Government finally tells taxpayers that they can't bump and strip.

• Author: Frankel, Michael G.

On Mar. 9, 1993, final regulations were issued addressing certain transactions between members of a consolidated group known as the "bump and strip" technique. Regs. Secs. 1.1502-13(o) and 1.1502-14(g) basically retain the rules of Temp. Regs. Secs. 1. 1502-13T(o) and 1.1502-14T(c). However, a change was made for distributions two years after disaffiliation. In general, if a shareholder becomes legally entitled to a distribution at least two years after leaving the consolidated group, the distribution will not trigger deferred gain under the special bump and strip rules.

The temporary and final regulations were promulgated to eliminate a basis step-up with respect to stock of a subsidiary in a consolidated group. The Service believes the basis step-up is both artificial and abusive; hence, the effective date for a portion of the regulations is retroactive.

The final regulations are best described by examples. For the following examples, assume that corporations P, S1, S2 and S3 file a consolidated return on a calendar-year basis. P owns all of the outstanding stock of S1 and S2. S1 owns all 100 shares of the outstanding stock of S3. The S3 shares have an adjusted basis of $1,000 and a value of $ 1 0, 000.

Example 1: Intercompany sale of stock followed by (1) distribution of cash and (2) deconsolidation: trigger of hypothetical excess loss account (ELA) (i) The bump: S1 sells all 100 shares of S3 stock to S2 for $10,000 and recognizes $9,000 of gain (which is deferred). Sec. 304 does not apply pursuant to Regs. Sec. 1.1502-80(b). S2 takes a $10,000 basis in the S3 stock under Regs. Sec. 1. 1502-3 1 (a). (ii) The strip: S3 borrows $5,000 in 1992 and distributes the $5,000 to S2 in the same year. S3 has no current earnings and profits (E&P), and the distribution reduces S2's basis in the S3 stock from $10,000 to $5,000. (iii) S3 has no current E&P in 1993. On Dec. 31, 1993, S3 issues 100 shares (50%) of its stock to X, an unrelated party. Since S2 now owns less than 80% of S3, S3 ceases to be a member of the group and an ELA disposition event occurs under Regs. Sec. 1.1502-19(b)(2)(i). Note that none of the deferred gain would be triggered under Regs. Sec. 1.1502-13(f)(1)(i), since X acquires newly issued stock (the S3 stock to which the deferred gain is attached does not leave the consolidated group). Also, none of the deferred gain would be triggered under Regs. Sec. 1.1502-13(f)(1)(iii), since neither the selling member (S1) nor the owning...