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Federal Taxation of Bankruptcies and Workouts

Prof. Liquerman
Fall 2012

Chapter 1
1) Alternatives to Bankruptcy
a) Out-of-court Settlements
i) Extended time to pay
ii) Cash settlement
iii) Issuance of stock
b) Assignment of Assets
i) Sign over title of assets to creditors
2) Bankruptcy
a) Common to All Proceedings
i) Automatic stay
(1) Creditors cannot take action with respect to liens on assets
ii) Priority of claims
iii) Discharge of Debts
iv) Disallowance of preferential payments
3) Chapter 7 – Liquidation
a) Income
i) Means Test –
(1) Can be transferred to a chapter 11 or 13 proceeding
(a) Exception: Mean income is below state determined level
(2) Presumed to be abuse if:
(a) Monthly income – monthly expenses * 60 is not less than the lesser
(i) The greater of 25% of unsecured claims or $7,025; or
(ii) $11.725
b) Deductions
i) National standards
ii) Local Standards
c) Appointment of Trustee
4) Chapter 11 – Reorganization
a) Goal – allow company to continue business with protection from the court in
order to minimize losses from liquidation
b) Creditors’ committee
i) 7 (or more) of the largest unsecured creditors
ii) Act as negotiators for all creditors
c) Develop a plan
i) Get approval of plan
d) Advantages –
i) Less % of creditors needed for approval
ii) Creditors bargain for rights
iii) Assets are safe
iv) Cancellation of contracts
v) Avoidance of certain transfers
5) Chapter 12 – Adjustment of Debts for Farmers
6) Chapter 13 – Adjustment of Debts for Individuals
a) Requirements –
i) Limits on how much secured and unsecured debt an filer can have
ii) Stable income
b) Plan
i) Submit t supervision by trustee
ii) Full payment of priority claims unless creditors agrees otherwise
iii) Same treatment for each class of creditors

Chapter 2 – Discharge of Indebtedness Income

1) §61(a)(12) – Gross Income Defined
a) Income from the discharge of indebtedness
b) Exceptions (when COD is NOT income)
c) Original Issue Discount (1.61-1(c)ish)
i) Definition: when debt does not call for interest, but you pay back more
than you borrowed at the end of the term
ii) Example:
(1) 100 borrowed, 160 at the end
1 100 10 110
2 110 11 121
3 121 12 133
4 133 13 146
5 146 14 160
iii) Terms:
(1) SRPM – treats “interest” as if it accrued over the life of the debt
(2) AIP – adjusted interest price
iv)  use AIP as the amount of the debt
v) Hypothetical –
(1) Facts:
(a) X Corporation has single SH and borrows money from the bank. SH
guarantees the debt. Company pays off the debt later on.
(b) Did SH have cancellation of indebtedness?
(i) 50 tc 803 (“Landra” case)
1. Ct. said – “SH did not have an accession to wealth” (never
really got anything from taking on the debt)
2. Prevents from losing money, but never really enriches them
2) Early Idea
a) Kirby Lumber Case
i) Supreme Court Rule
ii) Test:
(1) “Accession to wealth”
(2) “Freeing of assets”
b) Centennial Savings Case
i) Look to both the end result of the transaction and the repayment terms
agreed to by the parties
c) §108(a) – Discharge of indebtedness income
i) Excluded from gross income when:
(1) Discharged in a Title 11 case
(2) Discharged when taxpayer is insolvent
(a) *Only to the extent of insolvency
(3) Qualified farm indebtedness
(4) Qualified real property business indebtedness
(5) Qualified principal residence indebtedness
(a) Passed as salve to huge present issue: if foreclosed on not only lose
the house, but also get DOI income that is taxable as regular income
(b) To be excluded debt must be
(i) Acquisition debt
1. Including refinance, construction, and substantial remodeling
(ii) AND must be secured by the residence
(c) §108(h): special rules pertaining to the Qualified Principal Residence
(i) Amount excluded from GI shall be used to reduce basis of the
residence, but not below zero
(ii) If any loan is discharged, and only portion is actually Principal
Residence Indebtedness, then only can exclude the amount
discharged which is greater than portion that is not qualified
(d) Hypo: bought for 25k; worth 100k. Borrowed another 75k, of which
used 40k to improve the house, and 35k for other uses
(i) 25k + 40k = the acquisition debt.
1. The 35k is NOT
(ii) House now worth 70k, foreclosed and all debt forgiven → 30k of
1. [‘gave’ creditor 70k in satisfaction of 100k debt]
2. Because there is 30k of DOI, and 35k of the debt is not
qualified, TP is not entitled to any exclusion
ii) If excluded, tax attributes will be reduced.
3) §1.1001-3 – Modification of Debt instruments
a) If it is a “modification,” it will be treated as an exchange
b) Modification –
i) Any deletion or addition of a legal right or obligation of issuer or holder
(1) NOT if the modification is by operation of the debt instrument
(2) NOT failure of issuer to perform duties
ii) Modifications (even if by operation of instrument)
(1) Substitution of obligor, co-obligor, or a change to the recourse nature
of the instrument
(2) Change to something that is not debt, unless pursuant to instrument
(3) Exercise of an option to change provided to issuer or holder; UNLESS:
(a) Unilateral option; and
(b) Holder’s option does not result in a deferral or reduction of any
iii) Significant modifications
(1) Change in yield of debt
(a) Greater of:
(i) ¼ of one percent; or
(ii) 5% of annual yield of the unmodified instrument
(2) Change in timing of payments
(a) If deferral is “material”  modification
(3) Change in obligor or security
(a) New obligor on recourse debt
(i) NOT on nonrecourse debt
(b) Addition or deletion of co-obligor
(i) IF change in payment changes “payment expectations”
(c) Change in security (Recourse Debt)
(i) Release, substitute, or addition of any collateral
1.  IF results in change of “payment expectations”
(d) Change in priority of debt of issuer
(e) “payment expectation”
(i) substantial enhancement of obligor’s ability to pay
1. speculative to adequate
(ii) Substantial impairment of obligor’s ability to pay
1. Adequate to speculative
4) Questions to Consider
a) What is it?
i) Definition:
(1) A forgiveness of, or release from, an obligation to repay.
ii) Classifications:
(1) Discharge of indebtedness Income;
(2) Not Discharge of indebtedness Income; or
(a) Examples:
(i) Setoff of mutual obligations
(ii) Cancel debt in exchange for release of contract counterclaim
(3) Not Income
(a) Gifts
(i) Cannot be a gift if in a commercial setting
(b) For Guarantor when principal debtor satisfies the debt
iii) Recourse vs. Non-recourse debt
(1) Definitions:
(a) Recourse – debtor is personally liable for the amount debt
(i) Steps:
1. Compare Debt to FMV (Debt – FMV)
a. Difference = DOI
2. Amount Realized (FMV) – A/B = gain on disposition
(ii) Lower FMV is better for TP, because more will be DOI and
(b) Non-recourse – the debtor is not personally liable and the creditor
may look only to the property securing the debt for satisfaction
(i) Generally NOT DOI (so income from sale)
1. Liability Relief – A/B
(2) Examples:
(a) Corporation buys your house and assumes the recourse mortgage,
but you remain liable  NOT DOI
(b) Receive a discount when you prepay a recourse mortgage  DOI
iv) Transfer or Repurchase of Debt
(1) Recognize DOI income when repurchasing debt for an amount less
than its adjusted issue price
(a) Amount = excess of adjusted issue price over repurchase price
b) Is the obligation Indebtedness?
i) Definition:
(1) If the obligation does not exceed the amount that a reasonable
unrelated lender would lend to the debtor under commercially
reasonable terms
c) Who is the Debtor?
d) When does Discharge of Indebtedness Occur?
5) Debt-for-Debt Exchanges
a) §108(e)(10) – for purposes of determining COD, if debtor issues debt in
satisfaction of another debt, the debtor is treated as satisfying the
indebtedness in an amount = to the price of the new issue (under OID rules)
i) What’s important?
(1) Company X has $1,000 debt outstanding (adjusted issue price). Pays
off that debt with new debt (face value of $1,000) and paying 5% rate
of interest
(2) General Rule  if paying interest (at least semi annually) and the rate
is similar to primes….then adjusted issue price will be its face amount
(a) Same if the debt is not publically traded.
(b)  i.e. NOT an OID instrument
(c) If publically traded for $920  then the new face amount is worth
(i) “Public trading” is very broad to the IRS
(3) If agree to lower the interest rate –
(a) §1.1001-3 –
(i) Need significant modification
(ii) Modification?
1. Rule:
a. Alteration, including the addition or deletion in whole
or in part of a legal right or obligation of the issuer or
the holder
2. When?
a. Express agreement
b. Conduct of the parties
c.  when the AGREEMENT takes place, not when the
obligation kicks in.
3. Exceptions: (NOT modification)
a. Change that occurs because of the terms of the
instrument (automatically or option of the parties)
b. Option must be a unilateral right
i. Unilateral – “allows for change, but no permission is
needed from the other party”
ii.  other party cannot: terminate, alter, or put it on a
different party
c. Failure of issuer to perform on the debt is NOT an
alteration (NOT modification)
i.  if holder does not enforce acceleration clause it is
NOT a modification until it exceeds 2 years from the
default AND any additional period
4. Exceptions to the exception: (Back to modification)
a. Change in obligor
b. Addition or deletion of co-obligor
c. Change in the recourse nature of the instrument
d. Some options (exercisable by the holder and holder
cannot have the option to defer)
(iii) Significant?
1. Definition – “The extent to which the legal rights are altered
are economically significant”
2. Terms:
a. Change in Yield
i. Significant if: more than the greater of: (1) ¼ of 1%
OR (2) 5% of the annual yield of the unmodified
b. Change in Timing of payment
i. Significant: material deferral of scheduled payments
(maturity or interest) (Look to length of deferral or
amount of payment) (Regs – “safe harbor”: lesser of
(1) 5 years OR (2) 50% of the term of the original
c. Change in obligor or security
i. Significant if the obligor is changed
ii. Exceptions:
iii.  381(a) transaction (Reorganization)
iv.  If new debtor acquires substantially all of debtors
assets and no change in payment expectations and
no significant alteration (Sig. Alt  something that
would have been a significant modification, but for it
occurred pursuant to the terms of the agreement)
v.  338 election –
vi.  substitute a new obligor on non-recourse debt
vii.  addition or deletion of a co-obligor (significant if:
material change in payment expectations)
viii.  change in security on recourse debt
(Significant if change in payment expectations)
ix.  change in security on non-recourse debt (always
significant) (Exception: change fungible units)
d. Change in nature of debt instrument
i. Significant if modified terms that is no longer debt
for income tax purposes
ii.  if determining if it is still debt: a deterioration of
financial position of obligor in between dates; FD
will not be taken into account (debt for debt); unless
substitution of new obligor or addition or deletion of
a co-obligor
e. Change in accounting requirement
f. Change in financial covenants
3. “Change in payment expectations:”
a. Substantial enhancement and payment assurance was
speculative before;
b. Substantial impairment and payment assurance was
adequate before
4. Change recourse to non-recourse
a. Generally yes (Sig. Mod)
i. Exception:
ii. If remains secured by original collateral and no
change in payment expectation
5. Change non-recourse to recourse
a. Generally Sig. Mod
ii) No need to retest every year – Reg. §
(1) Unless:
(a) Change in obligor
(b) Addition/deletion of co-obligor
iii) Examples:
(1) In the Regs.
iv) Operating Rules:
(1) Must apply all the rules
(2) If enumerated items, do not look to changes cumulatively
(a) All individually
(3) If within a test (multiple changes in maturity date), you must
accumulate those changes
(a) Exception:
(i) If within test, and those happen more than 5 years apart, you
do NOT have to accumulate them
6) Additions to DOI income
a) Debt Acquired by a related party
i) §108(e)(4) –
(1) “Related” – family, SHs, controlled corporations, fiduciaries, and more
(a) leaves out brother/sister
(2) “Acquisition” –
(a) Direct:
(i) Purchasing the related person’s debt on the open market from
an unrelated 3rd party
1.  DOI income to the debtor
(b) Indirect:
(i) Holder of debt becomes related to the debtor AND acquired the
debt in anticipation of becoming related.
(ii) Timing – If become related within 6 months after the debtor
was acquiring the debt, the companies are assumed to have
done so in anticipation. (Facts and circumstances can prove
(iii) Disclosure - Taxpayer MUST disclose in the year debtor
became related whether either of the two tests are met:
1. 25% Test – Met if:
a. On the date the debtor becomes related, the debt
represents MORE THAN 25% of the FMV of the assets of
the Holder.
b. Excluded from FMV:
i. Cash, marketable securities, ST debt, Options,
futures contracts
2. 6-to-24 months Test – Met if:
a. holder acquired the indebtedness less than 24 months,
but at least 6 months before they became related
3. **If no disclosure, there is a rebuttable presumption that
the acquisition was in anticipation of becoming related
4. Statement to include: (Debtor’s obligation to file)
a. Identify disclosure under §1.108-2(c)
b. Identification of the indebtedness
c. Amount of debt and the income that could apply under
d. Which “test” is satisfied
e. Reasoning on why the debtor believes the debt was
NOT acquired in anticipation
(3) Income Calculation for Related party Acquisitions
(a) What happens:
(i) ON the acquisition date, the debtor has DOI income = to
1. Adjusted Issue Price - Related party’s A/B in the debt (cost)
2. **FMV is used if acquired > 6 months
(ii) Debtor is deemed to issue new debt in an amount = to the
amount used to compute DOI
1. **Watch out for Original Issue Discount here**
(b) Example: H acquires D’s $1000 debt in open market for $700. 5
months later, H and D become related.
(i) D’s DOI income = $300
(ii) D deemed new debt = 1000 face value and 700 issue price
(4) Correlative adjustments
(a) Why?  When step transactions, must do something to resurrect
the debt
(b) Treat P as if they issued debt to S for the same amount as you are
deemed to satisfy the debt
(i) OID obligation
(c) Treated as Interest
(i) S has interest income
(5) Exceptions: (NOT related party transactions)
(a) Debt acquired that matures within a year of purchase AND is
actually retired on or before that date
(b) Acquisition by security dealer in ordinary course of business
ii) Regulation Examples:
(1) Example 1. (i) P, a domestic corporation, owns 70 percent of the
single class of stock of S, a domestic corporation. S has outstanding
indebtedness that has an issue price of $10,000,000 and provides for
monthly interest payments of $80,000 payable at the end of each
month and a payment at maturity of $10,000,000. The indebtedness
has a stated maturity date of December 31, 1994. On January 1, 1992,
P purchases S's indebtedness from I, an individual not related to S
within the meaning of paragraph (d)(2) of this section, for cash in the
amount of $9,000,000. S repays the indebtedness in full at maturity.
(a) (ii) Under section 61(a)(12), section 108(e)(4), and paragraphs (a)
and (f) of this section, S realizes $1,000,000 of income from
discharge of indebtedness on January 1, 1992.
(b) (iii) Under paragraph (g)(1) of this section, the indebtedness is
treated as issued to P on January 1, 1992, with an issue price of
$9,000,000. Under section 1273(a), the $1,000,000 excess of the
stated redemption price at maturity of the indebtedness
($10,000,000) over its issue price ($9,000,000) is original issue
discount, which is includible in gross income by P and deductible
by S over the remaining term of the indebtedness under sections
163(e) and 1272(a).
(c) (iv) Accordingly, S deducts and P includes in income original issue
discount, in addition to stated interest, as follows: in 1992,
$289,144.88; in 1993, $331,286.06; and in 1994, $379,569.06.
(2) Example 2. The facts are the same as in Example 1, except that on
January 1, 1992, P sells S's indebtedness to J, who is not related to S
within the meaning of paragraph (d)(2) of this section, for $9,400,000
in cash. J holds S's indebtedness to maturity. On January 1, 1993, P's
adjusted basis in S's indebtedness is $9,289,144.88. Accordingly, P
realizes gain in the amount of $110,855.12 upon the disposition. S and
J continue to deduct and include the original issue discount on the
indebtedness in accordance with Example 1. The amount of original
issue discount includible by J is reduced by the $110,855.12
acquisition premium as provided in section 1272(a)(7).
(3) Example 3. The facts are the same as in Example 1, except that on
February 1, 1992 (one month after P purchased S's indebtedness), S
retires the indebtedness for an amount of cash equal to the fair
market value of the indebtedness. Assume that the fair market value
of the indebtedness is $9,022,621.41, which in this case equals the
issue price of indebtedness determined under paragraph (g)(1) of this
section ($9,000,000) plus the accrued original issue discount through
February 1 ($22,621.41). Section 1.61–12(c)(3) provides that if
indebtedness is repurchased for a price that is exceeded by the issue
price of the indebtedness plus the amount of discount already
deducted, the excess is income from discharge of indebtedness.
Therefore, S does not realize income from discharge of indebtedness.
The result would be the same if P had contributed the indebtedness to
the capital of S. Under section 108(e)(6), S would be treated as having
satisfied the indebtedness with an amount of money equal to P's
adjusted basis and, under section 1272(d)(2), P's adjusted basis is
equal to $9,022,621.41.
(4) Example 4. (i) P, a domestic corporation, owns 70 percent of the
single class of stock of S, a domestic corporation. On January 1, 1986,
P issued indebtedness that has an issue price of $5,000,000 and
provides for no stated interest payments and a payment at maturity of
$10,000,000. The indebtedness has a stated maturity date of
December 31, 1995. On January 1, 1992, S purchases P's indebtedness
from K, a partnership not related to P within the meaning of
paragraph (d)(2) of this section, for cash in the amount of $6,000,000.
The sum of the debt's issue price and previously deducted original
issue discount is $7,578,582.83. P repays the indebtedness in full at
(a) (ii) Under section 61(a)(12), section 108(e)(4), and paragraphs (a)
and (f) of this section, P realizes $1,578,582.83 in income from
discharge of indebtedness ($7,578,582.83 minus $6,000,000) on
January 1, 1992.
(b) (iii) Under paragraph (g)(1) of this section, the indebtedness is
treated as issued to S on January 1, 1992, with an issue price of
$6,000,000. Under section 1273(a), the $4,000,000 excess of the
stated redemption price at maturity of the indebtedness
($10,000,000) over its issue price ($6,000,000) is original issue
discount, which is includible in gross income by S and deductible
by P over the remaining term of the indebtedness under sections
163(e) and 1272(a).
(c) (iv) Accordingly, P deducts and S includes in income original issue
discount as follows: in 1992, $817,316.20; in 1993, $928,650.49;
in 1994, $1,055,150.67; and in 1995, $1,198,882.64
b) Indebtedness contributed to Capital (§108(e)(6))
i) Scenario: when SH cancels or satisfies Corporate debt.
ii) Effect:
(1) When debtor corporation acquires its debt from a SH as a
contribution to capital, §118 (exclusion from gross income) does NOT
apply and the corporation is deemed to satisfy the debt with cash (=
to SH’s A/B in debt)
(a) Debt – A/B = DOI
iii) Amounts:
(1) SH – increased value of stock held PLUS the amount the debtor
became solvent
iv) Principal vs. Interest
(1) Generally applied towards interest first
c) Stock for Debt (§108(e)(8))
i) Scenario: when SH transfers corporate debt to the corporation in
exchange for corporate shares.
ii) Effect:
(1) Corporation has DOI income to the extent the amount of debt
discharged exceeds FMV of the stock
(a) (Deemed to pay cash in an amount equal to the FMV of the stock)
iii) Advantages and Disadvantages
(1) If SH basis > FMV  capital contribution is better
(2) **Could be an OWNERSHIP CHANGE**
d)  Overlap of (e)(6) and (e)(8)
i) If 100% SH contributes debt to corporation, there would be no COD
under (e)(6), but if stock were issued in the exchange, (e)(8) would have
a portion be COD
ii) IRS Stance
(1) They will respect the form you choose
7) EXCLUDED from DOI Income
a) §108(e)(2) – Otherwise deductible debts
i) No income realized to the extent the payment would have given rise to a
(1) Examples:
(a) forgiving expenses for a cash-basis taxpayer that were never paid
(b) Settling a tort claim for less than judgment
(i) *If arose in course of business
ii) Why? – So no advantage/disadvantage for different methods of
b) §108(e)(5) – Purchase Price Reduction
i) Consequence: Reduction in basis of property
ii) Factors:
(1) Debt of the purchaser of the property
(2) Owed to the seller
(3) Arose from the purchase of the property
(4) Debt is reduced
(5) Does NOT occur in a title 11 case OR when debtor was insolvent
(a) If BECOMES insolvent due to the reduction  Bifurcate the
(i) Example: Corp. has $180 of assets and $200 of liabilities. $110
of the debt is reduced to $80.
(ii) Answer:
1. To the extent of insolvency (200-180 = $20), the discharge
is NOT covered by §108(e)(5) and the corporation has DOI
2. Remainder (30 reduction – 20 DOI = $10) is covered by this
section and subsequently reduces the basis by $10.
(6) Would be otherwise treated as DOI income (but for this provision)
(7) Other factors
iii) Example –
(1) Rev. Ruling 92-99
(a) A borrows money from O. A uses money to buy a Truck. Some of
the debt is discharged.
(b) Can a 3rd party debt be a purchase price reduction?
(i) Even though debt arose in connection with purchase of
property. It is not a debt of the purchaser TO the seller as
(ii) Nothing to do with the sale of the asset
(iii) Exception:
1. Could be a Reduction that relates to the “infirmity” of the
product that relates back to the sale
a. Fraud
b. Misrepresentation
iv) Specific Exceptions NOT included:
(1) If creditor was not original seller
(2) Debtor does not own the property at time of reduction
(3) Reduced for other reasons than agreement between the two parties
8) Exclusions from Income
a) Situations:
i) Title 11 Exclusion
(1) If debtor is in a Title 11 case, DOI income is excluded from gross
income (All chapters)
(a) Requirements:
(i) Under jurisdiction of the court; and
(ii) Discharge is granted or part of court-approved plan
(2) This exclusion trumps ALL others
(a) Better b/c this can exclude even if discharge renders debtor
ii) Insolvency Exclusion
(1) Definition - “Amount by which the liabilities exceed FMV of assets”
(a) *Need not be in declared bankruptcy
(2) Amount – only to the extent insolvent
(a) If $10K debt and $7K assets and $4K was forgiven 
(i) $3K covered under this exclusion
(ii) $1K included in income
(3) Timing – “immediately before the discharge”
(4) Non-recourse Debt –
(a) May be included in liabilities calculation only to the extent of FMV
of property securing the debt + nonrecourse debt actually
(5) Example: (Rev. Ruling - 91-31)
(a) R borrows $100 from bank on non-recourse basis. R buys a truck
for $100. Truck goes down in value to $80. Taken $30 of
(i) Basis = $70
(ii) Bank wants $100 back, but only secured by truck.
1. Bank agrees to reduce debt by $20  COD of $20
(b) What if bank forecloses instead?
(i) Not COD income because the debt was settle by the “terms of
the deal”  based on Centennial Savings Case
(ii)  1.1001-2(c) Example 7 – Amount realized is greater of FMV
of truck or amount of debt.
1. 100- AB of 70 = $30 gain
a. Insolvent  rather have COD income
b. Not  rather have this type of gain b/c capital rather
than ordinary
(c) What if fully RECOURSE debt?
(i) Keep property  same answer ($20 of COD)
(ii) Foreclosure  in full satisfaction
1. 1.1001-2(c) Example 8
a. Gain of $30 ($10 of capital gain and $20 of COD)
b. Capital = FMV – Basis
(6) Example:
(a) Facts: TP has P1 with FMV of 100, FMV of P2 100. Two debts of 40-
recourse and 500-nonrecourse (secured by P2).
(i) If reduces recourse debt to 30  would be $10 COD because
(b) Insolvency calculation: (Rev. Ruling 92-53)
(i) Always get Recourse: 40
(ii) Value of NR up to value secured: 100
(iii) Include any discharged NR debt
(iv) Total = $140
1. Therefore, Solvent!
(c) Change to Example: Write down NR debt to $400.
(i) 40 recourse + 100 (valued secured) + 100 discharged
1. = 240  therefore Insolvent
(ii) 100 of COD; exclude 40 (to extent of insolvency); 60 of CODI
taxable income
(7) Example #2:
(a) Facts – Buy a business for $100 note (“fixed obligation”), payable
in 5 years. Pay another 60 dollars if business makes over $100
each of 1st 3 years (“contingent obligation”).
(b) Assets = $230; Unrelated debt = $100; Note = $100; Contingent =
(c) IF $40 of unrelated debt is discharged:
(i) Am I insolvent?
1. Merkel Case  must show by a preponderance of the
evidence that you would have to pay the contingent in
order to include it (otherwise nothing).
(8) Contingent Debt
(a) How does it factor into solvency/insolvency discussion?
(i)  depends on likelihood of payment under Merkel
(b) Is discharge of contingency discharge of indebtedness?
(i) Landrith – possible site for non-discharge
(9) Asset side:
(a) Should an exempt asset be included for solvency/insolvency
(i) Example: Debt of $100; Assets of $100 ($60 non-exempt/$40
(ii) Private Level Ruling – 1999-32-013
1. Have “ability to pay”  include
(b) 116-TC9 2001
(i) Jones Tax Court Case
1. Overruled cases that you did not have to include
2. So now you include them because “ability to pay”
iii) Qualified Farm Indebtedness Exclusion
iv) Qualified Real Property Indebtedness (§108-c)
(1) Hypo: Really rich real estate developer. Not insolvent or in title 11.
Very rich and has 1 HUGE building. Borrowed $1,000 (Non-recourse)
from bank. 3 years later, real estate plummeted. FMV dropped by
$400 to $600. 900 basis after 100 depreciation.
(a) If Mr. T threatens to just walk away.
(i)  1000 realized – 900 basis = 100 taxable gain.
1. *40% tax makes Mr. T $40 better off
(b) If Bank agrees to reduce debt down to FMV
(i)  COD of $400
1. Tax of $160
(2) What does §108(c) do?
(a) Only applies to tax payer that is NOT a C-Corp.
(b) Must have “Qualified Real property business indebtedness” in
order to qualify
(i) Debt incurred by taxpayer in connection with real property
used in a trade or business, secured by that property.
(ii) Incurred or assumed before January 1993
1. Or If After, “Qualified acquisition indebtedness”
a. “Indebtedness incurred to acquire, construct,
reconstruct, or substantially improve real property”
(iii) Taxpayer makes election for this rule to apply
(c) It also includes any refinancing
(i) Except to the extent you have more debt afterwards
(d) Limits on amount excluded: (See handout example)
(i) Only exclude cancelation to the extent the amount of the debt
is greater than the FMV of the property less any other qualified
real property business indebtedness on that property
1. Debt – (FMV-Other) = amount of cap
2. Called  “mini-insolvency calculation”
(ii) Only exclude an amount to the extent of aggregate basis in
depreciable real property other than depreciable real property
acquired in contemplation of the discharge
1. ALL assets, not just the cancelation one
(iii) Example – TP bought a casino for 5, borrowing all. A/B
is 4.5 and FMV is only 3.
1. Lender agrees to reduce debt to 3
a.  DOI of 2
2. Lender agrees to reduce to 2.5
a. Limitation applies
i. 5 (debt) – 3 (FMV) = 2
ii.  can only exclude 2
3. What if A/B was 1.5
a. Can only exclude up to A/B of ALL property
i.  limited to 1.5 exclusion
b) Consequences
i) Attribute Reduction - §1017
(1) Applies to TP when:
(a) Title 11,
(b) Insolvency, or
(c) Qualified Farm
(2) Ordering:
(a) NOLs
(i) For current year and carryovers to the tax year
(ii) Usually start with the oldest one
(b) General Business Credits
(i) Credits are usually reduced $0.33/$1 of COD
(c) Minimum Tax Credit
(i) Credits are usually reduced $0.33/$1 of COD
(d) Capital Loss Carryovers
(e) Basis Reduction
(i) §1017 –
1. Special Rule (b)(2): Even if within basis, there is a
maximum amount of basis you must use (can keep some)
a. “Basis Immediately after the discharge – liabilities after
the discharge (debts left over) = maximum basis
b. Example: COD – 1,000, AB – 500, Liab – 300
i.  maximum basis reduction is $200 ($300
remaining basis)
c. Reg 1.1017-1 – What if they have cash (included in
i. Include cash in the “basis” calculation
(ii) What basis and what property to reduce?
1. Categories:
a. Real property securing the debt (being discharged)
i. Pro rata over multiple properties
b. Personal property securing the debt
c. Property used in trade or business or held for
i. Other than inventory
ii. Pro rata over all available assets
iii. (relative basis over all property of the class)
d. Inventory, A/R, notes receivable
i. *Favorable because more likely to sell inventory
(and thus get a COGS deduction)
e. Property NOT used in a trade or business
(f) Passive Activity losses
(g) Foreign Tax Credit
(i) Credits are usually reduced $0.33/$1 of COD
(3) Amounts  generally $-for-$
(a) **Any DOI remaining after reduction is discharged
(4) Timing –
(a) (b)(4) – reduce attributes after determination of the tax for the
(i) Why favorable?
1. Example: LossCo has 1000 COD, NOL carryovers of 700,
General Bus. Credits of 100, Net capital loss carryovers of
a. 1000 CD eaten up by NOL and bus. Credit
i. because NOL is $for$ and credit is 3:1
2. Example: what if 700 of operating income
a. Can use against 700 NOL before reducing attributes
b.  GBC gone; 700 gone from NCL (300 left)
(5) Steps:
(a) Exclude debt to the extent of insolvency (remainder is DOI
(b) DOI income and operating income for the year can be offset by
(c) Debt excluded then applied against attributes
(6) Example:
(a) Facts: Company has $1000 in assets and $1200 in liabilities. NOL
carryover of $400 and assets with basis of $100.
(b) If the creditors agree to lower debt to $700:
(i) $200 – excluded to the extent TP was “insolvent” before
(ii) $300 – DOI income
(iii) If no other income gained on the year, the $300 in DOI
income offsets the NOL.
(iv) $200 excluded is then applied to eliminate the NOL and
reduce basis down to $0
(7) Regulation Examples:
ii) Basis Reduction Election (§108(b)(5))
(1) Debtor may elect to reduce basis before other attributes (save NOLs)
(a) Of “depreciable property”
(b) NOT available for qualified real property business indebtedness
(c) Very flexible: can make election for any portion of the COD you
(i) Go back to the top for the portion not selected
(d) **1017 does NOT apply for the 108(b)(5) election
(i) i.e. – no maximum basis reduction
(ii) If going back to 1017 reduction, take out the amount you
elected from the basis after COD
(2) Election = File a form
(3) Application:
(a) For Title 11 and Insolvency:
(i) Reduction is limited to the excess of the aggregate basis of
property and money held by the taxpayer, over the liabilities
immediately after discharge.
(ii) Order:
1. Real property used in business (that secured obligation)
2. Personal property used in business (that secured
3. Other business property
4. Inventory, A/R, etc. held for sale
5. Other property
iii) Example:
(1) Facts – DOI income of 5,000 and tax attributes of:
(a) NOL: 2,000
(b) Bus. Credit – 600
(c) Cap. Loss – 500
(d) A/B – 3,000
(2) Answer –
(a) First look to NOL
(i) Reduced $-for-$ to zero; DOI of 3,000 remaining
(b) Next, Bus. Credit
(i) Reduced $1 of credit offsets $3 of DOI
1. 600 takes up 1,800 of DOI
a. DOI of 1200 remaining
(c) Cap. Loss –
(i) $-For-$ down to zero; $700 left
(d) Basis reduction
(i) $-for-$. Left with 2300 of basis
(3) What if debtor had 2,900 in liabilities after bankruptcy?
(a) When Bankruptcy or Insolvency, reduction in basis cannot exceed
aggregate basis – aggregate liabilities
(i) Calculation – 3000 A/B – 2900 liabilities = 100 maximum
basis reduction available
(ii) Answer: Can only offset 100 of A/B, so 600 DOI still remains
1. Basis is reduced by 100 down to 2900
(4) What if they made a (b)(5) Election?
(a) Start first with A/B reduction (assume all is depreciable property)
(i) Left with 2,000 DOI
(b) Remaining DOI reduces NOL to $0
(c) Liability Limitation does NOT apply
(i)  can use ALL A/B, not just aggregate over liabilities
9) §108(i) – Deferral Election
a) Idea: Allows for an election to defer recognition of COD income
i) From Economic Recovery Act
ii) *cannot revoke election
b) Elect if “reacquisition” of an “applicable debt instrument”
i) Timing:
(1) DOI included ratably over the five-year period beginning with:
(a) 5th taxable year following the tax year in which the reacquisition
occurs for 2009 (i.e. – 2014)
(b) 4th taxable year following the tax year in which the reacquisition
occurs for 2010 (i.e. – 2014)
ii) Instruments:
(1) Issued by a C Corporation or any other person in connection with the
conduct of a trade or business
(2) “Reacquired” – acquisition of the debt by debtor or a related party
c) Acceleration Provisions:
i) If any of the following, any item deferred shall be recognized in the year
of occurrence:
(1) Death of tax payer
(2) Liquidation
(3) Corporate reorganization
(4) Change in tax status of entity
(5) Transactions that affect net worth
(a) Examples:
(i) Large dividends
(ii) Redemption of stock
(iii) Issue debt for less than adequate payment
(iv) Sell asset in bargain transaction
(b) Test: (after transaction)
(i) IF FMV of Gross Assets < 110% of liabilities + deferred tax
items  then accelerate the payments
(c) Ways to get out: (restore by tax return due date)
(i) Restore the lesser of:
1. Impairment (the amount removed); or
2. Amount required to meet equation
d) Examples:
i) 1.
(1) Facts – S reacquires it own note in 2009 and realizes $500 DOI. It
makes the election to defer it. In 2010, it makes a $40 distribution to
its sole owner A. S has 100 in gross assets, no liabilities and $175 in
deferred taxes.
(2) Answer –
(a) Because 110% of the deferred tax items (192.50) exceeds the FMV
of net assets (100), the deferment will be accelerated.
(b) It can avoid this by restoring the lesser of:
(i) $40 (taken out); or
(ii) the amount that makes the equation work (92.50)

Chapter 5 – Reorganizations
1) Common Elements
a) Business Purpose
i) Regulations:
(1) “undertaken for reasons germane to the continuance of the business;”
(2) “required by business exigencies”
ii) Bad:
(1) Purely avoiding tax
(2) Sham
iii) Good:
(1) Operating efficiencies
(2) Penetrate new markets
(3) Diversify product lines
b) Continuity of Business Enterprise
c) Continuity of Interest
i) SHs of target continue holding an interest in the new company/Acquirer
ii) Generally 40% or more
2) Types of Reorganizations
a) Acquisitive Asset Reorganizations
i) Type “A” – Merger or consolidation
(1) Benefits:
(a) No G/L on transfer (corp. to corp.)
(b) No G/L for SH
ii) Type “C” – Voting Stock
iii) Triangle
iv) Type “D” –
b) Stock Acquisitions
i) Type “B” –
ii) Reverse Triangle
c) Single Entity Reorganizations
i) Type “E” Reorganizations - recapitalization
ii) Type “F” Reorganizations
d) Devisive
e) Bankruptcy Reorganizations
i) Type “G”
(1) Transfer by corp. or all or part of assets to another corp. in a title 11
or similar case, but only if plan, stock or securities of Acquiring are
distributed in a transactions that fits under 354, 355, 356.
(a) 354 is key
(i) stockholder or security holder
1. need at least 1
2. If not, only NON-SC get taxed
(2) Continuity of Interest
(a) Example: Company has 3 classes of debt (senior, junior,
(i) In reorg, mixture of stock and boot
1. Stock/All consideration
(ii) Seniors get cash
(iii) Juniors get stock and cash
(iv) Sub gets only stock
(v) Proprietary interests = Juniors and Subordinated
(b) Regs – look at THE most senior claim to get stock. Bifurcate it into
continuity part and non-continuity part.
(i) Disregard the non-continuity part.
(3) Proposed Regulation 163313-03 (2005-1 cum. Bul 835)
(a) “Net positive valuation”
(b) Create requirements of Reorganizations:
(i) Surrender of net value
1. If FMV of property transferred by T to A exceeds any
liabilities of T assumed by A + any money received by
target + FMV of other property transferred to target
2. (must be room for some equity)
(ii) Receipt of net value
1. After transaction, FMV of A’s assets must exceed liabilities
(iii) Apply to acquisitive
(4) Example: LossCo is in bankruptcy, 1B assets and 3B debt. Lossco gives
1B of stock to Creditors.
(a) Not a G, but a recapitalization
(b) Gain or Loss at corporate level?
(i) No
(c) G/L to creditor?
(i) Depends if security holder or not
(d) G/L on Corporation issuance?
(i) No
(e) COD income?
(i) Yes, §108(e)(8) – stock for debt exchange
1. Reduce attributes
2. Look for an ownership change
a.  limits NOL
3. Special 382 rules
a. (l) 5 & 6
(5) Example w/G reorganization
(a) A has 3B. T is in bankruptcy. T has 1B is assets and 3B in debt. T
transfers all assets (no debt) for 1B of stock.
(b) Steps:
(i) Determine if SH or security holder
(ii) Qualify as G-reorg?
(iii) COD income to T?
1. Yes, 2B
(iv) Reduce attributes
1. What If not in title 11?  just partial exclusion
(v) §382
1. % of old = 75
2. % of new = 25
3.  ownership change!
(vi) What’s the limitation?
1. Does not qualify for L(5)
(vii) Look to l(6)
1. Lower of:
a. Pre-change gross assets = 1B; or
b. Post change stock value = 4B
2. * tax rate
(viii) Any gain for T on transfer?
1. NO
(ix) A’s basis?
1. 362 (subject to reduction)
(x) No g/L on issuance
1. 1032
3) Why we care for this Class?
a) Loss Trafficking: When profitable company buys loss company to use NOLs
to offset their own income
b) Types of Items Trafficked:
i) Built-in losses
ii) NOLs
iii) Capital Loss carry forward
iv) Credits
a) Application
i) When there is an Ownership Change
(1) “The % of stock of a “loss corporation” owned by one or more 5% SHs
has increased by more than 50 percentage points relative to the
lowest percentage owned by the same 5% SHs during the testing
(2) What is a “Loss Corporation”?
(a) A corporation with a:
(i) NOL
1. For that year, or one that can be carried into that year
(ii) NUBIL (Net Unrealized Built-In Loss)
1. RBIL  when you recognize the loss
a. Only subject to the limitation for 5 years after the
“ownership change”
(iii) Capital loss in year of change (or carryover)
1. §383
(iv) Credit in year (or carryover)
1. §383
(3) What is the “testing date”
(a) “Any day on which the ownership interest of ANY 5% SH changes
(i) Sale
(ii) Issuance
(iii) Redemption
(iv) Tax-free reorganization
(4) Percentage of Stock of Corporation
(a) Includes:
(i) Stock other than under §1504(a)(4)
1. Affiliated group for consolidated returns
2. Characteristics (need all to be §1504) – non-voting, limited
and preferred as to dividends, no participation to
significant extent, not convertible into common
(ii) Attribution Rules:
(5) Owned by 1 or more 5% SHs (Directly or indirectly)
(a) Attribution Rules: §1.382-2T-J1
(i) Example:
1. Loss Co has Public L owns 41%, C1 owns 50% (Owned by
X10%, Y20%, Z6%, and 64% by Public C), C2 owns 4%, and
X owns 5%
2. Who are 5% SH? (must = 100%)
a. X owns 5% and 5% = 1-%
b. Y owns 10%
c. Public L owns 45% (Public L and C2)
d. (Z is 6% owner but NOT at 5% Shareholder)
e. Public C owns 35% (Z + Public C)
3. If public group from above is NOT a 5% holder, add them to
the lower Public
(b) Aggregation Rules: (combine small SHs into a “Public Group”)
(c) Segregation Rules: (separate the public group into other groups)
(i) Example:
1. Loss Co has 20 shares owned by A and 80 owned by Public.
It has a debt that it pays off using 40 shares (Public 2)
2. Chart
a. A = 14%, 20, 0
b. P1 = 57%, 80, 0
c. P2 = 29%, 0, 29
(ii) Exceptions:
1. Small Issuance (3J) (**still shift, but just reduces it)
a. If issuance is “small” then the shares are acquired by the
direct public group
i. If more than one public groups, it will be acquired
proportionally according to their interests
b. “Small”:
i. Corporate-wide – 10% or less of the total value of
the shares of the corporation outstanding (at the
beginning of the year)
ii. If over, the remaining goes to a new public group
iii. Class-by-class – less than 10% of the number of
shares outstanding at the beginning of each year
2. Cash Issuance
a. Exempts a portion of shares that were issued for cash
an amount = to ½ of the aggregate % of the amount
owned by direct public groups before the issuance
(Public % * ½ * shares sold for cash)  that number
treated as acquired by old Public (remaining are not
exempt and are put into New Public)
b. Chart –
i. A – 14%, 20, 0
ii. P1 – 69%, 80, 0
iii. P2 – 17%, 0, 17
(d) Segregation of Loss corporation
(i) Example: L owned by: A-20 and Public #1–80. A sells 10 shares
to the Public.
1. 1.382-2Ta(j)(3)
a.  Event because A is 5% holder
b. A “sold” to new public
i. If you didn’t create new pubic groups, it would
decrease the shifts over time.
(ii) What if A sold 3 shares?
1. Still segregation event because disposition by 5% holder.
a. Treat new public as 5% SH.
(iii) Notice 2010-49 –
1. 2 approaches to look at for segregation rules
a. Ownership tracking
i. Tend to create more public groups after 5%
transaction (maximizes ownership shift)
b. Purposive –
i. Treat as sale back to the existing public groups (if no
one person becomes a 5% owner)
ii. No one “becomes” a 5%
iii. Example – A owns 20, Public owns 80. If A sells 2…
iv.  A sells to current
2. IRS proposed Reg. – 1.382-3 I and J
a. Examples
b. **Not covered because not officially released**
(6) Increased by more than 50 percentage points over the lowest
percentage owned by those SHs at any time
(a) General rule  VALUE of the stock
(7) During a testing period
(a) General  3 years back from testing date
(b) Exception:
(i) If ownership change within 3 years, only have to look back as
far as your latest ownership change
ii) Determining Ownership Change
(1) Example:
(a) Loss Co has 3 direct SHs, A, B, & C. A has 30 shares, B has 30
shares, and C has 40 shares.
(b) Tests:
(i) Who is 5% SH?
(ii) What do they own at the end of the testing date?
(iii) What was the lowest of what they otherwise owned
during testing period
(iv) What % increase did they have?
(c) Transactions:
(i) A sold 30 shares to D

5% TD Lowest TP %
B 30 30 0
C 40 40 0
D 30 0 30
(ii) The next day, B sells all stock to E (assume all are unrelated)

5% TD Lowest TP %
C 40 40 0
D 30 0 30
E 30 0 30

1. Now the company has had an ownership change

(iii) What if B sells to E six years later? (after A sells to D)

5% TD Lowest TP %
C 40 40 0
D 30 30 0
E 30 0 30

(iv) A sells to D; next day D sells to E

5% TD Lowest TP %
B 30 30 0
C 40 40 0
E 30 0 30

iii) Example: (Fluctuations of Value)

(1) A owns $20 of PS and B owns $80 of CS (only 2 shares) of L.
(a) Does it count?  depends, look to §1504 rules
(2) If value of company drops to $25
(a) What would you expect PS to be worth?
(i)  $20
(ii) CS  $5 (2.50/sh)
(3) If B sells 1 share of CS, is it a ownership change?
(a) Do the chart:
(i) A - 80% (20/25), 20% (20/100), change = 60
1.  IRS 2010-50 – for the time being, compute ownership on
“full value” methodology (this example) if you want or
“Hold constant principle” (pretend the values never
fluctuated; value that share sold at the actual FMV (2.50/25
= 10% change))
iv) Example: (Ownership meaning)
(1) Family –
(a) Build the “family” around the person who causes the smallest shift
(2) Entity –
(3) Option Attribution – if you fail a number of tests (need fail part 1 and
one of part 2) and you have the option, it is deemed that you exercised
the option and acquired the stock
(a) Part 1 – same as other tests (§1.382-4)
(i) A principal purpose of issuance, transfer, or structure of option
is to avoid or ameliorate impact of ownership change
1. Test at all three stages
(b) Part 2 –
(i) 3 options:
1. Ownership – option provides holder prior to exercise with
a substantial portion of the attributes of the ownership of
the underlying shares
2. Control – holder of option (and any related party) would
own 50% or more of shares (including shares they have the
option to buy)
3. Income – If option facilitates the creation of income before
ownership change (or deferral of deductions after)
2) Consequences of an Ownership Change
a) Options:
i) NUBIL (Net unrealized Built in loss)
(1) Company, when looking at all assets, the basis exceeds the FMV of
(2) Take these into account when finding out in NUBIL or NUBIG:
(a) Built-in Income
(b) Built-in Deductions
(c) Notice 2003-65 –
(i) On items of income and deduction it gave 2 choices: (Election
at this point)
1. 1374 approach (Built in income for s-corp)
a. With a few exceptions…we are following accrual
method of accounting, so if it hasn’t been included in
income yet  so if its not included before change, it is
not built in
b. Tax Payer wants this method for built in losses (“give it
a pass”)
c. **Not subject to limitations
2. 338 approach
a. Compare items of income and deduction after the
change (actual) compared to make believe amount as if
all assets were bought under 338 election (for FMV)
b. Tax payer likes this if NUBIG
(3) When recognizing some of the loses  RBIL
(a) §382 – only use up to that amount of limitation
(b) Only limited for 5 years
(4) If not in NUBIL, not subject to 382 limitation on RBILs
(5) Threshold –
(a) If BIL number does not exceed lesser of:
(i) 15% of the FMV of assets; or
1. NOT included:
a. Cash
b. Certain marketable securities
(ii) $10,000,000
(iii) Then your NUBIL is deemed to be $0 (and RBILs NOT
subject to limitation)
(6) New Limitations:
(a) RBIL never exceeds:
(i) Loss that is built in to the specific asset
1. Example: 50 AB and 30 FMV
a. Within 5 year period (recognition period)
b. Sell asset for $20
c.  assume the (30) loss is an RBIL
d.  burden on Tax payer to show that it all wasn’t built it
2. Example: A1 = AB 950, FMV 10; A2 = AB 0, FMV 50
a. Build it loss = 940
b. Built in gain = 50
c. NUBIL = 890
d. Overall limitation of 890 because that is the amount
that could have been trafficked upon the sale.
ii) NUBIG (net unrealized built in gain)
(1) First, if you determine value > AB
(2) Threshold – NUBIG = 0 if it doesn’t:
(a) Exceed lesser of:
(i) 15% of FMV; or
(ii) $10 million
(3) RBIG applies if recognize within 5 years.
(a) Increase 382 limitation by amount of RBIG
(4) If $10 BIG and sell for $12, how much RBIG is there?
(a) $10  the part that was built in
(5) Reg. presumes $0 RBIG  so Taxpayer must show that value exceed
basis by a certain amount on the change date
iii) Example: Assets FMV of 50 and liabilities of 75. Cancels debt for issuance
of all the stock
(1) Inherent 25 of COD…should that count to determine NUBIG or NUBIL?
(a)  notice says: when you determine NUBIL and NUBIG, you do
NOT take the basis reduction into account
(i) Because formula in notice:
1. Says when determining, part of formula, as if bought assets
at FMV but if any liabilities, deemed to have assumed all of
them (even if discharged in transaction)
(b)  take basis reduction into account for RBIG and RBIL
(i) Formula: subtract basis; purchased at FMV and assumed pre-
change liabilities…
b) What is better?
(1) If NUBIG, gains can increase 382 limitations (that’s good)
(a) RBILs are not subject to limitations if in NUBIG
(i) If in NUBIL, RBILs are subject to 382 limitation
(b) If some RBIGs, they do NOT increase 382 limitations
(2) If NUBIL,
(a) RBIG  do not help limitation
3) Special Rules in Bankruptcy
a) Example: (when creditors take over all stock in exchange for debt)
i) What is the 382 limitation going to be:
(1) $0 because no value  NO NOL
ii) What is the value of the stock:
(1) $0
b) ownership change must occur due to reorganization plan
c) (L)(5)
i) When does it apply?
(1) Corporation has to be in Title 11 or similar case
(2) Pre-change SHs and qualified creditors, together, have to own 50% or
more of FMV and voting power of the company immediately after the
ownership change (no vanilla preferred stock). (Must have had that
stock as a result of being creditor before or pre-change SH)
(a) Qualified Creditor –
(i) Held debt for at least 18 months before bankruptcy (NOT
before ownership change;
(ii) Ordinary course debt
ii) What happens?
(1) No §382 limitations
(2) Still have ownership change
(3) Make you go back and look at NOLs; what would they have been if you
had no interest deduction in year of change and prior 3 years?
(a) Would they have been there? (Interest Haircut)
(4) If another ownership change within 2 years, the limitation on the next
change is 0 (**biggest reason why people elect out**)
d) (L)(6)
i) *Prof. wrote regulations
ii) What does it do?
(1) Example: C has assets of 400 and liabilities of 1,000. Transfers stock
for debt down to 300. (Stock worth 100)
(2) Gives different way to compute value of stock:
(a) Lesser of:
(i) Gross pre-change assets ; or
(ii) Post change stock value
iii) (L)(1) – if you “stuff” a company with bad value, you don’t get the
increased limitation.
(1) Will get increase in value
e) (g)(4)(D) –
i) if stock held by SH who owns 50% or more, and that SH takes a worthless
stock deduction, then that SH is treated as if at the close of the year that
SH never held any stock before, and then owns amount of stock at the end
(0 whatever they held after = Ownership change)
f) §269 –
i) Elements:(meet both)
(1) if someone does either: (1) acquires control (50% or more of vote OR
value); or (2) One corporation acquires the assets of another
corporation in a carryover basis transaction (A,C,D,G,351) AND (a)
neither corp or SH controlled the transferring corporation.
(2) And THE principal purpose is tax evasion by securing the benefit of a
deduction, credit, or other allowance, which such person would not
otherwise enjoy.
ii) Special Bankruptcy Rules:
(1) §1.269-3(d) –
(a) If ownership change and 382(L)(5) applies, and the company
afterwards is only carrying on an insignificant amount of business
 absent strong evidence to the contrary, it is considered to be
done for tax evasion
(2) §1.269-3(e) –
(a) If IRS does not like bankruptcy plan, they can object
(b) If principal purpose of plan is tax avoidance, it cannot approve the
(c) If government does not make a motion (1129 of bankruptcy code)
or any determination  NOT controlling under 269
4) What Happens If it applies?
a) Base limitation - (annual limitation; can use that on a yearly basis)
i) Calculation:
(1) Figure out FMV of stock immediately before the ownership change
(a) Can add the value of the “vanilla preferred” (§1504) for the
purposes of “stock”
(b) ALL the stock, not just the portion being exchanged!!
(2) Multiply by long-term applicable federal rate
ii) Annual limit
(1) Can keep using that amount year-to-year
(2) Similar in amount to the interest earned on a tax-free T-Bill
iii) If your annual limit is not used, that changes into a “real” NOL and can
offset more than annual limit in your next year
b) NOLs generated AFTER the change  NOT subject to limitations
i) Go all the way back to earliest and apply whatever type of NOL is there

Limitations on NOLs