Ownership changes under the new Sec. 382 segregation rules.

• Author: Layne, Scott

In certain circumstances, loss corporations previously subject to a Sec. 382 limitation due to an ownership change may retroactively elect that the ownership change did not occur.

On Oct. 4, 1993, the IRS issued final regulations relating to the Sec. 382 segregation rules. These regulations modified proposed regulations published in November 1992, which had been reserved in the 1987 temporary regulations. This six-year process culminated in final regulations more lenient to loss corporations.

The final regulations provide for two exceptions to the segregation rules: a small issuance exception and a stock for cash exception. Although the exceptions do not apply to most equity structure shifts, the small issue exception will apply if the issuance is pursuant to a type E recapitalization. In addition, transitory ownership of stock by an underwriter is not taken into account in determining an ownership change.

Most importantly, these exceptions can be applied retroactively at the election of the loss corporation to undo a previously reported ownership change.

Exceptions

Small issuance: An issuance of stock will not create a new public group if the amount of stock issued, when aggregated with all other issuances during a corporation's tax year, does not exceed the small issue limitation. Instead, the stock is considered as acquired by the existing public group(s). At the loss corporation's election, this limitation may be calculated in either of two ways: 1. 10% of the total value of all the corporation's outstanding stock at the beginning of the tax year, or 2. 10% of the number of shares of the class of stock issued at the beginning of the tax year. (This option is not available, if more than one class of stock is issued in a single issuance.) This limitation is prorated for loss corporations issuing stock in short tax years.

Example 1: Loss corporation L is a calendar-year corporation with 1,000 outstanding shares of ordinary common stock - its only class of stock. These 1,000 shares are owned by Public L, and no one shareholder owns 5% of the stock. During 1994 L sells newly issued common shares to its employees: 35 in April and 75 in November. No employee becomes a 5% shareholder as a result of this issuance.

Under the temporary regulations, L would be considered as having three public groups: Public L with 1,000 shares, "New Public 1" with 35 shares and "New Public 2" with 75 shares. This results in a 9.91% change in ownership.

Under the...