Comments on REG , Redetermination of the Consolidated Built-In Gain and Loss

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1 The Honorable Mark Mazur Assistant Secretary (Tax Policy) Department of the Treasury 1500 Pennsylvania Avenue, NW Washington, D.C Commissioner Internal Revenue Service 1111 Constitution Avenue, NW Washington, D.C Chief Counsel Internal Revenue Service 1111 Constitution Avenue, NW Washington, D.C RE: Comments on REG , Redetermination of the Consolidated Built-In Gain and Loss Dear Mr. Mazur and Messrs. Shulman and Wilkins: The American Institute of CPAs (AICPA) is pleased to submit this letter providing comments and recommendations on the proposed regulations (the Proposed Regulations ) released October 24, 2011 by the Treasury Department and the Internal Revenue Service (IRS) under section Specifically, we are responding to a request for comments pursuant to the preamble for Prop. Treas. Reg (g) (REG ). These comments were developed by the AICPA Corporations and Shareholders Taxation Technical Resource Panel and approved by the AICPA Tax Executive Committee. The AICPA is the national professional organization of certified public accountants comprised of approximately 377,000 members. Our members advise clients on federal, state and international tax matters and prepare income and other tax returns for millions of Americans. Our members provide services to individuals, not-for-profit organizations, small and medium-sized businesses, as well as America s largest businesses. 1 Unless otherwise stated, all references to Section are to the Internal Revenue Code of 1986, as amended, and all references to the Regulations or to Treas. Reg. are to the Treasury Regulations promulgated thereunder.

2 Page 2 of 7 Executive Summary Treasury has issued proposed regulations on the redetermination of a net unrealized built-in gain (NUBIG) and a net unrealized built-in loss (NUBIL) for consolidated groups when certain events occur under Prop. Treas. Reg (g). While the AICPA would like to submit two recommendations for your consideration, it also notes that it is critical that finalized regulations (and the preamble thereto) be coordinated with existing guidance applicable to built-in gains and losses both inside and outside of the consolidated return area. Accordingly, we submit two recommendations for your consideration: Background Section 382 First, we recommend that the redetermination of NUBIG and NUBIL be consistent with the rules under section 56(g), which require a loss corporation that has undergone an ownership change under section 382(g) to adjust its basis for alternative minimum tax (AMT) purposes if the loss corporation is in a NUBIL. We request that a loss group, which has a NUBIL that is redetermined under the proposed rules to a NUBIG, be permitted to re-adjust its basis for AMT purposes to restore the adjusted current earnings (ACE) basis that was previously reduced. Second, we recommend that if a loss group s NUBIG or NUBIL is redetermined, that it be permitted to change its method for calculating the NUBIG or NUBIL under Notice , Built-in Gains and Losses under section 382(h), to either of the safe harbor methods. Section 382 was initially enacted to prevent trafficking in tax net operating losses. Section 382(b)(1) limits the ability of a loss corporation to utilize its net operating losses that arose prior to an ownership change against income earned in post-change tax years. The amount of prechange loss that can be used in a post-change year is limited to the value of the loss corporation immediately before the ownership change multiplied by the long-term tax-exempt rate. A loss corporation with a NUBIG in its assets immediately prior to an ownership change may generally increase its section 382 limitation, to the extent of its NUBIG, by recognized built-in gains (RBIG) during the 5-year post-change recognition period under section 382(h)(1)(A). A loss corporation with a NUBIL in its assets immediately prior to an ownership change must generally treat recognized built-in losses (RBIL) during the 5-year post-change recognition period as if such losses, to the extent of NUBIL, were pre-change losses subject to the section 382 limitation.

3 Page 3 of 7 NUBIG/NUBIL is measured under section 382(h)(3)(A)(i) as the amount that the fair market value of the loss corporation s assets immediately before the ownership change is more or less than the aggregate adjusted tax basis of such assets. The calculated NUBIG or NUBIL is treated as if it is zero, unless it exceeds a threshold amount under section 382(h)(3)(B), which is the lesser of $10 million or 15 percent of the fair market value of the loss corporation s assets (less cash and cash equivalents) immediately before the ownership change. Current Consolidated Built-in Gain and Loss Regulations The current version of Treas. Reg (g) (the Current Regulations ) provides that the determination of whether a consolidated group has a NUBIG or NUBIL is based on the aggregate amount of the separately computed NUBIGs or NUBILs of each member that is included in the consolidated group. 2 All members of a loss group on the date of the ownership change are included in the determination of whether the loss group has a NUBIG. For purposes of determining whether a loss group has a NUBIL, certain members may not, however, be included. 3 Current Regulations further provide that the separately-computed NUBIG or NUBIL amount of a member included in a group does not include any unrealized built-in gain or loss on stock of another member included in the group. 4 Generally, unrecognized gain or loss on included subsidiary stock reflects the same economic gain or loss reflected in the subsidiary s assets, and the consolidated return regulations generally prevent the group from taking that duplicative gain or loss into account more than once. Treas. Reg generally eliminates the recognition of duplicative loss. Consequently, under the Current Regulations, consolidated NUBIG and NUBIL do not include any unrealized built-in gain or loss on stock of another member included in the group, because such amounts are typically already reflected in the assets of such member, and, consequently, NUBIG or NUBIL would be distorted if the same economic gain or loss was included more than once. Analysis & Recommendations Although the general rules of eliminating built-in gain and loss in a member s stock yield consistent results, the IRS and Treasury have identified situations where they believe inequitable results have occurred in applying the rules. In some situations, the unrecognized gain or loss in subsidiary stock may exceed the gain or loss in such group member s assets. In response, the IRS and Treasury issued REG on October 24, 2011 proposing changes to Treas. Reg (g). The IRS expressed its concern in the preamble to the Proposed Regulations that 2 Treas. Reg (g)(1). 3 See Treas. Reg (g)(2)(ii). Any member acquired within the 5-year period preceding the group change is excluded unless the member was acquired (1) with a NUBIG but had a NUBIL at the time of the change or (2) with a Separate Return Limitation Year (SRLY) built-in loss under Treas. Reg (c) and either has a NUBIL at the time of the group change or underwent an ownership change in connection with or since becoming a member of the group. 4 Treas. Reg (g)(1).

4 Page 4 of 7 disregarding this unduplicated gain or loss in the stock of the group member in the NUBIG/NUBIL calculation understates the true amount that the group may take into account. The Proposed Regulations require that the unduplicated gain or loss in the stock of included subsidiaries be taken into account in calculating NUBIG and NUBIL to the extent that such unduplicated gain or loss is taken into account by the group during the recognition period. Generally, this occurs with respect to stock of a member with an unduplicated gain or loss only if (1) such stock is sold to a nonmember, (2) such stock becomes worthless, or (3) a group member takes an intercompany item into account with respect to such stock. Thus, the Proposed Regulations do not require an immediate inclusion of unduplicated built-in stock gain or loss in the NUBIG/NUBIL calculation, but instead delay the calculation and require a redetermination of NUBIG/NUBIL only when one of these three triggering events occurs. Taxpayers must, therefore, redetermine NUBIG/NUBIL each time gain or loss on member stock with an unduplicated built-in gain or loss is taken into account. The term unduplicated built-in stock gain or loss, as used in the Proposed Regulations, refers to the portion of the built-in stock gain or loss that was not originally reflected in the loss group s NUBIG or NUBIL. The redetermined NUBIG or NUBIL under the Proposed Regulations does not change the treatment of built-in gain or loss recognized before the time of the redetermination. The redetermined NUBIG or NUBIL is given effect only immediately before the gain or loss on the stock is taken into account. Thus, the Proposed Regulations do not require an immediate inclusion of unduplicated built-in stock gain or loss in the NUBIG/NUBIL calculation and instead delay the redetermination until such gain or loss is actually taken into account. Section 56(g)(4)(G) Section 55 imposes an AMT system on certain taxpayers, including corporations. In general, the AMT rules require corporate taxpayers to calculate a tentative minimum tax based on alternative minimum taxable income ( AMTI ). AMTI is calculated by adding or subtracting certain adjustments under sections 56 and 58 and by adding certain preference items under section 57. Preliminarily determined AMTI may be adjusted under section 56(g) based on ACE. In general, section 56(g)(4)(G) provides that for purposes of calculating ACE, if a corporation undergoes an ownership change as defined in section 382 and there is a NUBIL with respect to such corporation, then the adjusted basis of each asset of such corporation (immediately after the ownership change) shall be its proportionate share (determined on the basis of respective fair market value) of the fair market value of the assets of such corporation (determined under section 382(h)) immediately before the ownership change. This is different than the general NUBIL rules described above that maintain the loss corporation s asset basis and treats the RBIL as pre-change losses. The ACE rule reduces asset basis to fair market value and consequently lowers the future ACE depreciation.

5 Page 5 of 7 As discussed above, the redetermined NUBIG or NUBIL under the Proposed Regulations does not change the treatment of built-in gain or loss recognized before the time of the redetermination. Thus, the Proposed Regulations appear to prevent a corporation with a NUBIL that adjusts the basis of each of its assets under section 56(g)(4)(G) from subsequently recalculating its basis write-down under section 56(g)(4)(G) even if such corporation redetermines its NUBIL under the Proposed Regulations. 5 Thus, we recommend conformity between the Proposed Regulations and section 56(g)(4)(G) in that if a loss group redetermines a NUBIL to a NUBIG, its ACE basis should be adjusted accordingly to reverse the effect of the prior section 56(g)(4)(G) downward basis adjustment by restoring the original ACE basis prior to the mark down at the time of the ownership change. For example, an asset that had an ACE basis that was marked down at the time of the ownership change would have the basis restored to its original ACE basis less the ACE deprecation previously claimed by the taxpayer in the years following the ownership change but before the redetermination under Treas. Reg (g). 6 Notice Notice , C.B. 747 (Sept. 12, 2003), provides that taxpayers with a NUBIG or NUBIL may rely on either of two methods regarding whether items of income, deduction, gain, or loss that a loss corporation recognizes following an ownership change, should be treated as RBIG or RBIL. The first approach is based on section 338 (the Section 338 Approach ), and the second approach is based on section 1374 (the Section 1374 Approach ). Taxpayers with a NUBIG generally prefer the Section 338 Approach, and taxpayers with a NUBIL generally prefer the Section 1374 Approach. Notice provides that taxpayers may use either the Section 338 Approach or the Section 1374 Approach, but not elements of both. Thus, once a loss corporation has chosen one approach, it cannot change to another approach during the recognition period. As discussed above, the redetermined NUBIG or NUBIL under the Proposed Regulations does not change the treatment of built-in gain or loss recognized before the time of the redetermination. Thus, the Proposed Regulations appear to prevent a corporation with a NUBIG or NUBIL that has chosen to apply either the Section 338 Approach or the Section 1374 Approach from changing approaches even if such corporation redetermines its NUBIG to be a NUBIL (or NUBIL to be a NUBIG) under the Proposed Regulations. We would recommend that the taxpayer be able to calculate its NUBIG or NUBIL under the new approach as if it had applied that approach at the time of the ownership change with the corresponding RBIGs or RBILs, however, recognized following the redetermination under the new approach. 5 For example, companies in bankruptcy often are AMT taxpayers and have a NUBIL in their assets. 6 For example, a taxpayer with a 10-year asset life with an ACE basis of $100 but a value of $50 at the time of an ownership change where a NUBIL exists must write down the asset to $50. In year 3, the taxpayer redetermines its NUBIL to a NUBIG. The ACE basis in year 3 is $40. We would recommend that the basis be adjusted in year 3 back to $100 less the $10 of previously-recognized depreciation or $90 of ACE basis going forward.

6 Page 6 of 7 For example, assume a taxpayer with a NUBIG applied the Section 338 Approach and sold shares of stock in a subsidiary that is redetermined under the Proposed Regulations to now be in a NUBIL position and would apply the Section 1374 Approach to calculating its NUBIL. Under this methodology, the taxpayer would calculate its NUBIL using the Section 1374 Approach using the values at the time of the ownership change and not at the time of the redetermination. The effect, however, would be the RBILs recognized during the remaining part of the recognition period would only be after the redetermination occurs. Prior to issuing regulations under section 382(h) or reissuing Notice , when the Proposed Regulations are finalized, the related preamble should clearly provide that taxpayer s switching from NUBIG to NUBIL (or from NUBIL to NUBIG) should be permitted to adopt a different approach under Notice prospectively. Concluding Remarks The AICPA recommends that the final regulations include a mechanism to permit corporate taxpayers with a NUBIL that have reduced their asset basis for ACE purposes under section 56(g)(4)(G) and subsequently redetermined their NUBIL to a NUBIG under the Proposed Regulations, to allow a portion of the section 56(g)(4)(G) basis adjustment to be recoverd. We recommend that the final regulations permit corporate taxpayers that apply either the Section 338 Approach or the Section 1374 Approach of Notice and subsequently redetermine their NUBIG or NUBIL under the Proposed Regulations to change the approach used under Notice on a prospective basis from the time of the redetermination. * * * * * We appreciate your consideration of our recommendations and welcome the opportunity to discuss these issues further. If you have any questions, please contact Todd Reinstein, Chair, AICPA Corporations and Shareholders Taxation Technical Resource Panel, at (202) or reinstet@pepperlaw.com; or Abe Schneier, AICPA Senior Technical Manager, at (202) , or aschneier@aicpa.org Sincerely, Patricia Thompson, CPA Chair, AICPA Tax Executive Committee cc: Lee Kelley, Senior Counsel (Tax Policy), Department of the Treasury Lisa Zarlenga, Acting Tax Legislative Council (Regulatory Affairs), Department of the Treasury

7 Page 7 of 7 Erik Corwin, Deputy Chief Counsel (Technical), Internal Revenue Service William Alexander, Associate Chief Counsel (Corporate), Internal Revenue Service Grid Glyer, Attorney, Office of Associate Chief Counsel (Corporate), Internal Revenue Service