[Federal Register Volume 65, Number 95 (Tuesday, May 16, 2000)]
[Rules and Regulations]
[Pages 31073-31078]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-11900]



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

[[Page 31073]]



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 Sec. 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

[[Page 31074]]

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 Sec. 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

[[Page 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 Sec. 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 Sec. 1.83-7(a), the grant of 
such options is effectively treated as an open transaction. Section 
Sec. 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 Sec. 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 
Sec. 1.83-6(d) to these final regulations has been added to indicate 
that the mechanics of Sec. 1.1032-3, rather than the mechanics of 
Sec. 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 Sec. 1.1502-13(f)(6)(ii)
    The Treasury and the IRS believe that the finalization of these 
Sec. 1.1032-3 regulations renders Sec. 1.1502-13(f)(6)(ii) superfluous 
because there should be no cases which would be subject to recast under 
Sec. 1.1502-13(f)(6)(ii), but in which a member would ``otherwise 
recognize gain'' as required for Sec. 1.1502-13(f)(6)(ii) to apply. 
Accordingly, the effective date paragraph in the Sec. 1.1502-13(f)(6) 
regulations has been modified to limit the applicability of 
Sec. 1.1502-13(f)(6)(ii) and the last sentence of Sec. 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

[[Page 31076]]

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:


Sec. 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 
Sec. 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:


Sec. 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:


Sec. 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 Sec. 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

[[Page 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 Sec. 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 Sec. 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 Sec. 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 Sec. 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 Sec. 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

[[Page 31078]]

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 Sec. 1.1502-13, paragraph (f)(6)(v) is amended by adding 
a sentence after the first sentence to read as follows:


Sec. 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