Part III. Administrative, Procedural, and Miscellaneous

Notice Providing Disaster Relief to Sponsors of Pre-Approved Defined Contribution Plans

Notice 2010–48

I. PURPOSE

This notice provides relief to sponsors of defined contribution pre-approved plans ( i.e., master and prototype (“M&P”) and volume submitter (“VS”) plans) affected by recent federally declared disasters (as defined in § 165(h)(3)(C)(i) of the Internal Revenue Code (the “Code”)). The relief provided by this notice extends to July 30, 2010, the April 30, 2010, deadline for restating affected pre-approved defined contribution plans and, if applicable, for submitting determination letters to the Service. The § 401(b) remedial amendment period with respect to these plans is also extended to July 30, 2010. The relief provided by this notice is in addition to the relief already provided by the Internal Revenue Service (IRS) to those affected by the federally declared disasters identified in this notice.

II. BACKGROUND

A. Provisions Relating to Disaster Relief

Under § 7508A of the Code, relief may be provided by the Secretary when there has been a federally declared disaster or a terroristic or military action (as defined in § 692(c)(2)). Under Treas. Reg. § 301.7508A–1(a), affected taxpayers are eligible for the postponement of certain tax-related deadlines to file returns, pay taxes, or perform other acts related to income taxes administered by the IRS. Pursuant to § 7508A, the IRS has provided relief to certain counties in the following states:

Connecticut victims of March 2010 severe storms and flooding. See, News Release CT–2010–35, June 1, 2010.

Tennessee victims of April-May 2010 severe storms and flooding. See, News Release AL/TN–2010–56T, May 5, 2010.

Alabama victims of April 2010 severe storms and flooding. See, News

Release AL/TN–2010–55A, May 4, 2010. Mississippi victims of April 2010 severe storms, tornadoes and flooding. See, News Release LA/MS–2010–21, April 30, 2010.

New Jersey victims of March 2010 storms and flooding. See, News Re- lease NJ–2010–32, April 5, 2010.

Massachusetts victims of March storms and flooding. See, News Re- lease MA–2010–15, March 31, 2010.

Rhode Island victims of March storms and flooding. See, News Re- lease RI–2010–11, March 31, 2010.

West Virginia victims of March storms and flooding. See, News Re- lease WVA–2010–12, March 31, 2010.

B. Provisions Relating to Defined Contribution Pre-approved Plan Program Adoption Deadlines

Revenue Procedure 2007–44, 2007–2 C.B. 54 (as modified by Rev. Proc. 2008–56, 2008–2 C.B. 826; Rev. Proc. 2009–36, 2009–35 I.R.B. 304; and Notice 2009–97, 2009–52 I.R.B. 972) and Rev. Proc. 2005–16, 2005–1 C.B. 674, describe a staggered remedial amendment system for plans that are qualified under § 401(a) of the Code, with five-year amendment/approval cycles for individually designed plans and six-year cycles for pre-approved plans. The submission period for the initial cycle for pre-approved defined contribution plans was February 17, 2005, through January 31, 2006. Plan sponsors and practitioners were required to restate their pre-approved defined contribution plans for the Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. 107–16, (EGTRRA) and Notice 2004–84, 2004–2 C.B. 1030 (the “2004 Cumulative List”) and apply for new opinion or advisory letters during that submission period.

Section 16.03 of Rev. Proc. 2007–44 provides that when the review of a cycle for pre-approved plans has neared completion, the IRS will publish an announcement providing the date by which adopting employers must adopt the newly approved plans. This date is intended to give adopting employers a period of approximately two years in which to adopt the plans.

Announcement 2008–23, 2008–1 C.B. 731, provides the deadline by which adopting employers must adopt EGTRRA-approved M&P and VS defined contribution plans. The two-year window in which to adopt a pre-approved defined contribution plan ended on April 30, 2010, and the Service accepted applications for determination letters from May 1, 2008, through April 30, 2010. Thus, the end of the sixyear remedial amendment cycle for preapproved defined contribution plans was April 30, 2010.

III. RELIEF

A. Provision of Disaster Relief

Due to damage caused by the federally declared disasters identified in section II.A. of this notice, employers that maintain M&P or VS defined contribution plans may have missed the April 30, 2010, deadline to adopt an EGTRRA-approved M&P or VS defined contribution plan and/or to submit, if applicable, a determination letter application to the IRS. As a result, the IRS believes that it is appropriate to provide an administrative extension to adversely affected employers. Thus, the deadline by which an employer that maintains an Affected Plan (as defined in III.B.) must adopt an EGTRRA-approved M&P or VS defined contribution plan and submit a determination letter application, if applicable, is extended to July 30, 2010. The remedial amendment period is also extended to July 30, 2010.

B. Definition of Affected Plan

A plan is an Affected Plan only if any of the following locations relating to the plan were in the federally declared disaster areas (identified in section II.A. of this notice) at the time of the disasters:

1. The principal place of business of the employer that maintains the plan (in the case of a single-employer plan, determined by disregarding the rules of § 414(b) and (c) of the Code);

2. The principal place of business of the employer that employs more than 50% of the active participants covered by the plan (in the case of a plan covering employees of more than one em

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ployer, determined by disregarding the rules of § 414(b) and (c));

3. The office of the plan or the plan administrator;

4. The office of the primary recordkeeper serving the plan; or

5. The office of any advisor that had been retained by the plan or the employer at the time of the storms or other severe weather that is directly involved with the adoption of the EGTRRA-approved M&P or VS defined contribution plan or that is directly involved in submitting a determination letter application to the IRS by the due date of April 30, 2010. For purposes of items 3, 4, and 5, above, the term “office” includes only the worksite of those individuals, and the location of any records, necessary to adopt the EGTRRA-approved M&P or VS defined contribution plan or to submit the plan’s determination letter application to the IRS.

IV. SUBMISSION OF A DETERMINATION LETTER APPLICATION

In addition to the general requirements for submitting a determination letter application set forth in Rev. Proc. 2010–6, 2010–1 I.R.B. 193, an employer submitting a determination letter application pursuant to this notice should write “Extension Relief per Notice 2010–48” in the upper margin of the cover letter (do not write this on the determination letter application form).

V. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2007–44 is modified.

DRAFTING INFORMATION

The principal author of this notice is Angelique Carrington of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this notice, please contact the Employee Plans taxpayer assistance answering service at 1–877–829–5500 (a toll-free number) or e-mail Ms. Carrington at RetirementPlanQuestions@irs.gov .

Request for Comments: Modification to the Regulations Under § 382 Regarding the Treatment of Shareholders who are not 5-Percent Shareholders

Notice 2010–49

This notice invites public comments relating to possible modifications to the regulations under § 382 of the Internal Revenue Code regarding the treatment of shareholders who are not 5-percent shareholders (Small Shareholders).

I. PURPOSE

The Internal Revenue Service (Service) and Treasury Department (Treasury) are currently considering modifying the regulations under § 382. In particular, the Service and Treasury are studying the operation of the rules relating to Small Shareholders, including the application of the aggregation and segregation rules to public groups. This notice sets forth policy considerations underlying § 382 and requests comments on what modifications would better reflect those policy considerations.

II. BACKGROUND

Section 382 provides special rules for Small Shareholders. Under § 382(g)(4)(A), Small Shareholders are aggregated and treated as one 5-percent shareholder. Section 382(g)(4)(B), however, requires that this aggregation rule must be applied separately to Small Shareholders of parties to certain § 368 reorganizations. Section 382(g)(4)(C) broadens the scope of the segregation rule of § 382(g)(4)(B) and provides that, except as provided in the regulations, similar segregation rules shall apply in determining whether there has been an owner shift involving a 5-percent shareholder and whether such shift (or a subsequent transaction) results in an ownership change.

III. POLICY CONSIDERATIONS UNDERLYING § 382

The proper treatment of Small Shareholders under § 382(g)(4)(C) depends

upon a determination concerning the policy considerations underlying § 382. This request for comments describes two general approaches, the Ownership Tracking Approach and the Purposive Approach, and sets forth some of the policy considerations underlying each. Both approaches recognize that one of the primary abuses § 382 seeks to prevent involves an acquisition of loss corporation stock followed by the contribution of income-producing assets or the diversion of income-producing opportunities to the corporation. The two approaches differ, however, in the extent they seek to identify and limit their effect to circumstances in which that abuse is most likely to occur.

A. OWNERSHIP TRACKING APPROACH

Under the Ownership Tracking Approach, it generally is of no significance whether the shareholders who increase their ownership are Small Shareholders or 5-percent shareholders. This approach ensures that abusive transactions are addressed by tracking all changes in ownership without regard to their particular circumstances. Thus, any transaction that allows the corporation to track the increase in ownership interests held by Small Shareholders results in the segregation of Small Shareholders into a new public group, which is treated as a 5-percent shareholder. See § 1.382–2T(j)(3)(i) of the Income Tax Regulations. The creation of the new, segregated public group results in an increase in ownership for that public group. For example, if a 5-percent shareholder sells stock to Small Shareholders, these Small Shareholders are segregated into a separate public group because it is not unduly burdensome for the corporation to know that a 5-percent shareholder has reduced its ownership and that ownership interest has been acquired by Small Shareholders. However, the Ownership Tracking Approach makes a concession to administrative convenience and acknowledges that “public trading,” which is the purchase by one Small Shareholder of stock from another Small Shareholder, should not be taken into account because it is unduly burdensome for a corporation to take into account all such transactions. See § 1.382–2T(e)(1)(ii).

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B. PURPOSIVE APPROACH

Consistent with the purpose of § 382, the Purposive Approach seeks to identify more specifically the circumstances in which abuses are likely to arise. This approach reflects the view that it is unnecessary to take into account all readily-identifiable acquisitions of stock by Small Shareholders, because Small Shareholders are generally not in a position to acquire loss corporation stock in order to contribute income-producing assets or divert income-producing opportunities. Instead, if the Purposive Approach is adopted, special rules generally could provide for a lesser percentage change in ownership for acquisitions of stock by Small Shareholders.

C. CURRENT REGULATIONS UNDER § 382

The current regulations primarily reflect the Ownership Tracking Approach. Although certain provisions may seem to follow the Purposive Approach, their justification is nevertheless based upon the Ownership Tracking Approach. For example, the cash issuance exception of § 1.382–3(j)(3) reduces the segregation effect of an issuance of stock to Small Shareholders by treating existing direct public groups as buying some of the stock sold in the issuance. However, this rule is justified on the grounds that there is likely to be substantial overlap between Small Shareholders who acquire stock in such an issuance and the existing Small Shareholder ownership base.

D. OWNERSHIP TRACKING APPROACH VERSUS PURPOSIVE APPROACH

The different consequences of the two approaches may be illustrated by the treatment of 5-percent shareholders that acquire stock from Small Shareholders, and then sell the acquired stock back to Small Shareholders.

Example (1) . Facts . All the stock of loss corporation is owned by a single public group, Original Public Group. The following acquisitions and dispositions each occur during the testing period. First, Investor A acquires 10 percent of the corporation’s stock from Small Shareholders, and sells it to Small Shareholders a few months later. Second, Investor B acquires 10 percent of the stock from Small Shareholders, and

sells it a few months later to Small Shareholders. Third, Investor C does the same.

Analysis . (i) Ownership Tracking Approach . The regulations reflect the Ownership Tracking Approach, and require the creation of a new, segregated public group when each of Investors A, B and C sells its stock back to Small Shareholders. As a result, the loss corporation has four 5-percent shareholders, Original Public Group and three new, segregated public groups (New Public Group 1, New Public Group 2, and New Public Group 3). Each investor is treated as acquiring the loss corporation stock proportionately from the direct public groups that exist immediately before the acquisition. See § 1.382–2T(j)(2)(vi). Accordingly, New Public Group 1, New Public Group 2, and New Public Group 3, the only 5-percent shareholders whose interests in loss corporation have increased during the testing period, have increased their respective ownership interest by 27.1 percent, in the aggregate

• from zero to 8.1 percent for New Public Group 1, from zero to 9 percent for New Public Group 2, and from zero to 10 percent for New Public Group

3. This is so even though the stock is now, and at the beginning of the testing period was, held 100 percent by Small Shareholders, and even though no actual 5-percent shareholder ever held more than 10 percent of the corporation’s stock. This treatment is justified on the grounds that the corporation is able to track each time a 5-percent shareholder sells stock to new shareholders, including Small Shareholders.

(ii) Purposive Approach . Under the Purposive Approach, the amount of change in ownership is different from the amount under the Ownership Tracking Approach. When each investor sells its shares to Small Shareholders, the shares could be treated as being re-acquired by Original Public Group rather than the new, segregated public groups. As a result, the aggregate effect on the change in ownership is significantly reduced. Accordingly, Original Public Group is treated as increasing its ownership interest from 90 percent to 100 percent during the testing period.

A full embrace of the Purposive Approach could go further. For example, when Original Public Group acquires shares from each investor, Original Public Group could be treated, for testing dates on or after such an acquisition, as having owned them during the period they were owned by the seller. Under such a rule, there would have been no increase in ownership of any 5-percent shareholder during the testing period. Instead, Original Public Group would be treated, for testing dates on or after its reacquisition of the shares from the investors, as owning 100 percent of the corporation during the entire period. Such a result would be justified on the grounds that where Small Shareholders owned the shares at the beginning of the testing period and on the last testing date, no shareholder has increased its ownership interest in such a way that would allow

it to engage in any abuse that § 382 was enacted to prevent.

Example (2) . Facts . The facts are the same as Example (1), except each acquisition by Investors A, B, and C precedes all dispositions by the investors to Small Shareholders.

Analysis . (i) Ownership Tracking Approach . The results are the same as in Example (1) .

(ii) Purposive Approach . Under a limited application of the Purposive Approach, Original Public Group would be treated as increasing its ownership interest from 70 percent to 100 percent for an increase of 30 percentage points. However, under an expanded application of this principle, Original Public Group could be treated as always having owned the stock owned by Investors A, B, and C for testing dates on or after the sales to Small Shareholders. Under this rule, for testing dates on or after the reacquisition of the shares by Original Public Group from the investors, there would have been no increase in the ownership interest of any 5-percent shareholder during the testing period.

Other transactions would also receive different treatment under the Purposive Approach. For example, when stock is issued by a loss corporation, the stock could be treated as being acquired by the existing public group or groups, instead of by a new, segregated public group. Some type of look-back rule could also be employed in this context to mitigate the change in ownership that results from an issuance to Small Shareholders. The effect of redemptions of stock held by Small Shareholders under a Purposive Approach would also be different from the treatment of such transactions under the existing regulations.

The complete adoption of a Purposive Approach to public groups would require significant changes to the existing regulations. Alternatively, it may be appropriate to adopt new rules reflecting the Purposive Approach only for certain transactions. For example, stock issuances, which allow the loss corporation to receive additional income-producing capital, present concerns that shareholder-toshareholder sales do not.

The Service and Treasury are also studying more modest changes. For example, the cash issuance exception is currently limited, as the name implies, to issuances of stock for cash. Under consideration is the possible expansion of this rule to issuances for other property, including the debt of the loss corporation. The Service and Treasury also are considering whether it would be appropriate to expand the small issuance exception

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to exempt larger share issuances from the application of the segregation rules.

IV. REQUEST FOR COMMENTS

The Service and Treasury request comments concerning what modifications, if any, to the existing rules for public groups are appropriate, and an analysis of whether authority exists for any recommended changes. Comments are requested concerning whether the regulations under § 382 should follow the Ownership Tracking Approach, Purposive Approach, or another approach. Additionally, consistent with an application of a Purposive Approach, comments are requested regarding whether the look-through treatment of first-tier and higher-tier entities should be limited in cases where these entities have a relatively small direct or indirect investment in the loss corporation. Due to the complexity of the existing regulations under § 382, modifications to the treatment of public groups would likely raise questions regarding how such modifications should be harmonized with other rules. The Service and Treasury also request comments on the consequences of any recommended modifications on these questions.

Comments should be submitted by September 9, 2010, and include a reference to Notice 2010–49. Send submissions to Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2010–49), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044 or hand-deliver Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to Courier’s Desk, Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2010–49), 1111 Constitution Avenue, N.W., Washington, D.C. 20044. Alternatively, comments may be submitted electronically via the following e-mail address: Notice.Comments@irscounsel.treas.gov . Please include “Notice 2010–49” in the subject line. All comments will be available for public inspection and copying.

DRAFTING INFORMATION

The principal author of this notice is Rubin B. Ranat of the Office of Associate Chief Counsel (Corporate). For further information regarding this notice, contact

Rubin B. Ranat at (202) 622–7530 (not a toll-free call).

Section 382(l)(3)(C) Fluctuations in Values

Notice 2010–50

This notice provides guidance under § 382 of the Internal Revenue Code for measuring owner shifts of loss corporations that have more than one class of stock outstanding, and, in particular, regarding the effect of fluctuations in the value of one class of stock relative to another class of stock (fluctuations in value). It provides interim guidance to the effect that the Internal Revenue Service (IRS) will accept certain methodologies for taking into account or not taking into account fluctuations in value, and identifies one methodology that the IRS views as inconsistent with § 382(l)(3)(C). It also requests comments to assist in the development of future guidance. Any terms and definitions used in this notice have the same meaning as they do in § 382 and the § 382 regulations unless otherwise provided in this notice.

I. Background

A. Overview of § 382(l)(3)(C)

Many of the critical determinations under § 382 depend upon the value of the stock owned by a particular shareholder. For example, whether an ownership change under § 382(g) occurs depends upon whether one or more 5-percent shareholders have increased their ownership in the loss corporation by more than 50 percentage points. Such ownership determinations are by reference to value; i.e., the relative fair market value of the stock owned to the total fair market value of the corporation’s outstanding stock. See § 1.382–2(a)(3)(i) of the Income Tax Regulations.

Section 382(l)(3)(C) provides that, except as provided in regulations, any change in proportionate ownership of the stock of a loss corporation attributable solely to fluctuations in the relative fair market values of different classes of stock shall not be taken into account. The regulations under § 382 do not provide any specific guidance on § 382(l)(3)(C). Instead,

§ 1.382–2T(l) sets forth a heading and a reservation: “ Changes in Percentage Own- ership which are attributable to fluctua- tions in value.— [Reserved.]”

The Treasury Department (Treasury) and the IRS are aware that taxpayers employ a number of different methodologies in interpreting and applying § 382(l)(3)(C). For example, some taxpayers have interpreted more general provisions of the regulations to require the valuation of all outstanding shares of stock of a corporation on every testing date. See §§ 1.382–2(a)(3)(i) and 1.382–2T(c)(1). Under this interpretation, the effect of § 382(l)(3)(C) is limited to ensuring that a testing date does not occur solely by virtue of a fluctuation in the relative values of different share classes. For purposes of this notice, such a valuation of all shares on every testing date is referred to as a “Full Value Methodology.” Other taxpayers have interpreted § 382(l)(3)(C) more broadly, factoring out fluctuations in value on a testing date based upon relative value ratios among different classes of stock established at the time a particular share of stock was acquired. There are variations in the methods that apply this view, described in more detail below, but the essential principle upon which the broader interpretation is based is that, as to a particular share, value ratios between and among various classes of stock are fixed, or “held constant,” on the date a particular share is acquired (hereafter, the “Hold Constant Principle,” or “HCP”). The remainder of this section describes the government’s understanding of the Full Value Methodology, the Hold Constant Principle, and two methodologies that implement the HCP.

B. Full Value Methodology

Under a Full Value Methodology, the determination of the percentage of stock owned by any person is made on the basis of the relative fair market value of the stock owned by such person to the total fair market value of the outstanding stock of the corporation. Thus, changes in percentage ownership as a result of fluctuations in value are taken into account if a testing date occurs, regardless of whether a particular shareholder actively participates or is otherwise party to the transaction that causes the testing date to occur;

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essentially, all shares are “marked to market” on each testing date.

Example 1 . Upon formation, corporation X issues $20 of convertible preferred stock to A and issues two shares of common stock to B for $80, such that A and B own 20 percent and 80 percent, respectively, of X. The fortunes of X deteriorate, and, two years later, when the common stock has a value of $2.50 per share and the preferred stock has a value of $20, B sells one share of common stock to C. At the time of B’s sale to C, X is a loss corporation. On that testing date, A will be treated as increasing its proportionate interest from 20 percent to 80 percent ($20/$25) under the Full Value Methodology as a result of the upward fluctuation in value of the preferred stock relative to the common stock. As Example 1 illustrates, an ownership change under § 382 would occur as a consequence of the sale of stock worth 10% of the loss corporation’s value because a stake originally representing 20% of the corporation’s value has fluctuated upward to 80% on the testing date, for a cumulative shift of 70 percentage points. The Full Value Methodology is a narrow interpretation of § 382(l)(3)(C), but it may be viewed as giving effect to the statutory language by not requiring value marks more frequently than each testing date ( e.g., daily fluctuations in value between various classes are ignored, where such fluctuations occur between testing dates).

C. Hold Constant Principle

Broadly stated, under the Hold Constant Principle, the value of a share, relative to the value of all other stock of the corporation, is established on the date that share is acquired by a particular shareholder. On subsequent testing dates, the percentage interest represented by that share (the “tested share”) is then determined by factoring out fluctuations in the relative values of the loss corporation’s share classes that have occurred since the acquisition date of the tested share. Thus, as applied, the HCP is individualized for each acquisition of stock by each shareholder. Moreover, the ownership interest represented by a tested share is adjusted for the dilutive effects of subsequent issuances and the accretive effects of subsequent redemptions following the tested share’s acquisition date.

Example 2 . Upon formation, corporation X issues $20 of convertible preferred stock to A and issues two shares of common stock to B for $80, such that A and B own 20 percent and 80 percent, respectively, of X. The fortunes of X deteriorate, and, two years later, when the common stock has a value of $2.50 per share and the preferred stock

has a value of $20, B sells one share of common stock to C. At the time of B’s sale to C, X is a loss corporation. On that testing date, although A actually owns 80% of the value of X, A will be treated as owning 20% of the value of X for purposes of § 382(g), under the Hold Constant Principle. As Example 2 illustrates, A would still be treated as owning 20 percent of X on the testing date because the HCP hypothesizes that (for purposes of determining A’s percentage ownership) the common stock and the preferred stock maintain the relative values that existed on the acquisition date of the tested share (here, each share held by A). The only share that is “marked” to value is the one share acquired by C, representing only 10% of the corporation’s equity value on the date of acquisition. Thus, no ownership change under § 382 would occur as a consequence of the acquisition of that share by C. The Hold Constant Principle may thus be viewed as giving effect to the statutory language of § 382(l)(3)(C) by factoring out fluctuations in the value of stock held by passive shareholders across multiple testing dates. The “factoring out” process generally continues for a particular share until the holder is no longer treated as owning the tested share for § 382 purposes ( e.g., the holder engages in affirmative activity such as a taxable sale). What follows is a description of two methodologies that implement the HCP.

1. Alternative Methodology 1: Look Back from Testing Date

One methodology for implementing the Hold Constant Principle is to recalculate the hold constant percentage represented by a tested share to factor out changes in its relative value since the share’s acquisition date (hereafter, “Alternative 1”). This methodology was described by a commentator in 2005. See generally Mark R. Hoffenberg, Owner Shifts and Fluctuations in Value: A Theory of Relativity, 106 Tax Notes 1446 (March 21, 2005). Generally, this methodology calculates the percentage interest represented by a tested share on a testing date, beginning with the value of the tested share on the testing date, and then making adjustments based on the changes in relative value of the tested share to the value of all the stock of the loss corporation that have occurred since the tested share’s acquisition date.

2. Alternative Methodology 2: Ongoing Adjustments from Acquisition Date

The second methodology for implementing the HCP tracks the percentage interest represented by a tested share from the date of acquisition forward, adjusting for subsequent dispositions and for the subsequent issuance or redemption of other stock (hereafter, “Alternative 2”). Generally, the increase in percentage ownership represented by the acquisition of a tested share during the testing period is established on the date the tested share is acquired. This increase is reduced (but not below zero) for subsequent dispositions of shares by the owner. To the extent the particular shareholder is not engaging in acquisitions or dispositions, the percentage ownership calculation “rolls over” from one testing date to another. Whereas under Alternative 1, the loss corporation generally determines the relative value of shares of its stock at the beginning of the testing period, or an earlier date, this may not be necessary under Alternative 2. Thus, Alternative 2 may involve fewer calculations on a particular testing date than Alternative 1.

3. Common Elements of Both HCP Methodologies

a. Acquisitions

Under either Alternative 1 or Alternative 2, the loss corporation determines, on each testing date during a testing period, the value of a tested share acquired on that testing date as compared to the value of all the stock of the loss corporation on that date ( i.e., neither alternative factors out value fluctuations for actual acquisitions).

b. Dispositions and sourcing

Under either of the HCP alternative methodologies, a shareholder’s increase in proportionate interest during a testing period will be reduced by share dispositions. The government is aware of at least two methods to account for dispositions in such cases. One method may account for the effect of a share disposition based upon the percentage ownership that the sold share represents on the date of its disposition (as opposed to the percentage represented by that share on its acquisition date) (a “fair market value approach”).

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under § 382 and the regulations thereunder. See generally § 1.382–2T(h)(2) (relating to constructive stock ownership); § 1.382–2T(f)(18)(iv) (stock of the loss corporation, as the context may require, includes any indirect interest in the loss corporation); § 1.382–2T(j)(2)(iii)(B)( 1 )( i ) (relating to equity structure shifts). In these cases, the original acquisition date and other hold constant characteristics are preserved. Thus, for example, if a shareholder exchanges loss corporation stock for other loss corporation stock in a value-for-value recapitalization, the stock received in the exchange would retain the same hold-constant characteristics as the surrendered shares. This principle also applies to reorganizations described in § 1.382–2T(j)(2)(iii)(B)( 1 )( i ) and holding company formations.

II. Guidance

Because of the complexity of the issues involved in measuring owner shifts of loss corporation stock where fluctuations in value are present, the IRS and Treasury have determined that it is appropriate to accept taxpayers’ reasonable attempts to measure increases in ownership where fluctuations in value are present. Accordingly, the IRS will not challenge any reasonable application of either a Full Value Methodology or the HCP, provided that a single methodology (as described below) is applied consistently to the extent required in this notice. The IRS and Treasury believe that each of the HCP alternative methodologies discussed in section I above-including the common elements of both for dealing with various transactions such as issuances and redemptions-are reasonable applications of the HCP.

Taxpayers may rely on the guidance provided in this notice until such time as the IRS and Treasury issue additional guidance under § 382(l)(3)(C).

A. Acquisitions

All reasonable applications of either the Full Value Methodology or the HCP must determine the increase in ownership represented by the acquisition of a share of stock by dividing the fair market value of that share on the acquisition date by the fair market value of all of the outstanding stock of the loss corporation on that date. For this purpose, an acquisition does

Another method may account for the effect of a share disposition based upon the percentage ownership that the sold share represented on another testing date during the testing period upon which the selling shareholder acquired shares. As one example, if the shares disposed of are being offset against shares of another class acquired during the testing period, the percentage offset could be determined as of the date the other class was acquired (a “share equivalent approach”). The results obtained would be as if sold shares were converted into a share-equivalent number of shares of the acquired class.

Example 3 . A purchases 10 shares of X’s common stock for $10 on testing date 1, when each share of common stock represents one percent of X. X is a loss corporation. On testing date 1, A also holds 2 shares of participating preferred stock, with each share valued at $2 and each preferred share representing 2 percent of X. On testing date 2, A disposes of one share of the preferred stock. Under a share-equivalent approach, A may be considered to have disposed of two shares of common stock, which is the common share equivalent of one share of preferred stock as determined on the acquisition date of the common stock. If a taxpayer determines the effect of a share disposition based upon the percentage represented by the sold share on the share’s acquisition date, under either of the two methodologies, the taxpayer must also determine the source of shares disposed of where a 5-percent shareholder has had multiple acquisitions and dispositions of loss corporation stock. For example, tested shares of a single class likely will represent different percentages of a loss corporation depending upon when the tested shares were acquired. In these cases, taxpayers may treat sold shares as being sourced pro rata from all acquisitions, as being sourced first from the most recent acquisition (“LIFO”), or as being sourced first from the first acquisition (“FIFO”).

c. Redemptions and issuances

Section 382 takes into account not only trading in loss corporation shares, but also the redemptions and issuances of shares, for purposes of tracking changes in percentage ownership by 5-percent shareholders. For this purpose, a redemption may be analogized to a pro-rata acquisition by non-redeeming shareholders of the redeemed shares, while an issuance may be analogized to a pro-rata sale of shares by shareholders holding stock im

mediately before the issuance to those shareholders acquiring shares in the issuance. There are a variety of possible approaches in applying the HCP to stock redemptions and issuances.

In a redemption, § 382 views the remaining shareholders as having acquired a greater interest in the corporation with respect to their shares held immediately after the redemption. Applying the HCP, the size of this acquisition for each shareholder could be determined either by reference to current values at the time of the redemption or relative values in effect when the non-redeemed shareholders established their positions.

In an issuance, § 382 views the interest in the corporation held by pre-existing shareholders with respect to their preexisting shares as being reduced. In applying the HCP, the effect of the issuance on preexisting shares, could also be determined by reference to current or relative historical values.

Whether current or historical values are used in determining the effect of subsequent redemptions or issuances can make a substantial difference in the amount of the owner shifts determined for 5-percent shareholders. Moreover, even if historical values are used, the use of one HCP alternative versus another can produce differing results. See generally NYSBA Tax Section, Report on the Treatment of Fluctuations in Value under Section 382(l)(3)(C), Dec. 22, 2009, reprinted in 2009 TNT 245–16 (Example 5 in the report).

Finally, §§ 1.382–3(j)(3) and (5) contain a special rule for determining the effects of certain cash issuances. Sections 1.382–3(j)(2) and (5) contain a special rule for determining the effect of certain small issuances. The issues discussed in this notice are relevant in determining the amount of exempted stock under the cash issuance rule, and the allocation of exempted stock among direct public groups under both rules.

d. Non-disposition transactions

For purposes of applying a method based on the HCP, an owner of loss corporation stock is not treated as disposing of or acquiring loss corporation stock to the extent the owner remains treated as an owner of the loss corporation, or its successor,

July 6, 2010 14 2010–27 I.R.B.

the small issuance and cash issuance exceptions) should be determined under that same methodology.

III. Request for Comments

The IRS and Treasury plan to issue proposed or temporary regulations on the application of § 382(l)(3)(C) in fluctuation in value situations, and request comments on that subject, including the issues addressed in this notice.

A. Threshold Question

The threshold question is whether interpreting § 382(l)(3)(C) broadly to require rules for factoring out fluctuations in value, such as may be done through methodologies employing the HCP, is appropriate in light of the purposes of § 382 and administratively viable.

The primary purpose of § 382’s loss limitation rules is to preserve the integrity of the carryover provisions. The carryover provisions perform a needed averaging function by reducing distortions caused by the annual accounting system. If carryovers can be transferred in a way that permits a loss to offset unrelated income, no legitimate averaging function is performed. The loss limitation rules of § 382 generally apply when shareholders who bore the economic burden of a corporation’s pre-change loss no longer hold a controlling interest in the corporation. In such a case, the possibility arises that new shareholders will contribute income producing assets (or divert income producing opportunities) to the loss corporation, resulting in a greater utilization of the loss corporation’s pre-change losses than would have been the case had there been no ownership change. See Staff of the Joint Comm. on Taxation, 100th Cong., 1st Sess., General Explanation of the Tax Reform Act of 1986 288 (Comm. Print 1987). The application of the HCP could result in the avoidance of an ownership change, even though the shareholders who did not bear the economic burden of the loss corporation’s pre-change loss have assumed a controlling interest in the loss corporation. Consider, for example, a case in which the value of a loss corporation’s common stock declines steeply in relation to the relative value of its voting preferred stock, permitting preferred share

not include a deemed acquisition of stock by non-redeeming shareholders resulting from a redemption. In addition, under a HCP methodology, an acquisition is not an event upon which the acquiring shareholder marks to fair market value other shares that it holds.

However, the IRS and Treasury view any alternative treatment of an acquisition as inconsistent with § 382(l)(3)(C). For example, the IRS intends to challenge a methodology that fixes the relative fair market value of a class of preferred stock to common stock on the issue date of the preferred stock, regardless of the actual value of either class on the subsequent date that a shareholder whose percentage ownership is being computed acquires a share of either such class of stock.

B. Consistency

In general, a taxpayer may employ any methodology that is a reasonable application of either a Full Value Methodology or the HCP in determining when an ownership change has occurred. For prior years, a taxpayer may change its methodology by amending returns. However, a taxpayer must generally employ a single methodology consistently to all testing dates in a “consistency period.” With respect to a particular testing date (the “current testing date”), the consistency period includes all prior testing dates, beginning with the latest of—

(1) the first date on which the taxpayer had more than one class of stock;

(2) the first day following an ownership change; or

(3) the date six years before the current testing date.

In some cases, a methodology implementing the HCP may treat as the acquisition date for a tested share a date that is later than the date the share was actually acquired. The issuance of a second class of stock generally establishes the acquisition date for the preexisting class as well as the second class. Moreover, taxpayers may substitute certain other dates, if later, for the date shares were acquired, such as, if used consistently: May 6, 1986; January 1, 1987; or the beginning of the testing period.

C. Closed Years

Notwithstanding the foregoing, a taxpayer may not employ a methodology in a year not barred by the statute of limitations (an “open year”) if using that methodology would have changed the taxpayer’s Federal income tax liability for a year barred by the statute of limitations (a “closed year”) in the consistency period, unless the position taken in the closed year is not consistent with any reasonable methodology. A taxpayer taking a position in a closed year that is not consistent with any reasonable methodology may adopt any single methodology that is a reasonable application of either the Full Value Methodology or the HCP, regardless of whether use of that methodology would have changed its liability in a closed year, provided that the adopted methodology is applied consistently to the greatest extent permitted by the statute of limitations.

The effect of the consistency period rule is that a taxpayer generally is free to adopt any reasonable methodology as long any inconsistent returns in the consistency period can be and are amended. In addition, there is no necessary correlation between the start of a consistency period, which governs the taxpayer’s choice of methodology, and the acquisition date for shares of stock, which is an element of HCP methodologies.

D. Single Methodology

For purposes of this notice, a “single methodology” means a methodology that applies a consistent treatment to a given situation, even on different testing dates ( e.g., applying a LIFO convention for all share disposition sourcing determinations if using an HCP alternative). A single HCP methodology might treat the accretive effect of redemptions differently from other acquisitions but should not treat the dilutive effect of issuances differently from other dispositions. To determine the amount of exempted stock pursuant to the cash issuance exception of § 1.382–3(j)(3), a taxpayer using an HCP methodology may either use the hold constant percentages determined for its direct public groups under its methodology or the percentages determined based upon current values. Allocations of exempted stock under § 1.382–3(j)(5) (relating to

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Service, 1111 Constitution Avenue, NW, Washington, DC 20224. Alternatively, comments may be sent electronically via the following email address: Notice.Comments@irscounsel.treas.gov . Please include the notice number 2010–50 in the subject line of any electronic communication. All materials submitted will be available for public inspection and copying.

The principal author of this notice is Keith E. Stanley of the Office of Associate Chief Counsel (Corporate). For further information regarding this notice, contact Mr. Stanley at 202–622–7700 (not a toll-free number).

26 CFR 601.201: Rulings and determination letters. (Also: Part I, §§ 25, 103, 143.)

Rev. Proc. 2010–25