Blue Cross/Blue Shield Groups Losing Tax-Exempt Status -- Temporary and Proposed Regulations Under Section 833

 [4830-01]

 ACTION: Temporary regulations.

 SUMMARY: This document contains temporary regulations that add a new section 1.1502-75T(d)(5) of the consolidated return regulations. The regulations supplement the existing consolidated return regulations by providing rules relating to the removal of the tax-exempt status of organizations described in section 833 of the Internal Revenue Code (relating to certain Blue Cross or Blue Shield organizations and certain other health insurers). The rules are needed because, as a result of the loss of tax-exempt status, such organizations are, for taxable years beginning after 1986, includible corporations under section 1504(b) of the Code. The text of the temporary regulations set forth in this document also serves as the text of the proposed regulations cross-referenced in the notice of proposed rulemaking in the proposed rules section of this issue of the Federal Register.

 EFFECTIVE DATE: The regulations are effective for taxable years beginning after December 31, 1986.

 FOR FURTHER INFORMATION CONTACT: Jean M. Whalen at telephone 202-566-3938 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

This document adds new section 1.1502-75T(d)(5) to Part 1 of Title 26 of the Code of Federal Regulations. Section 1012 of the Tax Reform Act of 1986 ("1986 Act") denied, for taxable years beginning after December 31, 1986, tax-exempt status to certain organizations described in section 833(c) of the Internal Revenue Code ("section 833 organizations"), relating to certain Blue Cross or Blue Shield organizations and certain other health insurers. As a result, such organizations now are includible corporations under section 1504(b) of the Code. Under section 1.1502-75(d)(1), as a result of a section 833 organization becoming the new common parent of an existing consolidated group ("old group"), the old group terminates and a new affiliated group with the section 833 organization as the new common parent is created.

 There is no indication that Congress intended the termination of the old group and the creation of a new affiliated group as a consequence of the denial of tax-exempt status to section 833 organizations. Therefore, on September 14, 1988, the Service announced in Notice 88-107, 1988-2 C.B. 445, that it would promulgate regulations ameliorating the harsh results that would follow from the termination of the old groups.

EXPLANATION OF PROVISIONS

 The regulations published in this document adopt a neutrality principle which is intended to preclude treating members of an old group better or worse by reason of the enactment of section 833. Thus, some of the tax consequences parallel those applicable to a reverse acquisition as described in section 1.1502-75(d)(3).

 The regulations allow an affiliated group created as a result of the enactment of section 833 to elect to be treated as a continuation of the old group. For this election to apply, all old groups having the same new common parent must make the election. If, as a result of the enactment of section 833, a section 833 organization became the new common parent of an affiliated group that did not file a consolidated return before 1987, the old affiliated group is treated as an old group for purposes of this regulation. Such an affiliated group and its new section 833 organization common parent may elect to file consolidated returns and to be treated as a continuation of the old group.

 The election to continue is deemed to have been made if the parent section 833 organization and all the members of all the old groups file a consolidated (or amended consolidated) return without filing a Form 1122. Alternatively, an election to file as a new group is deemed to have been made if the parent section 833 organization and all the members of all the old groups file a consolidated (or amended consolidated) return and file a Form 1122. If the latter choice is selected, a waiver is granted under section 1504(a)(3) of the Code.

 Any group wishing to revoke an election either to be treated as a continuation of the old group or as a new group may do so if the election was made before September 5, 1990. In addition, an old group may make a delayed election to file a consolidated return as a continuing group or as a new group.

 If an election to continue is made, the section 833 organization will become the common parent without causing a termination of any old group. If the section 833 organization is itself owned by a section 833 organization, the parent section 833 organization will become the new common parent without causing a termination of any old group. Allowing old groups to continue in existence prevents the restoration of gain or loss from deferred intercompany transactions, excess loss accounts and other consequences which follow the termination of a consolidated group.

 Under the neutrality principle, application of the separate return limitation year principles of the existing consolidated return rules to carryovers from taxable years beginning before 1987 is modified by the new temporary regulations if an election to continue the old group or groups is made. Under this modification, a taxable year beginning before 1987 of a member of the old group is not treated as a separate return limitation year with respect to any corporation that was a member of the old group for each day of that taxable year. Additional guidance may be issued regarding the general application of the separate return limitation year rules. The existing consolidated return rules with respect to carrybacks apply without modification.

 The neutrality principle also applies to any life-nonlife consolidated return election under section 1504(c)(2). If the old group elects to continue in existence, the life-nonlife election will also continue. In addition, if an old group was eligible to make a life-nonlife election, it will remain eligible. If a life-nonlife election could not have been made prior to the inclusion of the section 833 organization in the affiliated group, then, for purposes of determining whether a life insurance company or other corporation is a member of a group for the 5-year base period under section 1.1502-47(d)(12), periods of affiliation before the effective date of section 833 are taken into account without excluding, under section 1504(b)(1), the section 833 organization. Thus, for example, if before January 1, 1987, a section 833 organization's only subsidiary was a life insurance company, the five-year period under sections 1503(c)(2) and 1504(c)(2) will commence as of the time the section 833 organization first owned the life insurance company and, after December 31, 1986, they may file an election under section 1504(c)(2) if the section 833 organization has the requisite five-year stock ownership. If the life insurance subsidiary has been held for less than five years, credit will be given for the years it was held.

 Under section 1012(c)(3)(A)(ii) of the 1986 Act, the basis of an existing Blue Cross or Blue Shield organization (as defined in section 833(c)(2)) in its assets, including subsidiary stock, is the fair market value of the asset as of the first date on which section 833 applies to the organization. Therefore, absent a special rule, if, for example, an old group elects to continue in existence, a deemed dividend election by the group under section 1.1502-32(f)(2) would further increase the organization's basis in its subsidiary's stock to the extent the subsidiary's earnings and profits were accumulated in a consolidated return year before January 1, 1966. This would be appropriate if the Blue Cross or Blue Shield organization had a basis in its subsidiary's stock that reflected only its original cost of the stock; in that case a deemed dividend election would prevent a Blue Cross or Blue Shield organization from realizing gain on the sale of the subsidiary stock attributable to amounts accumulated in consolidated return years before January 1, 1966, which are not reflected in the basis of the subsidiary's stock. However, because the Blue Cross or Blue Shield organization's basis in its subsidiary's stock is equal to its fair market value on January 1, 1987, the basis already reflects the subsidiary's earnings and profits accumulated before that date and should not be increased further by a deemed dividend election. New section 1.1502-75T(d)(5)(viii) provides that one consequence of filing consolidated returns after 1986 is that all distributions (whether actual or deemed) by the former common parent of an old group or by a corporation that was not a member of an old group out of earnings and profits accumulated before 1987 to the section 833 organization are deemed made out of earnings and profits accumulated in pre-affiliation years. Thus, such a distribution will result in a negative adjustment under section 1.1502-32(b)(2)(iii)(C) or (c)(2)(iii) to the section 833 organization's basis in the stock of the distributing corporation.

 If an election to file as a new group is made then the consequences which follow from the termination of a consolidated group apply. In addition, the five-year period for a life-nonlife consolidated return election under section 1504(c)(2) will commence as of the time the new group came into existence.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations will be submitted to the Administrator of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal author of these temporary regulations is Jean M. Whalen of the Office of Assistant Chief Counsel (Corporate), Internal Revenue Service. However, other personnel from the Internal Revenue Service and the Treasury Department participated in developing the regulations, on matters of both substance and style.

LIST OF SUBJECTS

 26 CFR 1.1501-1 through 1.1564-1

 Income taxes, Controlled group of corporations, Consolidated returns.

Treasury Decision 8310

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR Part 1 is amended as follows:

Paragraph 1. The authority citation for Part 1 continues to read as follows:

Authority: 26 U.S.C. 7805; * * * section 1.1502-75T also issued under 26 U.S.C. 1502.

Par. 2. Section 1.1502-75T is amended by revising the heading and by adding new paragraph (d) to read as follows:

SECTION 1.1502-75T. TEMPORARY REGULATIONS FOR FILING CONSOLIDATED RETURNS; COORDINATION WITH SECTION 338(h)(10) AND SECTION 833 (TEMPORARY).

* * * * *

(c) [Reserved.]

(d) WHEN GROUP REMAINS IN EXISTENCE.

(1) - (4) [Reserved.]

(5) COORDINATION WITH SECTION 833 -- (i) ELECTION TO CONTINUE OLD GROUP. If, solely by reason of the enactment of section 833 (relating to certain Blue Cross or Blue Shield organizations and certain other health insurers), an organization to which section 833 applies (a "section 833 organization") became the new common parent of an old group on January 1, .1987, the old group may elect to continue in existence with that section 833 organization as its new common parent, provided all the old groups having the same section 833 organization as their new common parent elect to continue in existence. To revoke this election, see paragraph (d)(5)(x) of this section. To file as a new group, see paragraph (d)(5)(v) of this section.

(ii) OLD GROUP. For purposes of this paragraph (d)(5), an old group is a group which, for its last taxable year ending in 1986, either filed a consolidated return or was eligible to (but did not) file a consolidated return.

(iii) MANNER OF ELECTING TO CONTINUE -- (A) DEEMED ELECTION. If all the members of all the old groups having the same section 833 organization as their new common parent are included for the first taxable year beginning after December 31, 1986, on the same consolidated (or amended consolidated) return and a Form 1122 was not filed, the old groups are deemed to have elected under paragraph (d)(5)(i) of this section to continue in existence.

(B) DELAYED ELECTION. If a deemed election to continue in existence was not made under paragraph (d)(5)(iii)(A) of this section, all the members of all the old groups having the same section 833 organization as their new common parent may make a delayed election under paragraph (d)(5)(i) of this section to continue in existence by

(1) filing an appropriate consolidated (or amended consolidated) return or returns for each taxable year beginning after December 31, 1986, (notwithstanding section 1.1502-75(a)(1)) on or before January 3, 1991, and

(2) on the top of any such return prominently affixing a statement containing the following declaration: "THIS RETURN" (or, if applicable, "AMENDED RETURN") "REFLECTS A DELAYED ELECTION TO CONTINUE UNDER SECTION 1.1502-75T(d)(5)(iii)(B)". A delayed election to continue in existence automatically revokes a deemed election to file as a new group which was made under paragraph (d)(5)(vi) of this section.

(iv) EFFECTS OF ELECTION TO CONTINUE IN EXISTENCE. If an old group or groups elect to continue in existence under paragraph (d)(5)(i) of this section, the following rules apply.

(A) TAXABLE YEARS. Each member that filed returns other than on a calendar year basis shall close its taxable year on December 31, 1986, and change to a calendar year beginning on January 1, 1987. See section 843 and section 1.1502-76(a)(1);

(B) CARRYOVERS FROM SEPARATE RETURN LIMITATION YEARS. For purposes of applying the separate return limitation year rules to carryovers from taxable years beginning before 1987 to taxable years beginning after 1986, the following rules apply:

(1) Any taxable year beginning before 1987 of a corporation that was not a member of an old group (including a section 833 organization) will be treated as a separate return limitation year;

(2) Any taxable year beginning before 1987 of a corporation that was a member of an old group that, without regard to this section and the enactment of section 833, was a separate return limitation year will continue to be treated as a separate return limitation year;

(3) Any taxable year beginning before 1987 of a member of an old group (other than a separate return limitation year described in paragraph (d)(5)(iv)(B)(2) of this section) will not be treated as a separate return limitation year with respect to any corporation that was a member of such group for each day of that taxable year; and

(4) Any taxable year beginning before 1987 of a member of an old group will be treated as a separate return limitation year with respect to any corporation that was not a member of such group for each day of that taxable year (e.g., a corporation that was not a member of an old group, including a section 833 organization, or a corporation that was a member of another old group).

(C) FIVE-YEAR RULES FOR LIFE-NONLIFE GROUPS. Any life-nonlife election under section 1504(c)(2) in effect for an old group remains in effect. Any old group which was eligible to make a life-nonlife election will remain eligible to make the election. For purposes of section 1503(c), a nonlife member is treated as ineligible under section 1.1502-47(d)(13) with respect to a life member, unless both were members of the same affiliated group (determined without regard to the exclusions in section 1504(b)(1) and (2)) for five taxable years immediately preceding the taxable year in which the loss arose. See paragraph (d)(5)(ix) of this section for a tacking rule.

(v) ELECTION TO FILE AS A NEW GROUP. If, solely by reason of the enactment of section 833, a section 833 organization became the new common parent of an old group on January 1, 1987, the application of the five-year prohibition on reconsolidation in section 1504(a)(3)(A) to the old group is waived and the old group together with the new section 833 organization common parent may elect to file as a new group provided that all includible corporations elect to file a consolidated (or amended consolidated) return as a new group for the first taxable year beginning after December 31, 1986. To revoke this election, see paragraph (d)(5)(x) of this section.

(vi) MANNER OF ELECTING TO FILE AS A NEW GROUP -- (A) DEEMED ELECTION. The old group or groups and the section 833 organization are deemed to have elected under paragraph (d)(5)(v) of this section to file as a new group by filing, for the first taxable year beginning after December 31, 1986, a Form 1122 and a consolidated (or amended consolidated) tax return.

(B) DELAYED ELECTION. If a deemed election to file as a new group was not made pursuant to paragraph (d)(5)(vi)(A) of this section, the old group or groups and the section 833 organization may make a delayed election under paragraph (d)(5)(v) of this section to file as a new group by

(1) filing an appropriate consolidated (or amended consolidated) return or returns for each taxable year beginning after December 31, 1986, (notwithstanding section 1.1502-75(a)(1)) on or before January 3, 1991, and

(2) on the top of any such return prominently affixing a statement containing the following declaration: "THIS RETURN" (or, if applicable, "AMENDED RETURN") "REFLECTS A DELAYED ELECTION TO FILE AS A NEW GROUP UNDER SECTION 1.1502-75T (d)(5)(vi)(B)". A delayed election to file as a' new group automatically revokes any deemed election to continue in existence which was made under paragraph (d)(5)(iii) of this section.

(vii) EFFECTS OF ELECTION TO FILE AS A NEW GROUP. If an old group or groups elect to file as a new group under paragraph (d)(5)(v) of this section, the following rules apply:

(A) TERMINATION. Each old group is treated as if it terminated on January 1, 1987, and the termination is not treated as resulting from the acquisition by a nonmember of all of the stock of the common parent.

(B) TAXABLE YEARS. Each member that filed returns other than on a calendar year basis shall close its taxable year on December 31, 1986, and change to a calendar year beginning on January 1, 1987. See section 843 and section 1.1502-76(a)(1).

(C) SEPARATE RETURN LIMITATION YEAR AND LIFE-NONLIFE GROUPS. For purposes of section 1.1502-1(f), sections 1503(c) and 1504(c), and section 1.1502-47, the group is treated as coming into existence as a new group on January 1, 1987. Thus, for example, paragraphs (d)(5)(iv)(B) and (C) of this section do not apply.

(viii) EARNINGS AND PROFITS. All distributions after January 1, 1987 by a corporation, whether or not such corporation was a member of an old group, to an existing Blue Cross or Blue Shield organization (as defined in section 833(c)(2)) out of earnings and profits accumulated before 1987 are deemed made out of earnings and profits accumulated in pre-affiliation years. See section 1.1502-32(b)(2)(iii)(6) and (c)(2)(iii).

(ix) FIVE-YEAR TACKING RULES FOR CERTAIN LIFE-NONLIFE GROUPS. For purposes of applying section 1.1502-47(d)(5) and (12) to any taxable year ending after 1986 to a corporation, whether or not the corporation was a member of an old group, (A) the determination of whether the corporation was in existence and a member or tentatively treated as a member of a group, for taxable years ending before 1987, is made without regard to the exclusions under section 1504(b)(1) and (2) of any section 833 organization or life insurance company (as the case may be) and (B) a section 833 organization is not treated as having a change in tax character solely by reason of the loss of its tax-exempt status due to the enactment of section 833. This paragraph (d)(5)(ix) does not apply if an election to file as a new group under paragraph (d)(5)(v) of this section is made.

(x) Time to revoke elections made before September 5, 1990. An election by an old group to continue in existence or to file as a new group that was made (or deemed made) before September 5, 1990, may be revoked by filing an appropriate return (or returns) on or before January 3, 1991. For purposes of this paragraph (d)(5)(x), appropriate returns include separate returns filed by each member of the group or consolidated returns filed in accordance with a delayed election either under paragraph (d)(5)(iii)(B) or (vi)(B) of this section.

(xi) EXAMPLES. The following examples illustrate this paragraph (d)(5). In these examples, each corporation uses the calendar year as its taxable year.

EXAMPLE 1. B is a section 833 organization. For several years, B has owned all of the outstanding stock of X, Y, and Z. X has owned all the outstanding stock of X1 throughout X1's existence and Y has owned all of the outstanding stock of Y1 throughout Y1`s existence. For 1986, X and X1 filed a consolidated federal income tax return but Y and Y1 filed separate returns. Under paragraph (d)(5)(ii) of this section, X and X1 and Y and Y1 each constitute an old group because they either filed a consolidated return or were eligible to file a consolidated return for 1986. The X and Y groups may elect under paragraph (d)(5)(i) of this section to continue in existence. If they elect to continue, under paragraph (d)(5)(iv)(B) of this section, the separate return limitation year rules apply as follows: any taxable year of B or Z beginning before 1987 is treated as a separate return limitation year with respect to each other and to all other members of the group; any taxable year of X or X1 beginning before 1987 is treated as a separate return limitation year with respect to B, Z, Y and Y1, but not with respect to each other; and any taxable year of Y or Y1 beginning before 1987 is treated as a separate return limitation year with respect to B, Z, X and X1, but not with respect to each other.

EXAMPLE 2. The facts are the same as in Example 1 except that B is owned by C, another section 833 organization. If the X and Y groups elect to continue, the results are the same as in Example 1, except that, under paragraph (d)(5)(iv)(B)(1) of this section, for purposes of applying the separate return limitation year rules, any taxable year of C beginning before 1987 is also treated as a separate return limitation year with respect to all other members of the group.

EXAMPLE 3. The facts are the same as in Example 1 except that Y purchased Y1 on January 1, 1985. If the X and Y groups elect to continue, the results are the same as in Example 1, except that, under paragraph (d)(5)(iv)(B)(2) of this section, for purposes of applying the separate return limitation year rules, any taxable year of Y1 beginning before 1985 is treated as a separate return limitation year with respect to Y as well as with respect to all other members of the group.

EXAMPLE 4. B, a section 833 organization, has owned all the stock of X since November 1984. X has owned all the stock of L, a life insurance company, throughout L's existence. In 1986, X and L properly filed a life-nonlife consolidated return. Under paragraph (d)(5)(i) of this section, the X group elects to continue in existence. Under paragraph (d)(5)(iv)(C) of this section, the life-nonlife election will remain in effect. However, losses of B which arise before 1990 cannot be used to offset the income of L. See section 1503(c)(2) and section 1.1502-47(d)(13) and paragraph (d)(5)(iv)(C) of this section. Under paragraph (d)(5)(iv)(B) of this section, the separate return limitation year rules apply as follows: any taxable year of B beginning before 1987 is treated as a separate return limitation year with respect to all other members of the group; and any taxable year of X or L beginning before 1987 is treated as a separate return limitation year with respect to B, but not with respect to each other.

EXAMPLE 5. The facts are the same as Example 4 except that, on January 1, 1984, B formed 11, a life insurance company. Under paragraph (d)(5)(ix) of this section and section 1504(c), the first year L1 is eligible to join in B's life-nonlife election is 1989.

EXAMPLE 6. The facts are the same as in Example 4 except that B and the X group elect under paragraph (d)(5)(v) of this section to file as a new group. The X group will be considered to have terminated under section 1.1502-75(d)(1) on December 31, 1986. X and L are each separately subject to the separate return limitation year rules of section 1.1502-1(f). The first year L and L1, are eligible to join the new group in a life-nonlife election is 1992 (five years after the new group is formed). See section 1504(c)(2) and paragraphs (d)(5)(vii)(C) and (ix) of this section.

* * * * *

The provisions contained in this Treasury decision are needed to immediately amend the consolidated return regulations in response to changes made by section 1012 of the Tax Reform Act of 1986. It is therefore found impracticable and contrary to the public interest to issue this Treasury decision with notice and public procedure under section 553(b) of Title 5 of the United States Code or subject to the effective date limitations of section 553(d) of Title 5, United States Code.