Reducing BIG for QSub stock.

• Author: Valdez, Domingo
• Position: Built-in gains

The IRS issued proposed changes to Regs. Sec. 1.13743(b) and (c) (REG-131486-03) on June 25, 2004. The changes address a narrow problem that may occur when a C corporation parent and its subsidiaries convert to S corporation status. When this happens, each entity must compute and track net unrealized built-in gain (NUBIG).

Problem

The transaction may be viewed as having two parts. The first part is converting the parent to an S corporation and leaving the subsidiary as a C corporation, which requires the parent to comply with the NUBIG rules. A component of the parent's NUBIG computation is the unrealized BIG/built-in loss (BIL) in the subsidiary stock ownership.

The second part of the transaction is the subsidiary's conversion to a qualified Subchapter S subsidiary (QSub), which requires the subsidiary to compute Sec. 1374's effects (i.e., "its own" separate NUBIG). The subsidiary's value consists of two separate NUBIG components: (1) the subsidiary stock's BIG/BIL; and (2) the BIG/BIL on the subsidiary's assets. For Federal income tax purposes, the QSub no longer exists; thus, why continue to track the stock in NUBIG? The proposed regulation addresses this problem.

Correction

The proposed changes to Kegs. Sec. 1.1374-3(b) and (c) will correct this problem with a NUBIG adjustment, which will be the BIG/BIL in the parent's ownership of the QSub stock. The net result is to remove the QSub stock as a component of NUBIG. Unfortunately, the proposed regulation does not dearly illustrate the problem and solution; however, the preamble does and should be read before studying the proposed regulation.

As stated above, there is an adjustment to NUBIG. However, there are exceptions or modifications to that adjustment; see Prop. Regs. Sec. 1.1374-3(c), Examples (2), (3), and (4).

Planning

Although the proposed regulation Hill correct a "double" inclusion, it may also yield a negative effect. One such possibility occurs when the parent's holding of the subsidiary's stock has a BIL, and the parent has other NUBIG assets with unrealized gain, such that the gain will reduce the parent's NUBIG to zero. Because of this, the S corporation will not owe any BIG tax, because the net recognized BIG is limited to the smaller of the "pre-limitation amount, taxable income limitation, and net unrealized built-in gain limitation"; see Prop. Pegs. Sec. 1.1374-3(c), Examples (2) and (3). If NUBIG is zero, then no BIG will be recognized when...