GainsKeeper Blog

IRS Issues Proposed Regulations on Allocation of Basis to Stock in Corporate Transactions

January 21, 2009

On Jan. 16, 2009, the IRS issued proposed regulations on the allocation of basis to stock in a range of corporate transactions (the Proposed Regulations—REG-143686-07). The Proposed Regulations principally address the allocation of basis to stock in connection with returns of capital when corporations distribute cash or property in excess of current and accumulated earnings and profits, redemptions treated as dividend distributions under Section 302 of the Internal Revenue Code (as well as certain other related transactions under Sections 304), and exchanges of stock or other distributions in connection with mergers, recapitalizations, spin-offs and other corporate transactions that are governed by Sections 351, 354, 355, 356 and 368. The Proposed Regulations would also make certain revisions to existing basis allocation regulations relating to mergers, spin-offs and related transactions under Section 358 in response to certain comments received.

The Proposed Regulations have general application to holders of stock issued by corporations and thus would be relevant to both corporations that hold stock as well as to individual investors. They would also appear relevant for computation of basis of stock for cost basis reporting purposes in connection with corporate actions.

In broad brush terms, the Proposed Regulations would require taxpayers to separately apply corporate transaction basis adjustments to each particular lot or block of related stock (on a share-by-share basis) rather than on an aggregate basis. Also, distributions with respect to stock, in connection with a redemption, would only affect shares of the related class of stock held on a pro-rata basis. And, the redemption of all of one class of shares of stock held would not result in shifting basis to outstanding shares of other classes of stock of the same corporation held by a taxpayer. This approach could require the recognition of gain on particular lots of stock even when, in the aggregate, corporate basis adjustments do not exceed the holder's basis in all of his or her shares of the related stock. This result, along with other potential complexities, could make the Proposed Regulations controversial and subject to negative commentary.

The Proposed Regulations retain current law principles permitting a holder to select the particular shares redeemed. This is important in redemptions under Section 302 that are treated as sales or exchanges rather than dividends because the taxpayer can select the tax lot with the most favorable basis (high, low or otherwise) for purposes of computing gain or loss on the exchange. In reorganizations that are not treated as dividend equivalent, the Proposed Regulations generally provide that the holder can specify the receipt solely of cash or other property (known as "boot") for particular shares if consistent with the terms of the exchange or reorganization. Thus, in a reorganization the exchange by a holder of one lot of stock for cash could result in taxable capital gain or loss (determined by reference to the basis in the lot exchanged for cash) while the exchange of another lot of stock by the holder solely for stock in the acquiring corporation could be tax-free and result in carry-over basis and holding period (based on the basis and holding period of the lot exchanged for stock).

The Proposed Regulations are not binding on taxpayers and generally provide for prospective effectiveness to transactions occurring after the date final regulations are published. Final regulations may not be published for at least a year or more, and their provisions (including effective dates) could differ substantially from the terms of the Proposed Regulations.

The IRS has solicited comments on the Proposed Regulations and will consider comments received in drafting final regulations. Comments are due by Apr. 21, 2009.

Stevie

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