Rev. Rul. 89-98

1989-2 C.B. 219, 1989-34 I.R.B. 4.

                       Internal Revenue Service

                                 Revenue Ruling

              EXCESS LOSS ACCOUNTS AND SECTION 338(H)(10) ELECTION

                           Published: August 21, 1989

Section 1502. - Regulations, 26 CFR 1.1502-19: Excess losses.

(Also Section 338: 1.338(H)(10)-1T.)

  Excess loss accounts and section 338(h)(10) election. When a parent corporation has an excess loss account in its subsidiary's stock and such stock is acquired by a third corporation in a qualified stock purchase for which a valid section 338(h)(10) of the Code election is made, the excess loss account is eliminated on the deemed section 331 liquidation resulting from the election.

                                     ISSUE

  If a parent corporation has an excess loss account in its subsidiary's stock and such stock is acquired by a third corporation in a qualified stock purchase for which an election under section 338(h)(10) of the Internal Revenue Code is made, is the excess loss account includible in the parent's income as a result of the purchase or is it eliminated on the deemed section 332 liquidation resulting from the election?

                                     FACTS

  § is the common parent of an affiliated group that files consolidated returns on a calendar year basis. Included in the group is T, the stock of which is wholly owned by S. T owns two assets, property A and property B. Property B has a basis of $50x.

  In 1987, T distributed property A to § creating an excess loss account in the T stock of $100x. In 1990, when the excess loss account was still $100x, P purchased directly from § all of the stock of T in a qualified stock purchase for its fair market value of $50x. An express election under section 338 of the Code and a joint election under section 338(h)(10) were made for T.

                                LAW AND ANALYSIS

  Section 338 of the Code provides that, if the stock of a corporation ('target ') is acquired by another corporation ('purchasing corporation') in a qualified stock purchase, the purchasing corporation may elect to have the purchase of the target stock treated as if the target sold all of its assets in a single transaction (as 'old target') at the close of the acquisition date and then purchased those same assets (as 'new target') as of the beginning of the day after the acquisition date.

  Section 338(h)(10) of the Code and section 1.338(h)(10)-1T(e)(1) of the temporary Income Tax Regulations provide that, if the target is a member of a selling consolidated group ('selling group') and if the selling group and the purchasing corporation make a joint election under section 338(h)(10) of the Code, old target recognizes gain or loss as if, while a member of the selling group, it sold all of its assets in a single transaction at the close of the acquisition date.

  Section 1.338(h)(10)-1T(e)(3) of the temporary regulations goes on to provide that, at the close of the acquisition date but after the deemed sale, old target is treated as if it distributed all of its assets while a member of the selling group in a liquidation to which section 332 of the Code applies. Section 332 generally provides that no gain or loss will be recognized by a corporation on the receipt of property distributed in complete liquidation of another corporation in which the distributee corporation owns stock meeting the requirements of section 1504(a)(2).

  Section 1.338(h)(10)-1T(e)(2) of the temporary regulations provides that, for purposes of Chapter 1 of the Code, gain or loss is ignored on the actual sale or exchange by the selling group to the purchasing corporation of target stock included in the qualified stock purchase. In addition, section 1.338(h)(10)-1T(e)(7)(i) provides that the deemed sale and liquidation rules of section 1.338(h)(10)-1T(e)(1) and (3) apply for purposes of the consolidated return regulations.

  Section 1.1502-19(a) of the regulations provides that, immediately before the disposition of stock of subsidiary, there will be included in the income of each member disposing of such stock that member's excess loss account in the stock disposed of. Under section 1.1502-19(b), a disposition includes a transfer of stock.

  Section 1.1502-19(e) of the regulations provides that, if the transaction is one to which section 381(a) of the Code applies, members owning stock in the member transferor or distributor corporation will not be considered for purposes of section 1.1502.- 19(b) of the regulations as having disposed of such stock. If the transaction is a distribution in complete liquidation to which section 334(b)(1) of the Code applies, the excess loss account in the stock of the distributor corporation will be eliminated. See also section 1.1502-19(f) Example 7 of the regulations. Section 334(b)(1) of the Code in general provides for a carryover basis for property received by a distributee corporation in a distribution in complete liquidation to which section 332 applies.

  The election under section 338(h)(10) of the Code for T triggers a deemed sale of T's assets followed by a deemed section 332 liquidation of T under section 1.338(h)(10)-1T(e)(1) and (3) of the temporary regulations. Under section 1.338(h)(10)-1T(e)(7)(i), these deemed sale and liquidation rules apply for purposes of the consolidated return regulations; therefore S's sale of T sock is ignored for purposes of determining whether the excess loss account is included in income. Accordingly, under section 1.1502-19(e), the deemed section 332 liquidation is not a disposition of T stock and the excess loss account in the T stock is eliminated on the liquidation.

                                    HOLDING

  The excess loss account in the T stock is eliminated as a result of the deemed liquidation of T rather than included in S's income.

DRAFTING INFORMATION

  The principal author if this revenue ruling is Keith Medleau of the Office of Assistant Chief Counsel (Corporate). For further information regarding this revenue ruling, contact Karen Holden or Keith Medleau on (202) 566-3250 or 566- 3551 (not a toll-free call).

Rev. Rul. 89-98, 1989-2 C.B. 219, 1989-34 I.R.B. 4.