IRS Publishes Final Regs on Treatment of Prepaid Income Under Built-In Gain Provisions

[Editor's Note: At 75 F.R. 44138, July 28, 2010, the IRS published minor corrections to the following Treasury Decision which have been incorporated below.]

 Built-in Gains and Losses under Section 382(h)

ACTION: Final regulations and removal of temporary regulations.

SUMMARY: This document contains final regulations that apply to loss corporations that have undergone an ownership change within the meaning of section 382. These regulations provide guidance regarding the treatment of prepaid income under the built-in gain provisions of section 382(h).

DATES: Effective Date: These regulations are effective on June 11, 2010.

Applicability Date: For dates of applicability see § 1.382-7(b). FOR FURTHER INFORMATION CONTACT: Keith E. Stanley, (202) 622-7750 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to 26 CFR Part 1. On June 14, 2007, temporary regulations (TD 9330; 72 FR 32792) regarding the treatment of prepaid income under the built-in gain provisions of section 382(h) were published in the Federal Register. A notice of proposed rulemaking (NPRM) (REG-144540-06) cross-referencing to temporary regulations was published in the Federal Register for the same day (72 FR 32828). The temporary regulations provided that prepaid income is not recognized built-in gain (“RBIG”) for purposes of section 382(h). They further provided that prepaid income means any amount received prior to the change date that is attributable to performance occurring on or after the change date. Examples of prepaid income include, but are not limited to, income received prior to the change date that is deferred until the five year section 382 recognition period under section 455, § 1.451-5, or Rev. Proc. 2004-34 (2004-1 CB 991 (June 1, 2004)) (or any successor revenue procedure) (see § 601.601(d)(2)(ii)(b)). These prepaid income provisions permit deferral in order to better match the taxpayer's income with the expenses incurred to earn that income and, as a result, to more clearly reflect the taxpayer's income both in the year of receipt and in the year of performance. The IRS and the Treasury Department therefore view such income to be properly attributable to the period when included in gross income, which may be within the recognition period. Accordingly, such income is not “attributable to periods before the change date” and so is not RBIG under section 382(h)(6)(A).

One comment was received and no public hearing was requested or held. The public comment focused on companies in the business of providing extended warranty coverage for automobiles or other products. The commenter presented an example under the facts of which the commenter argued that a portion of the prepaid income deferred to the recognition period should be treated as RBIG.

After giving consideration to the comment, the IRS and Treasury continue to believe that none of the prepaid income taken into account during the recognition period in the example should be RBIG. As noted above, where prepaid income is properly deferred from gross income under a permissible method of accounting, such deferral reflects a judgment that the income has not been earned, or, in the parlance of section 382(h)(6)(A), is not “attributable to” prior performance. The premise of this Treasury decision is that, for purposes of section 382, there is not a compelling policy underlying section 382(h) that warrants a different timing answer for the treatment of properly deferred prepaid income.

Accordingly, the proposed regulations set forth in the NPRM (REG-144540-06), which cross-referenced to the temporary regulations for their substance, are adopted with no substantive change by this Treasury decision, and the corresponding temporary regulations are removed.

Special Analyses

It has been determined that this regulation is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. Pursuant to 5 U.S.C. 553(d)(3), it has been determined that good cause exists to dispense with a delayed effective date on grounds that this regulation, which is substantively identical to currently effective temporary regulations, merely continues to provide necessary guidance to taxpayers with respect to the treatment of prepaid income under the built-in gain provisions of section 382(h). It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. These regulations only apply in the rare circumstance in which a qualifying loss corporation that uses a particular accounting method undergoes an ownership change. 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 final 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 Keith E. Stanley of the Office of Associate Chief Counsel (Corporate). Other personnel from the IRS and the Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order to read in part as follows:

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

Section 1.382-7 also issued under 26 U.S.C 382(m). * * *

Par. 2. Section 1.382-1T is added to read as follows:

§ 1.382-1T Table of contents (temporary).

This section lists the captions that appear in the regulations for § 1.382-2T.

1.382-2T Definition of ownership change under section 382, as amended by the Tax Reform Act of 1986 (temporary).

 (a) Ownership change.

 1. Revising the introductory text.

§ 1.382-1 Table of contents.

This section lists the captions that appears in the regulations for §§ 1.382-2 through 1.382-11.

* * * * *

§ 1.382-7 Built-in gains and losses.

(a) Treatment of prepaid income.

(b) Effective/applicability dates.

* * * * *

Par. 4. Section 1.382-7 is added to read as follows:

§ 1.382-7 Built-in gains and losses.

(a) Treatment of prepaid income. For purposes of section 382(h), prepaid income is not recognized built-in gain. The term prepaid income means any amount received prior to the change date that is attributable to performance occurring on or after the change date. Examples to which this paragraph (a) will apply include, but are not limited to, income received prior to the change date that is deferred under section 455, § 1.451-5, or Rev. Proc. 2004-34 (2004-1 CB 991 (June 1, 2004)) (or any successor revenue procedure) (see § 601.601(d)(2)(ii)(b)).

(b) Effective/applicability dates. This section applies to loss corporations that have undergone an ownership change on or after June 11, 2010.

For loss corporations that have undergone an ownership change before June 11, 2010, see § 1.382-7T as contained in 26 CFR part 1, revised April 1, 2009.

§ 1.382-7T [Removed]

Par. 5. Section 1.382-7T is removed.