Waiving a target's loss carryforwards - a preservation of stock basis.

• Author: Pellervo, Patricia W.

If a target corporation (T) is acquired by a member of a consolidated group (P) in a tax year beginning after 1994, and any portion of T's loss carryover expires unused, P's basis in its T stock is reduced by the amount of such expiration (Regs. Sec. 1.1502-32(b)(3)(iii)(A)). This downward stock basis adjustment in the T stock can be avoided or ameliorated through an election to waive all or a portion of T's loss carryover. The election, as described in Regs. Sec. 1.1502-32(b)(4), generally is made on the acquiring group's consolidated return for the year of T's acquisition. In certain situations, the tax consequences of failing to waive T's loss carryovers can be severe.

Example: On Jan. 1, 1997, P acquired all of T's stock for $100 in a qualified stock purchase under Sec. 338(d)(3). At the time of the acquisition, T had a net operating loss (NOL) carryover of $10,000, which was subject to a Sec. 382 limitation and the separate return limitation year rules, and was set to expire at the end of 1999. Due to limitations on the use of T's NOL, the entire NOL expires unused. Therefore, P must reduce its stock basis in T by the amount of the expired NOL, creating a 9,900 excess loss account with respect to P's T stock (disregarding other T activity). An election to waive T's NOL on the 1997 consolidated return would have prevented this downward-stock basis adjustment, thereby holding P's stock basis in T at $100.

If P is a subsidiary of Parent in a consolidated group, the downward adjustment to P's basis in T on expiration of T's loss carryover also results in a downward adjustment to Parent's basis in its P stock. Therefore, failure to waive T's loss carryovers can result in downward stock basis adjustments throughout the tiers of corporations in the corporate chain that holds T's stock.

If an election to waive T's loss carryforwards is made, its loss carryovers are treated as expiring for all Federal income tax purposes immediately before T becomes a member of the P consolidated group. If T is a member of another consolidated group immediately before its purchase by P, the expiration of its loss carryforwards is deemed to occur immediately after it ceases to be a member of the prior group (Regs. Sec. 1.1502-32(b)(4)(i)).

If T is purchased by P in a "qualifying cost basis transaction" (QCBT) and an election to waive T's loss carryovers is made, the noncapital, nondeductible expense resulting from the deemed loss expiration does not result in a...