions.

Section 1367(a)(1)(B) provides that the basis of each shareholder’s stock in an S corporation is increased for any period by any nonseparately computed income determined under § 1366(a)(1)(B).

Section 1367(a)(2)(B) provides that the basis of each shareholder’s stock in an S corporation is decreased for any period (but not below zero) by the items of loss and deduction described in § 1366(a)(1)(A).

Section 1.1367–1(f) provides that increases in an S corporation shareholder’s stock basis that are attributable to income items described in § 1367(a)(1)(B) are made before decreases in such basis that are attributable to items of loss or deduction described in § 1367(a)(2)(B).

Section 1203(a) of the Pension Protection Act of 2006 (Pension Act), P.L. 109–280, 120 Stat. 780 (2006), amended Code § 1367(a)(2) to provide that the decrease in shareholder basis under § 1367(a)(2)(B) by reason of a charitable contribution (as defined in § 170(c)) of property shall be the amount equal to the shareholder’s pro rata share of the adjusted basis of such property. The Technical Explanation of the Pension Act, Technical Explanation of H.R. 4, “The Pension Protection Act of 2006,” JCX–38–06 page

2008–11 I.R.B. 586 March 17, 2008

treated as incurred by the corporation in the corporation’s first succeeding taxable year, and subsequent taxable years, with respect to the shareholder.

DRAFTING INFORMATION

The principal author of this revenue ruling is Cynthia D. Morton of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this revenue ruling, contact Cynthia D. Morton at (202) 622–3060 (not a toll-free call).

Section 1502.—Regulations

26 CFR 1.1502–80: Applicability of other provisions of law.

T.D. 9376

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Guidance Under Section 1502; Miscellaneous Operating Rules for Successor Persons; Succession to Items of the Liquidating Corporation

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations under section 1502 of the Internal Revenue Code that provide guidance regarding the manner in which the items (including items described in section 381(c) but excluding intercompany items under §1.1502–13) of a liquidating corporation are succeeded to and taken into account in cases in which multiple members acquire the assets of the liquidating corporation in a complete liquidation to which section 332 applies. These final regulations affect corporations filing consolidated returns.

DATES: Effective Date: These regulations are effective January 15, 2008.

Applicability Date: For the date of applicability, see §1.1502–80(g)(7).

ANALYSIS

Under the facts of this revenue ruling, X makes a charitable contribution of unencumbered real property with an adjusted basis of $100x and a fair market value of $190x in a transaction that qualifies under § 170(c). The charitable contribution is treated as a separately stated item of deduction that passes through to A and is deductible in computing A ’s individual tax liability. Section 1.1366–1(a)(2)(iii).

Pursuant to § 1.1367–1(f), A ’s $50x basis in the X stock is first increased by $30x under § 1367(a)(1)(B) to reflect A ’s share of X ’s taxable income. A ’s basis in the X stock is then decreased (but not below zero) by A ’s pro rata share of the sum of the adjusted basis of the contributed property ($100x) pursuant to the flush language of § 1367(a)(2) and by A ’s pro rata share of X ’s long-term capital loss ($25x) pursuant to § 1367(a)(2)(B). However, A ’s pro rata share of the aggregate amount of losses and deductions ($125x) exceeds A ’s basis in the X stock of $80x. Section 1366(d)(1), accordingly, will limit the allowable losses and deductions to A for X ’s 2007 tax year.

Pursuant to § 1366(d)(4), the basis limitation rule in § 1366(d)(1) does not apply to a contribution of appreciated property to the extent the shareholder’s pro rata share of the contribution exceeds the shareholder’s pro rata share of the adjusted basis of the contributed property. Accordingly, the basis limitation rule of § 1366(d)(1) does not apply to A’s pro rata share of the amount of deductible appreciation in the contributed property ($90x).

Under § 1.1366–2(a)(4), when a shareholder has losses or deductions in excess of the sum of the shareholder’s basis in the stock plus indebtedness of the S corporation to the shareholder, the limitation on losses must be allocated pro rata to each item of loss or deduction. In the case of a charitable contribution deduction, the limitation amount allocable to such deduction is determined by reference to the shareholder’s pro rata share of the contributed property’s adjusted basis pursuant to § 1366(d)(4).

In applying § 1.1366–2(a)(4), the amount of the limitation allocable to a charitable contribution deduction is an amount that bears the same ratio to the § 1366(d) limitation as the shareholder’s

pro rata share of the contributed property’s adjusted basis bears to the total of the shareholder’s pro rata share of the corporation’s losses and deductions (excluding the charitable contribution deduction attributable to the shareholder’s pro rata share of the fair market value of the contributed property over the contributed property’s tax basis). Accordingly, the amount of the limitation allocable to A ’s share of X ’s charitable contribution deduction is determined by multiplying A ’s basis in the X stock ($80x) by a fraction, the numerator of which is $100x (the contributed property’s adjusted basis) and the denominator of which is $125x (the total of the capital loss and the contributed property’s adjusted basis). Thus, $64x is allocated to the charitable contribution deduction. The remaining $16x is allocated to the capital loss.

Accordingly, in 2007, the amount of the charitable contribution deduction that A may claim is $154x. This amount is comprised of A ’s pro rata share of the property’s appreciation ($90x) plus the amount of the loss limitation allocated to A ’s pro rata share of the contributed property’s adjusted basis ($64x). Under § 1367(a)(2)(B), A ’s basis in the X stock is reduced to 0 to reflect the $16x reduction in basis attributable to the capital loss and the $64x reduction in basis attributable to the charitable contribution deduction. Pursuant to § 1366(d)(2), the disallowed portion of the charitable contribution deduction ($36x) and the capital loss ($9x) shall be treated as incurred by X in the succeeding taxable year with respect to A .

HOLDING

If an S corporation makes a charitable contribution of appreciated property during a taxable year beginning after December 31, 2005, and before January 1, 2008, the amount of the charitable contribution deduction the shareholder may claim may not exceed the sum of (i) the shareholder’s pro rata share of the fair market value of the contributed property over the contributed property’s adjusted tax basis, and (ii) the amount of the § 1366(d) loss limitation amount that is allocable to the contributed property’s adjusted basis under § 1.1366–2(a)(4). Any disallowed portion of the charitable contribution retains its character and is

March 17, 2008 587 2008–11 I.R.B.

1504(a)(2) and the distribution is made in complete cancellation or redemption of all of the stock of the liquidating corporation. Section 1.1502–34 provides that in determining the stock ownership of a member in another corporation (the issuing corporation) for purposes of determining the application of section 332(b)(1) there shall be included the stock of the issuing corporation owned by all other members of the group.

Section 337(a) provides that the liquidating corporation shall not recognize gain or loss on the distribution to the 80-percent distributee of any property in a complete liquidation to which section 332 applies. Section 337(c) provides that, for purposes of section 337, the term “80-percent distributee” means only the corporation that meets the 80-percent stock ownership requirements of section 332(b) without regard to the application of any consolidated return regulation. If section 337(a) does not apply, under section 336, the liquidating corporation will generally recognize gain or loss on the distribution of property in complete liquidation as if such property were sold to the distributee at its fair market value. Therefore, a complete liquidation to which section 332 applies may be taxable in whole or in part to the liquidating corporation but tax-free to the distributee members.

Deferred Income Items of the Liquidating Corporation

Section 1.451–5 generally allows accrual method taxpayers to defer the inclusion in gross income of advance payments for goods until the taxable year in which properly accruable under the taxpayer’s method of accounting for tax purposes if such method results in gross income inclusion no later than when such items are included in gross income under the taxpayer’s method of accounting for financial reporting purposes. However, if in a taxable year the taxpayer ceases to exist in a transaction other than one to which section 381(a) applies, or the liability under the agreement otherwise ends, then deferred income amounts are includable in the taxpayer’s gross income for such taxable year.

Rev. Proc. 2004–34, 2004–1 C.B. 991, (see §601.601(d)(2)(ii)( b ) of this chapter) allows taxpayers a limited deferral beyond

FOR FURTHER INFORMATION CONTACT: Amber C. Vogel or Marie C. Milnes-Vasquez, (202) 622–7530 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On February 22, 2005, the IRS and Treasury Department published in the Federal Register (70 FR 8552) a notice of proposed rulemaking (REG–131128–04, 2005–1 C.B. 733) under section 1502 proposing guidance as to how multiple consolidated group members (distributee members) that acquire assets in a liquidation to which section 332 applies succeed to and take into account the items of the liquidating corporation. The proposed regulations apply single-entity principles and allocate the items of the liquidating corporation that could be used to offset the income or tax liability of the group or any member to each distributee member to the extent that such items would have been reflected in investment adjustments to the stock of the liquidating corporation owned by such distributee member under the principles of §1.1502–32(c) if, immediately before the liquidation, any stock of the liquidating corporation owned by nonmembers had been redeemed, and then such items had been taken into account.

The proposed regulations also provide allocation rules for the credits and earnings and profits of the liquidating corporation. Under the proposed regulations, each distributee member succeeds to the credits of the liquidating corporation to the extent that the items of income, gain, loss, or deduction attributable to the activities that gave rise to the credit would have been reflected in investment adjustments to the stock of the liquidating corporation owned by such distributee member under the principles of §1.1502–32(c) if, immediately before the liquidation, any stock of the liquidating corporation owned by nonmembers had been redeemed, and then such items had been taken into account. The proposed regulations provide similar rules for allocating the liquidating corporation’s earnings and profits to the distributee members.

Under the proposed regulations, a distributee member generally succeeds to any other items of the liquidating corporation

if, immediately before the liquidation, such distributee owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502–34. In contrast, a distributee member that does not meet the ownership requirements of section 1504(a)(2) without regard to the application of §1.1502–34 (a non-80-percent distributee) succeeds to any remaining items of the liquidating corporation only to the extent that it would have succeeded to those items if it had purchased, in a taxable transaction, the assets or businesses of the liquidating corporation that it received in the liquidation and had assumed the liabilities that it assumed in the liquidation.

In addition, the proposed regulations also provide guidance regarding the method for allocating the intercompany items of a liquidating subsidiary in cases in which multiple members acquire the assets of a liquidating subsidiary in a complete liquidation to which section 332 applies. The IRS and Treasury Department continue to study those rules. Accordingly, that portion of the notice of proposed rulemaking is withdrawn, and the final regulations do not apply to the intercompany items of the liquidating corporation. For rules applicable to the treatment of those items, see §1.1502–13(j)(2)(ii).

No public hearing was requested or held. Written and electronic comments responding to the notice of proposed rulemaking were received. After consideration of all the comments, the proposed regulations are adopted as amended by this Treasury decision. The revisions are discussed in this preamble.

Explanation and Summary of Comments

The Complete Liquidation Rules

Section 332(a) provides that no gain or loss shall be recognized on the receipt by a corporation of property distributed in complete liquidation of another corporation. Section 332(b) provides, in part, that a distribution shall be considered to be in complete liquidation only if the corporation receiving such property was, on the date of the adoption of the plan of liquidation and at all times thereafter until the receipt of the property, the owner of stock meeting the requirements of section

2008–11 I.R.B. 588 March 17, 2008

final regulations revise the credit allocation rule and provide that credits will be allocated proportionally based on the value of the stock of the liquidating corporation owned by each distributee member. The IRS and Treasury Department believe that this rule represents a reasonable and administrable approach to allocating credits.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. Further, 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 on the fact that these regulations will primarily affect affiliated groups of corporations that have elected to file a consolidated return, which tend to be larger businesses. Accordingly, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

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

Partial Withdrawal of Proposed Regulations

Accordingly, we are not adopting the amendments to §1.1502–13 as proposed in the notice of proposed rulemaking (REG–131128–04) that was published in the Federal Register on Tuesday, February 22, 2005 (70 FR 8552).

- - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

the taxable year of receipt for certain advance payments. However, inclusion of deferred income is accelerated to the taxable year of receipt if, in such taxable year, the taxpayer ceases to exist in a transaction other than a transaction to which section 381(a) applies or the taxpayer’s obligation with respect to the advance payment is satisfied or otherwise ends other than in certain types of section 351(a) transfers or in a transaction to which section 381(a) applies.

Section 455 provides accrual method taxpayers with an election to include prepaid subscription income in gross income in the taxable year in which the liability exists to furnish or deliver a newspaper, magazine, or other periodical. However, if the liability to furnish or deliver the periodical ends or the taxpayer ceases to exist, then the amount of prepaid subscription income not previously included in the taxpayer’s gross income is included in the taxpayer’s gross income for the taxable year in which the liability ends. If the taxpayer’s liability to furnish or deliver the periodical ends as a result of a transaction to which section 381(a) applies, the prepaid subscription income will generally not be included in the taxpayer’s gross income, and the acquiring corporation must continue to defer the prepaid subscription income under section 455. Treas. Reg. §1.455–4 (citing section 381(c)(4) and the regulations under that section).

Section 381(a) applies to a distribution to which section 332 applies. As described in this preamble, a complete liquidation to which section 332 applies is taxable to the liquidating corporation to the extent that it distributes property to a non80-percent distributee. In particular, the liquidating corporation is treated as if it had sold the property distributed to the non-80-percent distributee at its fair market value. If the liquidating corporation had sold a business with regard to which income items had been deferred (for example, deferred prepaid subscription income under section 455) and the purchaser had assumed the liquidating corporation’s obligation or liability to perform the services or provide the goods relating to the deferred income, then the liquidating corporation would have recognized the deferred income. However, the liquidating corporation would also have been entitled to a deduction under section 162 for any amount

paid (or deemed paid) to the purchaser for its assumption of the obligation or liability related to the deferred income. See Rev. Rul. 68–112, 1968–1 C.B. 62 (see §601.601(d)(2)(ii)( b ) of this chapter). The amount paid (or deemed paid) by the liquidating corporation to the purchaser for its liability assumption would have been includible in the purchaser’s gross income. See Rev. Rul. 71–450, 1971–2 C.B. 78 (see §601.601(d)(2)(ii)( b ) of this chapter).

The IRS and Treasury Department believe that it is appropriate for any deferred income items of a liquidating corporation attributable to assets and/or liabilities transferred to a non-80-percent distributee to be taken into account under applicable principles of law as a result of the liquidation despite the fact that the transaction is described in section 381(a). Likewise, section 332(a) does not apply in determining the recognition or nonrecognition of any income realized by the non-80-percent distributee attributable to its assumption of an obligation or liability related to the deferred income because such income is not gain or loss recognized with respect to the stock of the liquidating corporation. These final regulations include such rules.

Allocation of Items Specific to Property or a Business

The IRS and Treasury Department also believe that it is appropriate to allocate the full amount of deferred income items or deferred deductions of the liquidating corporation that are attributable to specific property or a specific business to the distributee member that receives such property or business in the liquidation. These final regulations include such a rule.

Succession to Credits of the Liquidating Corporation

As described in this preamble, the proposed regulations allocate credits to distributee members based on the items of income, gain, loss, or deduction attributable to the activities that gave rise to the credits. Comments were received indicating that it was unclear how to allocate credits that are not clearly associated with items of income, gain, loss, or deduction (for example, the section 53 minimum tax credit). The IRS and Treasury Department agree with those comments. Accordingly, these

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or deficit in earnings and profits, of the liquidating corporation (determined after taking into account the amount of earnings and profits properly applicable to distributions to non-member shareholders under §1.381(c)(2)–1(c)(2)). If the liquidating corporation is not a member of the group at the time of the liquidation, the rules of this paragraph (g)(3) are applied as if the liquidating corporation had been a member of the group.

(4) Other items . With regard to items to which neither paragraph (g)(1) nor (g)(3) of this section applies, a distributee member that, immediately prior to the liquidation, owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502–34 succeeds to the items of the liquidating corporation in accordance with section 381 and other applicable principles. A distributee member that, immediately prior to the liquidation, does not own stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502–34 succeeds to the items of the liquidating corporation to the extent that it would have succeeded to those items if it had purchased, in a taxable transaction, the assets or businesses of the liquidating corporation that it received in the liquidation and had assumed the liabilities that it assumed in the liquidation.

(5) Determination of the items of a liquidating subsidiary . For purposes of this section, the items of a liquidating subsidiary include the amount of any consolidated tax attribute attributable to the liquidating subsidiary that is determined pursuant to the principles of §1.1502–21(b)(2)(iv). In addition, if the liquidating subsidiary is a member of a separate return limitation year subgroup, the amount of a tax attribute that arose in a separate return limitation year that is attributable to that member shall also be determined pursuant to the principles of §1.1502–21(b)(2)(iv).

(6) Examples . The following examples illustrate the application of this paragraph (g):

Example 1 . Liquidation–80 percent distributee . (i) Facts . X has only common stock outstanding. On January 1 of year 1, X acquired equipment with a 10-year recovery period and elected to depreciate the equipment using the straight-line method of depreciation. On January 1 of year 7, M1 and M2 own 80 percent and 20 percent, respectively, of X’s stock. X

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 1.1502–80 also issued under 26 U.S.C. 1502. - * * Par. 2. Section 1.1502–80 is amended by:

Removing the second sentence from paragraph (a).
Revising the third sentence of paragraph (a).
Adding paragraph (g). The revision and addition read as follows:

§1.1502–80 Applicability of other provisions of law .

(a) * * * For example, sections 269 and 482 apply for any consolidated year. - * *

- - - (g) Special rules for liquidations to which section 332 applies . Notwithstanding the general rule of section 381, if multiple members (distributee members) acquire assets of a corporation in a liquidation to which section 332 applies (regardless of whether any single member owns stock in the liquidating corporation meeting the requirements of section 1504(a)(2)), such members succeed to and take into account the items of the liquidating corporation (including items described in section 381(c), but excluding intercompany items under §1.1502–13) as provided in this paragraph (g) to the extent not otherwise prohibited by any applicable provision of law. This paragraph (g) does not apply to the intercompany items of the liquidating corporation. See §1.1502–13(j)(2)(ii).

(1) Income offset items and deferred in- come . Except as otherwise provided in this paragraph (g)(1), each distributee member succeeds to and takes into account the items of the liquidating corporation that could be used to offset the income of the group or any member (including deferred deductions, net operating loss carryovers, and capital loss carryovers) (income offset items) to the extent that such items would have been reflected in investment adjustments to the stock of the liquidating corporation owned by such distributee member under §1.1502–32(c) if, immediately prior to the liquidation, any stock of the liqui

dating corporation owned by nonmembers had been redeemed and then such items had been taken into account. However, each distributee member succeeds to the full amount of any deferred deduction or deferred income item attributable to the particular property or business operations distributed to such distributee in the liquidation to the extent that such item is not taken into account in the determination of the income or loss of the liquidating corporation with regard to the liquidation under chapter 1 of the Internal Revenue Code (Code). If the liquidating corporation is not a member of the group at the time of the liquidation, the rules of this paragraph (g)(1) are applied as if the liquidating corporation had been a member of the group.

(2) Accounting for deferred income items . Solely for the purpose of determining whether deferred income items of a liquidating corporation are taken into account under applicable principles of law as a result of a liquidation to which section 332 applies, the transfer of property to, and the assumption of liabilities by, a distributee member that does not own stock in the liquidating corporation meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502–34 immediately prior to the liquidation is not treated as part of a transaction to which section 381(a) applies. In addition, section 332(a) does not apply in determining the recognition or nonrecognition of any income realized by the distributee member under applicable principles of law on account of consideration received (or deemed received) on the assumption of the liquidating corporation’s obligation or liability attributable to any deferred income item.

(3) Credits and earnings and profits . Each distributee member succeeds to and takes into account a percentage of each credit of the liquidating corporation equal to the value of the stock of the liquidating corporation owned by such distributee at the time of the liquidation divided by the total value of all the stock of the liquidating corporation owned by members of the group at the time of the liquidation. Except to the extent that the distributee member’s earnings and profits already reflect the liquidating corporation’s earnings and profits, each distributee member succeeds to and takes into account under the principles of §1.1502–32(c) the earnings and profits,

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is a domestic corporation but is not a member of the group that includes M1 and M2. On that date, X distributes all of its assets to M1 and M2 in complete liquidation. The equipment is distributed to M1. Under section 334(b), M1’s basis in the equipment is the same as it would be in X’s hands. After computing its tax liability for the taxable year that includes the liquidation, X has net operating losses of $100, business credits of $40, and earnings and profits of $80.

(ii) Succession to items described in section 381(c) . (A) Losses . Under paragraph (g)(1) of this section, each distributee member succeeds to X’s items that could be used to offset the income of the group or any member to the extent that such items would have been reflected in investment adjustments to the stock of X it owned under §1.1502–32(c) if, immediately prior to the liquidation, such items had been taken into account. Accordingly, M1 and M2 succeed to $80 and $20, respectively, of X’s net operating loss.

(B) Credits and earnings and profits . Under paragraph (g)(3) of this section, because, immediately prior to the liquidation, M1 and M2 hold 80 percent and 20 percent, respectively, of the value of the stock of X, M1 and M2 succeed to $32 and $8, respectively, of X’s $40 of business credits. In addition, because M1’s and M2’s earnings and profits do not reflect X’s earnings and profits, X’s earnings and profits are allocated to M1 and M2 under the principles of §1.1502–32(c). Therefore, M1 and M2 succeed to $64 and $16, respectively, of X’s earnings and profits.

(C) Depreciation of equipment’s basis . Under paragraph (g)(4) of this section, because M1 owns stock in X meeting the requirements of section 1504(a)(2) without regard to the application of §1.1502–34, M1 is required to continue to depreciate the equipment using the straight-line method of depreciation over the remaining recovery period of 4.5 years (assuming X used a half-year convention).

Example 2 . Liquidation-no 80 percent distribu- tee . (i) Facts . The facts are the same as in Example 1 except that M1 and M2 own 60 percent and 40 percent, respectively, of X’s stock. In addition, on January 1 of year 6, X entered into a long-term contract with Y, an unrelated party. The total contract price is $1000, and X estimates the total allocable contract costs to be $500. At the time of the liquidation, X had received $250 in progress payments under the contract and incurred costs of $125. X accounted for the contract under the percentage of completion method described in section 460(b). In the liquidation, M1 assumes X’s contract obligations and rights.

(ii) Succession to items described in section 381(c) . (A) Losses . Under paragraph (g)(1) of this

section, each distributee member succeeds to X’s items that could be used to offset the income of the group or any member to the extent that such items would have been reflected in investment adjustments to the stock of X it owned under §1.1502–32(c) if, immediately prior to the liquidation, such items had been taken into account. Accordingly, M1 and M2 succeed to $60 and $40, respectively, of X’s net operating loss.

(B) Credits and earnings and profits . Under paragraph (g)(3) of this section, because, immediately prior to the liquidation, M1 and M2 hold 60 percent and 40 percent, respectively, of the value of the stock of X, M1 and M2 succeed to $24 and $16, respectively, of X’s $40 of business credits. In addition, because M1’s and M2’s earnings and profits do not reflect X’s earnings and profits, X’s earnings and profits are allocated to M1 and M2 under the principles of §1.1502–32(c). Therefore, M1 and M2 succeed to $48 and $32, respectively, of X’s earnings and profits.

(C) Depreciation of equipment’s basis . Under section 334(a), M1’s basis in the equipment is its fair market value at the time of the distribution. Pursuant to section 168(i)(7), to the extent that M1’s basis in the equipment does not exceed X’s adjusted basis in the equipment at the time of the transfer, M1 is required to continue to depreciate the equipment using the straight-line method of depreciation over the remaining recovery period of 4.5 years (assuming X used a half-year convention). Any portion of M1’s basis in the equipment that exceeds X’s adjusted basis in the equipment at the time of the transfer is treated as being placed in service by M1 in the year of the transfer. Thus, M1 may choose any applicable depreciation method, recovery period, and convention under section 168 for such excess basis.

(D) Method of accounting for long-term contract . Under paragraph (g)(4) of this section, M1 does not succeed to X’s method of accounting for the contract. Rather, under §1.460–4(k)(2), M1 is treated as having entered into a new contract on the date of the liquidation. Under §1.460–4(k)(2)(iii), M1 must evaluate whether the new contract should be classified as a long-term contract within the meaning of §1.460–1(b) and account for the contract under a permissible method of accounting.

Example 3 . Liquidation—deferred items . (i) Facts . X has only common stock outstanding, and M1 and M2 (who are members of the same group) own 80 percent and 20 percent, respectively, of X’s stock. X operates two divisions, each of which defers prepaid subscription income pursuant to an election under section 455. X distributes all of its assets in complete liquidation. M1 receives all of the assets of

Division 1, including prepaid subscription income, and assumes X’s liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income received by M1 relates. M2 receives all of the assets of Division 2, including prepaid subscription income, and assumes X’s liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income received by M2 relates.

(ii) Acceleration of deferred income items and succession to other deferred items . Under paragraph (g)(1) of this section, M1 succeeds to the full amount of the deferred prepaid subscription income of X attributable to Division 1. Under applicable law, X does not recognize the deferred prepaid subscription income attributable to Division 1 because X’s liability to furnish or deliver the newspaper, magazine, or other periodical ends as a result of a transaction to which section 381(a) applies. Under paragraph (g)(2) of this section, solely for purposes of determining whether the deferred income items of X attributable to Division 2 are taken into account as a result of the liquidation, the distribution of property to M2 is not treated as a transaction to which section 381(a) applies. Therefore, under applicable law, X’s deferred prepaid subscription income attributable to Division 2 is taken into account in the determination of X’s income or loss with regard to the liquidation. Further, under paragraph (g)(2) of this section, section 332(a) does not apply in determining the recognition or nonrecognition of any income that M2 realizes on account of consideration received (or deemed received) on its assumption of X’s liability to furnish or deliver the newspaper, magazine, or other periodical to which the prepaid subscription income relates.

(7) Effective/applicability date . This paragraph (g) applies to transactions occurring after April 14, 2008.

Linda E. Stiff, Deputy Commissioner for Services and Enforcement.

Approved January 8, 2008.

Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on January 14, 2008, 8:45 a.m., and published in the issue of the Federal Register for January 15, 2008, 73 F.R. 2416)

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