Hindsight Is Prejudicial, Not 20/20

In guidance issued by the IRS, the chief counsel says a taxable stock distribution cannot be treated as an asset transfer years later.
Robert WillensMarch 22, 2010

In guidance laid out in a chief counsel advisory notice, the Internal Revenue Service concluded that under some circumstances, a company cannot make what is known under the tax code as a Section 336(e) election. A Section
336(e) election relates to the criteria allowing some stock sales and distributions to be treated as an asset transfer.

In the guidance (CCA 201009013, issued November 24, 2009), a corporate relationship was set up in the following manner: Psi Corp. owns all of the stock of Sigma Corp., and the latter owns all of the stock of Tau Corp.

In a transaction, Sigma distributed the stock of Tau to Psi, and Psi treated the distribution as a taxable transaction under Section 301 of the tax code, rather than as a tax-free spin-off under Section 355. (As a Section 355 spin-off, Sigma would have recognized a gain under Section 311(b) that would have been deferred under Regulation Section 1.1502-13.)

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Approximately four years later, Psi sold its Sigma stock to an unrelated purchaser and reported a capital loss from the sale. Psi then proposed to file an amended tax return and make a Section 336(e) election with respect to the distribution of Tau’s stock by Sigma. But the IRS concluded that the election could not be made.

Self-executing Statute?

Section 336(e) states that “under regulations prescribed by the Secretary,” if a corporation owns stock in another corporation that meets the requirements of “80-percent voting and value test” (Section 1504(a)(2)) and the corporation sells, exchanges, or distributes all of the stock, an election may be made to treat the transaction as a disposition of the assets. That means that no gain or loss is recognized on the sale, exchange, or distribution.

On August 22, 2008, the IRS issued proposed regulations under Section 336(e) to clarify that the regulations are prospective in nature and that Section 336(e) elections will only be permissible for stock dispositions occurring on or after the date final regulations are published. With that in mind, consider the following facts about self-executing regulations: a statute is self-executing if the regulation referred to in the law deals with how to apply the statute; and a regulation is self-executing when Congress states what a particular rule is to provide, and articulates the overall purpose behind a given section in the legislative history, but leaves the mechanics and details affecting the application of the statute to the Secretary.

WillensFinal“[The company] wishes to make an election more than five years after the date of the transaction…. ‘So doing’ cannot be within congressional intent and cannot be considered reasonable.” — Robert Willens

By contrast, a statute is not self-executing if a “whether” regulation is required. That is, the promulgation of the regulation is a necessary condition to determine whether the statute applies in the first instance. In these cases, the statute manifests the intent of Congress to require such regulations as a condition to impose the statute.

The IRS chief counsel concluded that Section 336(e) is not self-executing. Congress authorized regulations if the IRS determined that the regulations would help carry out the purposes of Subchapter C of the Internal Revenue Code (Corporate Distributions and Adjustments). But in no way did Congress mandate the regulations. Therefore, the promulgation of regulations under Section 336(e) is needed to carry out the election.

Elections in Amended Returns
Assuming arguendo that Section 336(e) is self-executing, case law provides that in implementing such a statute, courts must apply what they believe was congressional intent. Here, Psi wishes to make an election more than five years after the date of the transaction. We believe, the chief counsel’s advisory said, that “so doing” cannot be within congressional intent and cannot be considered reasonable.

The legislative history to Section 336(e) provides that any regulations that are promulgated may use principles similar to those in Section 338(h)(10). However, elections under Section 338(h)(10) must be made not later than the 15th day of the ninth month after the month in which the transaction occurs. We see nothing, the chief counsel observed, to suggest that Congress intended that any election to be authorized by regulations under Section 336(e) be available years after the transaction took place.

Moreover, if a taxpayer were allowed to make an election after the due date of its return, this would allow taxpayers the use of “hindsight” to retroactively reduce their tax liability, to the prejudice of the government. The chief counsel noted that Goldstone v. Commissioner, 65 T.C. 113 (1975), provides three fact patterns in which elections are allowed in amended returns:
• The amended return was filed prior to the due date of the original return;
• The taxpayer’s treatment of the item on the amended return is not inconsistent with the treatment on the original return; and
• The taxpayer’s original return with respect to the item was improper.

None of these three situations exists in the example case.

By reporting the transaction as a stock distribution on its income-tax return, the taxpayer made a binding election not to treat the transaction as an asset sale. Allowing recomputation and readjustment of Psi’s tax liability years after the original election “would impose burdensome uncertainties on the administration of the revenue laws.” (See Pacific National Co. v. Welch, 304 US 191 (1938).)

Therefore, the IRS chief counsel believes that no election is available prior to the issuance of regulations allowing such election because Section 336(e) is not self-executing. Further, even assuming it were self-executing in part, it would not be self-executing with respect to an intragroup distribution of stock.

Lastly, even if Section 336(e) were self-executing with respect to such an intragroup distribution of stock, allowing an election years after the date of the subject transaction would be a clear invitation to the use of hindsight, would not be a reasonable application of the statute, and would impose burdensome uncertainties on the administration of the revenue laws. Thus, Psi was denied access to the benefits of Section 336(e).

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for