Category: Corporations Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com S1, a New York S corporation, is owned equally by nine shareholders, SH1...SH9. S2, also a New York S corporation, is also owned equally by the same nine individuals. For 1996, both S1 and S2 incurred losses which were limited by the shareholder basis under IRC Section 1366(d). Your memo makes reference to the at-risk rules. I assume that only the basis rules of Section 1366(d) are involved, not the at-risk rules of IRC Section 465. S1 will merge into S2 in a transaction intended to qualify as an A-reorganization under IRC Section 368(a)(1)(A), a so-called statutory merger. S2 will survive the merger, and S1 will go out of existence. The issue is whether the basis-suspended losses of S1 survive the merger. There is no answer to this question. In Letter Ruling 9008041, the IRS refused to rule on this matter until regulations (presumably under Section 1366) are issued. No such regulations have been issued to date. It is possible to present a reasonable, sound argument that basis-suspended losses should carry over in this case. On the other hand, it is also possible to present an equally reasonable, equally sound argument that the losses should not carry over. Until the IRS issues regulations or the matter is resolved in the courts or by Congress, it seems to me that taxpayers are free to do what they want based on their feelings about taking risk. The whole issue boils down to whether a basis-suspended loss is a corporate level attribute or a shareholder level attribute. The Argument For Under Section 1366(d)(2), a basis-suspended loss with respect to a given shareholder is treated as incurred by the corporation in successive tax years with respect to that shareholder. The shareholders of S1 and S2 are identical in this case. Accordingly, there is no problem in this case regarding basis-suspended losses being personal to a given shareholder. If basis-suspended losses are indeed a corporate attribute, then the mechanics of Section 1366(d)(2) would arguably treat such losses as incurred by the successor corporation (i.e., the survivor of the merger) in post-merger tax years thereby allowing the shareholders of the target corporation (i.e., the shareholders of the corporation that did not survive the merger) to utilize those losses to the extent of stock basis in the surviving entity. There is an additional issue to consider if one takes that position that the losses carry over: can the shareholder's basis of the target stock be combined with the basis of the surviving corporation's stock for purposes of determining amount of the basis limitation under Section 1366(d)? Again, there is no answer to this question. The Argument Against It seems to me the same must be true if basis-suspended losses are not a Section 381 corporate attribute. Without the ability to somehow bridge the losses over to the successor corporation, there is no corporation in which the losses can be deemed to be incurred in post-merger tax years. In this case, the merger situation is identical to the dissolution situation with respect to the target entity. Observation |
