Corporate Tax | Just Tax

Loss Trafficking Anti-Abuse (§§ 384, 269)

Sections 384 and 269 operate as complementary anti-abuse guardrails against loss trafficking. § 384 limits the use of preacquisition losses to offset recognized built-in gains following corporate acquisitions. § 269 is a broader principal-purpose statute that can disallow any deduction, credit, or other allowance obtained through an acquisition made principally for tax avoidance. This checklist walks through the statutory structure, threshold determinations, and acquisition-type analyses required to assess whether either or both provisions apply.

Step 1. Scope and Triggering Events

§ 384(a) "For purposes of this chapter, in the case of an acquisition to which this section applies, the preacquisition loss of any old loss corporation or gain corporation for any recognition period taxable year (to the extent attributable to periods before the acquisition date) shall not be allowed--" § 269(a) "If ... (1) any person or persons acquire, or acquired on or after October 8, 1940, directly or indirectly, control of a corporation, or (2) any corporation acquires ... on or after October 8, 1940, directly or indirectly, property of another corporation ... and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy ..."

Both § 384 and § 269 must be analyzed whenever a corporate acquisition involves NOLs or built-in gains.

• § 384 applies when either party to an acquisition is a gain corporation.
  • The provision is triggered by two types of acquisitions under § 384(a)(1)(A) and § 384(a)(1)(B). First, any acquisition of stock of one corporation by another corporation that results in the acquiring corporation meeting the § 1504(a)(2) control test (80 percent of voting power and value). Second, any acquisition by one corporation of substantially all the assets of another corporation in a reorganization described in § 381(a). (§ 384(a)(1)(A)) (§ 384(a)(1)(B)) (Nugent, Tax Notes Federal (Sept. 18, 2023))
  • The gain corporation and the loss corporation can be either the acquirer or the target. The statute is bidirectional. If Corporation A (with NOLs) acquires Corporation B (with built-in gains), § 384 applies. If Corporation B acquires Corporation A, § 384 also applies.
  • The practitioner must identify which party is the gain corporation and which is the loss corporation before proceeding to the limitation computation.
• § 269 applies when the principal purpose of an acquisition is tax avoidance.
  • The provision reaches any acquisition of control (stock) or property (assets) where the motivating purpose is securing a deduction, credit, or other tax allowance that would not otherwise be available. (§ 269(a)) (Treas. Reg. § 1.269-1(a))
  • Unlike § 384, § 269 requires no built-in gain or formal reorganization structure. It applies to any corporate acquisition with a tax-avoidance purpose. Treas. Reg. § 1.269-1(a) states that the purpose "may be gathered from all the surrounding facts and circumstances."
  • The principal-purpose standard is a facts-and-circumstances test. The presence of a substantial business purpose may rebut a tax-avoidance finding, but the regulations make clear that tax avoidance need not be the sole or even the dominant purpose. It need only be a principal purpose. (Treas. Reg. § 1.269-1(a))
• Both provisions can apply to the same transaction.
  • Neither statute contains any cross-reference or mutual exclusivity provision. A single acquisition may independently trigger both § 384 (because a gain corporation is involved) and § 269 (because tax avoidance was a principal purpose). (JCT, Description of TCA 1988, at 421) (H.R. Rep. No. 391, 100th Cong., 1st Sess. 1093-94 (1987))
  • The practitioner must analyze each provision separately and then reconcile the interaction. If § 269 applies, the IRS may disallow the loss offset entirely. If § 384 applies but § 269 does not, the limitation is strictly mechanical under the statute.
  • The government can raise both provisions as alternative theories in litigation. The practitioner should be prepared to defend against both even if only one appears relevant on initial review.
• The § 382 limitation operates independently and may overlap.
  • Where both § 382 and § 384 apply, the § 384 disallowance reduces the amount of taxable income against which preacquisition losses could otherwise be applied. The § 382 limitation then caps the remaining NOL utilization. (JCT, Description of TCA 1988, at 421) (Nugent, Tax Notes Federal (Sept. 18, 2023))
  • An ownership change under § 382 occurs when a corporation's 5-percent shareholders increase ownership by more than 50 percentage points over a 3-year testing period. (§ 382(g)) § 382 applies an annual limitation based on value and long-term tax-exempt rate. § 384 applies a categorical prohibition on offsetting preacquisition losses against RBIG.
  • § 384 may produce a more severe limitation than § 382 in cases where the gain corporation has substantial RBIG and the loss corporation has substantial preacquisition losses. (JCT, Description of TCA 1988, at 421) (Nugent, Tax Notes Federal (Sept. 18, 2023))
• Roadmap of this checklist.
  • Steps 1 through 2 address the scope of both provisions and the statutory architecture of § 384(a), including the general rule and its two acquisition types.
  • Steps 3 through 4 address threshold determinations for gain corporation status, NUBIG computation, and the RBIG presumption structure under § 384(c)(1).
  • Step 5 addresses the definition and computation of preacquisition losses under § 384(c)(3), including current-year NOL allocation.
  • Step 6 addresses stock acquisitions under § 384(a)(1)(A), including the control standard and acquisition date.
  • Steps 7 through 9 address asset acquisitions, the common control exception, and § 384(d)-(e) ordering rules.
  • Steps 10 through 12 address § 269(a)-(c), including the principal-purpose test and the § 269(b) liquidation rule.
  • Steps 13 through 15 address coordination with §§ 382 and SRLY, anti-abuse doctrines, and § 269 case law.
  • Steps 16 and 17 address planning considerations and documentation requirements.

Step 2. § 384(a) General Rule and Statutory Structure

§ 384(a) "For purposes of this chapter, in the case of an acquisition to which this section applies, the preacquisition loss of any old loss corporation or gain corporation for any recognition period taxable year (to the extent attributable to periods before the acquisition date) shall not be allowed-- (1) as an offset against the recognized built-in gain of any gain corporation or old loss corporation, as the case may be, for such taxable year, or (2) as a deduction against any income attributable to periods after the acquisition date."

The § 384(a) prohibition operates in two directions and applies to both parties of an acquisition.

• Preacquisition losses are barred from offsetting RBIG of the other party.
  • If Corporation A (with preacquisition losses) acquires Corporation B (a gain corporation), Corporation A's preacquisition losses cannot offset Corporation B's RBIG. This is the primary anti-abuse target that § 384 was enacted to prevent. (§ 384(a)(1)) (H.R. Rep. No. 391, 100th Cong., 1st Sess. 1093 (1987))
  • The House Report explained that Congress enacted § 384 to prevent "trafficking in built-in gains and losses" where a corporation with NOLs would acquire a corporation with appreciated assets and then use its NOLs to shelter the gain on disposition of those assets. (H.R. Rep. No. 391, 100th Cong., 1st Sess. 1093 (1987))
  • The prohibition applies regardless of whether the acquisition has a valid business purpose. § 384 is a mechanical limitation. Business purpose is relevant to § 269 but not to § 384.
• Preacquisition losses are barred from offsetting post-acquisition income of the other party.
  • Even if the gain corporation does not generate RBIG in a given year, the loss corporation's preacquisition losses cannot shelter post-acquisition income of the gain corporation. (§ 384(a)(2))
  • This second prong ensures that preacquisition losses cannot be used against any income of the gain corporation, not just recognized built-in gains. It closes a potential loophole where a gain corporation might generate non-RBIG income that the acquirer attempts to shelter with preacquisition losses.
  • The bar on offsetting post-acquisition income applies only to income of the gain corporation. If the loss corporation generates its own post-acquisition income, its preacquisition losses can offset that income subject to any § 382 limitation.
• The bar runs in both directions.
  • If Corporation B (gain corporation) instead acquires Corporation A (loss corporation), the same prohibition applies. Corporation B's preacquisition losses cannot offset Corporation A's RBIG. The statute refers to "the preacquisition loss of any old loss corporation or gain corporation" and offsets against "the recognized built-in gain of any gain corporation or old loss corporation, as the case may be." (§ 384(a)) (Nugent, Tax Notes Federal (Sept. 18, 2023))
  • This bidirectional structure is critical. It means the acquirer cannot evade § 384 by structuring the transaction so that the gain corporation is the acquirer rather than the target. The statute looks to the economic substance of the combination, not the formal acquisition direction.
  • The practitioner must identify the gain corporation and the loss corporation without regard to which is the acquirer and which is the target. The limitation applies based on status, not role in the transaction.
• Two acquisition types trigger § 384(a).
  • Stock acquisitions meeting the § 1504(a)(2) control test. An acquisition of stock of one corporation (the target) by another corporation (the acquirer) triggers § 384 if, immediately after the acquisition, the acquirer holds stock meeting the requirements of § 1504(a)(2). This requires ownership of stock possessing at least 80 percent of the total combined voting power and at least 80 percent of the total value of all classes of stock. (§ 384(a)(1)(A)) (§ 1504(a)(2))
  • Asset acquisitions in a § 381(a) reorganization. An acquisition of substantially all of the assets of one corporation by another corporation in a reorganization described in § 381(a) triggers § 384. (§ 384(a)(1)(B)) This covers Type A (statutory mergers), Type C (substantially all assets), and Type D (divisive) reorganizations. It also covers acquisitive reorganizations under § 368(a)(1)(A), (C), and (D) because § 381(a)(1) and § 381(a)(2) specify which reorganizations result in carryover.
  • Type B reorganizations are not covered by the asset acquisition rule. A pure Type B reorganization is a stock-for-stock acquisition. It does not involve an asset acquisition. Thus it does not trigger § 384 under § 384(a)(1)(B). However, a Type B reorganization may still trigger § 384 under the stock acquisition rule of § 384(a)(1)(A) if the acquiring corporation meets the § 1504(a)(2) control test after the transaction. (§ 384(a)(1)(A)) (Nugent, Tax Notes Federal (Sept. 18, 2023))
• No Treasury regulations have been issued under § 384 despite multiple delegations of authority.
  • Congress delegated regulatory authority in 1987 and 1988 but Treasury never acted. The Omnibus Budget Reconciliation Act of 1987 (OBRA 1987, P.L. 100-203) originally enacted § 384 and directed the Secretary to prescribe regulations. The Technical and Miscellaneous Revenue Act of 1988 (TAMRA 1988, P.L. 100-647) expanded the delegation. (H.R. Rep. No. 391, 100th Cong., 1st Sess. 1093-94 (1987))
  • Notice 92-12 confirmed no regulations forthcoming. The IRS announced in Notice 92-12, 1992-1 C.B. 16 I.R.B. 35, that it would not issue regulations under § 384 in the near future. As a result, practitioners must work directly from the statutory text, legislative history, and sparse administrative guidance. (Notice 92-12, 1992-16 I.R.B. 35) (Fairbanks, The Tax Adviser (Feb. 2023))
  • The absence of regulations creates interpretive uncertainty. Key questions remain unresolved. These include the proper method for allocating current-year NOLs between pre-acquisition and post-acquisition periods, the treatment of reverse triangular mergers, and the application of § 384 to consolidated groups. Letter rulings and technical advice have partially filled the gap but do not carry precedential weight. (Fairbanks, The Tax Adviser (Feb. 2023))

Step 3. Gain Corporation Status and NUBIG Determination

§ 384(c)(4) "The term 'gain corporation' means any corporation with a net unrealized built-in gain." § 384(c)(8) "The terms 'net unrealized built-in gain', 'net unrealized built-in loss', 'recognized built-in gain', 'recognized built-in loss', and 'recognition period taxable year' have the same respective meanings as when used in section 382(h), except that in applying such section for purposes of this section--" § 382(h)(3)(A) "The term 'net unrealized built-in gain' means the amount (if any) by which-- (i) the fair market value of the assets of the corporation immediately before the ownership change, exceeds (ii) the aggregate adjusted basis of such assets at such time."

The gain corporation threshold determination requires computing NUBIG as of the acquisition date.

• A corporation is a gain corporation if its NUBIG exceeds the de minimis threshold.
  • NUBIG is the amount by which the aggregate fair market value of the corporation's assets exceeds the aggregate adjusted basis of those assets immediately before the acquisition date. (§ 384(c)(4)) (§ 382(h)(3)(A), incorporated by § 384(c)(8)) This is an entity-level determination. It does not depend on the specific assets that will be sold or the timing of recognition.
  • The de minimis exception eliminates small amounts of built-in gain. § 382(h)(3)(B), incorporated by § 384(c)(8), provides that the NUBIG is treated as zero if it does not exceed the lesser of (1) $10,000,000 or (2) 15 percent of the fair market value of the corporation's assets. (§ 382(h)(3)(B)) This means a corporation with $9 million of built-in gain on $200 million of assets has no NUBIG for § 384 purposes because $9 million is less than both $10 million and 15 percent of $200 million ($30 million).
  • NUBIG computation requires a pre-acquisition date balance sheet and FMV appraisal. Because the statute compares FMV to adjusted basis, the practitioner needs both. The adjusted basis is drawn from the corporation's books and records. The FMV requires appraisals or other credible valuation evidence. The IRS can challenge both the valuation methodology and specific asset valuations. (Nugent, Tax Notes Federal (Sept. 18, 2023)) (Fairbanks, The Tax Adviser (Feb. 2023))
• § 384(c)(6) provides a single-entity rule for affiliated groups.
  • All members of the acquiring corporation's affiliated group are treated as a single corporation. § 384(c)(6) states that "all corporations which are members of the same affiliated group immediately before the acquisition date shall be treated as 1 corporation." (§ 384(c)(6)) This means the NUBIG of the entire pre-acquisition affiliated group is computed on an aggregate basis.
  • The affiliated group is defined by reference to § 1504(a). § 1504(a) generally includes corporations connected by at least 80 percent stock ownership (voting power and value), with the exclusions of § 1504(b) applying. (§ 384(c)(6)) (§ 1504(a)) This is the same control standard used for consolidated returns.
  • The single-entity rule prevents intra-group gain stripping. Without § 384(c)(6), a corporation could transfer appreciated assets to a newly formed subsidiary with zero basis, isolating the built-in gain in a separate entity. The single-entity rule aggregates all members, so pre-acquisition transfers within the group do not alter the aggregate NUBIG. (§ 384(c)(6)) (Nugent, Tax Notes Federal (Sept. 18, 2023))
• Accurate documentation of NUBIG is essential for both § 384 analysis and potential audit defense.
  • Maintain contemporaneous appraisals of all material assets. The NUBIG determination is only as reliable as the underlying valuations. Obtain independent qualified appraisals for real property, intangible assets, and any asset class where FMV materially exceeds book basis. (Nugent, Tax Notes Federal (Sept. 18, 2023))
  • Document the adjusted basis of each asset class. The basis side of the NUBIG computation is factual but can become complex if the corporation has undergone prior reorganizations, § 338 elections, or basis adjustments from partnership interests. Reconcile the adjusted basis schedule to the corporation's tax returns and financial statements. (Fairbanks, The Tax Adviser (Feb. 2023))
  • Recompute NUBIG if the acquisition structure changes. If the transaction is restructured from an asset acquisition to a stock acquisition (or vice versa), the acquisition date and the entity whose assets are being measured may change. This can affect whether the de minimis threshold is met and which affiliated group aggregation rule applies.

Step 4. Recognized Built-In Gain Under § 384(c)(1)

§ 384(c)(1) "For purposes of this section, in the case of a gain corporation, the recognized built-in gain of such corporation for any recognition period taxable year is-- (A) the amount of the gain recognized during such year on the disposition of any asset (except to the extent the gain corporation establishes that-- (i) such asset was not held by the gain corporation on the acquisition date, or (ii) such gain exceeds the unrealized built-in gain of such asset on the acquisition date), plus (B) the income which is properly taken into account for such year and which is attributable to periods before the acquisition date (to the extent the gain corporation establishes that the amount of such income does not exceed the unrealized built-in gain of the asset to which such income is attributable on the acquisition date), and reduced by (C) the amount (if any) of net unrealized built-in gain taken into account under subparagraphs (A) and (B) for prior taxable years ending after the acquisition date."

RBIG under § 384 uses a presumption structure opposite to § 382.

• All gain recognized during the recognition period is presumed to be RBIG unless rebutted.
  • Under § 384(c)(1)(A), any gain recognized by a gain corporation during the recognition period on the disposition of any asset is treated as RBIG. The gain corporation bears the burden of proving either that the asset was not held on the acquisition date or that the recognized gain exceeds the unrealized built-in gain on the acquisition date. (§ 384(c)(1)(A)) (Nugent, Tax Notes Federal (Sept. 18, 2023))
  • This is a rebuttable presumption favorable to the government. It is the mirror image of § 382(h)(2), which requires the IRS to prove that gain is attributable to pre-change built-in gain. Under § 384, the taxpayer must affirmatively disprove RBIG status.
  • The rebuttal is available on either of two grounds. First, the gain corporation can show the asset was not held on the acquisition date. This applies to post-acquisition acquisitions that are later sold at a gain. (§ 384(c)(1)(A)(i)) Second, the gain corporation can show the recognized gain exceeds the unrealized built-in gain on the acquisition date. This protects against treating post-acquisition appreciation as RBIG. (§ 384(c)(1)(A)(ii))
• Accrued income items under § 384(c)(1)(B) expand RBIG beyond asset dispositions.
  • Items of income attributable to pre-acquisition periods are treated as RBIG. § 384(c)(1)(B) reaches income items that are properly taken into account during the recognition period but that are attributable to periods before the acquisition date. This includes items such as cash-method receivables collected after the acquisition date, installment payments received on pre-acquisition sales, income recognized under the completed-contract method for contracts performed before the acquisition date, and § 481 adjustments triggered by accounting method changes made after the acquisition date. (§ 384(c)(1)(B)) (Fairbanks, The Tax Adviser (Feb. 2023))
  • The same rebuttal structure applies. The gain corporation can reduce the RBIG inclusion by showing the income amount exceeds the unrealized built-in gain of the underlying asset on the acquisition date. For a cash-basis receivable, the built-in gain is typically the full face amount (since basis is zero), so no rebuttal is available. For installment obligations, the built-in gain is the unrecognized gain inherent in the obligation at the acquisition date. (§ 384(c)(1)(B)) (Fairbanks, The Tax Adviser (Feb. 2023))
  • § 382 uses the opposite presumption. Under § 382(h)(2), gain recognized during the recognition period is RBIG only if it is attributable to an asset that had built-in gain at the ownership change date. The taxpayer does not need to prove the negative. § 384 deliberately inverts this burden. (§ 382(h)(2)) (§ 384(c)(1)(A)) (JCT, Description of TCA 1988, at 421)
• The NUBIG ceiling and the 5-year recognition period govern RBIG computation.
  • § 384(c)(1)(C) imposes a NUBIG ceiling. The total RBIG recognized across all recognition period taxable years cannot exceed the NUBIG as of the acquisition date. Once cumulative RBIG equals NUBIG, no further RBIG is recognized. (§ 384(c)(1)(C)) This operates as a lifetime cap, not an annual limitation. It prevents the total RBIG amount from exceeding the total unrealized appreciation that existed at the acquisition date.
  • RBIG is recognized only if it arises during the 5-year post-acquisition period. § 382(h)(7), incorporated by § 384(c)(8), defines the "recognition period" as the 5-year period beginning on the acquisition date. (§ 382(h)(7)) (§ 384(c)(8)) Gains recognized after this period are not RBIG and can be offset by preacquisition losses without § 384 restriction.
  • A "recognition period taxable year" is any taxable year any portion of which is in the recognition period. (§ 382(h)(7)) Thus a taxable year that straddles the end of the 5-year period is partially within the recognition period. Only gain recognized during the portion of the year within the 5-year window is potentially RBIG. The recognition period runs from the acquisition date, not the taxable year beginning date. For stock acquisitions, the acquisition date is the date control is acquired. For asset acquisitions, it is the date of the reorganization. (§ 384(c)(2))

Step 5. Preacquisition Loss Under § 384(c)(3)

§ 384(c)(3) "The term 'preacquisition loss' means-- (A) any net operating loss carryforward to the taxable year in which the acquisition date occurs (or which arises in a recognition period taxable year by reason of a loss recognized in a taxable year before the acquisition date), and (B) any net operating loss for the taxable year in which the acquisition date occurs to the extent such loss is allocable to the period in such year on or before the acquisition date. For purposes of subparagraph (B), the amount of net operating loss for any taxable year which is allocable to the period in such year on or before the acquisition date shall be determined without regard to recognized built-in gains or losses and shall be determined on a ratable basis unless the taxpayer establishes the amount of net operating loss attributable to such period on some other basis."

Preacquisition losses include both carryforward NOLs and current-year NOLs.

• NOL carryforwards from pre-acquisition taxable years are preacquisition losses.
  • Any NOL that arose in a taxable year ending before the acquisition date and that is carried forward to a recognition period taxable year is a preacquisition loss. This includes NOLs generated by the loss corporation in its ordinary course of business and NOLs inherited from subsidiaries in prior transactions. (§ 384(c)(3)(A))
  • Current-year NOLs must be bifurcated between pre-acquisition and post-acquisition periods. If the acquisition date falls mid-year, the taxable year in which the acquisition occurs is split. The portion of the year's NOL attributable to the period ending on the acquisition date is a preacquisition loss. The portion attributable to the period after the acquisition date is not. (§ 384(c)(3)(B))
  • The statute mandates ratable allocation absent regulations. § 384(c)(3)(B) states that the current-year NOL allocation "shall be determined on a ratable basis unless the taxpayer establishes the amount of net operating loss attributable to such period on some other basis." Because Treasury never issued regulations, this default ratable method remains the only statutorily prescribed approach. (§ 384(c)(3)(B)) (Notice 92-12, 1992-16 I.R.B. 35)
• Letter rulings permit closing-of-the-books allocation as an alternative to ratable allocation.
  • Closing-of-the-books is permissible if the taxpayer can substantiate the pre-acquisition results. LTR 201806005, LTR 200238017, and LTR 9027008 each permitted taxpayers to allocate the current-year NOL using a closing-of-the-books method rather than a strict ratable allocation. Under this approach, the taxpayer treats the acquisition date as a taxable year-end, computes income and deductions for the pre-acquisition period on that basis, and reports the resulting NOL as a preacquisition loss. (LTR 201806005) (LTR 200238017) (LTR 9027008)
  • The taxpayer bears the burden of establishing the closing-of-the-books results. The statutory language requires the taxpayer to "establish[] the amount of net operating loss attributable to such period on some other basis." A closing-of-the-books allocation requires actual books and records that clearly segregate pre-acquisition and post-acquisition income, deductions, gains, and losses. Unsupported estimates or pro rata extrapolations do not satisfy this standard. (§ 384(c)(3)(B)) (LTR 201806005)
  • Letter rulings are not precedential but reflect current IRS practice. Only the IRS National Office can issue letter rulings, and they indicate the Service's position on the specific facts presented. The consistent pattern across multiple rulings permitting closing-of-the-books allocation suggests this is a viable alternative where the taxpayer has adequate records. (LTR 201806005) (LTR 200238017) (LTR 9027008)
• Preacquisition losses may include RBIL items for NUBIL corporations.
  • The RBIL rule applies when a NUBIL corporation is involved in the transaction. § 384(c)(3)(B) provides that for a corporation with a net unrealized built-in loss, any recognized built-in loss (RBIL) during the recognition period is treated as a preacquisition loss. This ensures symmetric treatment. Built-in losses are walled off from offsetting RBIG or post-acquisition income of the other party, just as preacquisition NOLs are walled off. (§ 384(c)(3)(B))
  • The RBIL rule applies only to NUBIL corporations, not to all loss corporations. A corporation must have a net unrealized built-in loss exceeding the de minimis threshold (the lesser of $10 million or 15 percent of FMV, by analogy to § 382(h)(3)(B)) for RBIL to be treated as preacquisition loss. (§ 384(c)(3)(B)) (§ 382(h)(3)(B), incorporated by analogy through § 384(c)(8))
  • TAM 200447037 illustrates the combined group approach to preacquisition losses. In TAM 200447037, the IRS addressed a situation involving a consolidated group and held that the preacquisition losses of the group must be analyzed on a combined basis. The TAM treated the acquiring group's preacquisition losses as aggregated for purposes of applying the § 384 limitation, consistent with the single-entity rule of § 384(c)(6) for NUBIG determination. (TAM 200447037)

TRAP. The closing-of-the-books method is available only if the taxpayer can produce contemporaneous books and records that clearly reflect the pre-acquisition period's income and deductions. A taxpayer that lacks such records is relegated to ratable allocation, which may produce a materially different (and often less favorable) preacquisition loss amount.

Step 6. Stock Acquisitions Under § 384(a)(1)(A)

§ 384(a)(1)(A) "Any acquisition by a corporation of stock of another corporation which, but for this section, would result in an ownership change (as defined in section 382(g)) of such other corporation and which would result in the acquiring corporation meeting the requirements of section 1504(a)(2) with respect to such other corporation." § 1504(a)(2) "Stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock ..."

The stock acquisition rule requires both an ownership change under § 382(g) and satisfaction of the § 1504(a)(2) control test.

• The § 382(g) ownership change requirement acts as a threshold filter.
  • The statutory text refers to an acquisition that "but for this section, would result in an ownership change (as defined in section 382(g))." (§ 384(a)(1)(A)) An ownership change under § 382(g) occurs when the percentage of stock owned by one or more 5-percent shareholders increases by more than 50 percentage points over the lowest percentage owned at any time during the preceding 3-year testing period. (§ 382(g)) This requirement narrows the scope of § 384(a)(1)(A) to acquisitions significant enough to trigger § 382.
  • The acquiring corporation must also satisfy the § 1504(a)(2) control test. Immediately after the acquisition, the acquiring corporation must hold stock possessing at least 80 percent of the total combined voting power and at least 80 percent of the total value of all classes of stock of the target. (§ 384(a)(1)(A)) (§ 1504(a)(2)) Both prongs (voting power and value) must be met. Ownership of nonvoting preferred stock alone does not satisfy this test.
  • The acquisition can be direct or indirect through one or more intervening corporations. The statute contemplates an acquisition "through 1 or more other corporations." (§ 384(a)(1)(A)) This covers situations where the acquiring corporation causes a subsidiary to acquire the target stock, or where a multi-tier acquisition structure is used. FSA 200125007 addressed the aggregation of stock held through multiple entities for purposes of determining whether the control test is met. (FSA 200125007)
• The acquisition date for stock acquisitions is the date control is acquired.
  • § 384(c)(2)(A) defines the acquisition date for stock acquisitions. The acquisition date is "the first day on which there is an acquisition by the acquiring corporation described in subsection (a)(1)(A)." (§ 384(c)(2)(A)) This is the date the acquiring corporation first satisfies both the § 382(g) ownership change requirement and the § 1504(a)(2) control test with respect to the target.
  • The acquisition date may differ from the closing date of the transaction. If control is acquired in stages, the acquisition date is the date the cumulative acquisitions first trigger both the ownership change and the control test. This may be earlier than the final closing if prior purchases plus the final purchase collectively trigger the thresholds. (§ 384(c)(2)(A)) (FSA 200125007)
  • The acquisition date determines the recognition period and the NUBIG measurement date. The 5-year recognition period under § 382(h)(7) begins on the acquisition date. The NUBIG is measured immediately before the acquisition date. (§ 384(c)(2)(A)) (§ 382(h)(3)(A), incorporated by § 384(c)(8)) These two dates are functionally the same moment for stock acquisitions.
• Reverse triangular mergers and other acquisitive structures.
  • Reverse triangular mergers are treated as stock acquisitions for § 384 purposes. In a reverse triangular merger, the target corporation survives as a subsidiary of the acquiring corporation. The acquisition is effected by a merger of a subsidiary of the acquirer into the target, with the target shareholders exchanging their stock for stock of the acquirer. Because the target corporation remains in existence and the acquiring corporation ends up holding its stock, this structure triggers the stock acquisition rule of § 384(a)(1)(A) rather than the asset acquisition rule. (Nugent, Tax Notes Federal (Sept. 18, 2023))
  • The control test is applied after the merger. If the acquiring corporation holds at least 80 percent of the voting power and value of the surviving target immediately after the reverse triangular merger, § 384(a)(1)(A) applies. The NUBIG is measured with respect to the target's assets immediately before the merger. The preacquisition losses are those of the acquiring corporation (or its affiliated group). (§ 384(a)(1)(A)) (§ 1504(a)(2))
  • Type B reorganizations are explicitly stock acquisitions. A Type B reorganization under § 368(a)(1)(B) is solely an exchange of voting stock of the acquiring corporation for stock of the target corporation, with the acquiring corporation obtaining control of the target. Because no assets are acquired, § 384(a)(1)(B) (the asset acquisition rule) does not apply. However, § 384(a)(1)(A) does apply if the control test is met. (§ 368(a)(1)(B)) (§ 384(a)(1)(A)) (Nugent, Tax Notes Federal (Sept. 18, 2023))

CAUTION. § 384(a)(1)(A) contains the parenthetical phrase "but for this section" in reference to the § 382(g) ownership change requirement. The meaning of this phrase is uncertain because § 384 does not override § 382. The most plausible reading is that the ownership change is determined under normal § 382(g) principles, without any special modification from § 384. The practitioner should apply the standard § 382(g) ownership change analysis to determine whether this prong is satisfied. (§ 384(a)(1)(A)) (§ 382(g))

Step 7. Asset Acquisitions and the Successor Rule

§ 384(a)(1)(B). This section shall apply in the case of any acquisition of assets of a corporation in a reorganization described in subparagraph (A), (C), or (D) of section 368(a)(1).

Step 7A. Reorganization Types Covered as Asset Acquisitions

• Type A statutory mergers. A statutory merger or consolidation under § 368(a)(1)(A) constitutes a covered asset acquisition.
  • In a Type A reorganization, the target corporation merges into the acquiring corporation under state or federal law, and the target ceases to exist as a separate entity. The acquiring corporation succeeds to all of the target's assets and tax attributes by operation of law. (§ 368(a)(1)(A))
  • The Supreme Court has characterized the Type A reorganization as a true fusion of corporate entities in which one corporation absorbs another. The continuity of business enterprise and continuity of interest requirements apply. (§ 384(a)(1)(B)) (§ 368(a)(1)(A))
• Type C asset acquisitions. An acquisition of substantially all of the properties of a target corporation for voting stock constitutes a covered asset acquisition.
  • The acquiring corporation must obtain substantially all of the target's assets in exchange for its voting stock or the voting stock of its parent corporation. The boot relaxation rule of § 368(a)(2)(B) permits limited other consideration without disqualifying the reorganization. (§ 384(a)(1)(B)) (§ 368(a)(1)(C)) (§ 368(a)(2)(B))
  • The substantially all test generally requires the acquiring corporation to obtain at least 90 percent of the fair market value of the target's net assets and at least 70 percent of the fair market value of the target's gross assets. Satisfaction of the continuity of interest requirement is independently required. (§ 368(a)(1)(C))
• Type D reorganizations. A transfer of all or part of a corporation's assets to another controlled corporation constitutes a covered asset acquisition.
  • A Type D reorganization under § 368(a)(1)(D) involves a transfer of assets by a corporation to another corporation controlled immediately after the transfer by the transferor or its shareholders. Both acquisitive and divisive transactions may qualify. (§ 384(a)(1)(B)) (§ 368(a)(1)(D))
  • The acquiring corporation takes a carryover basis in the transferred assets, and the transferor corporation's tax attributes may be subject to § 384 limitation. The control requirement means the transferor shareholders must retain a substantial equity stake in the transferee.

Step 7B. Reorganization Types Excluded From Asset Acquisition Coverage

• Type B stock acquisitions are excluded. A Type B reorganization under § 368(a)(1)(B) does not constitute a covered asset acquisition.
  • In a Type B reorganization, the acquiring corporation exchanges solely voting stock for control of the target, and the target remains in existence as a subsidiary. Because the target retains its corporate identity, assets, and tax attributes, there is no asset acquisition. (§ 368(a)(1)(B))
  • A Type B reorganization is instead treated as a stock acquisition under § 384(a)(1)(A) if the acquiring corporation obtains at least 80 percent of the total combined voting power and 80 percent of the total value of the target's stock. The built-in loss limitation applies only if the stock acquisition threshold is met. (§ 384(a)(1)(A))
• Type F reorganizations are excluded. A Type F reorganization under § 368(a)(1)(F) falls outside § 384(a)(1)(B).
  • A Type F reorganization is a mere change in identity, form, or place of organization of a single corporation. Because no assets are transferred from one corporation to another, there is no acquisition of assets to which built-in losses could attach. (§ 368(a)(1)(F))
  • The same corporation continues in modified form after a Type F reorganization, and no new entity acquires built-in losses from a separate predecessor. § 384 does not apply to the transaction. (§ 368(a)(1)(F))

Step 7C. Removal of § 332 Liquidations by TAMRA

• Original coverage and subsequent amendment. § 384(a)(1)(B) originally applied to complete liquidations under § 332.
  • As enacted in 1987, § 384(a)(1)(B) applied to any acquisition of assets of a corporation in a complete liquidation to which § 332 applied. A subsidiary liquidation into its parent was treated as a covered asset acquisition subject to the built-in loss limitation. (§ 384(a)(1)(B), prior to TAMRA amendment)
  • The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) removed § 332 liquidations from § 384(a)(1)(B) effective for acquisitions after December 15, 1987. Congress concluded that parent-subsidiary liquidations should not trigger the built-in loss limitation. (TAMRA 1988)
• Current treatment of subsidiary liquidations. A § 332 liquidation is no longer subject to § 384 as an asset acquisition.
  • In a current § 332 liquidation, the parent corporation takes a carryover basis in the subsidiary's assets under § 334(b)(1), and the subsidiary's tax attributes generally survive at the parent level. The built-in loss limitation of § 384 does not apply to the liquidation itself. (§ 332(a)) (§ 334(b)(1))
  • This statutory exclusion creates a significant planning opportunity. A loss subsidiary may be liquidated into its parent without triggering the five-year RBIG limitation. The successor rule of § 384(c)(7) may still apply if the parent is subsequently acquired. (§ 384(c)(7))

Step 7D. The Predecessor and Successor Rule

§ 384(c)(7). For purposes of this section, any reference to a corporation shall be treated as including a reference to a predecessor or successor of such corporation.

• Operation and purpose of the successor rule. § 384(c)(7) expands every reference to a corporation in § 384 to include predecessors and successors.
  • The rule ensures that built-in loss limitations follow the corporate entity through subsequent reorganizations, liquidations, and structural changes. A corporation that succeeds to another corporation's assets and attributes is treated as the same corporation for § 384 purposes. (§ 384(c)(7))
  • The rule prevents taxpayers from avoiding § 384 through intervening transactions that change corporate identity without altering economic substance. Mergers, consolidations, and divisive reorganizations cannot be used to cleanse a corporation of built-in loss limitations. (§ 384(c)(7))
• Application to section 332 liquidations after TAMRA. The successor rule may cause § 384 to apply where a parent corporation that liquidated a loss subsidiary is subsequently acquired.
  • If the parent corporation is treated as a successor to the liquidated subsidiary under § 384(c)(7), the subsidiary's built-in losses may be subject to limitation in the parent's hands after the parent's acquisition. The analysis requires tracing the chain of corporate successors to determine whether loss attributes have been transmitted. (§ 384(c)(7))
  • This application is limited and fact-specific. The successor rule does not resurrect § 384(a)(1)(B) for the liquidation itself but may affect the analysis of a subsequent acquisition of the parent corporation. (§ 384(c)(7))
• Mergers into unrelated corporations. The successor rule clearly applies where a loss corporation merges into an unrelated corporation.
  • Where a corporation with built-in losses merges into an unrelated corporation in a statutory merger, the surviving corporation is a successor to the loss corporation. The five-year recognition period and built-in loss limitation apply to the surviving corporation as if it were the original loss corporation. (§ 384(c)(7)) (§ 368(a)(1)(A))
  • The rule prevents a loss corporation from merging into a profitable corporation as a means of unlocking pre-acquisition losses. The surviving corporation's RBIG is measured by reference to the predecessor's built-in gain assets. (Coastal Oil Storage Co. v. Commissioner, 242 F.2d 396 (4th Cir. 1957) (corporate predecessor doctrine applied for tax attribute tracing))

Step 7E. Triangular Reorganizations Under § 384

• Forward triangular mergers as asset acquisitions. A forward triangular merger under § 368(a)(2)(D) is treated as an asset acquisition.
  • In a forward triangular merger, the target corporation merges into a subsidiary of the acquiring corporation, with the subsidiary surviving the transaction. Because the target's assets are acquired by the subsidiary in a statutory merger, § 384(a)(1)(B) applies. (§ 368(a)(2)(D)) (§ 384(a)(1)(B))
  • The acquiring corporation's ownership of the surviving subsidiary does not alter the asset acquisition character. The target's built-in losses are limited to the subsidiary's RBIG for the five-year recognition period. The subsidiary is treated as the acquiring corporation for § 384 purposes. (§ 368(a)(2)(D))
• Reverse triangular mergers as stock acquisitions. A reverse triangular merger under § 368(a)(2)(E) is treated as a stock acquisition.
  • In a reverse triangular merger, a subsidiary of the acquiring corporation merges into the target corporation, with the target surviving as a subsidiary of the acquiring corporation. Because the target retains its corporate identity and assets, the transaction does not constitute an asset acquisition. (§ 368(a)(2)(E))
  • The transaction is classified as a stock acquisition under § 384(a)(1)(A). The built-in loss limitation applies only if the acquiring corporation obtains at least 80 percent of the total combined voting power and 80 percent of the total value of the target's stock. The target's losses remain subject to any pre-existing § 382 limitations. (§ 384(a)(1)(A)) (§ 368(a)(2)(E))

Step 8. The Common Control Exception

§ 384(b)(1). This section shall not apply to any acquisition if, immediately after such acquisition, both the acquiring corporation and the acquired corporation (or in the case of an acquisition of assets, the corporation to which the assets are transferred) are members of the same controlled group (as defined in paragraph (2)).

Step 8A. The Five-Year Common Control Requirement

• General exception rule. § 384(b)(1) provides an exception when both parties are members of the same controlled group.
  • The exception applies only if the acquiring corporation and the acquired corporation have been members of the same controlled group for a five-year period ending on the acquisition date. Both corporations must remain members immediately after the acquisition. (§ 384(b)(1))
  • The exception prevents § 384 from applying to internal restructurings within an existing affiliated group. Where the same economic owners have controlled both corporations for five years, there is no meaningful trafficking of losses to new ownership. (§ 384(b)(1))
• Shorter period rule. § 384(b)(3) modifies the five-year requirement for recently formed corporations.
  • If either corporation was not in existence throughout the entire five-year period, the exception applies only if both corporations have been members of the same controlled group for the entire period that the shorter-lived corporation has been in existence. (§ 384(b)(3))
  • A corporation that is a successor to another corporation under § 384(c)(7) is treated as having been in existence during the period the predecessor was in existence. This prevents the formation of new corporations to restart the five-year clock. (§ 384(b)(3)) (§ 384(c)(7))

Step 8B. Three Critical Modifications to § 1563(a)

§ 384(b)(2). For purposes of paragraph (1), the term "controlled group" means a controlled group of corporations as defined in section 1563(a), except that (A) "more than 50 percent" shall be substituted for "at least 80 percent" each place it appears in section 1563(a)(1), and (B) section 1563(a)(1) shall be applied by substituting "the stock of each of such corporations" for "the total combined voting power of all classes of stock entitled to vote".

• Reduced ownership threshold. § 384(b)(2)(A) lowers the controlled group ownership threshold.
  • The statute substitutes "more than 50 percent" for "at least 80 percent" each place the 80-percent threshold appears in § 1563(a)(1). An affiliated group that would not qualify as a controlled group under § 1504 may nonetheless satisfy the more-than-50-percent test. (§ 384(b)(2)(A))
  • The lower threshold reflects congressional intent to apply the exception broadly to economically integrated corporations. A parent corporation that owns 51 percent of two subsidiaries may qualify for the § 384 exception even though the group is not a § 1504 affiliated group. (§ 384(b)(2)(A))
• Dual stock requirement. § 384(b)(2)(B) requires satisfaction of both a voting power and value test.
  • The modification requires that the more-than-50-percent ownership test be satisfied with respect to both the voting power and the value of the stock of each corporation. The statute achieves this by referencing "the stock of each of such corporations." (§ 384(b)(2)(B))
  • Unlike § 1563(a)(1), which permits satisfaction through voting power alone, the § 384 exception requires the same controlling shareholders to own more than 50 percent of both voting power and value. Complex capital structures with multiple stock classes must be analyzed carefully. (§ 384(b)(2)(B))
• Exclusion of family attribution. § 384(b)(2)(C) excludes § 1563(a)(4) from application.
  • § 1563(a)(4) would otherwise treat stock owned by a member of a family as owned by other family members. By excluding this provision, the § 384 exception requires direct stock ownership by common controlling interests. (§ 384(b)(2)(C))
  • Family members who do not actually coordinate their ownership cannot qualify for the exception. The exclusion prevents unrelated family members from aggregating their ownership to meet the more-than-50-percent threshold. (§ 384(b)(2)(C))

Step 8C. Planning Implications of the Exception

• Internal restructurings within existing groups. The exception facilitates tax-efficient internal reorganizations.
  • A parent corporation may merge a loss subsidiary into a profitable subsidiary without triggering § 384 if both have been under common control for five years. Asset acquisitions, mergers, and other covered transactions between group members are shielded. (§ 384(b)(1))
  • The exception applies regardless of the relative size of the built-in losses. A group member with substantial built-in losses may be merged into a group member with substantial RBIG without the five-year limitation. (§ 384(b)(1))
• Trap of the dual stock requirement. Complex capital structures may defeat the exception.
  • Preferred stock with limited voting rights but substantial liquidation value may cause a failure of the dual test. If the controlling shareholders own more than 50 percent of voting power but less than 50 percent of total value, the exception does not apply. (§ 384(b)(2)(B))
  • Nonqualified preferred stock and stock subject to options, warrants, or convertible debt must be included in the value calculation. Practitioners must verify actual direct ownership percentages in both voting power and value for all outstanding classes. (§ 384(b)(2)(B))
• Shortened period for new entities. Newly formed corporations cannot immediately access the exception.
  • If a loss corporation is formed and immediately acquired by an existing group, the exception does not apply because the loss corporation has not been a group member for the requisite period. The rule prevents formation of shell loss corporations within existing groups. (§ 384(b)(3))
  • The practitioner must verify the formation dates and group membership history of both corporations before relying on the exception. A representation and warranty regarding group membership history should be included in acquisition agreements. (§ 384(b)(3))

Step 9. Credits, Capital Losses, and Ordering Rules

Step 9A. Extension to Excess Credits and Net Capital Losses

• Application to excess credits. § 384(d) extends similar rules to excess credit carryovers.
  • An excess credit is defined in § 383(a)(2) as unused general business credits under § 39 plus unused minimum tax credits under § 53. The credit carryover is subject to the same five-year recognition period and RBIG offset mechanism that applies to NOL carryforwards. (§ 384(d)) (§ 383(a)(2)) (§ 39) (§ 53)
  • The acquiring corporation may use the target's excess credits only to the extent of RBIG recognized by the target during the five-year post-acquisition period. Credits that cannot be used due to the RBIG limitation are carried forward within the constraints of their original carryover periods. (§ 384(d))
• Application to net capital losses. § 384(d) also extends similar rules to net capital loss carryovers.
  • A pre-acquisition net capital loss of the target may be carried forward and used only against recognized built-in capital gain of the target during the five-year recognition period. The RBIG measured for capital loss purposes is limited to recognized built-in capital gain from assets held at the acquisition date. (§ 384(d)) (§ 1212)
  • Capital losses are separately stated under § 1212 and may not offset ordinary income. The § 384(d) limitation applies independently to capital loss carryovers. The practitioner must track capital gain RBIG separately from ordinary income RBIG. (§ 384(d)) (§ 1212)
• Interaction with section 383 credit limitation. Both § 383(a) and § 384(d) may limit credit utilization.
  • § 383(a) independently limits excess credits by imposing a tax liability limitation based on the corporation's hypothetical tax without the credit. § 384(d) operates as a further restriction in the acquisition context. (§ 383(a)) (§ 384(d))
  • Even if a corporation has sufficient tax liability to absorb excess credits under § 383(a), § 384(d) may deny the credit if the corporation lacks adequate RBIG from the loss corporation. The practitioner must apply both limitations sequentially. (§ 383(a)) (§ 384(d))

Step 9B. Carryover and Ordering Rules

• RBIG exclusion from section 172(b)(2) computation. § 384(e)(1) modifies the NOL carryover computation.
  • RBIG shall not be taken into account for purposes of determining the amount of any NOL carryover under § 172(b)(2). § 172(b)(2) requires that taxable income for a carryover year be computed without regard to the NOL deduction itself. (§ 384(e)(1)) (§ 172(b)(2))
  • By excluding RBIG from this computation, § 384(e)(1) ensures that RBIG does not reduce the acquiring corporation's own NOL carryforwards. RBIG is allocated exclusively to the pre-acquisition loss limitation under § 384(a) and is unavailable for other absorption purposes. (§ 384(e)(1))
• Ordering rule for limited and unlimited losses. § 384(e)(2) establishes a loss utilization sequence.
  • When both limited pre-acquisition losses and unlimited post-acquisition losses arise in the same taxable year, the limited pre-acquisition losses must be used before the unlimited post-acquisition losses from the same year. (§ 384(e)(2))
  • This ordering rule maximizes the utilization of constrained losses while preserving the more flexible post-acquisition losses for future years. Post-acquisition losses that are not subject to § 384 retain their character and carryforward period under § 172. (§ 384(e)(2)) (§ 172)
• Practical application of the ordering rule. The rule requires careful tracking of loss categories.
  • If RBIG exceeds pre-acquisition losses, the excess RBIG does not carry over to absorb post-acquisition losses from the same year. The RBIG cap is a ceiling on pre-acquisition loss usage, not a pool of income available to absorb other losses. (§ 384(e)(2))
  • Post-acquisition losses retain their character as unlimited losses and may be used without RBIG limitation in subsequent years. The practitioner must maintain separate schedules for pre-acquisition and post-acquisition losses to ensure correct ordering. (§ 384(e)(2)) (§ 172)

Step 10. General Rule and Acquisition Types Under § 269(a)

§ 269(a). If (1) any person or persons acquire, or acquired on or after October 22, 1968, directly or indirectly, control of a corporation, or (2) any corporation acquires, or acquired on or after October 22, 1968, directly or indirectly, property of another corporation (not controlled, directly or indirectly, immediately before such acquisition, by such acquiring corporation or its stockholders), the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation, and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then the deduction, credit, or other allowance shall not be allowed.

Step 10A. Two Acquisition Types

• Stock acquisition with control. The first acquisition type under § 269(a)(1) is a stock acquisition.
  • Control for § 269 purposes means ownership of stock possessing at least 50 percent of the total combined voting power, or at least 50 percent of the total value of shares of all classes of stock. This threshold is lower than the 80 percent test in many other Code provisions. (§ 269(a)(1)) (Treas. Reg. § 1.269-1(b))
  • Multiple acquiring persons are aggregated for purposes of the 50-percent test. An acquisition by a group of related purchasers is treated as a single acquisition. Indirect acquisitions through partnerships, trusts, or other entities are included. (§ 269(a)(1))
• Asset acquisition with carryover basis. The second acquisition type under § 269(a)(2) is an asset acquisition.
  • The acquiring corporation must obtain property of another corporation where the basis in the hands of the acquiring corporation is determined by reference to the basis in the hands of the transferor. The carryover basis requirement links § 269(a)(2) to nonrecognition transactions. (§ 269(a)(2))
  • The target corporation must not have been controlled by the acquiring corporation or its stockholders immediately before the acquisition. This provision covers acquisitions by merger, consolidation, liquidation, and direct asset purchase with carryover basis. (§ 269(a)(2))
• Simultaneous application of both acquisition types. A single transaction may satisfy both prongs of § 269(a).
  • A triangular merger may involve both the acquisition of control of a target and the acquisition of the target's assets with a carryover basis. The IRS may rely on either or both prongs to disallow claimed benefits. (§ 269(a)(1)) (§ 269(a)(2))
  • The practitioner must analyze both acquisition types independently. A failure to satisfy the control test for the stock acquisition prong does not preclude application of the asset acquisition prong if carryover basis property is acquired. (§ 269(a))

Step 10B. The Principal Purpose Standard

• Statutory scope of tax avoidance purpose. § 269(a) applies only when tax avoidance is the principal purpose.
  • The purpose need not be illegal or fraudulent. Lawful tax reduction may trigger § 269 if it is the principal purpose. The standard is intent-based but proven through objective factors surrounding the transaction. (§ 269(a)) (Treas. Reg. § 1.269-3(a))
  • The statutory language requires both an objective acquisition of control or carryover-basis property and a subjective principal purpose of tax avoidance. Both elements must be present for § 269 to apply. (§ 269(a))
• Deduction, credit, or other allowance broadly defined. Treasury Regulation § 1.269-1(a) defines the scope of disallowed benefits.
  • The term "allowance" includes any reduction of tax liability authorized by the Code. The term encompasses deductions, credits, exclusions from gross income, preferential rates, and deferral provisions. (Treas. Reg. § 1.269-1(a))
  • Courts have applied § 269 to NOL deductions, capital loss carryovers, investment tax credits, depreciation deductions, and subchapter S elections. The breadth of the definition means that virtually any tax benefit obtained through an acquisition may fall within § 269's scope. (Treas. Reg. § 1.269-1(a)) (Briarcliff Candy Corp. v. Commissioner, T.C. Memo. 1987-487 (§ 269 is broadly drafted and intended to cover a wide range of tax-motivated acquisitions))
• Formation of a corporation as acquisition of control. Treasury Regulation § 1.269-1(c) extends § 269 to incorporation transactions.
  • The organization of a new corporation and the transfer of properties to it is treated as an acquisition of control by the transferors. This regulation extends § 269 to § 351 exchanges and transfers to newly formed corporations. (Treas. Reg. § 1.269-1(c))
  • A taxpayer who incorporates a business with existing loss or credit attributes may face § 269 challenge if the principal purpose was tax avoidance. The regulation prevents taxpayers from using the incorporation mechanism to obtain tax benefits that would not be available in unincorporated form. (Treas. Reg. § 1.269-1(c))

Step 11. The Principal Purpose Test Under § 269

Treas. Reg. § 1.269-3(a). In determining the principal purpose for the acquisition of control or property, the purpose to evade or avoid Federal income tax by securing the benefit of the deduction, credit, or other allowance which would otherwise not be enjoyed need not be the sole purpose. The principal purpose is the purpose of first importance. If the purpose to evade or avoid Federal income tax exceeds in importance any other purpose, it is the principal purpose.

Step 11A. The Principal Purpose Framework

• Tax purpose need not be the sole purpose. The principal purpose test is comparative, not exclusive.
  • Treasury Regulation § 1.269-3(a) expressly provides that the tax-avoidance purpose need not be exclusive. An acquisition may have multiple legitimate business purposes and still violate § 269 if the tax-avoidance purpose is the purpose of first importance. (Treas. Reg. § 1.269-3(a))
  • Courts weigh the relative importance of tax and non-tax motivations. The inquiry focuses on whether the tax purpose exceeds in importance any other single purpose, not whether it outweighs all other purposes combined. (Rocco, Inc. v. Commissioner, 72 T.C. 140 (1979) (tax purpose need not be sole purpose but must be principal))
• Objective factors considered by courts. Courts rely on objective factors to infer subjective intent.
  • The presence of a substantial business purpose may negate a finding of principal tax purpose. Relevant factors include the existence of a legitimate business reason for the transaction, the economic substance, whether the acquiring corporation continued the target's business, and whether the transaction was structured in an unusual manner. (Ach v. Commissioner, 358 F.2d 342 (6th Cir. 1966) (beneficial ownership analysis relevant to principal purpose))
  • The timing of the acquisition relative to the emergence of losses is a critical factor. Acquisition of a corporation shortly before or after the accumulation of substantial losses creates a strong inference of tax-avoidance purpose. (Borge v. Commissioner, 405 F.2d 673 (2d Cir. 1968) (anticipation of losses by acquiring corporation supported § 269 finding))

Step 11B. Indicative Transactions and Regulatory Presumptions

• Transactions indicative of tax avoidance purpose. Treasury Regulation § 1.269-3(b) identifies suspect patterns.
  • Acquisitions of corporations with substantial unused loss or credit carryovers where the acquiring corporation lacks a business need for the target's assets or operations are indicative of tax avoidance. Acquisitions followed by liquidation and discontinuation of the target's business also suggest improper purpose. (Treas. Reg. § 1.269-3(b))
  • Treasury Regulation § 1.269-3(c) adds that the acquisition of a corporation with accumulated losses followed by a change in its business may indicate tax-avoidance purpose. An acquiring corporation that purchases a loss company and immediately changes its line of business faces heightened scrutiny. (Treas. Reg. § 1.269-3(c))
• § 382(l)(5) bankruptcy presumption. Treasury Regulation § 1.269-3(d) creates a rebuttable presumption.
  • The regulation presumes that the principal purpose of an acquisition is tax avoidance when the acquisition occurs in connection with a bankruptcy reorganization to which § 382(l)(5) applies. § 382(l)(5) allows a corporation emerging from bankruptcy to retain NOL carryforwards without an ownership change limitation if qualified creditors retain at least 50 percent of the stock. (Treas. Reg. § 1.269-3(d)) (§ 382(l)(5))
  • The taxpayer bears the burden of rebutting the presumption by demonstrating a substantial non-tax purpose for the acquisition. The presumption reflects congressional and administrative concern about trafficking in bankruptcy-generated losses. (Treas. Reg. § 1.269-3(d))
• Western Hemisphere Trade Corp benefit. Rev. Rul. 70-238 illustrates the breadth of § 269.
  • A domestic corporation acquired control of a foreign corporation and transferred its export business to obtain Western Hemisphere Trade Corporation status under § 921 and a reduced tax rate. The IRS ruled that the principal purpose was tax avoidance and disallowed the benefit. (Rev. Rul. 70-238, 1970-1 C.B. 61)
  • The ruling demonstrates that § 269 applies to rate benefits and structural elections, not just loss deductions. The specific tax benefit sought was lawfully available under the Code but was denied because the acquisition was structured solely to obtain it. (Rev. Rul. 70-238, 1970-1 C.B. 61)
• Subchapter S election benefit. Rev. Rul. 76-363 applies § 269 to passthrough benefits.
  • The acquiring corporation purchased stock of a target and caused the target to elect subchapter S status to pass through losses to individual shareholders. The IRS ruled that the principal purpose was to obtain the subchapter S benefit and disallowed the election's effect. (Rev. Rul. 76-363, 1976-2 C.B. 90)
  • The ruling demonstrates that § 269 applies to benefits flowing to shareholders rather than the corporation itself. An acquisition structured to obtain a tax election that the shareholders could not otherwise utilize violates § 269. (Rev. Rul. 76-363, 1976-2 C.B. 90)

Step 11C. The Deliberate Granting Exception and Circuit Split

• The conscious purpose exception from Rocco. Rocco establishes a narrow exception for congressionally intended benefits.
  • In Rocco, Inc. v. Commissioner, 72 T.C. 140 (1979), the Tax Court held that § 269 does not apply when the tax benefit was consciously and deliberately granted by Congress. The taxpayer acquired a corporation with an unused investment tax credit and claimed the credit. The court found that Congress specifically designed the credit carryover provisions to encourage investment by profitable corporations in credits generated by other entities. (Rocco, Inc. v. Commissioner, 72 T.C. 140 (1979))
  • The deliberate granting exception applies only where the Code provision at issue specifically contemplates the transfer of tax benefits through acquisition. General loss or credit carryover provisions do not trigger the exception. (Rocco, Inc. v. Commissioner, 72 T.C. 140 (1979))
• Modern Home and the subchapter S context. Modern Home addresses the scope of the exception.
  • In Modern Home Fire & Casualty Ins. Co. v. Commissioner, 54 T.C. 839 (1970), the Tax Court considered whether the deliberate granting exception applied to subchapter S elections. The court distinguished between the general availability of subchapter S and an acquisition structured solely to obtain that benefit. (Modern Home Fire & Casualty Ins. Co. v. Commissioner, 54 T.C. 839 (1970))
  • Modern Home is frequently cited alongside Rocco for the proposition that not every tax-motivated acquisition violates § 269. The case emphasizes that the principal purpose inquiry requires examining whether Congress intended to encourage the particular transaction. (Modern Home Fire & Casualty Ins. Co. v. Commissioner, 54 T.C. 839 (1970))
• Circuit split on post-acquisition losses. Courts are divided on whether § 269 applies to post-acquisition losses.
  • The First Circuit in R.P. Collins Inv. Co. v. Commissioner, 3 F.3d 554 (1st Cir. 1993), the Seventh Circuit in Luke v. Commissioner, 351 F.2d 568 (7th Cir. 1965), the Fifth Circuit in Hall Paving Co. v. Commissioner, 263 F.2d 253 (5th Cir. 1959), and the Second Circuit in Borge v. Commissioner, 405 F.2d 673 (2d Cir. 1968), have held or suggested that § 269 may apply to post-acquisition losses if the principal purpose of the acquisition was to create a structure that would generate future tax benefits. (R.P. Collins Inv. Co. v. Commissioner, 3 F.3d 554 (1st Cir. 1993)) (Luke v. Commissioner, 351 F.2d 568 (7th Cir. 1965)) (Hall Paving Co. v. Commissioner, 263 F.2d 253 (5th Cir. 1959)) (Borge v. Commissioner, 405 F.2d 673 (2d Cir. 1968))
  • The Third Circuit in Herculite Protective Fabrics Corp. v. Commissioner, 43 F.3d 936 (3d Cir. 1994), and the Sixth Circuit in Zanesville Inv. Co. v. Commissioner, 111 F.2d 184 (6th Cir. 1940), have taken a narrower view limiting § 269 to pre-acquisition tax benefits. The practitioner must determine which circuit's law applies. (Herculite Protective Fabrics Corp. v. Commissioner, 43 F.3d 936 (3d Cir. 1994)) (Zanesville Inv. Co. v. Commissioner, 111 F.2d 184 (6th Cir. 1940))

Step 12. Special Rule for Liquidations After Qualified Stock Purchases

§ 269(b)(1). If (A) there is a qualified stock purchase with respect to a target corporation, (B) an election under section 338 is not made with respect to such purchase, (C) the target corporation is liquidated in a distribution to which section 332(a) applies in pursuance of a plan of liquidation adopted (i) within 2 years after the acquisition date, or (ii) on or before the acquisition date pursuant to an irrevocable commitment to adopt such a plan which was entered into on or before such date, and (D) the principal purpose for the liquidation is the evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which the acquiring corporation would not otherwise enjoy, then the deduction, credit, or other allowance shall not be allowed.

Step 12A. Four Conditions for Application

• Qualified stock purchase requirement. The acquisition must constitute a QSP under § 338(d)(3).
  • A QSP requires the purchasing corporation to acquire by purchase within a 12-month period stock possessing at least 80 percent of the total combined voting power and at least 80 percent of the total value of all classes of stock of the target. The purchase must be a taxable transaction. (§ 269(b)(1)(A)) (§ 338(d)(3))
  • Stock acquired from related persons or by gift, inheritance, or in a liquidation does not count toward the QSP requirement. The purchasing corporation must acquire the stock in a bona fide purchase for consideration. (§ 338(d)(3))
• No section 338 election. The absence of a § 338 election is a statutory prerequisite.
  • A § 338 election would treat the acquisition as a deemed asset purchase with stepped-up basis, eliminating the carryover basis that gives rise to the tax avoidance concern. If either a § 338(g) or § 338(h)(10) election is made, § 269(b) does not apply. (§ 269(b)(1)(B))
  • The absence of a § 338 election is itself an indication that the taxpayer may be seeking to preserve carryover basis tax attributes. The practitioner should document the business reasons for not making the election. (§ 269(b)(1)(B)) (§ 338(g)) (§ 338(h)(10))
• Liquidation within two years. The target must be liquidated within the prescribed timeframe.
  • The target corporation must be liquidated in a distribution to which § 332(a) applies pursuant to a plan adopted within two years after the acquisition date. Alternatively, an irrevocable commitment to adopt a plan entered into on or before the acquisition date satisfies this condition. (§ 269(b)(1)(C)) (§ 332(a))
  • § 332 requires the parent to own at least 80 percent of the subsidiary's stock at the time of liquidation. The two-year window provides a clear temporal test for identifying potentially abusive liquidations. (§ 332(a))
• Principal purpose of tax avoidance. The liquidation must have tax avoidance as its principal purpose.
  • This test mirrors the standard in § 269(a) and requires a comparative analysis of tax and non-tax motivations. The focus is on the purpose of the liquidation, not merely the purpose of the stock acquisition. (§ 269(b)(1)(D))
  • A liquidation with a valid business purpose, such as operational integration or elimination of redundant entities, may satisfy this prong even if the stock acquisition had a tax-avoidance purpose. The principal purpose of the liquidation itself is the dispositive inquiry. (§ 269(b)(1)(D))

Step 12B. Comparison With § 384

• Liquidation requirement. § 269(b) requires a subsequent liquidation, and § 384 does not.
  • § 269(b) applies only when the target is actually liquidated into the parent under § 332 within the two-year period. An acquiring corporation that purchases a loss target and continues to operate it as a subsidiary may be subject to § 384 but not to § 269(b). (§ 269(b)(1)(C)) (§ 384(a)(1))
  • The liquidation requirement narrows § 269(b)'s scope to a specific subset of acquisition structures. The provision targets the specific pattern of purchasing stock and then liquidating to obtain carryover basis assets with tax attributes. (§ 269(b)(1)(C))
• Intent versus mechanical application. § 269(b) is intent-based, and § 384 is largely mechanical.
  • § 269(b) requires a finding of principal tax-avoidance purpose. § 384 applies once a covered acquisition and built-in loss are established, regardless of subjective intent. The mechanical nature of § 384 provides more predictable outcomes. (§ 269(b)(1)(D)) (§ 384(a))
  • § 269(b) gives the IRS a scalpel to target abusive liquidations while leaving non-abusive transactions unaffected. § 384 operates as a blunter instrument that applies across all covered acquisitions. (§ 269(b)) (§ 384)
• Overlap and concurrent application. Both provisions may apply to the same transaction.
  • If a QSP is followed by a § 332 liquidation and the target has built-in losses, the IRS may assert both provisions. § 384 would limit the target's built-in losses to RBIG for five years, while § 269(b) could disallow the losses entirely if the liquidation's principal purpose was tax avoidance. (§ 269(b)) (§ 384)
  • The practitioner must analyze both provisions and advise on exposure under each. The more favorable § 384 result may still apply if the IRS cannot prove the principal purpose required by § 269(b). (§ 269(b)) (§ 384)

Step 12C. Secretary's Discretionary Authority

• Authority to allow partial deduction. § 269(c) provides a safety valve.
  • The Secretary may allow all or part of a deduction, credit, or other allowance otherwise disallowed under § 269(a) or § 269(b) if the Secretary determines that disallowance would result in inequitable deprivation of a tax benefit that was not a principal purpose of the acquisition. (§ 269(c))
  • This discretionary authority is available for both § 269(a) stock and asset acquisitions and § 269(b) liquidation transactions. The provision applies where some portion of the claimed benefit reflects legitimate business activity or pre-acquisition economic loss. (§ 269(c))
• Procedure and standards for seeking relief. There is no formal regulatory framework for § 269(c) relief.
  • Taxpayers must demonstrate that disallowance would produce an inequitable result beyond the normal consequences of § 269 application. Factors supporting relief include substantial non-tax business purposes and evidence that the benefit would have been available absent the acquisition. (§ 269(c))
  • The Secretary's discretion is unfettered, and there is no judicial review of a denial. The practitioner should document the non-tax business purposes of the transaction thoroughly in the event a § 269(c) request becomes necessary. All communications and board resolutions supporting business purpose should be preserved. (§ 269(c))## Step 13. Coordination of §§ 384, 269, 382, and SRLY Rules

Step 13. Coordination of §§ 384, 269, 382, and SRLY Rules

§ 384. Limitation on use of built-in losses and section 382 limitations to offset certain built-in gains

§ 269. Acquisitions made to evade or avoid income tax

• All four limitation regimes apply cumulatively with no statutory hierarchy.
  • § 384 operates independently and in addition to § 382 (Joint Committee on Taxation, Description of the Technical Corrections Act of 1988, at 421 (JCT Print 1988))
  • The Joint Committee stated that Congress enacted § 384 as a supplement to § 382 to address a specific gap in built-in loss trafficking that § 382 did not reach
  • A single transaction may trigger § 382 (ownership change), § 384 (gain corporation acquisition of loss corporation assets), § 269 (tax avoidance purpose), and SRLY rules (separate return limitation year) simultaneously
  • No statute provides that compliance with one regime insulates the taxpayer from another
  • The practitioner must analyze each regime separately because each has distinct elements, thresholds, and limitation mechanisms
• § 384 incorporates § 382(h) definitions through § 384(c)(8) and extends to credits through § 383.
  • § 384(c)(8) provides that the definitions in § 382(h) of RBIG (recognized built-in gain), RBIL (recognized built-in loss), NUBIG (net unrealized built-in gain), and NUBIL (net unrealized built-in loss) apply for purposes of § 384
  • Treas. Reg. § 1.382-6 provides the allocation rules for NUBIG and NUBIL that practitioners must incorporate into § 384 computations
  • § 384(d) provides that the limitations of § 384 apply to the utilization of credits in the same manner as § 383(a)(2) applies § 382 limitations to credits
  • § 383(a)(2) reduces the section 382 limitation dollar for dollar by the amount of any RBIG, and § 384(d) extends this parallel treatment so that built-in losses cannot offset credit carryforwards through the gain corporation
  • EXAMPLE. If a gain corporation acquires loss corporation assets and the gain corporation has $10 million of NUBIG while the loss corporation has $5 million of NUBIL, the § 384 limitation would cap the use of the loss corporation's recognized built-in losses at the amount of the gain corporation's recognized built-in gains in each year
• § 269 and § 384 differ fundamentally in structure, standard, and remedy.
  • § 269 is a subjective-purpose test that looks to the taxpayer's principal purpose for the acquisition, while § 384 is a mechanical test that applies automatically when the statutory thresholds are met
  • § 269 applies when a person or persons acquire 50 percent or more of the vote or value of a corporation (§ 269(a)(1)) or when a corporation acquires 50 percent or more of another corporation's properties (§ 269(a)(2)), whereas § 384 applies at the 80 percent control threshold for stock acquisitions (§ 384(c)(1)(A))
  • § 269 can result in total disallowance of the loss or deduction if the principal purpose is tax evasion or avoidance, while § 384 permits partial utilization of built-in losses up to the amount of recognized built-in gains
  • § 269 requires the Commissioner to assert the disallowance through examination, while § 384 is self-executing on the return
  • § 269 has no temporal limitation once triggered, while § 384 operates only during the 5-year recognition period
  • The § 269 five-year exception under § 269(c) looks to whether the benefit was consciously granted by Congress, while § 384 has no comparable safe harbor for business purpose
• SRLY rules overlap with §§ 382, 384, and 269 in consolidated return settings.
  • Treas. Reg. § 1.1502-21(c) provides that a net operating loss carryover from a SRLY may be applied only against the consolidated taxable income attributable to the member that generated the loss
  • TAM 200447037 (Oct. 26, 2004) applied a combined group approach for analyzing SRLY limitations where multiple members with loss histories joined a consolidated group
  • SRLY and § 382 operate in tandem. § 1.1502-21(c)(1)(ii) provides that the SRLY limitation applies after the § 382 limitation, so the § 382 limitation is applied first to cap the amount of loss available, and then the SRLY limitation restricts which income can absorb the available loss
  • SRLY rules do not supplant § 384. If a gain corporation acquires a loss corporation's assets in a transaction that also causes the loss corporation to join the acquirer's consolidated group, both the § 384 limitation on built-in losses and the SRLY limitation on NOL carryovers apply
  • § 384 can apply even when SRLY does not, such as when the transaction is an asset acquisition that does not result in the loss corporation becoming a member of a consolidated group
• Practical ordering of the limitation analysis.
  • First apply the SRLY limitation to determine how much consolidated taxable income is available from the loss-generating member
  • Second apply the § 382 limitation to determine the annual cap on NOL utilization from any ownership change
  • Third apply the § 384 limitation to determine how much built-in loss from a loss corporation can offset the gain corporation's recognized built-in gains
  • Fourth apply § 269 as a backstop if the acquisition was principally motivated by tax avoidance, which could result in total disallowance regardless of the mechanical limitations
  • CAUTION. Applying the limitations in the wrong order can overstate the available loss deduction. The SRLY limit applies to post-change years in the consolidated context, § 382 applies to all pre-change losses after an ownership change, and § 384 applies specifically to built-in losses of a loss corporation acquired by a gain corporation
• TAM 200447037 provides the IRS approach to layered limitation analysis in consolidated groups.
  • The TAM involved a parent corporation that acquired multiple loss corporations and sought to use their NOLs against the consolidated group's income
  • The IRS National Office concluded that the SRLY rules and § 382 must both be applied and that neither provision alone controlled the result
  • The TAM emphasized that Congress enacted these provisions as overlapping safeguards against trafficking in tax attributes
  • The practitioner should treat TAM 200447037 as indicative of the IRS examination position in any consolidated group acquisition involving loss corporations

Step 14. Anti-Abuse Doctrines and Penalty Exposure

26 U.S.C. § 7701(o). In the case of any transaction to which the economic substance doctrine is relevant, such transaction shall be treated as having economic substance only if (1) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer's economic position, and (2) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction.

26 U.S.C. § 6662(i). Any portion of an understatement with respect to which a taxpayer fails to disclose the relevant facts affecting the tax treatment of an item described in subsection (b)(6) shall be treated as attributable to a noneconomic substance transaction for purposes of paragraph (1)(A).

• Step-transaction doctrine may recharacterize a multi-step acquisition as a single integrated transaction subject to §§ 269 and 384.
  • The step-transaction doctrine has three judicially recognized tests, each developed in a separate line of cases
  • The binding commitment test, articulated in Commissioner v. Gordon, 391 U.S. 83 (1968), asks whether at the time the first step was entered into there was a binding commitment to undertake the later steps. The Supreme Court held that the binding commitment test was not met where there was no legal obligation to complete a later step
  • The mutual interdependence test, explained in Penrod v. Commissioner, 88 T.C. 1415 (1987), asks whether the steps were so interdependent that the legal relations created by one transaction would have been fruitless without the completion of the later transactions
  • The end result test, from King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969), asks whether the transaction is viewed in its entirety in order to ascertain whether the separate steps are actually the components of a single transaction intended from the outset to reach the ultimate result
  • Falconwood Corp. v. Commissioner, 422 F.3d 1341 (Fed. Cir. 2005), applied the step-transaction doctrine to recharacterize a corporate acquisition as an integrated transaction, resulting in the application of loss limitation rules that would not have applied to any single step in isolation
  • EXAMPLE. If a gain corporation first acquires 40 percent of a loss corporation's stock and then, six months later, acquires the remaining 60 percent in a purportedly unrelated transaction, the IRS may invoke the step-transaction doctrine to treat the two acquisitions as a single transaction that triggers both the 80 percent threshold for § 384 and the ownership change for § 382
  • TRAP. The step-transaction doctrine does not require that the steps occur simultaneously. Steps separated by months or even a year or more may be stepped together if they were part of a single plan from the outset
• Economic substance doctrine is codified at § 7701(o) and applies a strict conjunctive two-prong test.
  • § 7701(o)(1)(A) requires that the transaction change in a meaningful way apart from Federal income tax effects the taxpayer's economic position. This is the objective prong that examines whether the transaction had real profit potential
  • § 7701(o)(1)(B) requires that the taxpayer have a substantial purpose apart from Federal income tax effects for entering into the transaction. This is the subjective prong that examines business motivation
  • Both prongs must be satisfied. The statute uses the word "and" between the two requirements, making the test conjunctive
  • § 7701(o)(2)(A) provides that the determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if § 7701(o) had never been enacted, meaning courts continue to decide when the doctrine applies
  • Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004), applied the economic substance doctrine to disallow losses from a structured transaction where the court found no realistic possibility of profit and no genuine business purpose predating the tax motivation
  • EXAMPLE. A gain corporation acquires a loss corporation primarily to absorb the loss corporation's built-in losses against the gain corporation's built-in gains. If the acquisition has no independent business rationale (no synergies, no operational integration, no market expansion), the transaction may fail the economic substance test even if it technically complies with § 384's mechanical rules
• Substance over form and sham transaction doctrines provide additional bases for IRS challenge.
  • Gregory v. Helvering, 293 U.S. 465 (1935), is the foundational substance-over-form case. The Supreme Court held that a transaction that complies with the literal terms of the statute may still be disregarded if its substance differs from its form and the transaction was undertaken solely for tax avoidance. In Gregory, a taxpayer transferred assets to a new corporation and immediately liquidated it to extract the assets, all to create a reorganization and tax-free distribution. The Court looked to the business purpose and substance of the transaction and denied the tax benefit
  • Knetsch v. United States, 364 U.S. 361 (1960), established the sham transaction doctrine. The Supreme Court held that a transaction creating no genuine economic rights or obligations other than tax benefits is a sham and will be disregarded for tax purposes. In Knetsch, the taxpayer borrowed money at 3.5 percent interest to purchase annuity contracts paying 2.5 percent interest, generating deductible interest expense in excess of taxable annuity income with no realistic possibility of economic profit
  • In the loss trafficking context, these doctrines may apply where the form of a transaction (such as a purported asset purchase or corporate reorganization) masks its true substance as a sale of tax losses for cash or other consideration
  • The sham transaction doctrine requires two prongs under most circuits' case law. First, the transaction must have objective economic substance. Second, the taxpayer must have a subjective business purpose. These parallel but are not identical to the § 7701(o) test
  • TRAP. A transaction that satisfies the mechanical requirements of § 384 (proper asset acquisition, within the 5-year recognition period, under the NUBIG ceiling) may still be challenged under substance over form if the transaction was structured solely to create the appearance of a legitimate business combination while the true purpose was tax loss absorption
• § 6662 accuracy-related penalties apply at 20 percent generally and 40 percent for undisclosed noneconomic substance transactions.
  • § 6662(a) imposes a 20 percent accuracy-related penalty on the portion of any underpayment attributable to negligence or disregard of rules or regulations, any substantial understatement of income tax, or any substantial valuation misstatement
  • § 6662(b)(6) adds a 20 percent penalty for any disallowance of claimed tax benefits by reason of a transaction lacking economic substance as defined in § 7701(o)
  • § 6662(i) provides that any portion of an understatement with respect to which a taxpayer fails to disclose the relevant facts affecting the tax treatment of an item described in § 6662(b)(6) shall be treated as attributable to a transaction lacking economic substance, which raises the penalty rate from 20 percent to 40 percent under § 6662(a) as applied through § 6662(b)(6)
  • § 6664(c)(2) expressly provides that reasonable cause and good faith under § 6664(c)(1) shall not apply to any reportable transaction understatement attributable to a transaction described in § 6662(b)(6) that lacks economic substance. This means the reasonable cause defense is unavailable for noneconomic substance penalties
  • EXAMPLE. A corporation claims a $5 million loss deduction under § 384 and fails to disclose the transaction on Form 8886 (Reportable Transaction Disclosure Statement). The IRS disallows the loss under § 7701(o). The 40 percent penalty under § 6662(i) applies to the entire understatement, and the corporation cannot assert reasonable cause even if it relied on a tax opinion
  • CAUTION. The lack of a reasonable cause defense for noneconomic substance transactions makes disclosure and contemporaneous documentation of business purpose absolutely critical. A well-documented business purpose can defeat the § 7701(o) challenge at the merits level, but once the transaction is found to lack economic substance, no penalty defense remains
• Business purpose must be documented contemporaneously and must be genuine rather than post hoc.
  • The business purpose analysis examines whether the taxpayer had a genuine non-tax reason for the acquisition or reorganization beyond the tax benefits of the loss
  • Courts look for objective evidence of business purpose, including board minutes, internal memoranda, due diligence reports, fairness opinions, and third-party valuations prepared at the time of the transaction
  • A business purpose created after the fact through litigation-position papers or reconstructed memoranda carries little weight and may be viewed as evidence that no genuine purpose existed
  • The presence of a tax motivation does not defeat a transaction if a genuine business purpose also exists. Plains Petroleum Co. v. Commissioner, T.C. Memo. 1999-241 (discussed in detail in Step 15 below), demonstrates that strong business purpose can defeat a § 269 challenge even where tax benefits were substantial
  • Briarcliff Candy Corp. v. Commissioner, T.C. Memo. 1987-487 (discussed in detail in Step 15 below), illustrates that courts will scrutinize claimed business purposes carefully and may reject them as pretextual if they do not match the economic reality of the transaction
  • TRAP. A common planning error is to draft board resolutions reciting general business purposes (synergies, economies of scale, market expansion) without any supporting analysis or follow-through. Courts treat generic boilerplate language as weak evidence of genuine business purpose

Step 15. § 269 Case Law - Detailed Holdings and Practical Application

26 U.S.C. § 269(a). If (1) any person or persons acquire, or acquired on or after October 8, 1940, directly or indirectly, control of a corporation, or (2) any corporation acquires, or acquired on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately before such acquisition, by such acquiring corporation or its stockholders, and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then the Secretary may disallow such deduction, credit, or other allowance.

• Briarcliff Candy Corp. v. Commissioner, T.C. Memo. 1987-487 - § 269 is broadly drafted and applies to loss corporation acquisitions of profitable subsidiaries.
  • The Tax Court held that § 269 is broadly drafted to cover a wide range of acquisition strategies. The case involved a loss corporation that acquired a profitable subsidiary, with the tax benefit of the subsidiary's income offsetting the parent's losses being a significant motivating factor
  • The court examined the legislative history of § 269 and noted that Congress intended the statute to reach any acquisition where tax avoidance was the principal purpose, regardless of how the transaction was structured
  • The court emphasized that the presence of some business purpose does not automatically defeat § 269 if the principal purpose (the primary motivating factor) was tax avoidance
  • The practical application for practitioners is that § 269 can apply even when a loss corporation is the acquirer rather than the target, and even when the acquired corporation is profitable
  • The case also demonstrates that courts will aggregate the tax benefits of all claimed deductions, credits, and allowances in assessing whether tax avoidance was the principal purpose
  • CAUTION. Briarcliff stands for the proposition that the direction of the acquisition (loss corporation acquiring profitable subsidiary, rather than profitable corporation acquiring loss corporation) does not insulate the transaction from § 269 scrutiny
• Rocco, Inc. v. Commissioner, 72 T.C. 140 (1979) - The "consciously granted" exception applies where Congress intended the tax benefit.
  • The Tax Court held that § 269 does not apply where the tax benefit was one that Congress consciously granted and intended taxpayers to enjoy. The case involved a cash method accounting election
  • The court analyzed the legislative history and concluded that § 269(c) reflects a congressional intent to limit the statute's application to deductions, credits, or allowances that are not inherent features of the tax provisions under which they arise
  • The court stated that where Congress has deliberately made a benefit available to all taxpayers meeting objective criteria, the IRS cannot use § 269 to deny that benefit merely because the taxpayer's principal purpose in qualifying for it was tax reduction
  • The practical application is that practitioners should argue the § 269(c) defense whenever the tax benefit at issue flows directly from a provision that Congress enacted with full awareness of how it would operate
  • TRAP. The "consciously granted" exception is narrow. It does not apply to NOL carryovers from a different corporation because Congress enacted specific anti-trafficking provisions (§§ 382, 384) precisely to limit cross-corporate loss utilization
• Modern Home Fire & Casualty Ins. Co. v. Commissioner, 54 T.C. 839 (1970) - Subchapter S election as a consciously granted Congressional benefit.
  • The Tax Court held that a Subchapter S election was a benefit that Congress consciously granted to qualifying corporations, and therefore § 269 did not apply to disallow the benefits of the election even if tax avoidance was the principal purpose
  • The court reasoned that the Subchapter S provisions were designed to provide a tax benefit to small business corporations, and that once a corporation met the objective statutory requirements, the IRS could not invoke § 269 to deny the intended tax treatment
  • This case reinforces Rocco and establishes that § 269(c) applies to entire statutory regimes, not just individual deductions
  • The practical application is that when a tax benefit is an inherent, integral feature of a statutory provision available to all qualifying taxpayers, § 269(c) provides a defense
  • However, the defense does not apply to cross-corporate loss trafficking because §§ 382 and 384 demonstrate that Congress did not intend losses to flow freely between corporations
• Borge v. Commissioner, 405 F.2d 673 (2d Cir. 1968) - Incorporation to avoid § 270 and the treatment of anticipated losses.
  • The Second Circuit held that a taxpayer who incorporated a proprietorship and then immediately liquidated the corporation to obtain stepped-up basis for depreciable property did so with the principal purpose of tax avoidance
  • The taxpayer sought to avoid the limitation on loss carrybacks that existed under then-§ 270 by generating losses within the corporate form
  • The Second Circuit held that § 269 applied to the liquidation and subsequent loss claims because the principal purpose of the corporate formation was to secure tax benefits not otherwise available
  • The court rejected the taxpayer's argument that anticipated or prospective losses could not be the subject of § 269
  • The practical application is that § 269 applies not just to the trafficking of existing losses but also to transactions structured to create losses that would not have been available but for the acquisition form
  • EXAMPLE. A taxpayer forms a new corporation, transfers assets with built-in losses to it, and then merges the new corporation into an operating corporation. The IRS may invoke § 269 to disallow the resulting loss deductions if the principal purpose was to create artificial loss recognition
• Ach v. Commissioner, 358 F.2d 342 (6th Cir. 1966) - Beneficial ownership test for control and transfer of profitable business to loss corporation.
  • The Sixth Circuit held that the constructive ownership rules of § 269(a)(1) require analysis of beneficial ownership, and that the transfer of a profitable business to a loss corporation could trigger § 269
  • The case involved a corporate acquisition where the same shareholders controlled both the acquiring and acquired corporations through overlapping stock ownership
  • The Sixth Circuit applied a beneficial ownership analysis to determine whether the control requirement was satisfied, looking through the formal ownership structure to the economic reality
  • The court held that the principal purpose of transferring a profitable business to a loss corporation was to absorb the loss corporation's NOLs against the profitable business's income
  • The practical application is that practitioners must apply the constructive ownership rules of § 318 (as incorporated through § 269(a)(1)) carefully and must look through overlapping shareholder groups
  • CAUTION. The beneficial ownership test in Ach means that even an acquisition at arm's length between unrelated parties may trigger § 269 if the same persons ultimately control both corporations through indirect or constructive ownership
• Coastal Oil Storage Co. v. Commissioner, 242 F.2d 396 (4th Cir. 1957) - Multiple corporations formed to obtain surtax exemptions.
  • The Fourth Circuit held that the formation of multiple corporations by a single shareholder group, each claiming the corporate surtax exemption, violated § 269 because the principal purpose was tax avoidance
  • The case is one of the earliest circuit-level applications of § 269 and establishes that the statute applies to the initial formation of corporations, not just acquisitions of existing corporations
  • The court held that the formation of the additional corporations had no business purpose other than multiplying the available surtax exemptions
  • The practical application is that § 269 can apply to de novo formations, not just acquisitions. A practitioner should not assume that § 269 is inapplicable simply because no existing corporation was acquired
  • TRAP. Coastal Oil Storage is frequently cited by the IRS in the context of corporate separations and spin-offs where the separated entity has loss attributes and the separating entity has income against which the losses can be used
• Brumley-Donaldson Co. v. Commissioner, 443 F.2d 501 (9th Cir. 1971) - NOL carryover disallowance under § 269.
  • The Ninth Circuit held that § 269 authorized the IRS to disallow NOL carryovers where the principal purpose of the corporate acquisition was to obtain the benefit of the acquired corporation's net operating losses
  • The case involved an acquisition of stock in a corporation with substantial NOL carryovers, followed by a merger of the acquired corporation into the acquirer
  • The Ninth Circuit affirmed the Tax Court's finding that the principal purpose was tax avoidance and upheld the total disallowance of the NOL carryovers
  • The court rejected the taxpayer's argument that the business purpose for the acquisition (entering a new line of business) precluded application of § 269, holding that the presence of some business purpose does not negate a finding that tax avoidance was the principal purpose
  • The practical application is that § 269 can result in total disallowance of NOL carryovers, which is a far more severe result than the partial limitation under § 384
• Plains Petroleum Co. v. Commissioner, T.C. Memo. 1999-241 - Strong business purpose defeats § 269 even with substantial tax benefits.
  • The Tax Court held that a genuine, well-documented business purpose for a corporate acquisition can defeat § 269 even where the tax benefits of the acquired corporation's loss attributes were substantial
  • The case involved a complex corporate reorganization where the taxpayer could demonstrate detailed business planning, third-party valuations, arm's-length negotiations, and post-acquisition operational integration
  • The court distinguished Briarcliff and Brumley-Donaldson on the ground that in Plains Petroleum, the taxpayer's business purpose was not merely pretextual but was supported by objective evidence of genuine commercial activity
  • The court held that the phrase "principal purpose" in § 269(a) means the primary or predominant purpose, not merely a significant purpose. Where the business purpose predominates, § 269 does not apply even if tax savings were substantial
  • The practical application is that practitioners should build a comprehensive contemporaneous record of business purpose evidence before the transaction closes, not after the fact
  • EXAMPLE. If a gain corporation acquires a loss corporation and can demonstrate that the acquisition was the result of a year-long search process, involved competitive bidding, was approved by independent directors based on a fairness opinion, and resulted in actual operational consolidation (closing duplicate facilities, integrating management, cross-selling products), the business purpose defense to § 269 is substantially strengthened
• CCA 202501008 (Jan. 3, 2025) represents an IRS expansion of § 269 to check-the-box elections.
  • The Chief Counsel Advice addressed whether § 269 could apply to a check-the-box election under Treas. Reg. § 301.7701-3 that changed the classification of an eligible entity from a corporation to a partnership or disregarded entity
  • The IRS concluded that § 269(a)(2) can apply to a check-the-box election if the election results in the constructive acquisition of corporate property and the principal purpose of the election was tax avoidance
  • This represents a significant expansion of § 269 beyond traditional stock and asset acquisitions into the entity classification area
  • The CCA reasoned that a check-the-box election that causes a corporation to be treated as a disregarded entity effectively transfers the corporation's property to its parent for § 269 purposes
  • CAUTION. CCA 202501008 signals that the IRS will scrutinize check-the-box elections in the loss trafficking context. Practitioners should document business purpose for any entity classification change that affects the utilization of loss attributes
  • TRAP. The CCA applies the constructive acquisition theory broadly. Even a domestic entity election that is within the taxpayer's unilateral rights under the check-the-box regulations may trigger § 269 if the principal purpose analysis points to tax avoidance

Step 16. Planning Considerations and Avoidance Strategies

• The § 384 common control exception provides a safe harbor for long-standing affiliated groups.
  • § 384(c)(1)(C) provides the common control exception. It applies if the gain corporation and the loss corporation were members of the same controlled group at all times during the 5-year period ending on the acquisition date
  • A controlled group is defined by reference to § 1563(a), which requires 80 percent vote or value ownership and certain threshold tests for combined groups
  • The practical effect of the exception is that a corporation cannot traffic in losses by acquiring an unrelated loss corporation and then claiming an intra-group exception. The affiliated relationship must predate the loss generation
  • The 5-year lookback period is measured from the acquisition date of the loss corporation's assets or stock
  • EXAMPLE. If Parent Corp and Sub Corp have filed consolidated returns together for 10 years, and Sub Corp has built-in losses, Parent Corp can acquire Sub Corp's assets in a tax-free distribution under § 301 without triggering § 384 because the common control exception applies
  • CAUTION. The common control exception requires that the controlled group relationship existed at all times during the entire 5-year period. Even a brief period of non-affiliation during the 5-year lookback can destroy the exception
• Timing of asset sales outside the 5-year recognition period eliminates the § 384 limitation.
  • § 384(a) limits the use of built-in losses only for gains recognized during the 5-year recognition period following the acquisition date
  • The recognition period is defined by reference to § 382(h)(7)(A), which provides a 5-year period beginning on the change date
  • Built-in losses recognized after the 5-year recognition period are not subject to the § 384 limitation
  • Practitioners planning transactions with built-in loss assets should consider whether the recognition of the loss can be deferred until after the 5-year period expires
  • TRAP. Deferring loss recognition may not avoid other limitations. If the transaction also triggered an ownership change under § 382, the pre-change losses remain subject to the § 382 limitation even after the 5-year § 384 recognition period expires
• De minimis threshold planning and NUBIL management can reduce § 384 exposure.
  • § 382(h)(3)(B)(i) provides a de minimis threshold. A loss corporation has a NUBIL only if the amount of the net unrealized built-in loss exceeds the lesser of $10,000,000 or 15 percent of the fair market value of the loss corporation's assets
  • Because § 384(c)(8) incorporates § 382(h) definitions, the same de minimis threshold applies for § 384 purposes
  • If the loss corporation's NUBIL is below the de minimis threshold, it is treated as zero and no RBIL limitation applies under § 384
  • EXAMPLE. A loss corporation has assets with a total FMV of $50 million and an adjusted basis of $55 million, producing a NUBIL of $5 million. The lesser of $10 million or 15 percent of FMV ($7.5 million) is $7.5 million. Because $5 million is less than $7.5 million, the de minimis exception applies and no NUBIL exists
  • Practitioners can manage NUBIL exposure by structuring acquisitions so the loss corporation's aggregate built-in losses fall below the de minimis floor
  • CAUTION. The de minimis threshold is applied on a corporation-by-corporation basis. If multiple loss corporations are acquired in a single transaction, each corporation's NUBIL is measured separately
• Structuring to avoid gain corporation status eliminates § 384 before it applies.
  • § 384 applies only if the acquiring corporation is a "gain corporation" as defined in § 384(c)(2)
  • A gain corporation is any corporation with a NUBIG greater than zero, determined as of the acquisition date
  • If the acquiring corporation has no NUBIG (or a NUBIL), § 384 does not apply because there are no built-in gains to protect
  • Practitioners can structure transactions so the acquiring corporation recognizes its built-in gains before the acquisition date, thereby reducing or eliminating its NUBIG
  • Alternatively, if the acquiring corporation has built-in losses, it can contribute assets with built-in gains to reduce its NUBIG before acquiring the loss corporation
  • TRAP. § 384(f) contains an anti-circumvention provision that prevents taxpayers from artificially creating or eliminating gain corporation status through contribution or distribution transactions structured to avoid § 384
• § 384(f) anti-circumvention limits contribution and distribution strategies.
  • § 384(f) provides that § 384 applies to any property acquired by a corporation if the property's basis is determined (in whole or in part) by reference to the basis of the property in the hands of the person from whom the property was acquired
  • The provision prevents taxpayers from contributing built-in loss assets to a new subsidiary and then having the gain corporation acquire the subsidiary's stock to avoid direct application of § 384
  • The practical effect is that indirect acquisitions of built-in loss assets through subsidiaries, partnerships, or other pass-through entities are treated the same as direct acquisitions for § 384 purposes
  • § 384(f) applies the carryover basis tracing rule so that if the acquired property's basis carries over from a loss corporation, the § 384 limitation applies
  • CAUTION. § 384(f) is broadly worded. Even a multi-tier acquisition structure where the gain corporation acquires a holding company that owns a loss corporation is subject to § 384 if the ultimate assets have carryover basis from the loss entity
• § 269 defensive planning requires contemporaneous documentation of business purpose and economic substance.
  • Document the business purpose for every acquisition that involves a loss corporation or loss attributes before the transaction closes
  • Maintain a record of arm's-length negotiations, including competitive bidding processes, independent valuations, and fairness opinions where applicable
  • Retain evidence of operational integration following the acquisition, including closing redundant facilities, combining management teams, cross-selling products, and achieving documented cost savings
  • Ensure that the transaction has independent economic substance apart from the tax benefits. The acquiring corporation should actually operate the acquired business, not merely hold it as a loss-generating shell
  • TRAP. Post-transaction board minutes that recite business purposes are weak evidence if they were drafted after the IRS examination began. Courts routinely give little weight to reconstructed business justifications
• Due diligence checklist items for loss corporation acquisitions.
  • Obtain a complete schedule of the target's NOL carryovers, capital loss carryovers, credit carryovers, and built-in loss assets with adjusted tax basis and estimated FMV for each
  • Analyze whether any of these attributes are subject to § 382 limitation from a prior ownership change
  • Determine whether the target is a loss corporation under § 384(b)(1) by comparing the aggregate basis of its assets to their aggregate FMV
  • Determine whether the acquirer is a gain corporation under § 384(c)(2) by comparing the aggregate basis of its assets to their aggregate FMV
  • If the target has a NUBIL, calculate the de minimis threshold under § 382(h)(3)(B)(i) to determine if the NUBIL is below the floor
  • Model the § 384 limitation by projecting the acquirer's RBIG over the 5-year recognition period and capping the target's RBIL at that amount
  • Review the target's SRLY history if the acquisition will result in a consolidated group membership change
• Representations, warranties, and tax opinion considerations.
  • The acquisition agreement should include representations from the seller regarding the existence, amount, and limitation status of all tax attributes
  • Warranties should cover whether the target has undergone an ownership change under § 382 within the prior three years
  • The agreement should allocate risk for any IRS adjustment that disallows loss deductions under § 269 or § 384
  • Tax opinions should address the application of § 384 mechanically if the relevant thresholds are met, but should also include a prominent risk disclosure regarding § 269 and judicial anti-abuse doctrines
  • Reasonable reliance on a tax opinion may support a reasonable cause defense for § 6662 penalties for non-disclosed positions, but § 6664(c)(2) eliminates this defense for transactions lacking economic substance under § 7701(o)

Step 17. Documentation, Reporting, and Recordkeeping

26 U.S.C. § 384(c)(1). For purposes of this section, a corporation shall be treated as a loss corporation if (A) for the taxable year in which the determination is being made (or for a taxable year beginning in the 3-year period ending on the last day of such taxable year), such corporation had a net operating loss or a net capital loss, (B) such corporation was entitled to a credit under section 38 (relating to general business credit) for such taxable year (or for a taxable year beginning in such 3-year period), or (C) such corporation had an excess foreign tax credit for such taxable year (or for a taxable year beginning in such 3-year period).

• No dedicated IRS form exists for § 384 reporting. Taxpayers self-report through Form 1120.
  • Unlike § 382, which requires disclosure on Form 8820 (Change of Control), § 384 has no dedicated information return or attachment requirement
  • The taxpayer must compute and apply the § 384 limitation on the corporation's Form 1120, U.S. Corporation Income Tax Return, and maintain supporting workpapers
  • Because there is no mandated disclosure, § 384 is often underreported or ignored entirely by taxpayers who are unaware of its application
  • The IRS relies on examination to enforce § 384 compliance, which means the statute of limitations under § 6501 may run before the IRS discovers the omission
  • CAUTION. The lack of a dedicated reporting form does not excuse the taxpayer from compliance. If the IRS discovers the § 384 violation on examination, the full deficiency, interest, and potentially penalties apply
  • TRAP. Many taxpayers assume that if no form is required, no limitation exists. This is incorrect. § 384 is self-executing and applies regardless of whether the taxpayer reports it
• Asset-by-asset basis and FMV schedules are foundational documentation for § 384 compliance.
  • The § 384 analysis requires determining whether the acquired corporation is a loss corporation under § 384(c)(1) and whether the acquiring corporation is a gain corporation under § 384(c)(2)
  • This determination requires comparing the adjusted tax basis of each asset to its FMV as of the acquisition date
  • The practitioner must maintain a schedule listing every asset of both the gain corporation and the loss corporation, the adjusted tax basis of each asset, the FMV of each asset, and the resulting built-in gain or built-in loss
  • For intangible assets (goodwill, going concern value, intellectual property, customer lists), independent valuations or purchase price allocations under § 1060 should be obtained
  • The § 1060 allocation under the residual method (Treas. Reg. § 1.1060-1) provides a framework for assigning the purchase price among asset classes, which directly affects the NUBIG and NUBIL computations
  • EXAMPLE. A gain corporation acquires a loss corporation for $20 million. The § 1060 allocation assigns $5 million to Class I assets (cash), $8 million to Class V assets (tangible personal property with built-in losses), and $7 million to Class VI and VII (intangibles and goodwill). The practitioner must compare the allocated purchase price for each asset to its adjusted basis to compute the aggregate NUBIG or NUBIL
• NUBIG and NUBIL computation workpapers must be maintained with detailed methodology.
  • § 382(h)(1)(A) defines NUBIG as the amount by which the FMV of the corporation's assets immediately before the ownership change exceeds the aggregate adjusted basis of the corporation's assets at that time
  • § 382(h)(1)(B) defines NUBIL as the amount by which the aggregate adjusted basis of the corporation's assets exceeds the FMV of the corporation's assets immediately before the ownership change
  • § 384(c)(8) adopts these definitions for purposes of § 384
  • The computation workpaper should show every asset, its basis, its FMV, the resulting gain or loss, and the aggregate total
  • The workpaper should also show the application of the de minimis threshold under § 382(h)(3)(B)(i), which is the lesser of $10,000,000 or 15 percent of FMV
  • Notice 2003-65, 2003-2 C.B. 747, provides safe harbor methods for identifying RBIG and RBIL. The notice provides two alternative safe harbors. Method 1 is the 1374 approach (items of income, gain, deduction, and loss attributable to periods before the change date), and Method 2 is the 338 approach (deemed sale and reacquisition of all assets at FMV)
  • TRAP. Notice 2003-65 was issued before the American Jobs Creation Act of 2004 modified § 382(h), and certain aspects may no longer fully reflect current law. Practitioners should verify that any safe harbor method used is consistent with the current statutory language
• Independent appraisals provide critical support for FMV determinations.
  • The NUBIG and NUBIL computations depend entirely on the FMV of the corporation's assets as of the acquisition date
  • An independent third-party appraisal by a qualified valuator provides the strongest evidentiary support for the FMV determination
  • The appraisal should be obtained as close to the acquisition date as practicable and should value each significant asset class separately
  • For real property, a qualified real estate appraiser should provide a USPAP-compliant appraisal
  • For personal property and intangibles, a qualified business appraiser should provide a valuation report that explains the methodology, assumptions, and data sources
  • CAUTION. Self-prepared valuations or valuations obtained from related parties carry significantly less weight if the IRS challenges the NUBIG or NUBIL computation. The cost of an independent appraisal is far less than the cost of litigating a valuation dispute
• Acquisition date documentation and recognition period tracking are essential for temporal limitations.
  • The § 384 limitation applies only to built-in losses recognized during the 5-year recognition period following the acquisition date
  • § 382(h)(7)(A) defines the recognition period as the 5-year period beginning on the change date
  • The practitioner must document the exact acquisition date because it triggers both the start of the recognition period and the 5-year common control lookback period
  • A tracking calendar should be maintained for each acquisition that identifies the acquisition date, the 5-year recognition period end date, and any transactions within the recognition period that generate RBIG or RBIL
  • Notice 90-27, 1990-1 C.B. 336, provides that gain recognized on the installment method from a disposition of a built-in gain asset during the recognition period is treated as RBIG in the year of disposition, not in the year of payment. This accelerates RBIG recognition for installment sale purposes
  • EXAMPLE. A gain corporation sells a built-in gain asset during the recognition period on the installment method, receiving payments over 10 years. Under Notice 90-27, the full amount of built-in gain is treated as RBIG in the year of sale, not as each installment payment is received. This maximizes the RBIG available to absorb RBIL in the early years of the recognition period
• § 384(c)(1) creates a presumption that places the burden on the taxpayer to establish its loss corporation and gain corporation status correctly.
  • While § 384(c)(1) defines the mechanical tests for loss corporation status, the practical burden of proof rests with the taxpayer to demonstrate that its characterization is correct
  • If the IRS challenges the NUBIG or NUBIL computation on examination, the taxpayer bears the burden of proving the FMV and basis of each asset
  • Under § 7491, the burden of proof may shift to the IRS if the taxpayer introduces credible evidence, complies with substantiation requirements, maintains records, and cooperates with reasonable IRS requests
  • To satisfy the § 7491 burden-shifting requirements, the taxpayer must maintain all records described in this step contemporaneously with the filing of the return
  • CAUTION. Documentation created after the IRS examination begins is not contemporaneous and does not support burden shifting. Records must exist at the time of filing or shortly thereafter
  • TRAP. Many taxpayers discover the § 384 limitation for the first time during an IRS examination and then attempt to reconstruct NUBIG and NUBIL computations from incomplete records. This approach fails both on the merits and for § 7491 purposes
• NOL carryback claims require additional documentation.
  • Form 1139 (Corporation Application for Tentative Refund) or Form 1045 (Application for Tentative Refund) may be used to carry back NOLs to prior taxable years
  • Post-TCJA, most corporations cannot carry NOLs back. The TCJA eliminated NOL carrybacks for losses arising in taxable years ending after December 31, 2017, with limited exceptions for farming losses and insurance company losses under § 172(b)(1)(B) and (C)
  • § 384 applies to NOL carrybacks from the loss corporation in the same manner as it applies to current-year utilization. The § 384 limitation must be computed for the carryback year as well
  • If a § 384 limitation applies, the RBIL recognized in the carryback year cannot offset gain corporation income in excess of the gain corporation's RBIG for that year
  • The carryback claim must include the same NUBIG and NUBIL workpapers as the original return
• State tax considerations include non-conformity and state-specific limitations.
  • Many states conform to federal § 384, but practitioners must verify the conformity status of each relevant state
  • California has historically conformed to federal loss limitation provisions but with variations. California requires separate state-level NUBIG and NUBIL computations because state basis may differ from federal basis
  • California suspended the use of NOL deductions for tax years 2024 through 2026 for corporations with taxable income exceeding $1 million. This suspension applies regardless of whether the NOL is subject to federal § 384 limitation
  • States that do not conform to § 384 (such as certain states that follow pre-1988 federal law) may still apply their own anti-trafficking rules or judicial doctrines
  • The practitioner must analyze each state separately because the federal § 384 limitation does not automatically carry over to state returns
  • TRAP. Even states that conform to federal § 384 may require a separate computation because state basis in assets often differs from federal basis due to state-specific depreciation rules and different treatment of deferred items