This section of the FEDERAL REGISTER

contains regulatory documents having general

applicability and legal effect, most of which

are keyed to and codified in the Code of

Federal Regulations, which is published under

50 titles pursuant to 44 U.S.C. 1510.

The Code of Federal Regulations is sold by

the Superintendent of Documents. Prices of

new books are listed in the first FEDERAL

REGISTER issue of each week.

Rules and Regulations Federal Register

31073

Vol. 65, No. 95

Tuesday, May 16, 2000

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8883]

RIN 1545–AW53

Guidance Under Section 1032 Relating

to the Treatment of a Disposition by An

Acquiring Entity of the Stock of a

Corporation in a Taxable Transaction

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations relating to the treatment of

a disposition by a corporation or

partnership (the acquiring entity) of the

stock of a corporation (the issuing

corporation) in a taxable transaction.

The final regulations interpret section

1032 of the Internal Revenue Code.

They affect persons engaging in certain

taxable transactions, as described in the

final regulations, occurring after May

16, 2000.

EFFECTIVE DATE: These regulations are

effective May 16, 2000.

FOR FURTHER INFORMATION CONTACT: Filiz

Serbes, (202) 622–7550 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Background

On September 23, 1998, the Treasury

and the IRS issued a notice of proposed

rulemaking in the Federal Register (63

FR 50816), setting forth rules relating to

the treatment of a disposition by a

corporation (the acquiring corporation)

of the stock of another corporation (the

issuing corporation) in a taxable

transaction. A public hearing regarding

these proposed regulations was held on

January 7, 1999. Written comments

responding to the notice were received.

After consideration of all of the

comments, the proposed regulations are

adopted as revised by this Treasury

decision.

Explanation of Revisions and Summary

of Comments

The Immediacy Requirement

The proposed regulations adopted a

cash purchase model in which certain

transactions involving a contribution of

issuing corporation stock by an issuing

corporation to an acquiring corporation

are recast as a contribution of cash by

the issuing corporation to the acquiring

corporation, which is used by the

acquiring corporation to purchase

issuing corporation stock from the

issuing corporation. As a condition for

application of the cash purchase model

of the proposed regulations, the

proposed regulations adopted the

requirement of § 1.1502–13(f)(6)(ii)(B)

that the issuing corporation stock

received by the acquiring corporation be

immediately transferred to acquire

money or other property.

A number of commentators requested

that the term ‘‘immediately’’ be

explicitly defined. Some suggested

replacing the temporal requirement with

a transactional approach, requiring only

that the stock be disposed of ‘‘pursuant

to a plan of acquisition.’’ Others

suggested that the immediacy

requirement be waived in certain

circumstances, such as with respect to

a nonqualified deferred compensation

arrangement involving a grantor trust

(commonly referred to as a ‘‘Rabbi

Trust’’) that is established to provide

future benefits to the employees of an

acquiring corporation and that is funded

with issuing corporation stock.

After considering the purposes of

section 1032 and issues of

administrative burden and technical

complexity, the Treasury and the IRS

believe that the immediacy requirement

should neither be waived nor construed

to permit the acquiring corporation to

hold issuing corporation stock for a

period of time during which the value

of the stock could fluctuate.

The Treasury and the IRS believe that,

in a case where the issuing corporation

contributes its stock to the acquiring

corporation and the acquiring

corporation does not immediately

dispose of that stock, it is not

appropriate to increase the basis of

either the issuing corporation stock

transferred to the acquiring corporation

or the stock of the acquiring corporation

held by the issuing corporation. In the

cases addressed by the proposed

regulations, in which the acquiring

corporation exchanges the stock

immediately for property owned by a

third party, the transaction is

indistinguishable from one in which the

issuing corporation directly exchanges

its stock for the property of the third

party (an exchange to which section

1032 would apply) and contributes that

property to the acquiring corporation, a

transaction whose tax result would be

the same as the cash purchase model set

forth in the proposed regulations.

However, in cases where the acquiring

corporation’s ownership of the issuing

corporation stock is more than

transitory, there appears to be no

comparable transaction which would

generate the same tax consequences as

the cash purchase model.

Implementation of an approach that

waives the immediacy requirement

would raise administrative and policy

concerns. If the acquiring corporation

were to be permitted to hold the issuing

corporation stock for a period of time,

the regulations would have to adopt one

of two alternative approaches. Under

the first alternative, the regulations

would provide that the cash purchase

model would be deemed to apply at the

time that the stock is contributed to the

acquiring corporation, giving the

acquiring corporation a fair market

value basis in the stock. However, such

an approach would raise at least two

concerns. First, in the case that the

issuing corporation stock is not publicly

traded, such an approach would impose

administrative burdens requiring a

valuation of the stock at a time when

there is no related transaction to assist

in such valuation. Thus, there is a

potential for the stock to be overvalued,

with a result of inflating the basis in

both the contributed issuing corporation

stock and the acquiring corporation

stock held by the issuing corporation.

Second, even if the valuation were

accurate, providing for the cash

purchase model on the date of the

contribution would facilitate selective

loss recognition. If the acquiring

corporation could receive the stock at a

fair market value basis and hold on to

it, then if the value of the stock

decreased, the subsidiary could sell the

stock and recognize a loss. The Treasury

and the IRS believe that it is

31074 Federal Register / Vol. 65, No. 95 / Tuesday, May 16, 2000 / Rules and Regulations

inappropriate to issue regulations

facilitating selective loss recognition.

Under the second alternative, the

regulations would suspend the

operation of the cash purchase model

until such time as the acquiring

corporation actually disposes of the

issuing corporation stock. However,

such an approach also would give rise

to inappropriate tax results. In addition

to precluding gain recognition

attributable to the zero basis result, this

alternative would allow a subsidiary to

avoid recognition of gain attributable to

real appreciation in this asset.

Assume, for example, a case where

the issuing corporation contributes

issuing corporation stock worth $100 to

the acquiring corporation, the acquiring

corporation retains that stock while it

appreciates to $300, and then sells the

stock for $300 in cash. Absent an

immediacy requirement, under the

second alternative, the acquiring

corporation would be deemed to have

purchased the stock for $300 in cash

contributed by the issuing corporation

immediately before the sale of the stock

to the third party. As a result, the

acquiring corporation would not

recognize any gain or loss, and the

issuing corporation would increase its

basis in the stock of the acquiring

corporation by $300. More than merely

avoiding a zero basis result (i.e.,

taxation on the $100 value in the stock

when contributed to the acquiring

corporation), neither the acquiring

corporation nor the issuing corporation

would ever be taxed on the further $200

in appreciation of the issuing

corporation stock which occurred while

such stock was held by the acquiring

corporation. Such a result, which

effectively would provide full section

1032 protection for a subsidiary’s gain

in certain parent stock, would go well

beyond addressing the zero basis result,

the scope of these regulations.

Because each of those alternatives

would be unsatisfactory for the reasons

discussed above, the final regulations

retain the immediacy requirement

without further exception.

Consistent with that determination,

and as in the case of any other

transaction, the cash purchase model of

these regulations applies to

arrangements involving Rabbi Trusts

only if the immediacy requirement is

satisfied. Thus, these regulations do not

apply to Rabbi Trust arrangements in

which the stock of an issuing

corporation is treated for federal tax

purposes as owned for a period of time

by its subsidiary. However, the Treasury

and the IRS have reconsidered certain

aspects of Rabbi Trust arrangements and

have determined that the fact that trust

assets are subject to the claims of

creditors of the subsidiary corporation

does not necessarily establish that the

subsidiary should be treated as a grantor

of the trust at the time the trust is

funded. Guidance regarding the effects

of this reconsideration on existing Rabbi

Trusts will be forthcoming. In addition,

the final regulations contain a new

example describing an arrangement in

which the issuing corporation (and not

the subsidiary) is treated as the grantor

and owner of the Rabbi Trust, with the

result that the immediacy requirement

is satisfied upon the transfer of issuing

corporation stock by the trust to the

subsidiary’s employees.

Taxpayers could have reasonably

anticipated that Rabbi Trust

arrangements could not be structured

without causing subsidiaries to be

treated as grantors and owners of the

trust. For that reason and because of the

potential ambiguities in interpreting

Rev. Rul. 80–76 (1980–1 C.B. 15), the

IRS will not challenge a taxpayer’s

position that no gain is recognized by an

acquiring corporation upon the

disposition by a Rabbi Trust, established

on or before June 15, 2000, of issuing

corporation stock if that stock was

contributed by the issuing corporation

to the Rabbi Trust on or before May 16,

2001.

Exchanges by the Acquiring Corporation

of Stock of the Issuing Corporation for

Other Issuing Corporation Stock

Commentators noted that, unlike

§ 1.1502–13(f)(6)(ii), the recast of the

proposed regulations applies even

where the acquiring corporation

exchanges stock of the issuing

corporation for other issuing

corporation stock. Allowing a subsidiary

to receive parent stock it immediately

swaps for other parent stock, which it

could hold long term with a cost basis,

would facilitate selective loss

recognition with respect to parent stock

by a subsidiary. Accordingly, the final

regulations adopt, as a precondition for

the recast, a requirement that the issuing

corporation stock not be exchanged for

other issuing corporation stock.

Exchanges by the Acquiring Corporation

of Stock of the Issuing Corporation for

Acquiring Corporation Debt

Commentators contended that it is

unclear whether the proposed

regulations are applicable when the

acquiring corporation uses issuing

corporation stock to satisfy acquiring

corporation debt. The Treasury and the

IRS believe that the regulations do apply

to an exchange of issuing corporation

stock for acquiring corporation debt.

Although section 1032 refers to an

exchange for money or other property

and does not expressly refer to

exchanges of stock for debt, it is

generally acknowledged that section

1032 applies to an exchange of a

corporation’s stock for its debt, subject

to sections 61(a)(12) and 108, which

provide that a corporation may have

income from a cancellation of

indebtedness on an exchange of its stock

for its own debt (that is, cancellation of

indebtedness income can be realized

and recognized when debt is satisfied

with stock of the debtor corporation,

even though no gain is recognized on

the issuance of the stock). Similarly,

therefore, the requirement set forth in

these regulations that the acquiring

corporation transfer issuing corporation

stock to acquire money or other

property is satisfied where the stock is

used to satisfy acquiring corporation

debt (although the acquiring corporation

may be subject to sections 61(a)(12) and

108). No modifications to the language

of the final regulations are needed to

achieve this result.

Similarly, a commentator expressed

concern that the proposed regulations

do not expressly apply to an acquiring

corporation’s exchange of issuing

corporation stock for the acquiring

corporation’s own outstanding acquiring

corporation stock held by a shareholder

other than the issuing corporation. The

Treasury and the IRS believe that the

regulations do apply to such an

exchange.

Acquiring Corporation’s Use of Issuing

Corporation’s Debt

Commentators also requested that the

regulations be extended to issuing

corporation debt instruments used by

the acquiring corporation to acquire

money or other property from unrelated

third parties. Because section 1032 only

refers to corporate stock, debt

instruments are beyond the scope of

these final regulations.

Reorganizations Coupled With Taxable

Transactions

The proposed regulations do not

apply if any party to the exchange

receives a substituted basis in the

issuing corporation stock.

Commentators suggested that the final

regulations provide that the above rule

does not preclude application of the

final regulations if a taxable exchange of

issuing corporation stock for property

accompanies a reorganization.

The Treasury and the IRS believe that

a taxable transaction to which the

regulations apply can accompany a

reorganization, provided that the

exchanges are separate and that the

assets acquired in the taxable

Federal Register / Vol. 65, No. 95 / Tuesday, May 16, 2000 / Rules and Regulations 31075

transaction and the assets acquired as

part of the reorganization can be

identified. If these elements can be

established, the substituted basis

prohibition should not preclude

application of the final regulations to

the taxable portion of the exchange.

Accordingly, clarifying language has

been added to § 1.1032–3(c)(3).

Options Without a Readily

Ascertainable Fair Market Value

Several commentators asked how the

proposed regulations apply to a

compensatory stock option without a

readily ascertainable fair market value.

Pursuant to section 83(e)(3) and § 1.83–

7(a), the grant of such options is

effectively treated as an open

transaction. Section § 1.83–7(a) provides

that section 83(a) and (b) applies at the

time the option is exercised or is

otherwise disposed of. An example has

been added to confirm that the final

regulations do not apply to such

options.

When the option is exercised, section

83(a) and (b) applies to the transfer of

stock pursuant to the exercise. If all of

the requirements of § 1.1032–3 are met,

those regulations apply to determine the

treatment accorded the issuing

corporation and the acquiring

corporation upon transfer of the issuing

corporation stock to the employee.

Reversionary Interest in Issuing

Corporation Stock

Examples 4 and 5 of the proposed

regulations set forth situations in which

either the issuing corporation (X) or the

acquiring corporation (Y) retains a

reversionary interest in the issuing

corporation stock. One commentator pointed

out that the preamble of the proposed

regulations does not articulate reasons for

concern with reversionary interests.

These facts were included in the

examples in the proposed regulations to

indicate ownership of the stock for tax

purposes.

Example 6 of the final regulations has been

modified to state that X retains the only

reversionary interest in the X stock in the

event that A forfeits the right to the stock.

Actual Payment for Issuing Corporation

Stock

Under the cash purchase model of the

proposed regulations, the acquiring

corporation is deemed to have

purchased the issuing corporation stock

from the issuing corporation for fair

market value with cash contributed to

the acquiring corporation by the issuing

corporation. Commentators requested

clarification of the tax consequences in

cases where the acquiring corporation or

another party makes an actual payment

to the issuing corporation for issuing

corporation stock. Specifically, concern

was expressed as to whether any or all

of the amounts actually paid to the

issuing corporation are treated as a

distribution by the acquiring

corporation to the issuing corporation.

Assume, for example, that the issuing

corporation, which owns all the stock of

the acquiring corporation, transfers an

option for issuing corporation stock to

an employee of the acquiring

corporation. At a time when one share

of issuing corporation stock has a fair

market value of $100, that employee

exercises the option to acquire one share

of issuing corporation stock and pays a

strike price of $80 to the issuing

corporation. The acquiring corporation

pays some or all of the ‘‘spread’’ of $20

to the issuing corporation.

The Treasury and the IRS do not

believe that an actual payment to the

issuing corporation for issuing

corporation stock should be taxed as a

distribution with respect to acquiring

corporation stock. Accordingly, the final

regulations have been modified to

provide that the amount of cash deemed

contributed by the issuing corporation

to the acquiring corporation in the cash

purchase model is equal to the

difference between the fair market value

of the issuing corporation stock and the

fair market value of the money or other

property received by the issuing

corporation as payment from the

employee or the acquiring corporation.

An example to such effect has been

added to the final regulations.

Although in other contexts partial

payments received by a shareholder of

an acquiring corporation should be

characterized as boot under section

351(b), these final regulations integrate

such payments into the cash purchase

model described above. Because the

property transferred by the issuing

corporation to the acquiring corporation

in this context is the issuing

corporation’s stock (or is deemed to be

cash under the recast of these

regulations), characterization of the

payment as boot in this context would

have no effect. No inference should be

drawn from the recast in the final

regulations to transactions in which a

shareholder receives money or other

property in exchange for property other

than its own stock.

Section 1.83–6 is currently under

study. A cross-reference in § 1.83–6(d)

to these final regulations has been

added to indicate that the mechanics of

§ 1.1032–3, rather than the mechanics of

§ 1.83–6(d), apply to a corporate

shareholder’s transfer of its own stock to

any person in consideration of services

performed for another entity where the

conditions of the final regulations are

satisfied.

Applicability of the Final Regulations in

the Partnership Context

Consistent with a suggestion by

commentators that the regulations be

expanded to apply to transactions

involving partnerships, the final

regulations treat an acquiring

partnership’s disposition of the stock of

the issuing corporation in the same

manner as an acquiring corporation’s

disposition of such stock. The

regulations also have been expanded to

apply to transactions in which the stock

of the issuing corporation is obtained

indirectly by the acquiring entity in any

combination of exchanges under

sections 721 and 351.

In certain situations where the recast

of the final regulations does not apply

to the disposition by a partnership of a

corporate partner’s stock (for example,

because the immediacy requirement is

not satisfied), realized gain or loss that

is allocated to that corporate partner

may nonetheless not be recognized

pursuant to section 1032. See Rev. Rul.

99–57 (1999–51 I.R.B. 678).

Status of § 1.1502–13(f)(6)(ii)

The Treasury and the IRS believe that

the finalization of these § 1.1032–3

regulations renders § 1.1502–13(f)(6)(ii)

superfluous because there should be no

cases which would be subject to recast

under § 1.1502–13(f)(6)(ii), but in which

a member would ‘‘otherwise recognize

gain’’ as required for § 1.1502–

13(f)(6)(ii) to apply. Accordingly, the

effective date paragraph in the § 1.1502–

13(f)(6) regulations has been modified to

limit the applicability of § 1.1502–

13(f)(6)(ii) and the last sentence of

§ 1.1502–13(f)(6)(iv)(A) to periods before

the effective date of these regulations.

Status of Rev. Rul. 80–76

The preamble to the proposed

regulations states that Rev. Rul. 80–76

(1980–1 C.B. 15) addresses the same

issues as the proposed regulations and

that, when finalized, the regulations

will render Rev. Rul. 80–76 obsolete. In

Rev. Rul. 80–76, a majority shareholder

of parent transfers parent stock to an

employee of its subsidiary corporation

as compensation. The holding of the

revenue ruling that the subsidiary does

not recognize gain or loss on the transfer

of the parent stock is now governed by

these regulations. An example has been

added to the final regulations to clarify

how general tax principles (see

Commissioner v. Fink, 483 U.S. 89

(1987)) and these final regulations

interact when a shareholder of the

parent/issuing corporation compensates

31076 Federal Register / Vol. 65, No. 95 / Tuesday, May 16, 2000 / Rules and Regulations

an employee of the subsidiary/acquiring

corporation. With the finalization of

these regulations, Rev. Rul. 80–76 is

obsolete.

Additional Issues and Future Guidance

Since issuance of the proposed

regulations, commentators have raised

questions regarding the tax treatment of

restricted stock and options granted to

employees before or in connection with

a transaction in which an issuing

corporation distributes the stock of the

acquiring corporation under section 355

(commonly referred to as a ‘‘spin off’’).

For example, assume that employees of

both X corporation and its subsidiary Y

corporation have outstanding options to

acquire stock in X corporation. In

connection with a spin off of the Y stock

by X, the employees of both

corporations have their outstanding

options converted into options to

acquire stock of both X and Y, with

option terms preserving the overall

values of the original options.

Commentators have requested guidance

on the tax consequences to X when,

after the spin off, employees of X

exercise options to acquire Y stock and,

likewise, the tax consequences to Y

when, after the spin off, employees of Y

exercise options to acquire X stock.

Guidance addressing these issues will

be forthcoming.

Effective Date

Commentators suggested that

taxpayers who engaged in transactions

described in these final regulations prior

to the effective date should be eligible

for the tax treatment prescribed by the

regulations. While the final regulations

are applicable only prospectively, the

IRS will not challenge a taxpayer’s

position taken in a prior period that is

consistent with the requirements set

forth in the final regulations.

For a discussion of transitional relief

concerning certain Rabbi Trust

arrangements, see the discussion of the

immediacy requirement above.

Effect on Other Documents

Rev. Rul. 80–76 (1980–1 C.B. 15) is

obsolete.

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

also has been determined that section

553(b) of the Administrative Procedure

Act (5 U.S.C. chapter 5) does not apply

to these regulations, and, because these

regulations do not impose a collection

of information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, the notices of proposed

rulemaking preceding these regulations

were submitted to the Chief Counsel for

Advocacy of the Small Business

Administration for comment on their

impact on small business.

Drafting Information: The principal

author of these final regulations is Filiz

Serbes of the Office of the Assistant

Chief Counsel (Corporate), IRS.

However, other personnel from the IRS

and the Treasury Department

participated in its development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.83–6 is amended by

adding two sentences to the end of

paragraph (d)(1) to read as follows:

§ 1.83–6 Deduction by employer.

* * * * *

(d) * * * (1) * * * For special rules

that may apply to a corporation’s

transfer of its own stock to any person

in consideration of services performed

for another corporation or partnership,

see § 1.1032–3. The preceding sentence

applies to transfers of stock and

amounts paid for such stock occurring

on or after May 16, 2000.

* * * * *

Par. 3. Section 1.1032–2 is amended

by:

1. Revising paragraph (e).

2. Adding paragraph (f).

The addition and revision read as

follows:

§ 1.1032–2 Disposition by a corporation of

stock of a controlling corporation in certain

triangular reorganizations.

* * * * *

(e) Stock options. The rules of this

section shall apply to an option to buy

or sell P stock issued by P in the same

manner as the rules of this section apply

to P stock.

(f) Effective dates. This section

applies to triangular reorganizations

occurring on or after December 23, 1994,

except for paragraph (e) of this section,

which applies to transfers of stock

options occurring on or after May 16,

2000.

Par. 4. Section 1.1032–3 is added to

read as follows:

§ 1.1032–3 Disposition of stock or stock

options in certain transactions not

qualifying under any other nonrecognition

provision.

(a) Scope. This section provides rules

for certain transactions in which a

corporation or a partnership (the

acquiring entity) acquires money or

other property (as defined in § 1.1032–

1) in exchange, in whole or in part, for

stock of a corporation (the issuing

corporation).

(b) Nonrecognition of gain or loss—(1)

General rule. In a transaction to which

this section applies, no gain or loss is

recognized on the disposition of the

issuing corporation’s stock by the

acquiring entity. The transaction is

treated as if, immediately before the

acquiring entity disposes of the stock of

the issuing corporation, the acquiring

entity purchased the issuing

corporation’s stock from the issuing

corporation for fair market value with

cash contributed to the acquiring entity

by the issuing corporation (or, if

necessary, through intermediate

corporations or partnerships). For rules

that may apply in determining the

issuing corporation’s adjustment to

basis in the acquiring entity (or, if

necessary, in determining the

adjustment to basis in intermediate

entities), see sections 358, 722, and the

regulations thereunder.

(2) Special rule for actual payment for

stock of the issuing corporation. If the

issuing corporation receives money or

other property in payment for its stock,

the amount of cash deemed contributed

under paragraph (b)(1) of this section is

the difference between the fair market

value of the issuing corporation stock

and the amount of money or the fair

market value of other property that the

issuing corporation receives as payment.

(c) Applicability. The rules of this

section apply only if, pursuant to a plan

to acquire money or other property—

(1) The acquiring entity acquires stock

of the issuing corporation directly or

indirectly from the issuing corporation

in a transaction in which, but for this

section, the basis of the stock of the

issuing corporation in the hands of the

acquiring entity would be determined,

in whole or in part, with respect to the

issuing corporation’s basis in the issuing

corporation’s stock under section 362(a)

or 723;

(2) The acquiring entity immediately

transfers the stock of the issuing

corporation to acquire money or other

property (from a person other than an

Federal Register / Vol. 65, No. 95 / Tuesday, May 16, 2000 / Rules and Regulations 31077

entity from which the stock was directly

or indirectly acquired);

(3) The party receiving stock of the

issuing corporation in the exchange

specified in paragraph (c)(2) of this

section from the acquiring entity does

not receive a substituted basis in the

stock of the issuing corporation within

the meaning of section 7701(a)(42); and

(4) The issuing corporation stock is

not exchanged for stock of the issuing

corporation.

(d) Stock options. The rules of this

section shall apply to an option issued

by a corporation to buy or sell its own

stock in the same manner as the rules

of this section apply to the stock of an

issuing corporation.

(e) Examples. The following examples

illustrate the application of this section:

Example 1. (i) X, a corporation, owns all

of the stock of Y corporation. Y reaches an

agreement with C, an individual, to acquire

a truck from C in exchange for 10 shares of

X stock with a fair market value of $100. To

effectuate Y’s agreement with C, X transfers

to Y the X stock in a transaction in which,

but for this section, the basis of the X stock

in the hands of Y would be determined with

respect to X’s basis in the X stock under

section 362(a). Y immediately transfers the X

stock to C to acquire the truck.

(ii) In this Example 1, no gain or loss is

recognized on the disposition of the X stock

by Y. Immediately before Y’s disposition of

the X stock, Y is treated as purchasing the X

stock from X for $100 of cash contributed to

Y by X. Under section 358, X’s basis in its

Y stock is increased by $100.

Example 2. (i) Assume the same facts as

Example 1, except that, rather than X stock,

X transfers an option with a fair market value

of $100 to purchase X stock.

(ii) In this Example 2, no gain or loss is

recognized on the disposition of the X stock

option by Y. Immediately before Y’s

disposition of the X stock option, Y is treated

as purchasing the X stock option from X for

$100 of cash contributed to Y by X. Under

section 358, X’s basis in its Y stock is

increased by $100.

Example 3. (i) X, a corporation, owns all

of the outstanding stock of Y corporation. Y

is a partner in partnership Z. Z reaches an

agreement with C, an individual, to acquire

a truck from C in exchange for 10 shares of

X stock with a fair market value of $100. To

effectuate Z’s agreement with C, X transfers

to Y the X stock in a transaction in which,

but for this section, the basis of the X stock

in the hands of Y would be determined with

respect to X’s basis in the X stock under

section 362(a). Y immediately transfers the X

stock to Z in a transaction in which, but for

this section, the basis of the X stock in the

hands of Z would be determined under

section 723. Z immediately transfers the X

stock to C to acquire the truck.

(ii) In this Example 3, no gain or loss is

recognized on the disposition of the X stock

by Z. Immediately before Z’s disposition of

the X stock, Z is treated as purchasing the X

stock from X for $100 of cash indirectly

contributed to Z by X through an

intermediate corporation, Y. Under section

722, Y’s basis in its Z partnership interest is

increased by $100, and, under section 358,

X’s basis in its Y stock is increased by $100.

Example 4. (i) X, a corporation, owns all

of the outstanding stock of Y corporation. B,

an individual, is an employee of Y. Pursuant

to an agreement between X and Y to

compensate B for services provided to Y, X

transfers to B 10 shares of X stock with a fair

market value of $100. Under § 1.83-6(d), but

for this section, the transfer of X stock by X

to B would be treated as a contribution of the

X stock by X to the capital of Y, and

immediately thereafter, a transfer of the X

stock by Y to B. But for this section, the basis

of the X stock in the hands of Y would be

determined with respect to X’s basis in the

X stock under section 362(a).

(ii) In this Example 4, no gain or loss is

recognized on the deemed disposition of the

X stock by Y. Immediately before Y’s deemed

disposition of the X stock, Y is treated as

purchasing the X stock from X for $100 of

cash contributed to Y by X. Under section

358, X’s basis in its Y stock is increased by

$100.

Example 5. (i) X, a corporation, owns all

of the outstanding stock of Y corporation. B,

an individual, is an employee of Y. To

compensate B for services provided to Y, B

is offered the opportunity to purchase 10

shares of X stock with a fair market value of

$100 at a reduced price of $80. B transfers

$80 and Y transfers $10 to X as partial

payment for the X stock.

(ii) In this Example 5, no gain or loss is

recognized on the deemed disposition of the

X stock by Y. Immediately before Y’s deemed

disposition of the X stock, Y is treated as

purchasing the X stock from X for $100, $80

of which Y is deemed to have received from

B, $10 of which originated with Y, and $10

of which is deemed to have been contributed

to Y by X. Under section 358, X’s basis in its

Y stock is increased by $10.

Example 6. (i) X, a corporation, owns stock

of Y. To compensate Y’s employee, B, for

services provided to Y, X issues 10 shares of

X stock to B, subject to a substantial risk of

forfeiture. B does not have an election under

section 83(b) in effect with respect to the X

stock. X retains the only reversionary interest

in the X stock in the event that B forfeits the

right to the stock. Several years after X’s

transfer of the X shares, the stock vests. At

the time the stock vests, the 10 shares of X

stock have a fair market value of $100. Under

§ 1.83-6(d), but for this section, the transfer

of the X stock by X to B would be treated,

at the time the stock vests, as a contribution

of the X stock by X to the capital of Y, and

immediately thereafter, a disposition of the X

stock by Y to B. The basis of the X stock in

the hands of Y, but for this section, would

be determined with respect to X’s basis in the

X stock under section 362(a).

(ii) In this Example 6, no gain or loss is

recognized on the deemed disposition of X

stock by Y when the stock vests. Immediately

before Y’s deemed disposition of the X stock,

Y is treated as purchasing X’s stock from X

for $100 of cash contributed to Y by X. Under

section 358, X’s basis in its Y stock is

increased by $100.

Example 7. (i) Assume the same facts as in

Example 6, except that Y (rather than X)

retains a reversionary interest in the X stock

in the event that B forfeits the right to the

stock. Several years after X’s transfer of the

X shares, the stock vests.

(ii) In this Example 7, this section does not

apply to Y’s deemed disposition of the X

shares because Y is not deemed to have

transferred the X stock to B immediately after

receiving the stock from X. For the tax

consequences to Y on the deemed disposition

of the X stock, see § 1.83–6(b).

Example 8. (i) X, a corporation, owns all

of the outstanding stock of Y corporation. In

Year 1, X issues to Y’s employee, B, a

nonstatutory stock option to purchase 10

shares of X stock as compensation for

services provided to Y. The option is

exercisable against X and does not have a

readily ascertainable fair market value

(determined under § 1.83–7(b)) at the time

the option is granted. In Year 2, B exercises

the option by paying X the strike price of $80

for the X stock, which then has a fair market

value of $100.

(ii) In this Example 8, because, under

section 83(e)(3), section 83(a) does not apply

to the grant of the option, paragraph (d) of

this section also does not apply to the grant

of the option. Section 83 and § 1.1032–3

apply in Year 2 when the option is exercised;

thus, no gain or loss is recognized on the

deemed disposition of X stock by Y in Year

2. Immediately before Y’s deemed

disposition of the X stock in Year 2, Y is

treated as purchasing the X stock from X for

$100, $80 of which Y is deemed to have

received from B and the remaining $20 of

which is deemed to have been contributed to

Y by X. Under section 358, X’s basis in its

Y stock is increased by $20.

Example 9. (i) A, an individual, owns a

majority of the stock of X. X owns stock of

Y constituting control of Y within the

meaning of section 368(c). A transfers 10

shares of its X stock to B, a key employee of

Y. The fair market value of the 10 shares on

the date of transfer was $100.

(ii) In this Example 9, A is treated as

making a nondeductible contribution of the

10 shares of X to the capital of X, and no gain

or loss is recognized by A as a result of this

transfer. See Commissioner v. Fink, 483 U.S.

89 (1987). A must allocate his basis in the

transferred shares to his remaining shares of

X stock. No gain or loss is recognized on the

deemed disposition of the X stock by Y.

Immediately before Y’s disposition of the X

stock, Y is treated as purchasing the X stock

from X for $100 of cash contributed to Y by

X. Under section 358, X’s basis in its Y stock

is increased by $100.

Example 10. (i) In Year 1, X, a corporation,

forms a trust which will be used to satisfy

deferred compensation obligations owed by

Y, X’s wholly owned subsidiary, to Y’s

employees. X funds the trust with X stock,

which would revert to X upon termination of

the trust, subject to the employees’ rights to

be paid the deferred compensation due to

them. The creditors of X can reach all the

trust assets upon the insolvency of X.

Similarly, Y’s creditors can reach all the trust

assets upon the insolvency of Y. In Year 5,

the trust transfers X stock to the employees

31078 Federal Register / Vol. 65, No. 95 / Tuesday, May 16, 2000 / Rules and Regulations

of Y in satisfaction of the deferred

compensation obligation.

(ii) In this Example 10, X is considered to

be the grantor of the trust, and, under section

677, X is also the owner of the trust. Any

income earned by the trust would be

reflected on X’s income tax return. Y is not

considered a grantor or owner of the trust

corpus at the time X transfers X stock to the

trust. In Year 5, when employees of Y receive

X stock in satisfaction of the deferred

compensation obligation, no gain or loss is

recognized on the deemed disposition of the

X stock by Y. Immediately before Y’s deemed

disposition of the X stock, Y is treated as

purchasing the X stock from X for fair market

value using cash contributed to Y by X.

Under section 358, X’s basis in its Y stock

increases by the amount of cash deemed

contributed.

(f) Effective date. This section applies

to transfers of stock or stock options of

the issuing corporation occurring on or

after May 16, 2000.

Par. 5. In § 1.1502–13, paragraph

(f)(6)(v) is amended by adding a

sentence after the first sentence to read

as follows:

§ 1.1502–13 Intercompany transactions.

* * * * *

(f) * * *

(6) * * *

(v) Effective date. * * * However,

paragraph (f)(6)(ii) of this section and

the last sentence of paragraph

(f)(6)(iv)(A) of this section do not apply

to dispositions of P stock or options

occurring on or after May 16, 2000.

* * * * *

Approved: May 5, 2000.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

Jonathan Talisman;

Assistant Secretary of the Treasury.

[FR Doc. 00–11900 Filed 5–11–00; 2:30 pm]

BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8882]

RIN 1545–AV86

Reorganizations; Nonqualified

Preferred Stock

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations relating to nonqualified

preferred stock and rights to acquire

nonqualified preferred stock. The

regulations are necessary to reflect

changes to the law concerning these

instruments that were made by the

Taxpayer Relief Act of 1997. The

regulations affect shareholders who

receive nonqualified preferred stock, or

rights to acquire such stock, in certain

corporate reorganizations and divisions.

EFFECTIVE DATE: These regulations are

effective May 16, 2000.

FOR FURTHER INFORMATION CONTACT:

Michael J. Danbury, (202) 622–7750 (not

a toll-free number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of

Provisions

On January 6, 1998, a temporary

regulation (TD 8753) was published in

the Federal Register (63 FR 411). A

notice of proposed rulemaking (REG–

121755–97) cross-referencing the

temporary regulation was published in

the Federal Register (63 FR 453) on the

same day.

The temporary regulation provided

that, notwithstanding

contemporaneously issued final

regulations treating certain rights to

acquire stock as securities that can be

received tax-free in corporate

reorganizations and divisions,

nonqualified preferred stock (as defined

in section 351(g)(2) of the Internal

Revenue Code) (NQPS), or a right to

acquire NQPS, will in some

circumstances not be treated as stock or

securities for purposes of sections 354,

355, and 356. The temporary regulation

added § 1.356–6T, and applied to NQPS

received in connection with a

transaction occurring on or after March

9, 1998 (other than certain

recapitalizations of family-owned

corporations and transactions described

in section 1014(f)(2) of the Taxpayer

Relief Act of 1997, Public Law 105–34,

111 Stat. 788, 921). No written

comments responding to the notice of

proposed rulemaking were received,

and no public hearing was requested or

held.

The regulation proposed by REG–

121755–97 is adopted by this Treasury

decision, and the corresponding

temporary regulation is removed. Crossreferences to the temporary regulation

in §§ 1.354–1(e), 1.355–1(c), and 1.356–

3(b) have been removed and replaced

with cross-references to the final

regulation at § 1.356–6.

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

has also been determined that section

553(b) of the Administrative Procedure

Act (5 U.S.C. chapter 5) does not apply

to these regulations. Because the

regulations do not impose a collection

of information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, the notice of proposed rulemaking

preceding these regulations 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 Michael J. Danbury of the

Office of Assistant Chief Counsel

(Corporate). However, other personnel

from the IRS and Treasury participated

in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an entry

in numerical order to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.356–6 also issued under 26

U.S.C. 351(g)(4). * * *

§ 1.354–1 [Amended]

Par. 2. In § 1.354–1, paragraph (e),

first sentence, the language ‘‘§ 1.356–

6T’’ is removed and ‘‘§ 1.356–6’’ is

added in its place.

§ 1.355–1 [Amended]

Par. 3. In § 1.355–1, paragraph (c),

first sentence, the language ‘‘§ 1.356–

6T’’ is removed and ‘‘§ 1.356–6’’ is

added in its place.

§ 1.356–3 [Amended]

Par. 4. In § 1.356–3, paragraph (b),

first sentence, the language ‘‘§ 1.356–

6T’’ is removed and ‘‘§ 1.356–6’’ is

added in its place.

Par. 5. Section 1.356–6T is

redesignated as § 1.356–6 and the

section heading is revised to read as

follows: