Final Regs Cover Tax Treatment of Federal Assistance to Troubled Banks

 [4830-01]

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to Federal financial assistance, as defined in section 597(c) of the Internal Revenue Code, that is received by a financially troubled bank or thrift institution, and to acquisitions of financially troubled bank or thrift institutions in which Federal financial assistance is provided. This document also contains final regulations under section 7507. These regulations provide guidance concerning the proper tax treatment of various transactions involving the receipt of Federal financial assistance.

DATES: These regulations are effective December 21, 1995.

For dates of applicability, see the "Section 1.597-7 Effective date" section under the "SUPPLEMENTARY INFORMATION" portion of the preamble and the effective date provisions (section 1.597-7) of this document.

FOR FURTHER INFORMATION CONTACT: Steven M. Flanagan at 202-622-7790, Vicki J. Hyche at 202-622-7530, William D. Alexander at 202-622-7710, or Steven R. Glickstein at 202-622-4439 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collections of information contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1300. Responses to these collections of information are required to track deferred income and its subsequent recapture, elect to disaffiliate earlier than would otherwise be permitted, elect to apply the provisions of the regulation retroactively, and report uncollected income tax.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.

The estimated annual burden per respondent/recordkeeper varies from 1 hour to 11 hours, depending on individual circumstances, with an estimated average of 4.4 hours.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer T:FP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to these collections of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

BACKGROUND

This document contains final regulations under section 597, as amended by section 1401 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (Public Law 101-73) (FIRREA). The regulations provide guidance for banks and domestic building and loan associations (Institutions) and their affiliates in connection with receipt of Federal financial assistance (FFA), as defined in section 597(c).

Section 597(a) delegates to the Secretary of the Treasury authority to prescribe regulations concerning "any transaction in which Federal financial assistance is provided." These regulations are issued under the authority of section 597(a).

This document also amends the regulations under section 7507 to reflect the treatment of FFA under FIRREA.

The IRS published proposed regulations under sections 597 and 7507 on April 22, 1992 (57 FR 14794, FI-46-89, 1992-1 C.B. 1037).

PUBLIC COMMENTS AND THE FINAL REGULATIONS

The IRS received comments on the proposed regulations, and a public hearing was held on July 17, 1992. After consideration of the comments and the statements made at the hearing, the proposed regulations are adopted as revised by this Treasury decision. The principal comments and revisions are discussed below.

SECTION 1.597-2 TAXATION OF FFA

Section 1.597-2 contains rules concerning accounting for FFA as income. The final regulations retain the proposed rule that, generally, FFA is income to the failed Institution when it is received or accrued in accordance with the Institution's method of accounting. Section 1.597-2(c) contains rules permitting certain Institutions to defer the inclusion of FFA.

DEFERRAL FORMULA WITHOUT CONTINUING EQUITY. Under the proposed regulations, unresolved Institutions without Continuing Equity were permitted to defer inclusion of FFA in excess of amounts determined under a formula. The proposed formula required current inclusion equal to the sum of liabilities less aggregate adjusted basis at the beginning of the assistance year (representing losses already recognized), plus loss in the current year (disregarding FFA). The proposed formula generally allowed the Institution the benefit of any prior losses of its owners' equity, but offset any losses of creditors' capital by the inclusion of FFA. However, with respect to losses during the year FFA is received, the proposed formula did not distinguish between losses of owners' equity and losses of creditors' capital and, therefore, offset losses of owners' equity by inclusion of FFA. The formula (together with related recapture rules) in the final regulations has been changed to reflect that the owners' equity is the first capital lost and, in a transaction without Continuing Equity, is not offset by inclusion of FFA.

DEFERRAL FORMULA WITH CONTINUING EQUITY. The proposed regulations allowed deferral under different conditions where Continuing Equity is present. In that case, the Institution must include currently, in addition to the normal formula amount, income equal to all net operating loss carryovers available to it. Also, an Institution with Continuing Equity must recapture deferred FFA at least as quickly as pro rata over a maximum of six years, regardless of whether it recognizes all of its built-in losses during that time.

Commentators suggested that the proposed regulations unfairly limited deferral for Institutions with Continuing Equity and recommended the same deferral formula apply in all cases. They criticized the Continuing Equity concept because it focused on the identity of the Institution's shareholders after the assistance transaction.

Under the definition of Continuing Equity in the proposed regulations, an Institution generally would have Continuing Equity if five percent or more of its stock at the end of a taxable year was owned by shareholders who owned stock before the Institution was placed in receivership by a supervisory agency (Agency) or first received FFA. The five percent reference was misleading because, under section 1.597-5, a 50 percent change in ownership generally results in a deemed Taxable Transfer (now defined in section 1.597-5(a)(1)) in which the failed Institution is treated as a New Entity. The deferral rules do not apply after a deemed Taxable Transfer. The final regulations thus clarify that Continuing Equity exists only if the Institution is not (i) a Bridge Bank, (ii) in Agency receivership, or (iii) treated as a New Entity. The modification to the definition of Continuing Equity is not intended as a substantive change. The Continuing Equity deferral provisions apply only to the limited number of "open bank" resolutions not subject to the deemed Taxable Transfer rules. (As discussed below, the Taxable Transfer definitions have also been modified to clarify that most "open bank" assisted transactions are treated as Taxable Transfers.)

The final regulations do not eliminate the special treatment of Institutions with Continuing Equity. The regulations provide deferral rules to ameliorate a timing mismatch between FFA income and related losses. Deferral is not designed to allow built-in losses to offset operating income instead of FFA or to permit the permanent elimination of any subsidy provided by Agency. The requirement that Institutions with Continuing Equity recapture their deferred FFA within six years is a reasonable safeguard against indefinite deferral of FFA income. The results under these rules are comparable in effect to those applicable to acquirors in Taxable Transfers.

The final regulations do, however, modify the Continuing Equity formula, which, in the proposed regulations, counted some losses twice. Recognized losses represented in the first prong of the formula (liabilities minus asset bases) may comprise part of the third prong (net operating losses available to the Institution or its consolidated group). The final regulations correct this double counting of losses.

TRANSFERS OF MONEY AND PROPERTY TO AGENCY. The proposed regulations contained rules for taxing FFA if money or property is also transferred to Agency. These rules, together with rules for the treatment of FFA received pursuant to a Loss Guarantee, have been clarified, reorganized, and restated in section 1.597-2(d).

The proposed regulations provided an offset or deduction for payments by an Institution to Agency to the extent of previously received FFA. The rule as proposed provided limited relief for payments made to Agency by a New Entity or Acquiring, because they receive little or no FFA. However, an assisted acquisition can result in income to a New Entity or Acquiring in the form of built-in gain. Under section 597(c) and section 1.597-3(b), an instrument issued to Agency by a New Entity or Acquiring is, in effect, disregarded. If a New Entity or Acquiring issues its instrument to Agency in connection with the acquisition of an Institution, the value of the instrument is not included in the purchase price. Consequently, a New Entity or Acquiring may have a basis shortfall in the assets acquired (or deemed acquired) from the failed Institution. The final regulations provide a New Entity or Acquiring a purchase price adjustment upon any transfer to Agency (e.g., in satisfaction of the disregarded instrument).

In response to comments, the final regulations also specifically provide for repayments to Agency by Institution affiliates. Moreover, the final regulations provide that if Agency sells an Institution's instrument to a third party, the sales price is treated as a repayment to Agency by the issuer. Furthermore, the instrument is treated as having been newly issued by the issuer to the holder at that time. The IRS and Treasury believe that this is an appropriate time for the issuer to offset FFA or increase its basis, because the sales price reasonably fixes the value of the instrument, and any subsequent cost associated with the instrument should be accounted for in accordance with the nature of the instrument.

SECTION 1.597-4(g) ELECTIVE DISAFFILIATION

The proposed regulations would allow a consolidated group to elect (after the regulations became final) to exclude an Institution in receivership from its group. The election potentially requires the inclusion of a "toll charge" in the income of those members owning the common stock of the Institution (the member shareholders). The amount of the toll charge is the excess of the disaffiliated Institution's liabilities over the adjusted basis of its assets. The toll charge is intended to reflect the amount that would be included in income if Agency were to provide the entire amount of FFA necessary to restore the Institution's solvency at the time of the event permitting disaffiliation. Commentators suggested that the final regulations should include the toll charge in the income of the disaffiliated Institution (rather than its member shareholders), provide the group with a "toll charge deduction," and clarify the ability of the member shareholders to take a worthless stock deduction.

TOLL CHARGE. Commentators suggested that the final regulations include the toll charge in the income of the failed Institution rather than its member shareholders. According to the commentators, including the toll charge in the income of the member shareholders may result in disadvantageous state tax consequences in those states where banking corporations are not permitted to file consolidated returns with nonbanking corporations. Under the proposed regulations, a bank holding corporation (the disaffiliated Institution's shareholder) would have to include in income the toll charge without the benefit of the Institution's offsetting losses.

The IRS and Treasury agree that the toll charge is more appropriately included in the income of the Institution (i.e., the entity that is reimbursed by Agency for its loss), because the toll charge represents accelerated FFA income. Thus, the final regulations provide that the Institution, rather than its member shareholders, takes the toll charge into income.

TOLL CHARGE DEDUCTION. Under the proposed regulations, the Institution does not recognize built-in losses on disaffiliation. One commentator suggested the final regulations provide for a "toll charge deduction" for the excess of the Institution's adjusted basis over its liabilities. According to the commentator, such a deduction is appropriate because the Institution incurred economic loss while it was a member of the consolidated group, before the Institution was placed in receivership by Agency.

The commentator's recommendation is not adopted in the final regulations because a toll charge deduction would accelerate recognition of losses in advance of realization. Such a deduction is particularly inappropriate because federal banking laws now permit placing solvent institutions in receivership. In such cases, it is uncertain whether the loss represented by such a deduction will ever be realized.

WORTHLESS STOCK DEDUCTION. Under the proposed regulations, if an election to disaffiliate is made, the members of the consolidated group are treated as having disposed of their stock in the Institution. One commentator suggested that the final regulations clarify that, upon disaffiliation, the Institution's stock is worthless.

The final regulations address the commentator's concerns by providing that, as a consequence of the election, the members of the consolidated group treat their stock in the Institution as worthless if the Institution is factually insolvent on the date the Institution is placed in receivership (or on the date the consolidated group is deemed to make the election to disaffiliate). This rule preempts otherwise applicable tests for worthlessness under section 165 and section 1.1502-19. Any worthless stock deduction is subject to the limitations of the loss disallowance regulations (sections 1.337(d)-1 and 1.1502-20).

CONSISTENCY RULE. Under the proposed regulations, a consolidated group could elect to disaffiliate a subsidiary Institution only if the Institution was its first subsidiary placed in Agency receivership after the enactment of FIRREA. The election made for the first subsidiary bound all future subsidiaries placed in Agency receivership. To address the concern that the scope of the proposed consistency rule was too broad, the final regulations modify the consistency rule to require, generally, that a consolidated group must elect consistently only for subsidiary Institutions placed in Agency receivership within five years of each other.

SECTION 1.597-5 TAXABLE TRANSFERS

Section 597 applies to FFA and transactions in connection with which FFA is provided. The proposed regulations generally define a Taxable Transfer as a transfer of deposit liabilities or stock while an Institution is under Agency Control. However, IRS and Treasury now understand that it is possible for Agency to resolve an Institution under its control without providing assistance, or to provide assistance without placing an Institution under its control. In light of this information, the final regulations refine the definition of a Taxable Transfer.

Under the final regulations, Taxable Transfers include the transfer of any deposit liability in connection with which FFA is provided or the transfer of any asset for which Agency has an obligation (e.g., assets covered by Loss Guarantees). Certain transfers of stock cause a Taxable Transfer if FFA is provided in connection with the transfer, if the Institution is a Bridge Bank or if the Institution has a balance in its deferred FFA account. The phrase "in connection with" should be interpreted broadly. If any party to a transaction receives FFA, all parties and all related transactions are within the scope of these regulations. To provide certainty regarding tax treatment for purchasers of stock of subsidiaries of Institutions under Agency Control, the final regulations treat all transactions in which such a subsidiary leaves its group as Taxable Transfers.

SECTION 1.597-6 LIMITATION ON COLLECTION OF INCOME TAX

LIMITATION WHERE TAX IS BORNE BY AGENCY. The proposed regulations provided that income tax attributable to the receipt of FFA or gain on a Taxable Transfer would not be collected from an Institution without Continuing Equity if Agency would bear the burden of the tax. Commentators suggested that the limitation on noncollection in cases of Continuing Equity is inappropriate because it requires Agency to gross-up any assistance paid to cover the tax thereon.

The final regulations retain the limitation on noncollection in cases of Continuing Equity. The IRS and Treasury believe that the limitation is appropriate for transactions in which Agency assists an Institution while allowing old shareholders to retain their ownership. Noncollection should not inure to the benefit of the Institution's old shareholders, who would have use of the Institution's losses while escaping responsibility for the tax on related FFA income. The congressional purpose in FIRREA to eliminate any tax subsidy for assisted transactions requires that the IRS not waive its rights as a creditor in cases where all other creditors and equity holders retain their rights.

TRANSFEREE LIABILITY. The proposed regulations limited the collection of a failed Institution's income taxes from a transferee in a Taxable Transfer (i.e., a New Entity or Acquiring). This rule would not apply if (similar to the Continuing Equity rule discussed above under the heading "Deferral formula with Continuing Equity") there is a five percent overlap in the ownership of the transferor Institution and the New Entity or Acquiring.

Commentators suggested that the final regulations should not include the five percent overlap exception because the exception appears to punish former owners of Institutions, Institutions have difficulty tracking ownership, and the exception contains no limits on aggregation.

Because good faith purchasers of assets for value generally do not have transferee liability, the final regulations clarify that Acquiring (the purchaser of Institution's assets in an actual Taxable Transfer) is not subject to such liability in any case. This rule applies even if shareholders of Acquiring were shareholders of the selling Institution.

The final regulations do not, however, except a New Entity (the resulting corporation in a deemed Taxable Transfer) from collection if the Institution's previous equity interests remain outstanding in the New Entity, or are reacquired or exchanged for consideration. As in those cases in which a Taxable Transfer does not occur, the IRS should remain a creditor if all other creditors retain their interests and the Institution's previous equity interests had retained value. However, by focusing on whether previous equity interests retain value, the final regulations eliminate the need to track or aggregate ownership and do not penalize any particular potential acquirors.

SECTION 1.597-7 EFFECTIVE DATE

As proposed, these final regulations generally apply to taxable years ending on or after April 22, 1992. However, the provisions of these regulations do not apply to FFA received or accrued for taxable years ending after April 22, 1992, in connection with an Agency assisted acquisition that occurs before April 22, 1992. Taxpayers not subject to these regulations must comply with an interpretation of the statute that is reasonable in light of the legislative history and applicable administrative pronouncements. For this purpose, the rules contained in Notice 89-102 (1989-2 C.B. 436) apply to the extent provided in the Notice.

An irrevocable election is available to apply the regulations to taxable years prior to the general effective date. However, the election cannot be made if the Institution's statute of limitations has expired or a section 338 election was available but not made for the Institution. In addition, consistent treatment is required in "open bank" resolutions that would result under the regulations in deemed Taxable Transfers before April 22, 1992.

The proposed regulations required an electing taxpayer to extend the statute of limitations for all items for three years from the date of filing the election. The final regulations adopt a commentator's suggestion that the taxpayer extend the statute of limitations only for items affected by application of the regulations.

An Institution or consolidated group makes the election on its first annual income tax return filed on or after March 15, 1996. However, to make the affirmative election to disaffiliate under section 1.597-4(g)(5) for an Institution placed in Agency receivership in a taxable year ending before April 22, 1992, a consolidated group must send the affected Institution the required statement advising it of the elective disaffiliation on or before May 31, 1996. In that case, the consolidated group is deemed to have elected retroactive application of these regulations but must nevertheless attach the required statement to its first annual income tax return filed on or after March 15, 1996.

The final regulations provide that taxpayers may rely on the provisions of the proposed regulations to the extent they acted in reliance on the proposed regulations prior to December 21, 1995. Such reliance must be reasonable and transactions with respect to which such taxpayers rely must be consistent with the overriding policies of section 597, as expressed in the legislative history, as well as the overriding policies of the proposed regulations.

SPECIAL ANALYSES

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations do not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that these regulations will generally only apply to certain financially troubled financial institutions and the consolidated groups, if any, to which they belong. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

The principal author of these regulations is Steven M. Flanagan, Office of the Assistant Chief Counsel (Corporate), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR parts 1, 301 and 602 are amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority for part 1 is amended by adding the following citation:

Authority: 26 U.S.C. 7805 * * *

Sections 1.597-1 through 1.597-7 also issued under 26 U.S.C. 597 and 1502.

Par. 2. Sections 1.597-1 through 1.597-7 are added to read as follows:

SECTION 1.597-1 DEFINITIONS.

For purposes of the regulations under section 597 --

(a) Unless the context otherwise requires, the terms consolidated group, member and subsidiary have the meanings provided in section 1.1502-1; and

(b) The following terms have the meanings provided below --

ACQUIRING. The term Acquiring means a corporation that is a transferee in a Taxable Transfer, other than a deemed transferee in a Taxable Transfer described in section 1.597-5(b). Agency. The term Agency means the Resolution Trust Corporation, the Federal Deposit Insurance Corporation, any similar instrumentality of the United States government, and any predecessor or successor of the foregoing (including the Federal Savings and Loan Insurance Corporation).

AGENCY CONTROL. An Institution or entity is under Agency Control if Agency is conservator or receiver of the Institution or entity, or if Agency has the right to appoint any of the Institution's or entity's directors.

AGENCY OBLIGATION. The term Agency Obligation means a debt instrument that Agency issues to an Institution or to a direct or indirect owner of an Institution.

BRIDGE BANK. The term Bridge Bank means an Institution that is organized by Agency to hold assets and liabilities of another Institution and that continues the operation of the other Institution's business pending its acquisition or liquidation, and that is any of the following --

(1) A national bank chartered by the Comptroller of the Currency under section 11(n) of the Federal Deposit Insurance Act (12 U.S.C. 1821(n)) or section 21A(b)(10)(A) of the Federal Home Loan Bank Act (12 U.S.C. 1441a(b)(10)(A)) or any successor sections;

(2) A Federal savings association chartered by the Director of the Office of Thrift Supervision under section 21A(b)(10)(A) of the Federal Home Loan Bank Act (12 U.S.C. 1441a(b)(10)(A)) or any successor section; or

(3) A similar Institution chartered under any other statutory provisions.

CONSOLIDATED SUBSIDIARY. The term Consolidated Subsidiary means a member of the consolidated group of which an Institution is a member that bears the same relationship to the Institution that the members of a consolidated group bear to their common parent under section 1504(a)(1).

CONTINUING EQUITY. An Institution has Continuing Equity for any taxable year if, on the last day of the taxable year, the Institution is not (1) a Bridge Bank, (2) in Agency receivership, or (3) treated as a New Entity.

CONTROLLED ENTITY. The term Controlled Entity means an entity under Agency Control.

FEDERAL FINANCIAL ASSISTANCE (FFA). The term Federal Financial Assistance (FFA), as defined by section 597(c), means any money or property provided by Agency to an Institution or to a direct or indirect owner of stock in an Institution under section 406(f) of the National Housing Act (12 U.S.C. 1729(f)), section 21A(b)(4) of the Federal Home Loan Bank Act (12 U.S.C. 1441a(b)(4)), section 11(f) or 13(c) of the Federal Deposit Insurance Act (12 U.S.C. 1821(f), 1823(c)), or under any similar provision of law. Any such money or property is FFA, regardless of whether the Institution or any of its affiliates issues Agency a note or other obligation, stock, warrants, or other rights to acquire stock in connection with Agency's provision of the money or property. FFA includes Net Worth Assistance, Loss Guarantee payments, yield maintenance payments, cost to carry or cost of funds reimbursement payments, expense reimbursement or indemnity payments, and interest (including original issue discount) on an Agency Obligation.

INSTITUTION. The term Institution means an entity that is, or immediately before being placed under Agency Control was, a bank or domestic building and loan association within the meaning of section 597 (including a Bridge Bank). Except as otherwise provided in the regulations under section 597, the term Institution includes a New Entity or Acquiring that is a bank or domestic building and loan association within the meaning of section 597.

LOSS GUARANTEE. The term Loss Guarantee means an agreement pursuant to which Agency or a Controlled Entity guarantees or agrees to pay an Institution a specified amount upon the disposition or charge-off (in whole or in part) of specific assets, an agreement pursuant to which an Institution has a right to put assets to Agency or a Controlled Entity at a specified price, or a similar arrangement.

NET WORTH ASSISTANCE. The term Net Worth Assistance means money or property (including an Agency Obligation to the extent it has a fixed principal amount) that Agency provides as an integral part of a Taxable Transfer, other than FFA that accrues after the date of the Taxable Transfer. For example, Net Worth Assistance does not include Loss Guarantee payments, yield maintenance payments, cost to carry or cost of funds reimbursement payments, or expense reimbursement or indemnity payments. An Agency Obligation is considered to have a fixed principal amount notwithstanding an agreement providing for its adjustment after issuance to reflect a more accurate determination of the condition of the Institution at the time of the acquisition.

NEW ENTITY. The term New Entity means the new corporation that is treated as purchasing all of the assets of an Old Entity in a Taxable Transfer described in section 1.597-5(b).

OLD ENTITY. The term Old Entity means the Institution or Consolidated Subsidiary that is treated as selling all of its assets in a Taxable Transfer described in section 1.597-5(b).

RESIDUAL ENTITY. The term Residual Entity means the entity that remains after an Institution transfers deposit liabilities to a Bridge Bank.

TAXABLE TRANSFER. The term Taxable Transfer has the meaning provided in section 1.597-5(a)(1).

SECTION 1.597-2 TAXATION OF FEDERAL FINANCIAL ASSISTANCE.

(a) INCLUSION IN INCOME -- (1) IN GENERAL. Except as otherwise provided in the regulations under section 597, all FFA is includible as ordinary income to the recipient at the time the FFA is received or accrued in accordance with the recipient's method of accounting. The amount of FFA received or accrued is the amount of any money, the fair market value of any property (other than an Agency Obligation), and the issue price of any Agency Obligation (determined under section 1.597-3(c)(2)). An Institution (and not the nominal recipient) is treated as receiving directly any FFA that Agency provides in a taxable year to a direct or indirect shareholder of the Institution, to the extent money or property is transferred to the Institution pursuant to an agreement with Agency.

(2) CROSS REFERENCES. See paragraph (c) of this section for rules regarding the timing of inclusion of certain FFA. See paragraph (d) of this section for additional rules regarding the treatment of FFA received in connection with transfers of money or property to Agency or a Controlled Entity, or paid pursuant to a Loss Guarantee. See section 1.597-5(c)(1) for additional rules regarding the inclusion of Net Worth Assistance in the income of an Institution.

(b) BASIS OF PROPERTY THAT IS FFA. If FFA consists of property, the Institution's basis in the property equals the fair market value of the property (other than an Agency Obligation) or the issue price of the Agency Obligation, as determined under section 1.597-3(c)(2).

(c) TIMING OF INCLUSION OF CERTAIN FFA -- (1) SCOPE. This paragraph (c) limits the amount of FFA an Institution must include in income currently under certain circumstances and provides rules for the deferred inclusion in income of amounts in excess of those limits. This paragraph (c) does not apply to a New Entity or Acquiring.

(2) AMOUNT CURRENTLY INCLUDED IN INCOME BY AN INSTITUTION WITHOUT CONTINUING EQUITY. The amount of FFA an Institution without Continuing Equity must include in income in a taxable year under paragraph (a)(1) of this section is limited to the sum of --

(i) The excess at the beginning of the taxable year of the Institution's liabilities over the adjusted bases of the Institution's assets; and

(ii) The amount by which the excess for the taxable year of the Institution's deductions allowed by chapter 1 of the Internal Revenue Code (other than net operating and capital loss carryovers) over its gross income (determined without regard to FFA) is greater than the excess at the beginning of the taxable year of the adjusted bases of the Institution's assets over the Institution's liabilities.

(3) AMOUNT CURRENTLY INCLUDED IN INCOME BY AN INSTITUTION WITH CONTINUING EQUITY. The amount of FFA an Institution with Continuing Equity must include in income in a taxable year under paragraph (a)(1) of this section is limited to the sum of --

(i) The excess at the beginning of the taxable year of the Institution's liabilities over the adjusted bases of the Institution's assets;

(ii) The greater of --

(A) The excess for the taxable year of the Institution's deductions allowed by chapter 1 of the Internal Revenue Code (other than net operating and capital loss carryovers) over its gross income (determined without regard to FFA); or

(B) The excess for the taxable year of the deductions allowed by chapter 1 of the Internal Revenue Code (other than net operating and capital loss carryovers) of the consolidated group of which the Institution is a member on the last day of the Institution's taxable year over the group's gross income (determined without regard to FFA); and

(iii) The excess of the amount of any net operating loss carryover of the Institution (or in the case of a carryover from a consolidated return year of the Institution's current consolidated group, the net operating loss carryover of the group) to the taxable year over the amount described in paragraph (c)(3)(i) of this section.

(4) DEFERRED FFA -- (i) MAINTENANCE OF ACCOUNT. An Institution must establish a deferred FFA account commencing in the first taxable year in which it receives FFA that is not currently included in income under paragraph (c)(2) or (c)(3) of this section, and must maintain that account in accordance with the requirements of this paragraph (c)(4). The Institution must add the amount of any FFA that is not currently included in income under paragraph (c)(2) or (c)(3) of this section to its deferred FFA account. The Institution must decrease the balance of its deferred FFA account by the amount of deferred FFA included in income under paragraphs (c)(4)(ii), (iv) and (v) of this section. (See also paragraph (d)(5)(i)(B) of this section for other adjustments that decrease the deferred FFA account.) If, under paragraph (c)(3) of this section, FFA is not currently included in income in a taxable year, the Institution thereafter must maintain its deferred FFA account on a FIFO (first in, first out) basis (e.g., for purposes of the first sentence of paragraph (c)(4)(iv) of this section).

(ii) DEFERRED FFA RECAPTURE. In any taxable year in which an Institution has a balance in its deferred FFA account, it must include in income an amount equal to the lesser of the amount described in paragraph (c)(4)(iii) of this section or the balance in its deferred FFA account.

(iii) ANNUAL RECAPTURE AMOUNT -- (A) INSTITUTIONS WITHOUT CONTINUING EQUITY -- (1) IN GENERAL. In the case of an Institution without Continuing Equity, the amount described in this paragraph (c)(4)(iii) is the amount by which --

(i) The excess for the taxable year of the Institution's deductions allowed by chapter 1 of the Internal Revenue Code (other than net operating and capital loss carryovers) over its gross income (taking into account FFA included in income under paragraph (c)(2) of this section); is greater than

(ii) The Institution's remaining equity as of the beginning of the taxable year.

(2) REMAINING EQUITY. The Institution's remaining equity is --

(i) The amount at the beginning of the taxable year in which the deferred FFA account was established equal to the adjusted bases of the Institution's assets minus the Institution's liabilities (which amount may be positive or negative); plus

(ii) The Institution's taxable income (computed without regard to any carryover from any other year) in any subsequent taxable year or years; minus

(iii) The excess in any subsequent taxable year or years of the Institution's deductions allowed by chapter 1 of the Internal Revenue Code (other than net operating and capital loss carryovers) over its gross income.

(B) INSTITUTIONS WITH CONTINUING EQUITY. In the case of an Institution with Continuing Equity, the amount described in this paragraph (c)(4)(iii) is the amount by which the Institution's deductions allowed by chapter 1 of the Internal Revenue Code (other than net operating and capital loss carryovers) exceed its gross income (taking into account FFA included in income under paragraph (c)(3) of this section).

(iv) ADDITIONAL DEFERRED FFA RECAPTURE BY AN INSTITUTION WITH CONTINUING EQUITY. To the extent that, as of the end of a taxable year, the cumulative amount of FFA deferred under paragraph (c)(3) of this section that an Institution with Continuing Equity has recaptured under this paragraph (c)(4) is less than the cumulative amount of FFA deferred under paragraph (c)(3) of this section that the Institution would have recaptured if that FFA had been included in income ratably over the six taxable years immediately following the taxable year of deferral, the Institution must include that difference in income for the taxable year. An Institution with Continuing Equity must include in income the balance of its deferred FFA account in the taxable year in which it liquidates, ceases to do business, transfers (other than to a Bridge Bank) substantially all of its assets and liabilities, or is deemed to transfer all of its assets under section 1.597-5(b).

(v) OPTIONAL ACCELERATED RECAPTURE OF DEFERRED FFA. An Institution that has a deferred FFA account may include in income the balance of its deferred FFA account on its timely filed (including extensions) original income tax return for any taxable year that it is not under Agency Control. The balance of its deferred FFA account is income on the last day of that year.

(5) EXCEPTIONS TO LIMITATIONS ON USE OF LOSSES. In computing an Institution's taxable income or alternative minimum taxable income for a taxable year, sections 56(d)(1), 382 and 383 and sections 1.1502-15, 1.1502-21 and 1.1502-22 do not limit the use of the attributes of the Institution to the extent, if any, that the inclusion of FFA (including recaptured FFA) in income results in taxable income or alternative minimum taxable income (determined without regard to this paragraph (c)(5)) for the taxable year. This paragraph (c)(5) does not apply to any limitation under section 382 or 383 or section 1.1502-15, 1.1502-21 or 1.1502-22 that arose in connection with or prior to a corporation becoming a Consolidated Subsidiary of the Institution.

(6) OPERATING RULES -- (i) BAD DEBT RESERVES. For purposes of paragraphs (c)(2), (c)(3) and (c)(4) of this section, the adjusted bases of an Institution's assets are reduced by the amount of the Institution's reserves for bad debts under section 585 or 593, other than supplemental reserves under section 593.

(ii) AGGREGATION OF CONSOLIDATED SUBSIDIARIES. For purposes of this paragraph (c), an Institution is treated as a single entity that includes the income, expenses, assets, liabilities, and attributes of its Consolidated Subsidiaries, with appropriate adjustments to prevent duplication.

(iii) ALTERNATIVE MINIMUM TAX. To compute the alternative minimum taxable income attributable to FFA of an Institution for any taxable year under section 55, the rules of this section, and related rules, are applied by using alternative minimum tax basis, deductions, and all other items required to be taken into account. All other alternative minimum tax provisions continue to apply.

(7) EARNINGS AND PROFITS. FFA that is not currently included in income under this paragraph (c) is included in earnings and profits for all purposes of the Internal Revenue Code to the extent and at the time it is included in income under this paragraph (c).

(d) TRANSFERS OF MONEY OR PROPERTY TO AGENCY, AND PROPERTY SUBJECT TO A LOSS GUARANTEE -- (1) TRANSFERS OF PROPERTY TO AGENCY. The transfer of property to Agency or a Controlled Entity is a taxable sale or exchange in which the Institution is treated as realizing an amount equal to --

(i) The property's fair market value; or

(ii) For property subject to a Loss Guarantee, the greater of the property's fair market value or the guaranteed value or price at which the property can be put at the time of transfer.

(2) FFA WITH RESPECT TO PROPERTY COVERED BY A LOSS GUARANTEE OTHER THAN ON TRANSFER TO AGENCY. (i) FFA provided pursuant to a Loss Guarantee with respect to covered property is included in the amount realized with respect to the property to the extent the total amount realized does not exceed the greater of --

(A) The property's fair market value; or

(B) The guaranteed value or price at which the property can be put at the time of transfer.

(ii) For the purposes of this paragraph (d)(2), references to an amount realized include amounts obtained in whole or partial satisfaction of loans, amounts obtained by virtue of charging off or marking to market covered property, and other amounts similarly related to property, whether or not disposed of.

(3) TREATMENT OF FFA RECEIVED IN EXCHANGE FOR PROPERTY. FFA included in the amount realized for property under this paragraph (d) is not includible in income under paragraph (a)(1) of this section. The amount realized is treated in the same manner as if realized from a person other than Agency or a Controlled Entity. For example, gain attributable to FFA received with respect to a capital asset retains its character as capital gain. Similarly, FFA received with respect to property that has been charged off for income tax purposes is treated as a recovery to the extent of the amount previously charged off. Any FFA provided in excess of the amount realized under this paragraph (d) is includible in income under paragraph (a)(1) of this section.

(4) ADJUSTMENT TO FFA -- (i) IN GENERAL. If an Institution pays or transfers money or property to Agency or a Controlled Entity, the amount of money and fair market value of the property is an adjustment to its FFA to the extent the amount paid and transferred exceeds the amount of money and fair market value of property Agency or a Controlled Entity provides in exchange.

(ii) DEPOSIT INSURANCE. This paragraph (d)(4) does not apply to amounts paid to Agency with respect to deposit insurance.

(iii) TREATMENT OF AN INTEREST HELD BY AGENCY OR A CONTROLLED ENTITY -- (A) IN GENERAL. For purposes of this paragraph (d), an interest described in section 1.597-3(b) is not treated as property when transferred by the issuer to Agency or a Controlled Entity nor when acquired from Agency or a Controlled Entity by the issuer.

(B) DISPOSITIONS TO PERSONS OTHER THAN ISSUER. On the date Agency or a Controlled Entity transfers an interest described in section 1.597-3(b) to a holder other than the issuer, Agency or a Controlled Entity, the issuer is treated for purposes of this paragraph (d)(4) as having transferred to Agency an amount of money equal to the sum of the amount of money and the fair market value of property that was paid by the new holder as consideration for the interest.

(iv) CONSOLIDATED GROUPS. For purposes of this paragraph (d), an Institution will be treated as having made any transfer to Agency or a Controlled Entity that was made by any other member of its consolidated group. The consolidated group must make appropriate investment basis adjustments to the extent the member transferring money or other property is not the member that received FFA.

(5) MANNER OF MAKING ADJUSTMENTS TO FFA -- (i) REDUCTION OF FFA AND DEFERRED FFA. An Institution adjusts its FFA under paragraph (d)(4) of this section by reducing in the following order and in an aggregate amount not greater than the adjustment --

(A) The amount of any FFA that is otherwise includible in income for the taxable year (before application of paragraph (c) of this section); and

(B) The balance (but not below zero) in the deferred FFA account, if any, maintained under paragraph (c)(4) of this section.

(ii) DEDUCTION OF EXCESS AMOUNTS. If the amount of the adjustment exceeds the sum of the amounts described in paragraph (d)(5)(i) of this section, the Institution may deduct the excess to the extent the deduction does not exceed the amount of FFA included in income for prior taxable years reduced by the amount of deductions allowable under this paragraph (d)(5)(ii) in prior taxable years.

(iii) ADDITIONAL ADJUSTMENTS. Any adjustment to FFA in excess of the sum of the amounts described in paragraphs (d)(5)(i) and (ii) of this section is treated --

(A) By an Institution other than a New Entity or Acquiring, as a deduction of the amount in excess of FFA received that is required to be transferred to Agency under section 11(g) of the Federal Deposit Insurance Act (12 U.S.C. 1821(g)); or

(B) By a New Entity or Acquiring, as an adjustment to the purchase price paid in the Taxable Transfer (see section 1.338(b)- 3T).

(e) EXAMPLES. The following examples illustrate the provisions of this section:

EXAMPLE 1. TIMING OF INCLUSION OF FFA IN INCOME. (i) Institution M, a calendar year taxpayer without Continuing Equity because it is in Agency receivership, is not a member of a consolidated group and has not been acquired in a Taxable Transfer. On January 1, 1997, M has assets with a total adjusted basis of $100 million and total liabilities of $120 million. M's deductions do not exceed its gross income (determined without regard to FFA) for 1997. Agency provides $30 million of FFA to M in 1997. The amount of this FFA that M must include in income in 1997 is limited by section 1.597-2(c)(2) to $20 million, the amount by which M's liabilities ($120 million) exceed the total adjusted basis of its assets ($100 million) at the beginning of the taxable year. Pursuant to section 1.597-2(c)(4)(i), M must establish a deferred FFA account for the remaining $10 million.

(ii) If Agency instead lends M the $30 million, M's indebtedness to Agency is disregarded and the results are the same as in paragraph (i) of this Example 1. Section 597(c); sections 1.597-1(b) (defining FFA) and 1.597-3(b).

EXAMPLE 2. TRANSFER OF PROPERTY TO AGENCY. (i) Institution M, a calendar year taxpayer without Continuing Equity because it is in Agency receivership, is not a member of a consolidated group and has not been acquired in a Taxable Transfer. At the beginning of 1998, M's remaining equity is $0 and M has a deferred FFA account of $10 million. Agency does not provide any FFA to M in 1998. During the year, M transfers property not covered by a Loss Guarantee to Agency and does not receive any consideration. The property has an adjusted basis of $5 million and a fair market value of $1 million at the time of the transfer. M has no other taxable income or loss in 1998.

(ii) Under section 1.597-2(d)(1), M is treated as selling the property for $1 million, its fair market value, thus recognizing a $4 million loss ($5 million - $1 million). In addition, because M did not receive any consideration from Agency, under section 1.597-2(d)(4) M has an adjustment to FFA of $1 million, the amount by which the fair market value of the transferred property ($1 million) exceeds the consideration M received from Agency ($0). Because no FFA is provided to M in 1998, this adjustment reduces the balance of M's deferred FFA account to $9 million ($10 million - $1 million). Section 1.597-2(d)(5)(i)(B). Because M's $4 million loss causes M's deductions to exceed its gross income by $4 million in 1998 and M has no remaining equity, under section 1.597-2(c)(4)(iii)(A) M must include $4 million of deferred FFA in income, and must decrease the remaining $9 million balance of its deferred FFA account by the same amount, leaving a balance of $5 million.

EXAMPLE 3. LOSS GUARANTEE. Institution Q, a calendar year taxpayer, sells an asset covered by a Loss Guarantee to an unrelated third party for $4,000. Q's adjusted basis in the asset at the time of sale and the asset's guaranteed value are both $10,000. Pursuant to the Loss Guarantee, Agency pays Q $6,000 ($10,000 - $4,000). Q's amount realized from the sale of the asset is $10,000 ($4,000 from the third party and $6,000 from Agency). Section 1.597-2(d)(2). Q realizes no gain or loss on the sale ($10,000 - $10,000 = $0), and therefore includes none of the $6,000 of FFA it receives pursuant to the Loss Guarantee in income. Section 1.597-2(d)(3).

SECTION 1.597-3 OTHER RULES.

(a) OWNERSHIP OF ASSETS. For all income tax purposes, an Institution is treated as the owner of all assets covered by a Loss Guarantee, yield maintenance agreement, or cost to carry or cost of funds reimbursement agreement, regardless of whether Agency (or a Controlled Entity) otherwise would be treated as the owner under general principles of income taxation.

(b) DEBT AND EQUITY INTERESTS RECEIVED BY AGENCY. Debt instruments, stock, warrants, or other rights to acquire stock of an Institution (or any of its affiliates) that Agency or a Controlled Entity receives in connection with a transaction in which FFA is provided are not treated as debt, stock or other equity interests of or in the issuer for any purpose of the Internal Revenue Code while held by Agency or a Controlled Entity. On the date Agency or a Controlled Entity transfers an interest described in this paragraph (b) to a holder other than Agency or a Controlled Entity, the interest is treated as having been newly issued by the issuer to the holder with an issue price equal to the sum of the amount of money and the fair market value of property paid by the new holder in exchange for the interest.

(c) AGENCY OBLIGATIONS -- (1) IN GENERAL. Except as otherwise provided in this paragraph (c), the original issue discount rules of sections 1271 et seq. apply to Agency Obligations.

(2) ISSUE PRICE OF AGENCY OBLIGATIONS PROVIDED AS NET WORTH ASSISTANCE. The issue price of an Agency Obligation that is provided as Net Worth Assistance and that bears interest at either a single fixed rate or a qualified floating rate (and provides for no contingent payments) is the lesser of the sum of the present values of all payments due under the obligation, discounted at a rate equal to the applicable federal rate (within the meaning of section 1274(d)(1) and (3)) in effect for the date of issuance, or the stated principal amount of the obligation. The issue price of an Agency Obligation that bears a qualified floating rate of interest (within the meaning of section 1.1275-5(b)) is determined by treating the obligation as bearing a fixed rate of interest equal to the rate in effect on the date of issuance under the obligation.

(3) ADJUSTMENTS TO PRINCIPAL AMOUNT. Except as provided in section 1.597-5(d)(2)(iv), this paragraph (c)(3) applies if Agency modifies or exchanges an Agency Obligation provided as Net Worth Assistance (or a successor obligation). The issue price of the modified or new Agency Obligation is determined under paragraphs (c)(1) and (2) of this section. If the issue price is greater than the adjusted issue price of the existing Agency Obligation, the difference is treated as FFA. If the issue price is less than the adjusted issue price of the existing Agency Obligation, the difference is treated as an adjustment to FFA under section 1.597-2(d)(4).

(d) SUCCESSORS. To the extent necessary to effectuate the purposes of the regulations under section 597, an entity's treatment under the regulations applies to its successor. A successor includes a transferee in a transaction to which section 381(a) applies or a Bridge Bank to which another Bridge Bank transfers deposit liabilities.

(e) LOSS DISALLOWANCE. For purposes of section 1.1502-20, FFA and the amount described in section 1.597-4(g)(3) are treated as an extraordinary gain disposition within the meaning of section 1.1502-20(c)(2)(i) and a Taxable Transfer is treated as an applicable asset acquisition under section 1060(c) within the meaning of section 1.1502-20(c)(2)(i)(A)(4).

(f) LOSSES AND DEDUCTIONS WITH RESPECT TO COVERED ASSETS. Prior to the disposition of an asset covered by a Loss Guarantee, the asset cannot be charged off, marked to a market value, depreciated, amortized, or otherwise treated in a manner that supposes an actual or possible diminution of value below the greater of the asset's highest guaranteed value or the highest price at which the asset can be put.

(g) ANTI-ABUSE RULE. The regulations under section 597 must be applied in a manner consistent with the purposes of section 597. Accordingly, if, in structuring or engaging in any transaction, a principal purpose is to achieve a tax result that is inconsistent with the purposes of section 597 and the regulations thereunder, the Commissioner can make appropriate adjustments to income, deductions and other items that would be consistent with those purposes.

SECTION 1.597-4 BRIDGE BANKS AND AGENCY CONTROL.

(a) SCOPE. This section provides rules that apply to a Bridge Bank or other Institution under Agency Control and to transactions in which an Institution transfers deposit liabilities (whether or not the Institution also transfers assets) to a Bridge Bank.

(b) STATUS AS TAXPAYER. A Bridge Bank or other Institution under Agency Control is a corporation within the meaning of section 7701(a)(3) for all purposes of the Internal Revenue Code and is subject to all Internal Revenue Code provisions that generally apply to corporations, including those relating to methods of accounting and to requirements for filing returns, even if Agency owns stock of the Institution.

(c) NO SECTION 382 OWNERSHIP CHANGE. The imposition of Agency Control, the cancellation of Institution stock by Agency, a transaction in which an Institution transfers deposit liabilities to a Bridge Bank, and an election under paragraph (g) of this section are disregarded in determining whether an ownership change has occurred within the meaning of section 382(g).

(d) TRANSFERS TO BRIDGE BANKS -- (1) IN GENERAL. Except as otherwise provided in paragraph (g) of this section, the rules of this paragraph (d) apply to transfers to Bridge Banks. In general, a Bridge Bank and its associated Residual Entity are together treated as the successor entity to the transferring Institution. If an Institution transfers deposit liabilities to a Bridge Bank (whether or not it also transfers assets), the Institution recognizes no gain or loss on the transfer and the Bridge Bank succeeds to the transferring Institution's basis in any transferred assets. The associated Residual Entity retains its basis in any assets it continues to hold. Immediately after the transfer, the Bridge Bank succeeds to and takes into account the transferring Institution's items described in section 381(c) (subject to the conditions and limitations specified in section 381(c)), taxpayer identification number ("TIN"), deferred FFA account, and account receivable for future FFA as described in paragraph (g)(4)(ii) of this section. The Bridge Bank also succeeds to and continues the transferring Institution's taxable year.

(2) TRANSFERS TO A BRIDGE BANK FROM MULTIPLE INSTITUTIONS. If two or more Institutions transfer deposit liabilities to the same Bridge Bank, the rules in paragraph (d)(1) of this section are modified to the extent provided in this paragraph (d)(2). The Bridge Bank succeeds to the TIN and continues the taxable year of the Institution that transfers the largest amount of deposits. The taxable years of the other transferring Institutions close at the time of the transfer. If all the transferor Institutions are members of the same consolidated group, the Bridge Bank's carryback of losses to the Institution that transfers the largest amount of deposits is not limited by section 381(b)(3). The limitations of section 381(b)(3) do apply to the Bridge Bank's carrybacks of losses to all other transferor Institutions. If the transferor Institutions are not all members of the same consolidated group, the limitations of section 381(b)(3) apply with respect to all transferor Institutions. See paragraph (g)(6)(ii) of this section for additional rules that apply if two or more Institutions that are not members of the same consolidated group transfer deposit liabilities to the same Bridge Bank.

(e) TREATMENT OF BRIDGE BANK AND RESIDUAL ENTITY AS A SINGLE ENTITY. A Bridge Bank and its associated Residual Entity or Entities are treated as a single entity for income tax purposes and must file a single combined income tax return. The Bridge Bank is responsible for filing all income tax returns and statements for this single entity and is the agent of each associated Residual Entity to the same extent as if the Bridge Bank were the common parent of a consolidated group including the Residual Entity. The term Institution includes a Residual Entity that files a combined return with its associated Bridge Bank.

(f) RULES APPLICABLE TO MEMBERS OF CONSOLIDATED GROUPS -- (1) STATUS AS MEMBERS. Unless an election is made under paragraph (g) of this section, Agency Control of an Institution does not terminate the Institution's membership in a consolidated group. Stock of a subsidiary that is canceled by Agency is treated as held by the members of the consolidated group that held the stock prior to its cancellation. If an Institution is a member of a consolidated group immediately before it transfers deposit liabilities to a Bridge Bank, the Bridge Bank succeeds to the Institution's status as the common parent or, unless an election is made under paragraph (g) of this section, as a subsidiary of the group. If a Bridge Bank succeeds to an Institution's status as a subsidiary, its stock is treated as held by the shareholders of the transferring Institution, and the stock basis or excess loss account of the Institution carries over to the Bridge Bank. A Bridge Bank is treated as owning stock owned by its associated Residual Entities, including for purposes of determining membership in an affiliated group.

(2) NO 30-DAY ELECTION TO BE EXCLUDED FROM CONSOLIDATED GROUP. Neither an Institution nor any of its Consolidated Subsidiaries may be excluded from a consolidated group for a taxable year under section 1.1502-76(b)(5)(ii), as contained in 26 CFR part 1 edition revised April 1, 1994, if the Institution is under Agency Control at any time during the year.

(3) COORDINATION WITH CONSOLIDATED RETURN REGULATIONS. The provisions of the regulations under section 597 take precedence over conflicting provisions in the regulations under section 1502.

(g) ELECTIVE DISAFFILIATION -- (1) IN GENERAL. A consolidated group of which an Institution is a subsidiary may elect irrevocably not to include the Institution in its affiliated group if the Institution is placed in Agency receivership (whether or not assets or deposit liabilities of the Institution are transferred to a Bridge Bank). See paragraph (g)(6) of this section for circumstances under which a consolidated group is deemed to make this election.

(2) CONSEQUENCES OF ELECTION. If the election under this paragraph (g) is made with respect to an Institution, the following consequences occur immediately before the subsidiary Institution to which the election applies is placed in Agency receivership (or, in the case of a deemed election under paragraph (g)(6) of this section, immediately before the consolidated group is deemed to make the election) and in the following order --

(i) All adjustments of the Institution and its Consolidated Subsidiaries under section 481 are accelerated;

(ii) Deferred intercompany gains and losses with respect to the Institution and its Consolidated Subsidiaries are taken into account and the Institution and its Consolidated Subsidiaries take into account any other items required under the regulations under section 1502 for members that become nonmembers within the meaning of section 1.1502-32(d)(4);

(iii) The taxable year of the Institution and its Consolidated Subsidiaries closes and the Institution includes the amount described in paragraph (g)(3) of this section in income as ordinary income as its last item for that taxable year;

(iv) The members of the consolidated group owning the common stock of the Institution include in income any excess loss account with respect to the Institution's stock under section 1.1502-19 and any other items required under the regulations under section 1502 for members that own stock of corporations that become nonmembers within the meaning of section 1.1502-32(d)(4); and

(v) If the Institution's liabilities exceed the aggregate fair market value of its assets on the date the Institution is placed in Agency receivership (or, in the case of a deemed election under paragraph (g)(6) of this section, on the date the consolidated group is deemed to make the election), the members of the consolidated group treat their stock in the Institution as worthless. (See sections 1.337(d)-1 and 1.1502-20 for potential limitations on the group's worthless stock deduction.) In all other cases, the consolidated group will be treated as owning stock of a nonmember corporation until such stock is disposed of or becomes worthless under rules otherwise applicable.

(3) TOLL CHARGE. The amount described in this paragraph (g)(3) is the excess of the Institution's liabilities over the adjusted bases of its assets immediately before the Institution is placed in Agency receivership (or, in the case of a deemed election under paragraph (g)(6) of this section, immediately before the consolidated group is deemed to make the election). In computing this amount, the adjusted bases of an Institution's assets are reduced by the amount of the Institution's reserves for bad debts under section 585 or 593, other than supplemental reserves under section 593. For purposes of this paragraph (g)(3), an Institution is treated as a single entity that includes the assets and liabilities of its Consolidated Subsidiaries, with appropriate adjustments to prevent duplication. The amount described in this paragraph (g)(3) for alternative minimum tax purposes is determined using alternative minimum tax basis, deductions, and all other items required to be taken into account. In computing the increase in the group's taxable income or alternative minimum taxable income, sections 56(d)(1), 382 and 383 and sections 1.1502-15, 1.1502-21 and 1.1502-22 do not limit the use of the attributes of the Institution and its Consolidated Subsidiaries to the extent, if any, that the inclusion of the amount described in this paragraph (g)(3) in income would result in the group having taxable income or alternative minimum taxable income (determined without regard to this sentence) for the taxable year. The preceding sentence does not apply to any limitation under section 382 or 383 or sections 1.1502-15, 1.1502-21, or 1.1502-22 that arose in connection with or prior to a corporation becoming a Consolidated Subsidiary of the Institution.

(4) TREATMENT OF INSTITUTIONS AFTER DISAFFILIATION -- (i) IN GENERAL. If the election under this paragraph (g) is made with respect to an Institution, immediately after the Institution is placed in Agency receivership (or, in the case of a deemed election under paragraph (g)(6) of this section, immediately after the consolidated group is deemed to make the election), the Institution and each of its Consolidated Subsidiaries are treated for income tax purposes as new corporations that are not members of the electing group's affiliated group. Each new corporation retains the TIN of the corresponding disaffiliated corporation and is treated as having received the assets and liabilities of the corresponding disaffiliated corporation in a transaction to which section 351 applies (and in which no gain was recognized under section 357(c) or otherwise). Thus, the new corporation has no net operating or capital loss carryforwards. An election under this paragraph (g) does not terminate the single entity treatment of a Bridge Bank and its Residual Entities provided in paragraph (e) of this section.

(ii) FFA. A new Institution is treated as having a non-interest bearing, nontransferable account receivable for future FFA with a basis equal to the amount described in paragraph (g)(3) of this section. If a disaffiliated Institution has a deferred FFA account at the time of its disaffiliation, the corresponding new Institution succeeds to and takes into account that deferred FFA account.

(iii) FILING OF CONSOLIDATED RETURNS. If a disaffiliated Institution has Consolidated Subsidiaries at the time of its disaffiliation, the corresponding new Institution is required to file a consolidated income tax return with the subsidiaries in accordance with the regulations under section 1502.

(iv) STATUS AS INSTITUTION. If an Institution is disaffiliated under this paragraph (g), the resulting new corporation is treated as an Institution for purposes of the regulations under section 597 regardless of whether it is a bank or domestic building and loan association within the meaning of section 597.

(v) LOSS CARRYBACKS. To the extent a carryback of losses would result in a refund being paid to a fiduciary under section 6402(i), an Institution or Consolidated Subsidiary with respect to which an election under this paragraph (g) (other than under paragraph (g)(6)(ii) of this section) applies is allowed to carry back losses as if the Institution or Consolidated Subsidiary had continued to be a member of the consolidated group that made the election.

(5) AFFIRMATIVE ELECTION -- (i) ORIGINAL INSTITUTION -- (A) MANNER OF MAKING ELECTION. Except as otherwise provided in paragraph (g)(6) of this section, a consolidated group makes the election provided by this paragraph (g) by sending a written statement by certified mail to the affected Institution on or before the later of 120 days after its placement in Agency receivership or May 31, 1996. The statement must contain the following legend at the top of the page: "THIS IS AN ELECTION UNDER section 1.597-4(g) TO EXCLUDE THE BELOW-REFERENCED INSTITUTION AND CONSOLIDATED SUBSIDIARIES FROM THE AFFILIATED GROUP," and must include the names and taxpayer identification numbers of the common parent and of the Institution and Consolidated Subsidiaries to which the election applies, and the date on which the Institution was placed in Agency receivership. The consolidated group must send a similar statement to all subsidiary Institutions placed in Agency receivership during the consistency period described in paragraph (g)(5)(ii) of this section. (Failure to satisfy the requirement in the preceding sentence, however, does not invalidate the election with respect to any subsidiary Institution placed in Agency receivership during the consistency period described in paragraph (g)(5)(ii) of this section.) The consolidated group must include a copy of any election statement and accompanying certified mail receipt as part of its first income tax return filed after the due date under this paragraph (g)(5) for such statement. A statement must be attached to this return indicating that the individual who signed the election was authorized to do so on behalf of the consolidated group. Agency cannot make this election under the authority of section 6402(i) or otherwise.

(B) CONSISTENCY LIMITATION ON AFFIRMATIVE ELECTIONS. A consolidated group may make an affirmative election under this paragraph (g)(5) with respect to a subsidiary Institution placed in Agency receivership only if the group made, or is deemed to have made, the election under this paragraph (g) with respect to every subsidiary Institution of the group placed in Agency receivership on or after May 10, 1989 and within five years preceding the date the subject Institution was placed in Agency receivership.

(ii) EFFECT ON INSTITUTIONS PLACED IN RECEIVERSHIP SIMULTANEOUSLY OR SUBSEQUENTLY. An election under this paragraph (g), other than under paragraph (g)(6)(ii) of this section, applies to the Institution with respect to which the election is made or deemed made (the original Institution) and each subsidiary Institution of the group placed in Agency receivership or deconsolidated in contemplation of Agency Control or the receipt of FFA simultaneously with the original Institution or within five years thereafter.

(6) DEEMED ELECTION -- (i) DECONSOLIDATIONS IN CONTEMPLATION. If one or more members of a consolidated group deconsolidate (within the meaning of section 1.1502-19(c)(1)(ii)(B)) a subsidiary Institution in contemplation of Agency Control or the receipt of FFA, the consolidated group is deemed to make the election described in this paragraph (g) with respect to the Institution on the date the deconsolidation occurs. A subsidiary Institution is conclusively presumed to have been deconsolidated in contemplation of Agency Control or the receipt of FFA if either event occurs within six months after the deconsolidation.

(ii) TRANSFERS TO A BRIDGE BANK FROM MULTIPLE GROUPS. On the day an Institution's transfer of deposit liabilities to a Bridge Bank results in the Bridge Bank holding deposit liabilities from both a subsidiary Institution and an Institution not included in the subsidiary Institution's consolidated group, each consolidated group of which a transferring Institution or the Bridge Bank is a subsidiary is deemed to make the election described in this paragraph (g) with respect to its subsidiary Institution. If deposit liabilities of another Institution that is a subsidiary member of any consolidated group subsequently are transferred to the Bridge Bank, the consolidated group of which the Institution is a subsidiary is deemed to make the election described in this paragraph (g) with respect to that Institution at the time of the subsequent transfer.

(h) EXAMPLES. The following examples illustrate the provisions of this section:

FACTS. Corporation X, the common parent of a consolidated group, owns all the stock (with a basis of $4 million) of Institution M, an insolvent Institution with no Consolidated Subsidiaries. At the close of business on April 30, 1996, M has $4 million of deposit liabilities, $1 million of other liabilities, and assets with an adjusted basis of $4 million and a fair market value of $3 million.

EXAMPLE 1. EFFECT OF RECEIVERSHIP ON CONSOLIDATION. On May 1, 1996, Agency places M in receivership and begins liquidating M. X does not make an election under section 1.597-4(g). M remains a member of the X consolidated group after May 1, 1996. Section 1.597-4(f)(1).

EXAMPLE 2. EFFECT OF BRIDGE BANK ON CONSOLIDATION -- (i) ADDITIONAL FACTS. On May 1, 1996, Agency places M in receivership and causes M to transfer all of its assets and deposit liabilities to Bridge Bank MB.

(ii) CONSEQUENCES WITHOUT AN ELECTION TO DISAFFILIATE. M recognizes no gain or loss from the transfer and MB succeeds to M's basis in the transferred assets, M's items described in section 381(c) (subject to the conditions and limitations specified in section 381(c)) and TIN. Section 1.597-4(d)(1). (If M had a deferred FFA account, MB would also succeed to that account. Section 1.597-4(d)(1).) MB continues M's taxable year and succeeds to M's status as a member of the X consolidated group after May 1, 1996. Section 1.597-4(d)(1) and (f). MB and M are treated as a single entity for income tax purposes. Section 1.597-4(e).

(iii) CONSEQUENCES WITH AN ELECTION TO DISAFFILIATE. If, on July 1, 1996, X makes an election under section 1.597-4(g) with respect to M, the following consequences are treated as occurring immediately before M was placed in Agency receivership. M must include $1 million ($5 million of liabilities - $4 million of adjusted basis) in income as of May 1, 1996. Section 1.597-4(g)(2) and (3). M is then treated as a new corporation that is not a member of the X consolidated group and that has assets (including a $1 million account receivable for future FFA) with a basis of $5 million and $5 million of liabilities received from disaffiliated corporation M in a section 351 transaction. New corporation M retains the TIN of disaffiliated corporation M. Section 1.597-4(g)(4). Immediately after the disaffiliation, new corporation M is treated as transferring its assets and deposit liabilities to Bridge Bank MB. New corporation M recognizes no gain or loss from the transfer and MB succeeds to M's TIN and taxable year. Section 1.597-4(d)(1). Bridge Bank MB is treated as a single entity that includes M and has $5 million of liabilities, an account receivable for future FFA with a basis of $1 million, and other assets with a basis of $4 million. Section 1.597-4(d)(1).

SECTION 1.597-5 TAXABLE TRANSFERS.

(a) TAXABLE TRANSFERS -- (1) DEFINED. The term Taxable Transfer means --

(i) A transaction in which an entity transfers to a transferee other than a Bridge Bank --

(A) Any deposit liability (whether or not the Institution also transfers assets), if FFA is provided in connection with the transaction; or

(B) Any asset for which Agency or a Controlled Entity has any financial obligation (e.g., pursuant to a Loss Guarantee or Agency Obligation); or

(ii) A deemed transfer of assets described in paragraph (b) of this section.

(2) SCOPE. This section provides rules governing Taxable Transfers. Rules applicable to both actual and deemed asset acquisitions are provided in paragraphs (c) and (d) of this section. Special rules applicable only to deemed asset acquisitions are provided in paragraph (e) of this section.

(b) DEEMED ASSET ACQUISITIONS UPON STOCK PURCHASE -- (1) IN GENERAL. In a deemed transfer of assets under this paragraph (b), an Institution (including a Bridge Bank or a Residual Entity) or a Consolidated Subsidiary of the Institution (the Old Entity) is treated as selling all of its assets in a single transaction and is treated as a new corporation (the New Entity) that purchases all of the Old Entity's assets at the close of the day immediately preceding the occurrence of an event described in paragraph (b)(2) of this section. However, such an event results in a deemed transfer of assets under this paragraph (b) only if it occurs --

(i) In connection with a transaction in which FFA is provided;

(ii) While the Old Entity is a Bridge Bank;

(iii) While the Old Entity has a positive balance in a deferred FFA account (see section 1.597-2(c)(4)(v) regarding the optional accelerated recapture of deferred FFA); or

(iv) With respect to a Consolidated Subsidiary, while the Institution of which it is a Consolidated Subsidiary is under Agency Control.

(2) EVENTS. A deemed transfer of assets under this paragraph (b) results if the Old Entity --

(i) Becomes a non-member within the meaning of section 1.1502-32(d)(4) of its consolidated group (other than pursuant to an election under section 1.597-4(g));

(ii) Becomes a member of an affiliated group of which it was not previously a member (other than pursuant to an election under section 1.597-4(g)); or

(iii) Issues stock such that the stock that was outstanding before the imposition of Agency Control or the occurrence of any transaction in connection with the provision of FFA represents 50 percent or less of the vote or value of its outstanding stock (disregarding stock described in section 1504(a)(4) and stock owned by Agency or a Controlled Entity).

(3) BRIDGE BANKS AND RESIDUAL ENTITIES. If a Bridge Bank is treated as selling all of its assets to a New Entity under this paragraph (b), each associated Residual Entity is treated as simultaneously selling its assets to a New Entity in a Taxable Transfer described in this paragraph (b).

(c) TREATMENT OF TRANSFEROR -- (1) FFA IN CONNECTION WITH A TAXABLE TRANSFER. A transferor in a Taxable Transfer is treated as having directly received immediately before a Taxable Transfer any Net Worth Assistance that Agency provides to the New Entity or Acquiring in connection with the transfer. (See section 1.597-2(a) and (c) for rules regarding the inclusion of FFA in income and section 1.597-2(a)(1) for related rules regarding FFA provided to shareholders.) The Net Worth Assistance is treated as an asset of the transferor that is sold to the New Entity or Acquiring in the Taxable Transfer.

(2) AMOUNT REALIZED IN A TAXABLE TRANSFER. In a Taxable Transfer described in paragraph (a)(1)(i) of this section, the amount realized is determined under section 1001(b) by reference to the consideration paid for the assets. In a Taxable Transfer described in paragraph (a)(1)(ii) of this section, the amount realized is the sum of the grossed-up basis of the stock acquired in connection with the Taxable Transfer (excluding stock acquired from the Old or New Entity), plus the amount of liabilities assumed or taken subject to in the deemed transfer, plus other relevant items. The grossed-up basis of the acquired stock equals the acquirors' basis in the acquired stock divided by the percentage of the Old Entity's stock (by value) attributable to the acquired stock.

(3) ALLOCATION OF AMOUNT REALIZED -- (i) IN GENERAL. The amount realized under paragraph (c)(2) of this section is allocated among the assets transferred in the Taxable Transfer in the same manner as amounts are allocated among assets under sections 1.338(b)-2T(b), (c)(1) and (2).

(ii) MODIFICATIONS TO GENERAL RULE. This paragraph (c)(3)(ii) modifies certain of the allocation rules of paragraph (c)(3)(i) of this section. Agency Obligations and assets covered by Loss Guarantees in the hands of the New Entity or Acquiring are treated as Class II assets. Stock of a Consolidated Subsidiary is treated as a Class II asset to the extent the fair market value of the Consolidated Subsidiary's Class I and Class II assets exceeds the amount of its liabilities. The fair market value of an Agency Obligation is deemed to equal its adjusted issue price immediately before the Taxable Transfer. The fair market value of an asset covered by a Loss Guarantee immediately after the Taxable Transfer is deemed to be not less than the greater of the asset's highest guaranteed value or the highest price at which the asset can be put.

(d) TREATMENT OF A NEW ENTITY AND ACQUIRING -- (1) PURCHASE PRICE. The purchase price for assets acquired in a Taxable Transfer described in paragraph (a)(1)(i) of this section is the cost of the assets acquired. See section 1.1060-1T(c)(1). The purchase price for assets acquired in a Taxable Transfer described in paragraph (a)(1)(ii) of this section is the sum of the grossed-up basis of the stock acquired in connection with the Taxable Transfer (excluding stock acquired from the Old or New Entity), plus the amount of liabilities assumed or taken subject to in the deemed transfer, plus other relevant items. The grossed-up basis of the acquired stock equals the acquirors' basis in the acquired stock divided by the percentage of the Old Entity's stock (by value) attributable to the acquired stock. FFA provided in connection with a Taxable Transfer is not included in the New Entity's or Acquiring's purchase price for the acquired assets. Any Net Worth Assistance so provided is treated as an asset of the transferor sold to the New Entity or Acquiring in the Taxable Transfer.

(2) ALLOCATION OF BASIS -- (i) IN GENERAL. Except as otherwise provided in this paragraph (d)(2), the purchase price determined under paragraph (d)(1) of this section is allocated among the assets transferred in the Taxable Transfer in the same manner as amounts are allocated among assets under section 1.338(b)-2T(b), (c)(1) and (2).

(ii) MODIFICATIONS TO GENERAL RULE. The allocation rules contained in paragraph (c)(3)(ii) of this section apply to the allocation of basis among assets acquired in a Taxable Transfer. No basis is allocable to Agency's agreement to provide Loss Guarantees, yield maintenance payments, cost to carry or cost of funds reimbursement payments, or expense reimbursement or indemnity payments. A New Entity's basis in assets it receives from its shareholders is determined under general principles of income taxation and is not governed by this paragraph (d).

(iii) ALLOWANCE AND RECAPTURE OF ADDITIONAL BASIS IN CERTAIN CASES. If the fair market value of the Class I and Class II assets acquired in a Taxable Transfer is greater than the New Entity's or Acquiring's purchase price for the acquired assets, the basis of the Class I and Class II assets equals their fair market value. The amount by which the fair market value of the Class I and Class II assets exceeds the purchase price is included ratably as ordinary income by the New Entity or Acquiring over a period of six taxable years beginning in the year of the Taxable Transfer. The New Entity or Acquiring must include as ordinary income the entire amount remaining to be recaptured under the preceding sentence in the taxable year in which an event occurs that would accelerate inclusion of an adjustment under section 481.

(iv) CERTAIN POST-TRANSFER ADJUSTMENTS -- (A) AGENCY OBLIGATIONS. If an adjustment to the principal amount of an Agency Obligation or cash payment to reflect a more accurate determination of the condition of the Institution at the time of the Taxable Transfer is made before the earlier of the date the New Entity or Acquiring files its first post-transfer income tax return or the due date of that return (including extensions), the New Entity or Acquiring must adjust its basis in its acquired assets to reflect the adjustment. In making adjustments to the New Entity's or Acquiring's basis in its acquired assets, paragraph (c)(3)(ii) of this section is applied by treating an adjustment to the principal amount of an Agency Obligation pursuant to the first sentence of this paragraph (d)(2)(iv)(A) as occurring immediately before the Taxable Transfer. (See section 1.597-3(c)(3) for rules regarding other adjustments to the principal amount of an Agency Obligation.)

(B) ASSETS COVERED BY A LOSS GUARANTEE. If, immediately after a Taxable Transfer, an asset is not covered by a Loss Guarantee but the New Entity or Acquiring has the right to designate specific assets that will be covered by a Loss Guarantee, the New Entity or Acquiring must treat any asset so designated as having been subject to the Loss Guarantee at the time of the Taxable Transfer. The New Entity or Acquiring must adjust its basis in the covered assets and in its other acquired assets to reflect the designation in the manner provided by paragraph (d)(2) of this section. The New Entity or Acquiring must make appropriate adjustments in subsequent taxable years if the designation is made after the New Entity or Acquiring files its first post-transfer income tax return or the due date of that return (including extensions) has passed.

(e) SPECIAL RULES APPLICABLE TO TAXABLE TRANSFERS THAT ARE DEEMED ASSET ACQUISITIONS -- (1) TAXPAYER IDENTIFICATION NUMBERS. Except as provided in paragraph (e)(3) of this section, a New Entity succeeds to the TIN of the transferor in a deemed sale under paragraph (b) of this section.

(2) CONSOLIDATED SUBSIDIARIES -- (i) IN GENERAL. A Consolidated Subsidiary that is treated as selling its assets in a Taxable Transfer under paragraph (b) of this section is treated as engaging immediately thereafter in a complete liquidation to which section 332 applies. The consolidated group of which the Consolidated Subsidiary is a member does not take into account gain or loss on the sale, exchange, or cancellation of stock of the Consolidated Subsidiary in connection with the Taxable Transfer.

(ii) CERTAIN MINORITY SHAREHOLDERS. Shareholders of the Consolidated Subsidiary that are not members of the consolidated group that includes the Institution do not recognize gain or loss with respect to shares of Consolidated Subsidiary stock retained by the shareholder. The shareholder's basis for that stock is not affected by the Taxable Transfer.

(3) BRIDGE BANKS AND RESIDUAL ENTITIES -- (i) IN GENERAL. A Bridge Bank or Residual Entity's sale of assets to a New Entity under paragraph (b) of this section is treated as made by a single entity under section 1.597-4(e). The New Entity deemed to acquire the assets of a Residual Entity under paragraph (b) of this section is not treated as a single entity with the Bridge Bank (or with the New Entity acquiring the Bridge Bank's assets) and must obtain a new TIN.

(ii) TREATMENT OF CONSOLIDATED GROUPS. At the time of a Taxable Transfer described in paragraph (a)(1)(ii) of this section, treatment of a Bridge Bank as a subsidiary member of a consolidated group under section 1.597-4(f)(1) ceases. However, the New Entity deemed to acquire the assets of a Residual Entity is a member of the selling consolidated group after the deemed sale. The group's basis or excess loss account in the stock of the New Entity that is deemed to acquire the assets of the Residual Entity is the group's basis or excess loss account in the stock of the Bridge Bank immediately before the deemed sale, as adjusted for the results of the sale.

(4) CERTAIN RETURNS. If an Old Entity without Continuing Equity is not a subsidiary of a consolidated group at the time of the Taxable Transfer, the controlling Agency must file all income tax returns for the Old Entity for periods ending on or prior to the date of the deemed sale described in paragraph (b) of this section that are not filed as of that date.

(5) BASIS LIMITED TO FAIR MARKET VALUE. If all of the stock of the corporation is not acquired on the date of the Taxable Transfer, the Commissioner may make appropriate adjustments under paragraphs (c) and (d) of this section to the extent using a grossed-up basis of the stock of a corporation results in an aggregate amount realized for, or basis in, the assets other than the aggregate fair market value of the assets.

(f) EXAMPLES. The following examples illustrate the provisions of this section:

EXAMPLE 1. BRANCH SALE RESULTING IN TAXABLE TRANSFER. (i) Institution M is a calendar year taxpayer in Agency receivership. M is not a member of a consolidated group. On January 1, 1997, M has $200 million of liabilities (including deposit liabilities) and assets with an adjusted basis of $100 million. M has no income or loss for 1997 and, except as described below, receives no FFA. On September 30, 1997, Agency causes M to transfer six branches (with assets having an adjusted basis of $1 million) together with $120 million of deposit liabilities to N. In connection with the transfer, Agency provides $121 million in cash to N.

(ii) The transaction is a Taxable Transfer in which M receives $121 million of Net Worth Assistance. Section 1.597-5(a)(1). (M is treated as directly receiving the $121 million of Net Worth Assistance immediately before the Taxable Transfer. Section 1.597-5(c)(1).) M transfers branches having a basis of $1 million and is treated as transferring $121 million in cash (the Net Worth Assistance) to N in exchange for N's assumption of $120 million of liabilities. Thus, M realizes a loss of $2 million on the transfer. The amount of the FFA M must include in its income in 1997 is limited by section 1.597-2(c) to $102 million, which is the sum of the $100 million excess of M's liabilities ($200 million) over the total adjusted basis of its assets ($100 million) at the beginning of 1997, plus the $2 million excess for the taxable year, which results from the Taxable Transfer, of M's deductions (other than carryovers) over its gross income other than FFA. M must establish a deferred FFA account for the remaining $19 million of FFA. Section 1.597-2(c)(4).

(iii) N, as Acquiring, must allocate its $120 million purchase price for the assets acquired from M among those assets. Cash is a Class I asset. The branch assets are in Classes III and IV. N's adjusted basis in the cash is its amount, i.e., $121 million. Section 1.597-5(d)(2). Because this amount exceeds N's purchase price for all of the acquired assets by $1 million, N allocates no basis to the other acquired assets and, under section 1.597-5(d)(2), must recapture the $1 million excess at an annual rate of $166,667 in the six consecutive taxable years beginning with 1997 (subject to acceleration for certain events).

EXAMPLE 2. STOCK ISSUANCE BY BRIDGE BANK CAUSING TAXABLE TRANSFER. (i) On April 1, 1996, Institution P is placed in receivership and caused to transfer assets and liabilities to Bridge Bank PB. On August 31, 1996, the assets of PB consist of $20 million in cash, loans outstanding with an adjusted basis of $50 million and a fair market value of $40 million, and other non-financial assets (primarily branch assets and equipment) with an adjusted basis of $5 million. PB has deposit liabilities of $95 million and other liabilities of $5 million. P, the Residual Entity, holds real estate with an adjusted basis of $10 million and claims in litigation having a zero basis. P retains no deposit liabilities and has no other liabilities (except its liability to Agency for having caused its deposit liabilities to be satisfied).

(ii) On September 1, 1996, Agency causes PB to issue 100 percent of its common stock for $2 million cash to X. On the same day, Agency issues a $25 million note to PB. The note bears a fixed rate of interest in excess of the applicable federal rate in effect for September 1, 1996. Agency provides Loss Guarantees guaranteeing PB a value of $50 million for PB's loans outstanding.

(iii) The stock issuance is a Taxable Transfer in which PB is treated as selling all of its assets to a new corporation, New PB. Section 1.597-5(b)(1). PB is treated as directly receiving $25 million of Net Worth Assistance (the issue price of the Agency Obligation) immediately before the Taxable Transfer. Section 1.597-3(c)(2); section 1.597-5(c)(1). The amount of FFA PB must include in income is determined under section 1.597-2(a) and (c). PB in turn is deemed to transfer the note to New PB in the Taxable Transfer, together with $20 million of cash, all its loans outstanding (with a basis of $50 million) and its other non-financial assets (with a basis of $5 million). The amount realized by PB from the sale is $100 million, the amount of PB's liabilities deemed to be assumed by New PB. This amount realized equals PB's basis in its assets and thus, PB realizes no gain or loss on the transfer to New PB.

(iv) Residual Entity P also is treated as selling all its assets (consisting of real estate and claims in litigation) for $0 (the amount of consideration received by P) to a new corporation (New P) in a Taxable Transfer. Section 1.597-5(b)(3). (P's only liability is to Agency and a liability to Agency is not treated as a debt under section 1.597-3(b).) Thus, P realizes a $10 million loss on the transfer to New P. The combined return filed by PB and P for 1996 will reflect a total loss on the Taxable Transfer of $10 million ($0 for PB and $10 million for P). Section 1.597-5(e)(3). That return also will reflect FFA income from the Net Worth Assistance, determined under section 1.597-2(a) and (c).

(v) New PB is treated as having acquired the assets it acquired from PB for $100 million, the amount of liabilities assumed. In allocating basis among these assets, New PB treats the Agency note and the loans outstanding (which are covered by Loss Guarantees) as Class II assets. For the purpose of allocating basis, the fair market value of the Agency note is deemed to equal its adjusted issue price immediately before the transfer, $25 million. The fair market value of the loans is deemed not to be less than the guaranteed value of $50 million.

(vi) New P is treated as having acquired its assets for no consideration. Thus its basis in its assets immediately after the transfer is zero. New PB and New P are not treated as a single entity. Section 1.597-5(e)(3).

EXAMPLE 3. TAXABLE TRANSFER OF PREVIOUSLY DISAFFILIATED INSTITUTION. (i) Corporation X, the common parent of a consolidated group, owns all the stock of Institution M, an insolvent Institution with no Consolidated Subsidiaries. On April 30, 1996, M has $4 million of deposit liabilities, $1 million of other liabilities, and assets with an adjusted basis of $4 million and a fair market value of $3 million. On May 1, 1996, Agency places M in receivership. X elects under section 1.597-4(g) to disaffiliate M. Accordingly, as of May 1, 1996, new corporation M is not a member of the X consolidated group. On May 1, 1996, Agency causes M to transfer all of its assets and liabilities to Bridge Bank MB. Under section 1.597-4(e), MB and M are thereafter treated as a single entity which has $5 million of liabilities, an account receivable for future FFA with a basis of $1 million, and other assets with a basis of $4 million. Section 1.597-4(g)(4).

(ii) During May 1996, MB earns $25,000 of interest income and accrues $20,000 of interest expense on depositor accounts and there is no net change in deposits other than the additional $20,000 of interest expense accrued on depositor accounts. MB pays $5,000 of wage expenses and has no other items of income or expense.

(iii) On June 1, 1996, Agency causes MB to issue 100 percent of its stock to corporation Y. In connection with the stock issuance, Agency provides an Agency Obligation for $2 million and no other FFA.

(iv) The stock issuance results in a Taxable Transfer. Section 1.597-5(b). MB is treated as receiving the Agency Obligation immediately prior to the Taxable Transfer. Section 1.597-5(c)(1). MB has $1 million of basis in its account receivable for FFA. This receivable is treated as satisfied, offsetting $1 million of the $2 million of FFA provided by Agency in connection with the Taxable Transfer. The status of the remaining $1 million of FFA as includible income is determined as of the end of the taxable year under section 1.597-2(c). However, under section 1.597-2(b), MB obtains a $2 million basis in the Agency Obligation received as FFA.

(v) Under section 1.597-5(c)(2), in the Taxable Transfer, Old Entity MB is treated as selling, to New Entity MB, all of Old Entity MB's assets, having a basis of $6,020,000 (the original $4 million of asset basis as of April 30, 1996, plus $20,000 net cash from May 1996 activities, plus $2 million in the Agency Obligation received as FFA), for $5,020,000, the amount of Old Entity MB's liabilities assumed by New Entity MB pursuant to the Taxable Transfer. Therefore, Old Entity MB recognizes, in the aggregate, a loss of $1 million from the Taxable Transfer.

(vi) Because this $1 million loss causes Old Entity MB's deductions to exceed its gross income (determined without regard to FFA) by $1 million, Old Entity MB must include in its income the $1 million of FFA not offset by the FFA receivable. Section 1.597-2(c). (As of May 1, 1996, Old Entity MB's liabilities ($5,000,000) did not exceed MB's $5 million adjusted basis of its assets. For the taxable year, MB's deductions of $1,025,000 ($1,000,000 loss from the Taxable Transfer, $20,000 interest expense and $5,000 of wage expense) exceeded its gross income (disregarding FFA) of $25,000 (interest income) by $1,000,000. Thus, under section 1.597-2(c), MB includes in income the entire $1,000,000 of FFA not offset by the FFA receivable.)

(vii) Therefore, Old Entity MB's taxable income for the taxable year ending on the date of the Taxable Transfer is $0.

(viii) Residual Entity M is also deemed to engage in a deemed sale of its assets to New Entity M under section 1.597-5(b)(3), but there are no tax consequences as M has no assets or liabilities at the time of the deemed sale.

(ix) Under section 1.597-5(d)(1), New Entity MB is treated as purchasing Old Entity MB's assets for $5,020,000, the amount of New Entity MB's liabilities. Of this, $2,000,000 is allocated to the $2 million Agency Obligation, and $3,020,000 is allocated to the other assets New Entity MB is treated as purchasing in the Taxable Transfer.

EXAMPLE 4. LOSS SHARING. Institution N acquires assets and assumes liabilities of another Institution in a Taxable Transfer. Among the assets transferred are three parcels of real estate. In the hands of the transferring Institution, these assets had book values of $100,000 each. In connection with the Taxable Transfer, Agency agrees to reimburse Institution N for 80 percent of any loss (based on the original book value) realized on the disposition or charge-off of the three properties. This arrangement constitutes a Loss Guarantee. Thus, in allocating basis, Institution N treats the three parcels as Class II assets. By virtue of the arrangement with the Agency, Institution N is assured that the parcels will not be worth less to it than $80,000 each, because even if the properties are worthless, Agency will reimburse 80 percent of the loss. Although Institution could obtain payments under the Loss Guarantee if the properties are worth more, it is not guaranteed that it will realize more than $80,000. Accordingly, $80,000 is the highest guaranteed value of the three parcels. Institution N will allocate basis to the Class II assets up to their fair market value. For this purpose, the fair market value of the three parcels is not less than $80,000 each. Section 1.597-5(d)(2)(ii); section 1.597-5(c)(3)(ii).

SECTION 1.597-6 LIMITATION ON COLLECTION OF INCOME TAX.

(a) LIMITATION ON COLLECTION WHERE TAX IS BORNE BY AGENCY. If an Institution without Continuing Equity (or any of its Consolidated Subsidiaries) is liable for income tax that is attributable to the inclusion in income of FFA or gain from a Taxable Transfer, the tax will not be collected if it would be borne by Agency. The final determination of whether the tax would be borne by Agency is within the sole discretion of the Commissioner. In determining whether tax would be borne by Agency, the Commissioner will disregard indemnity, tax-sharing, or similar obligations of Agency, an Institution, or its Consolidated Subsidiaries. Collection of the several income tax liability under section 1.1502-6 from members of an Institution's consolidated group other than the Institution or its Consolidated Subsidiaries is not affected by this section. Income tax will continue to be subject to collection except as specifically limited in this section. This section does not apply to taxes other than income taxes.

(b) AMOUNT OF TAX ATTRIBUTABLE TO FFA OR GAIN ON A TAXABLE TRANSFER. For purposes of paragraph (a) of this section, the amount of income tax in a taxable year attributable to the inclusion of FFA or gain from a Taxable Transfer in the income of an Institution (or a Consolidated Subsidiary) is the excess of the actual income tax liability of the Institution (or the consolidated group in which the Institution is a member) over the income tax liability of the Institution (or the consolidated group in which the Institution is a member) determined without regard to FFA or gain or loss on the Taxable Transfer.

(c) REPORTING OF UNCOLLECTED TAX. A taxpayer must specify on the front page of Form 1120 (U.S. Corporate Income Tax Return), to the left of the space provided for "Total Tax," the amount of income tax for the taxable year that is potentially not subject to collection under this section. If an Institution is a subsidiary member of a consolidated group, the amount specified as not subject to collection is zero.

(d) ASSESSMENTS OF TAX TO OFFSET REFUNDS. Income tax that is not collected under this section will be assessed and, thus, used to offset any claim for refund made by or on behalf of the Institution, the Consolidated Subsidiary or any other corporation with several liability for the tax.

(e) COLLECTION OF TAXES FROM ACQUIRING OR A NEW ENTITY -- (1) ACQUIRING. No income tax liability (including the several liability for taxes under section 1.1502-6) of a transferor in a Taxable Transfer will be collected from Acquiring.

(2) NEW ENTITY. Income tax liability (including the several liability for taxes under section 1.1502-6) of a transferor in a Taxable Transfer will be collected from a New Entity only if stock that was outstanding in the Old Entity remains outstanding as stock in the New Entity or is reacquired or exchanged for consideration.

(f) EFFECT ON SECTION 7507. This section supersedes the application of section 7507, and the regulations thereunder, for the assessment and collection of income tax attributable to FFA.

SECTION 1.597-7 EFFECTIVE DATE.

(a) FIRREA EFFECTIVE DATE. Section 597, as amended by section 1401 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), Public Law 101-73, is generally effective for any FFA received or accrued by an Institution on or after May 10, 1989, and for any transaction in connection with which such FFA is provided, unless the FFA is provided in connection with an acquisition occurring prior to May 10, 1989. See section 1.597-8 for rules regarding FFA received or accrued on or after May 10, 1989, that relates to an acquisition that occurred before May 10, 1989.

(b) EFFECTIVE DATE OF REGULATIONS. Except as otherwise provided in this section, sections 1.597-1 through 1.597-6 apply to taxable years ending on or after April 22, 1992. However, the provisions of sections 1.597-1 through 1.597-6 do not apply to FFA received or accrued for taxable years ending on or after April 22, 1992, in connection with an Agency assisted acquisition within the meaning of Notice 89-102 (1989-2 C.B. 436; see section 601.601(d)(2)) (which does not include a transfer to a Bridge Bank), that occurs before April 22, 1992. Taxpayers not subject to sections 1.597-1 through 1.597-6 must comply with an interpretation of the statute that is reasonable in light of the legislative history and applicable administrative pronouncements. For this purpose, the rules contained in Notice 89-102 apply to the extent provided in the Notice.

(c) ELECTIVE APPLICATION TO PRIOR YEARS AND TRANSACTIONS -- (1) IN GENERAL. Except as limited in this paragraph (c), an election is available to apply sections 1.597-1 through 1.597-6 to taxable years prior to the general effective date of these regulations. A consolidated group may elect to apply sections 1.597-1 through 1.597-6 for all members of the group in all taxable years to which section 597, as amended by FIRREA, applies. The common parent makes the election for the group. An entity that is not a member of a consolidated group may elect to apply sections 1.597-1 through 1.597-6 to all taxable years to which section 597, as amended by FIRREA, applies for which it is not a member of a consolidated group. The election is irrevocable.

(2) ELECTION UNAVAILABLE IN CERTAIN CASES -- (i) STATUTE OF LIMITATIONS CLOSED. The election cannot be made if the period for assessment and collection of tax has expired under the rules of section 6501 for any taxable year in which sections 1.597-1 through 1.597-6 would affect the determination of the electing entity's or group's income, deductions, gain, loss, basis, or other items.

(ii) NO SECTION 338 ELECTION UNDER NOTICE 89-102. The election cannot be made with respect to an Institution if, under Notice 89-102, it was a Target with respect to which a qualified stock purchase was made, a timely election under section 338 was not made, and on April 22, 1992, a timely election under section 338 could not be made.

(iii) INCONSISTENT TREATMENT OF INSTITUTION THAT WOULD BE NEW ENTITY. If, under section 1.597-5(b), an Institution would become a New Entity before April 22, 1992, the election cannot be made with respect to that Institution unless elections are made by all relevant persons such that sections 1.597-1 through section 1.597-6 apply both before and after the deemed sale under section 1.597-5. However, this requirement does not apply if, under sections 1.597-1 through section 1.597-6, the Institution would not have Continuing Equity prior to the deemed sale.

(3) EXPENSE REIMBURSEMENTS. Notice 89-102, 1989-2 C.B. 436, provides that reimbursements paid or accrued pursuant to an expense reimbursement or indemnity arrangement are not included in income but the taxpayer may not deduct, or otherwise take into account, the item of cost or expense to which the reimbursement or indemnity payment relates. With respect to an Agency assisted acquisition within the meaning of Notice 89-102 that occurs before April 22, 1992, a taxpayer that elects to apply these regulations retroactively under this paragraph (c) may continue to account for these items under the rules of Notice 89-102. (4) Procedural rules -- (i) Manner of making election. An Institution or consolidated group makes the election provided by this paragraph (c) by attaching a written statement to, and including it as a part of, the taxpayer's or consolidated group's first annual income tax return filed on or after March 15, 1996. The statement must contain the following legend at the top of the page: "THIS IS AN ELECTION UNDER section 1.597-7(c)," and must contain the name, address and employer identification number of the taxpayer or common parent making the election. The statement must include a declaration that "TAXPAYER AGREES TO EXTEND THE STATUTE OF LIMITATIONS ON ASSESSMENT FOR THREE YEARS FROM THE DATE OF THE FILING OF THIS ELECTION UNDER section 1.597-7(c), IF THE LIMITATIONS PERIOD WOULD EXPIRE EARLIER WITHOUT SUCH EXTENSION, FOR ANY ITEMS AFFECTED IN ANY TAXABLE YEAR BY THE FILING OF THIS ELECTION," and a declaration that either "AMENDED RETURNS WILL BE FILED FOR ALL TAXABLE YEARS AFFECTED BY THE FILING OF THIS ELECTION WITHIN 180 DAYS OF MAKING THIS STATEMENT, UNLESS SUCH REQUIREMENT IS WAIVED IN WRITING BY THE DISTRICT DIRECTOR OR HIS DELEGATE" or "ALL RETURNS PREVIOUSLY FILED ARE CONSISTENT WITH THE PROVISIONS OF sections 1.597-1 THROUGH 1.597-6," and be signed by an individual who is authorized to make the election under this paragraph (c) on behalf of the taxpayer. An election with respect to a consolidated group must be made by the common parent of the group, not Agency, and applies to all members of the group.

(ii) EFFECT OF ELECTIVE DISAFFILIATION. To make the affirmative election described in section 1.597-4(g)(5) for an Institution placed in Agency receivership in a taxable year ending before April 22, 1992, the consolidated group must send the affected Institution the statement described in section 1.597-4(g)(5) on or before May 31, 1996. Notwithstanding the requirements of paragraph (c)(4)(i) of this section, a consolidated group sending such a statement is deemed to make the election described in, and to agree to the conditions contained in, this paragraph (c). The consolidated group must nevertheless attach the statement described in paragraph (c)(4)(i) of this section to its first annual income tax return filed on or after March 15, 1996.

(d) RELIANCE ON PRIOR GUIDANCE -- (1) NOTICE 89-102. Taxpayers may rely on Notice 89-102, 1989-2 C.B. 436, to the extent they acted in reliance on that Notice prior to April 22, 1992. Such reliance must be reasonable and transactions with respect to which taxpayers rely must be consistent with the overriding policies of section 597, as expressed in the legislative history.

(2) NOTICE FI-46-89 -- (i) IN GENERAL. Notice FI-46-89 was published in the Federal Register on April 23, 1992 (57 FR 14804). Taxpayers may rely on the provisions of sections 1.597-1 through 1.597-6 of that notice to the extent they acted in reliance on those provisions prior to December 21, 1995. Such reliance must be reasonable and transactions with respect to which taxpayers rely must be consistent with the overriding policies of section 597, as expressed in the legislative history, as well as the overriding policies of notice FI-46-89.

(ii) TAXABLE TRANSFERS. Any taxpayer described in this paragraph (d) that, under notice FI-46-89, would be a New Entity or Acquiring with respect to a Taxable Transfer on or after April 22, 1992, and before December 21, 1995, may apply the rules of that notice with respect to such transaction.

PART 301 -- PROCEDURE AND ADMINISTRATION

Par. 3. The authority citation for part 301 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 301.7507-1 also issued under 26 U.S.C. 597.

Section 301.7507-9 also issued under 26 U.S.C. 597. * * *

Par. 4. Section 301.7507-1 is amended by adding paragraph (b)(4) to read as follows:

SECTION 301.7507-1 BANKS AND TRUST COMPANIES COVERED.

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(b) * * *

(4) The term ceased to do business means the bank no longer accepts deposits or makes loans and discounts, and is winding up its affairs and is in the process of liquidating its assets to pay depositors. A bank will not be considered to have ceased to do business on account of a transaction in which the bank --

(i) Transfers assets and liabilities to a Bridge Bank in a transfer described in section 1.597-4 of this chapter;

(ii) Transfers assets and liabilities to any person in a transaction to which section 381(a) applies or in which the transferee receives property with a transferred basis;

(iii) Transfers assets or liabilities to any person in a transaction in which Federal Financial Assistance (as defined in section 597) is provided to any party to the transaction, unless all the Federal Financial Assistance is deposit insurance under section 301.7507-9(d); or

(iv) Transfers assets or liabilities to any person in a transaction similar to any transaction described in paragraphs (b)(4)(i) through (iii) of this section. This paragraph (b)(4) applies to taxable years ending on or after April 22, 1992.

Par. 5. Section 301.7507-9 is amended by adding a sentence to the end of paragraph (d) to read as follows:

SECTION 301.7507-9 TERMINATION OF IMMUNITY.

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(d) * * * For taxable years ending on or after April 22, 1992, deposit insurance does not include Federal Financial Assistance (as defined in section 597) and other payments described in section 597(a) prior to its amendment by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and, therefore, such payments must be taken into account to determine whether a bank's assets are sufficient to meet claims of depositors.

* * * * *

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 6. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 7. In section 602.101, paragraph (c) is amended by adding entries in numerical order to the table to read as follows:

SECTION 602.101 OMB CONTROL NUMBERS.

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(c) * * *

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