Par. 8. Section 1.1502-76 is amended: 1. By adding a sentence at the end of paragraph (b)(1)(i). 2. By revising paragraphs (b)(1)(ii)(A) and (B). 3. By adding paragraph (b)(1)(ii)(D). 4. By adding a sentence at the end of paragraph (b)(2)(i). 5. By revising paragraph (b)(2)(ii)(C)( 9 ). 6. By removing the last sentence of paragraph (b)(2)(iii). 7. By removing the last sentence of paragraph (b)(2)(v). 8. In paragraph (b)(2)(vi)(C) by removing “paragraph (b)(2)(v)” and adding “paragraph (b)(2)(vi)” in its place. 9. By revising paragraph (b)(3). 10. By adding a sentence at the end of paragraph (b)(4). 11. By adding Examples 8, 9, and 10 to paragraph (b)(5). 12. By revising paragraph (b)(6). The revisions and additions read as follows:
* * * * *
(b) * * *
(1) * * *
(i) * * * If a corporation (S) becomes or ceases to be a member in a stock disposition or purchase for which an election under section 336(e) or section 338 is made, paragraphs (b)(1)(ii), (b)(2)(ii), and (b)(2)(iii) of this section do not apply to the transaction.
(ii) * * *
(A) In general —( 1 ) End of the day rule. If S becomes or ceases to be a member during a consolidated return year, S's tax year ends, and (except as provided in paragraph (b)(1)(ii)(A)( 2 ) or paragraph (b)(1)(ii)(B) of this section) for purposes of determining the period in which S must report an item of income, gain, deduction, loss, or credit, S is treated as becoming or ceasing to be a member at the end of the day on which its status as a member changes (end of the day rule).
( 2 ) Next day rule. If an extraordinary item (as defined in paragraph (b)(2)(ii)(C) of this section) results from a transaction that occurs on the day of S's change in status as a member, but after the event resulting in the change, and the item would be taken into account by S on that day, the transaction resulting in the extraordinary item is treated as occurring at the beginning of the following day for purposes of determining the period in which S must report the item (next day rule). The next day rule does not apply to any extraordinary item that becomes includible or deductible simultaneously with the event that causes the change in S's status.
(B) Special rules for former S corporations —( 1 ) Beginning of the day rule. If an election under section 1362(a) is in effect for S immediately before S becomes a member, S is treated as becoming a member at the beginning of the day the termination of its election under section 1362(a) is effective (termination date), and S's taxable year ends at the end of the day preceding the termination date. See § 1.1361-5(a)(3) for the treatment of certain qualified S corporation subsidiaries.
( 2 ) Previous day rule. If an extraordinary item (as defined in paragraph (b)(2)(ii)(C) of this section) results from a transaction that occurs on the termination date, but before or simultaneously with the event resulting in the termination of S's election under section 1362(a), and the item would be taken into account by S on that day, the transaction resulting in the extraordinary item is treated as occurring at the end of the previous day for purposes of determining the period in which S must report the item (previous day rule). See § 1.1361-5(a)(3) for the treatment of certain qualified S corporation subsidiaries.
* * * * *
(D) Coordination with sections 382 and 1374. If the day of S's change in status is also the date of an ownership change for purposes of section 382, the rules and principles of this section apply in determining the treatment of any item or asset for purposes of section 382(h). Accordingly, if the day of S's change in status is also a change date, the determination of net unrealized built-in gain or loss will reflect the application of both the end of the day rule and the next day rule, to the extent each applies. Moreover, items includible in the taxable year that ends as a result of S's change in status are not treated as occurring in the recognition period described in section 382(h)(7)(A), and items includible in the taxable year that begins as a result of S's change in status are treated as occurring in the recognition period. If S ceases to be a corporation subject to the tax imposed by section 1374 upon becoming a member of a consolidated group, or if S elects to be a corporation that is subject to such tax for its first separate return year after ceasing to be a member, S's items of recognized built-in gain or loss for purposes of section 1374 will include only the amounts reported on S's separate return (including items reported on that return under the previous day rule or the next day rule).
* * * * *
(2) * * *
(i) * * * If a member distributes or transfers assets in an intercompany transaction to which section 381(a) applies, a short taxable year of the distributor or transferor corporation is not taken into account either for purposes of determining the taxable years to which any tax attribute of the distributor or transferor corporation may be carried or for purposes of determining the taxable years in which an adjustment under section 481(a) is taken into account.
(ii) * * *
(C) * * *
( 9 ) Any compensation-related deduction in connection with S's change in status (including, for example, a deduction for fees for services rendered in connection with S's change in status and for bonus, severance, and option cancellation payments made in connection with S's change in status);
* * * * *
(3) Anti-avoidance rule. If any person acts with a principal purpose contrary to the purposes of this paragraph (b) to substantially reduce the federal income tax liability of any person (including by modifying an existing contract or other agreement in anticipation of a change in S's status to shift an item between the taxable years that end and begin as a result of S's change in status), adjustments must be made as necessary to carry out the purposes of this section.
(4) * * * In addition, if S ceases to exist in the same consolidated return year in which S becomes a member, the due date for filing S's separate return shall be determined without regard to S's ceasing to exist in that year.
(5) * * *
Example 8.
Allocation of certain amounts that become deductible on the day of S's change in status —(a) Facts. P purchases all of the stock of S, an accrual-basis, stand-alone C corporation, on June 30 pursuant to a stock purchase agreement. At the time of the stock purchase, S has outstanding nonqualified stock options issued to certain employees. The options did not have a readily ascertainable fair market value when granted, and the options do not provide for a deferral of compensation (as defined in § 1.409A-1(b)). Under the option agreements, S is obligated to pay its employees certain amounts in cancellation of their stock options upon a change in control of S. P's purchase of S's stock causes a change in control of S, and S's obligation to make option cancellation payments to its employees becomes fixed and determinable upon the closing of the stock purchase. Several days after the closing of the stock purchase, S pays its employees the amounts required under the option agreements.
(b) Analysis. P's purchase of S's stock causes S to become a member of the P group at the end of the day on June 30. Under paragraph (b)(2)(ii)(C)( 9 ) of this section, a deduction arising from S's liability to pay its employees in cancellation of their stock options in connection with S's change in status is an extraordinary item that cannot be prorated and must be allocated to June 30. The next day rule is inapplicable to this deduction because S's liability to pay its employees becomes deductible on the day of S's change in status simultaneously with the event that causes S's change in status. Consequently, a deduction for the option cancellation payments must be reported under the end of the day rule on S's tax return for the period ending June 30.
(c) Success-based fees. The facts are the same as in paragraph (a) of this Example 8, except that S also engages a consulting firm to provide services in connection with P's purchase of S's stock. Under the terms of the engagement letter, S's obligation to pay for these services is contingent upon the successful closing of the stock purchase. The stock purchase closes successfully, and S's obligation to pay its consultants becomes fixed and determinable at closing. To the extent S's payment of a success-based fee to its consultants is otherwise deductible, this item is an extraordinary item that cannot be prorated and must be reported under the end of the day rule on S's return for the period ending June 30. (See paragraph (b)(2)(ii)(C)( 9 ) of this section.) The next day rule is inapplicable to the deduction because S's liability to pay its consultants becomes deductible on the day of S's change in status simultaneously with the event that causes S's change in status.
(d) Unwanted assets. The facts are the same as in paragraph (a) of this Example 8, except that, after closing on June 30, S sells to an unrelated party certain assets used in S's trade or business that are not wanted by the P group. Gain or loss on the sale of these assets is an extraordinary item that results from a transaction that occurs on the day of S's change in status, but after the event resulting in the change. Consequently, under the next day rule, the gain or loss must be reported on S's tax return for the period beginning July 1.
Example 9.
Redemption that causes a change in status —(a) Facts. P owns 80 shares of S's only class of outstanding stock, and a person whose ownership of S stock is not attributed to P under section 302(c) owns the remaining 20 shares. On June 30, S distributes land with a basis of $100 and a fair market value of $140 to P in redemption of all of P's stock in S.
(b) Analysis. As a result of the redemption, S ceases to be a member of P's consolidated group on June 30. S will recognize $40 of gain under section 311(b) on the distribution of the land to P. The next day rule is inapplicable because S's gain becomes includible on the day of S's change in status simultaneously with the event that causes S's change in status. Consequently, S's gain must be reported under the end of the day rule in its taxable year ending June 30, during which S was a member of the P group. Under § 1.1502-32(b)(2)(i), P's basis in its S stock is increased to reflect S's $40 gain immediately before the redemption of S's stock.
(c) Partial redemption. The facts are the same as in paragraph (a) of this Example 9, except that S distributes the land to P in redemption of 20 shares of P's stock in S. Thus, immediately after the redemption, P owns 75% (60 shares/80 shares) of S's outstanding stock, and S's minority shareholder owns 25% (20 shares/80 shares). The redemption does not satisfy the requirements of section 302(b) and is treated under section 302(d) as a distribution to which section 301 applies. The end of the day rule does not apply for purposes of determining whether P and S are members of the same consolidated group immediately after the redemption. Because P owns only 75% of S's stock immediately after the redemption, the distribution is not an intercompany distribution described in § 1.1502-13(f)(2)(i). Thus, P may not exclude any amount of the distribution that is a dividend, and P's basis in S's stock is not reduced under § 1.1502-32(b)(2)(iv). P may be entitled to a dividends received deduction under section 243(c) (but see section 1059(e)). For the reasons discussed in paragraph (b) of this Example 9, S's gain under section 311(b) must be reported under the end of the day rule in S's taxable year ending June 30, during which S was a member of the P group.
(d) Distribution of loss property. The facts are the same as in paragraph (a) of this Example 9, except that the land distributed by S to P has a fair market value of $60 rather than $140. The end of the day rule applies for purposes of determining the taxable year in which S must take into account its realized loss on the distribution of the land. Thus, under the end of the day rule, S's loss on the distribution of the land, which occurs simultaneously with S's ceasing to be a member, is taken into account in S's taxable year that ends as a result of the redemption. However, the end of the day rule does not apply for other purposes; for example, the rule does not apply in determining whether the transaction is an intercompany distribution or in determining the attributes (as defined in § 1.1502-13(b)(6)) of the loss. Therefore, because S is not a member immediately after the distribution, S's loss on the distribution is not recognized under section 311(a). Under the end of the day rule, the loss is taken into account as a noncapital, nondeductible expense on the P group's consolidated return, and under § 1.1502-32(b)(1)(i), P's basis in its S stock is decreased by $40 immediately before S leaves the group.
Example 10.Extraordinary item of S corporation —(a) Facts. On July 1, P purchases all the stock of S, an accrual-basis corporation with an election in effect under section 1362(a). Prior to the sale, S had engaged a consulting firm to find a buyer for S's stock, and the consulting firm's fee was contingent upon the successful closing of the sale of S's stock.
(b) Analysis. To the extent S's payment of the success-based fee to its consultants is otherwise deductible, this item is an extraordinary item (see paragraph (b)(2)(ii)(C)( 9 ) of this section) that becomes deductible on July 1 simultaneously with the event that terminates S's election as an S corporation. Under paragraph (b)(1)(ii)(B)( 2 ) of this section, S's obligation to pay the fee is treated as becoming deductible on June 30 under the previous day rule.
(6) Effective/applicability date. Paragraphs (b)(2)(i) and (b)(4) of this section apply to consolidated return years beginning on or after the date these regulations are published as final regulations in the Federal Register . Otherwise, this paragraph (b) applies to corporations becoming or ceasing to be members of consolidated groups on or after the date these regulations are published as final regulations in the Federal Register .
* * * * *