Parent can deduct as ordinary loss worthless securities in wholly-owned subsidiary PLR 201108001 IRS has privately ruled that, provided Code Sec. 165(a) 's and Code Sec. 165(g) 's requirements for claiming a worthless securities deduction are met, a savings and loan (S&L) company may claim an ordinary loss for its basis in the stock of its wholly-owned banking subsidiary. In so holding, IRS determined that the interest on and gains from the sale of the subsidiary's real estate and consumer loans were active receipts for purposes of applying the Code Sec. 165(g)(3) gross receipts test since, until the subsidiary was placed in receivership, it was an active operating company that performed significant services in its banking transactions. Background. If any security that is a capital asset becomes worthless during the tax year, the loss is treated as from the sale or exchange of a capital asset—that is, as a capital loss—on the last day of the tax year. ( Code Sec. 165(g)(1) ) A share of stock in a corporation is included in the definition of a security. ( Code Sec. 165(g)(2) ) Under the Code Sec. 165(g)(3) exception, a domestic corporation can claim an ordinary loss for worthless securities of an affiliated corporation. A corporation is affiliated with the taxpayer if it meets these two tests: ... Ownership test. The taxpayer must own directly stock in the corporation meeting the requirements of Code Sec. 1504(a)(2) (i.e., at least 80% of the voting power and value of the corporation's stock); ( Code Sec. 165(g)(3)(A) ) and ... Gross receipts test. More than 90% of the aggregate of the corporation's gross receipts for all tax years must be from sources other than royalties, rents (except rents derived from rental of properties to employees of the corporation in the ordinary course of its operating business), dividends, interest (except interest received on deferred purchase price of operating assets sold), annuities, and gains from sales or exchanges of stocks and securities. ( Code Sec. 165(g)(3)(B) ) Reg. § 1.165-5(d)(2)(iii) provides that the gross receipts test applies for all tax years during which the subsidiary has been in existence. Under Reg. § 1.1502-80(c) , subsidiary stock is not treated as worthless under Code Sec. 165 until immediately before the earlier of the time: (1) the stock is worthless within the meaning of Reg. § 1.1502-19(c)(1)(iii) ; or (2) the subsidiary for any reason ceases to be a member of the group. Under Code Sec. 582(c) , the sale or exchange of a bond, debenture, note, certificate, or other evidence of indebtedness by financial institutions (including banks) will generally result in ordinary gain or loss. Worthless stock in an affiliated bank (in which the taxpayer owns at least 80% of each class of stock) gives rise to an ordinary loss deduction if the stock becomes worthless. Facts. Parent and its domestic corporate subsidiaries are members of an affiliated group of corporations that has historically filed a U.S. consolidated federal income tax return. Parent is a S&L company, and the subsidiary at issue (Sub), in which Parent owns all outstanding stock, operated as a federally chartered savings bank and was Parent's principal operating subsidiary. Parent and one of its non-banking subsidiaries (bankrupt subsidiary) filed for chapter 11 bankruptcy on Date 1. The bankruptcy filing was precipitated by the seizure of Sub by the Office of Thrift Supervision and placement into a receivership with the Federal Deposit Insurance Corporation (FDIC) on Date 2, immediately followed by a receivership sale of substantially all of Sub's assets. The FDIC, as receiver, continues to act on Sub's behalf and holds Sub's remaining assets (including the sale proceeds). The receivership sale was a taxable transaction in which a separate entity purchased substantially all of Sub's assets and assumed all of its the deposits and certain other liabilities. Sub also had unassumed debt liabilities, and parent's group reported a net loss on its consolidated tax return with respect to the sale. Since the sale, Sub's assets have principally consisted of the cash proceeds, some amount of which has been invested in marketable securities, and certain intercompany claims and other causes of action. On Date 3, Parent and its bankrupt subsidiary filed a proposed plan of reorganization under chapter 11. The plan is premised on the Bankruptcy Court's approval of a proposed settlement agreement resolving numerous disputes among Parent and its bankrupt subsidiary, the corporation that purchased substantially all of Sub's assets, and the FDIC. The existing outstanding stock of Parent will be cancelled on the effective date of the plan, and it is currently contemplated that new common shares of reorganized Parent will be issued to certain claimholders. The plan also provides for the establishment of a liquidating trust. At the time that the private letter ruling (PLR) was issued, ignoring any possible recovery on the receiver's claims, the outstanding debt of Sub exceeds its assets, and Sub is expected to remain insolvent. Parent has an adjusted tax basis in its Sub stock of at least an undisclosed amount, Sub continues to be a member of Parent's group, and Parent has not claimed a worthless stock deduction with respect to the Sub stock under Reg. § 1.1502-80(c) . Parent expects to recognize its loss from its Sub stock no later than the cancellation of such stock upon the winding-up of the Sub receivership. But, Parent may seek to abandon its stock interest in Sub at an earlier time, in which case Parent will recognize the loss at the time of abandonment. Conclusion. IRS determined that, provided all the requirements for claiming a worthless securities deduction are met, Parent may claim an ordinary loss for its basis in Sub's stock. Parent represented that the stock would be worthless under Code Sec. 165(g)(1) at the time specified in Reg. § 1.1502-80(c) , and IRS concluded that Parent met the affiliation requirements under Code Sec. 165(g)(3) where it satisfied both the ownership test and the gross receipts test. The ownership test was readily met based on facts that (i) Parent directly owned all of the stock in Sub, (ii) Parent didn't elect under Reg. § 1.597-4(g) to disaffiliate Sub, and (iii) Sub would continue to be an affiliate until it was liquidated or until Parent abandoned its stock. IRS then examined the language and legislative history of Code Sec. 165(g)(3)(B) and determined that the interest on and gains from the sale of Sub's real estate and consumer loans were active receipts for purposes of applying the gross receipts test. IRS reasoned that the gross receipts test was intended to be a mechanism for determining whether a subsidiary is an operating company (for which an ordinary loss may be allowed) or a holding company (for which no ordinary loss is allowed), and Sub was clearly an operating company that performed significant services in conjunction with the banking transactions that yielded interest income and gain. IRS found that the legislative history of Code Sec. 582(c) further indicates that, for operating banks, gains from transactions involving items of indebtedness are more appropriately treated as yielding ordinary income since these items are akin to inventory or stock items. Thus, IRS reasoned that such gains from such transactions shouldn't be treated as passive for purposes of Code Sec. 165(g)(3)(B) . § 165 Losses. ________________________________________ (a) WG&L Treatises General rule. There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. (b) WG&L Treatises Amount of deduction. For purposes of subsection (a) , the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property. (c) WG&L Treatises Limitation on losses of individuals. In the case of an individual, the deduction under subsection (a) shall be limited to (1) WG&L Treatises losses incurred in a trade or business; (2) WG&L Treatises losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) WG&L Treatises except as provided in subsection (h) , losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. (d) WG&L Treatises Wagering losses. Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions. (e) Theft losses. For purposes of subsection (a) , any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss. (f) WG&L Treatises Capital losses. Losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212 . (g) WG&L Treatises Worthless securities. (1) WG&L Treatises General rule. If any security which is a capital asset becomes worthless during the taxable year, the loss resulting therefrom shall, for purposes of this subtitle, be treated as a loss from the sale or exchange, on the last day of the taxable year, of a capital asset. (2) WG&L Treatises Security defined. For purposes of this subsection , the term “security” means— (A) a share of stock in a corporation; (B) a right to subscribe for, or to receive, a share of stock in a corporation; or (C) a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form. (3) New Law AnalysisWG&L Treatises Securities in affiliated corporation. For purposes of paragraph (1) , any security in a corporation affiliated with a taxpayer which is a domestic corporation shall not be treated as a capital asset. For purposes of the preceding sentence, a corporation shall be treated as affiliated with the taxpayer only if— (A) New Law Analysis the taxpayer owns directly stock in such corporation meeting the requirements of section 1504(a)(2) , and (B) more than 90 percent of the aggregate of its gross receipts for all taxable years has been from sources other than royalties, rents (except rents derived from rental of properties to employees of the corporation in the ordinary course of its operating business), dividends, interest (except interest received on deferred purchase price of operating assets sold), annuities, and gains from sales or exchanges of stocks and securities. In computing gross receipts for purposes of the preceding sentence, gross receipts from sales or exchanges of stocks and securities shall be taken into account only to the extent of gains therefrom. (h) WG&L Treatises Treatment of casualty gains and losses. (1) New Law Analysis $100 limitation per casualty. Any loss of an individual described in subsection (c)(3) shall be allowed only to the extent that the amount of the loss to such individual arising from each casualty, or from each theft, exceeds $500 ($100 for taxable years beginning after December 31, 2009). (2) WG&L Treatises Net casualty loss allowed only to the extent it exceeds 10 percent of adjusted gross income. (A) In general. If the personal casualty losses for any taxable year exceed the personal casualty gains for such taxable year, such losses shall be allowed for the taxable year only to the extent of the sum of— (i) the amount of the personal casualty gains for the taxable year, plus (ii) so much of such excess as exceeds 10 percent of the adjusted gross income of the individual. (B) WG&L Treatises Special rule where personal casualty gains exceed personal casualty losses. If the personal casualty gains for any taxable year exceed the personal casualty losses for such taxable year— (i) all such gains shall be treated as gains from sales or exchanges of capital assets, and (ii) all such losses shall be treated as losses from sales or exchanges of capital assets. (3) Special rule for losses in federally declared disasters. (A) New Law AnalysisWG&L Treatises In general. If an individual has a net disaster loss for any taxable year, the amount determined under paragraph (2)(A)(ii) shall be the sum of— (i) such net disaster loss, and (ii) so much of the excess referred to in the matter preceding clause (i) of paragraph (2)(A) (reduced by the amount in clause (i) of this subparagraph ) as exceeds 10 percent of the adjusted gross income of the individual. (B) New Law AnalysisWG&L Treatises Net disaster loss. For purposes of subparagraph (A) , the term “net disaster loss” means the excess of— (i) New Law Analysis the personal casualty losses— (I) New Law Analysis attributable to a federally declared disaster occurring before January 1, 2010, and (II) New Law Analysis occurring in a disaster area, over (ii) New Law Analysis personal casualty gains. (C) Federally declared disaster. For purposes of this paragraph— (i) New Law Analysis Federally declared disaster. The term “federally declared disaster” means any disaster subsequently determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. (ii) New Law Analysis Disaster area. The term “disaster area” means the area so determined to warrant such assistance. (4) WG&L Treatises Definitions of personal casualty gain and personal casualty loss. For purposes of this subsection— (A) Personal casualty gain. The term “personal casualty gain” means the recognized gain from any involuntary conversion of property which is described in subsection (c)(3) arising from fire, storm, shipwreck, or other casualty, or from theft. (B) New Law Analysis Personal casualty loss. The term “personal casualty loss” means any loss described in subsection (c)(3) . For purposes of paragraphs (2) and (3) , the amount of any personal casualty loss shall be determined after the application of paragraph (1) . (5) Special rules. (A) Personal casualty losses allowable in computing adjusted gross income to the extent of personal casualty gains. In any case to which paragraph (2)(A) applies, the deduction for personal casualty losses for any taxable year shall be treated as a deduction allowable in computing adjusted gross income to the extent such losses do not exceed the personal casualty gains for the taxable year. (B) WG&L Treatises Joint returns. For purposes of this subsection , a husband and wife making a joint return for the taxable year shall be treated as 1 individual. (C) Determination of adjusted gross income in case of estates and trusts. For purposes of paragraph (2) , the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual, except that the deductions for costs paid or incurred in connection with the administration of the estate or trust shall be treated as allowable in arriving at adjusted gross income. (D) Coordination with estate tax. No loss described in subsection (c)(3) shall be allowed if, at the time of filing the return, such loss has been claimed for estate tax purposes in the estate tax return. (E) Claim required to be filed in certain cases. Any loss of an individual described in subsection (c)(3) to the extent covered by insurance shall be taken into account under this section only if the individual files a timely insurance claim with respect to such loss. (i) Disaster losses. (1) New Law Analysis Election to take deduction for preceding year. Notwithstanding the provisions of subsection (a) , any loss occurring in a disaster area (as defined by clause (ii) of subsection (h)(3)(C) ) and attributable to a federally declared disaster (as defined by clause (i) of such subsection) may, at the election of the taxpayer, be taken into account for the taxable year immediately preceding the taxable year in which the disaster occurred. (2) Year of loss. If an election is made under this subsection, the casualty resulting in the loss shall be treated for purposes of this title as having occurred in the taxable year for which the deduction is claimed. (3) Amount of loss. The amount of the loss taken into account in the preceding taxable year by reason of paragraph (1) shall not exceed the uncompensated amount determined on the basis of the facts existing at the date the taxpayer claims the loss. (4) New Law Analysis Use of disaster loan appraisals to establish amount of loss. Nothing in this title shall be construed to prohibit the Secretary from prescribing regulations or other guidance under which an appraisal for the purpose of obtaining a loan of Federal funds or a loan guarantee from the Federal Government as a result of a federally declared disaster (as defined by subsection (h)(3)(C)(i) may be used to establish the amount of any loss described in paragraph (1) or (2) . (j) WG&L Treatises Denial of deduction for losses on certain obligations not in registered form. (1) In general. Nothing in subsection (a) or in any other provision of law shall be construed to provide a deduction for any loss sustained on any registration-required obligation unless such obligation is in registered form (or the issuance of such obligation was subject to tax under section 4701 ). (2) Definitions. For purposes of this subsection— Caution: Code Sec. 165(j)(2)(A), following, is effective for obligations issued before 3/19/2012. For Code Sec. 165(j)(2)(A), effective for obligations issued after 3/18/2012, see below. (A) Registration-required obligation. The term “registration-required obligation” has the meaning given to such term by section 163(f)(2) except that clause (iv) of subparagraph (A) , and subparagraph (B) , of such section shall not apply. Caution: Code Sec. 165(j)(2)(A), following, is effective for obligations issued after 3/18/2012. For Code Sec. 165(j)(2)(A), effective for obligations issued before 3/19/2012, see above. (A) Registration-required obligation. The term “registration-required obligation” has the meaning given to such term by section 163(f)(2) . (B) Registered form. The term “registered form” has the same meaning as when used in section 163(f) . (3) Exceptions. The Secretary may, by regulations, provide that this subsection and section 1287 shall not apply with respect to obligations held by any person if— (A) such person holds such obligations in connection with a trade or business outside the United States, (B) such person holds such obligations as a broker dealer (registered under Federal or State law) for sale to customers in the ordinary course of his trade or business, (C) such person complies with reporting requirements with respect to ownership, transfers, and payments as the Secretary may require, or (D) such person promptly surrenders the obligation to the issuer for the issuance of a new obligation in registered form, but only if such obligations are held under arrangements provided in regulations or otherwise which are designed to assure that such obligations are not delivered to any United States person other than a person described in subparagraph (A) , (B) , or (C) . (k) Treatment as disaster loss where taxpayer ordered to demolish or relocate residence in disaster area because of disaster. In the case of a taxpayer whose residence is located in an area which has been determined by the President of the United States to warrant assistance by the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, if— (1) not later than the 120th day after the date of such determination, the taxpayer is ordered, by the government of the State or any political subdivision thereof in which such residence is located, to demolish or relocate such residence, and (2) the residence has been rendered unsafe for use as a residence by reason of the disaster, any loss attributable to such disaster shall be treated as a loss which arises from a casualty and which is described in subsection (i) . (l) Treatment of certain losses in insolvent financial institutions. (1) In general. If— (A) as of the close of the taxable year, it can reasonably be estimated that there is a loss on a qualified individual's deposit in a qualified financial institution, and (B) such loss is on account of the bankruptcy or insolvency of such institution, then the taxpayer may elect to treat the amount so estimated as a loss described in subsection (c)(3) incurred during the taxable year. (2) Qualified individual defined. For purposes of this subsection , the term “qualified individual” means any individual, except an individual— (A) who owns at least 1 percent in value of the outstanding stock of the qualified financial institution, (B) who is an officer of the qualified financial institution, (C) who is a sibling (whether by the whole or half blood), spouse, aunt, uncle, nephew, niece, ancestor, or lineal descendant of an individual described in subparagraph (A) or (B) , or (D) who otherwise is a related person (as defined in section 267(b) ) with respect to an individual described in subparagraph (A) or (B) . (3) Qualified financial institution. For purposes of this subsection , the term “qualified financial institution” means— (A) any bank (as defined in section 581 ), (B) any institution described in section 591 , (C) any credit union the deposits or accounts in which are insured under Federal or State law or are protected or guaranteed under State law, or (D) any similar institution chartered and supervised under Federal or State law. (4) Deposit. For purposes of this subsection , the term “deposit” means any deposit, withdrawable account, or withdrawable or repurchasable share. (5) Election to treat as ordinary loss. (A) In general. In lieu of any election under paragraph (1) , the taxpayer may elect to treat the amount referred to in paragraph (1) for the taxable year as an ordinary loss described in subsection (c)(2) incurred during the taxable year. (B) Limitations. (i) Deposit may not be federally insured. No election may be made under subparagraph (A) with respect to any loss on a deposit in a qualified financial institution if part or all of such deposit is insured under Federal law. (ii) Dollar limitation. With respect to each financial institution, the aggregate amount of losses attributable to deposits in such financial institution to which an election under subparagraph (A) may be made by the taxpayer for any taxable year shall not exceed $20,000 ($10,000 in the case of a separate return by a married individual). The limitation of the preceding sentence shall be reduced by the amount of any insurance proceeds under any State law which can reasonably be expected to be received with respect to losses on deposits in such institution. (6) Election. Any election by the taxpayer under this subsection for any taxable year— (A) shall apply to all losses for such taxable year of the taxpayer on deposits in the institution with respect to which such election was made, and (B) may be revoked only with the consent of the Secretary. (7) Coordination with section 166. Section 166 shall not apply to any loss to which an election under this subsection applies. (m) Cross references. (1) For special rule for banks with respect to worthless securities, see section 582 . (2) For disallowance of deduction for worthlessness of securities to which subsection (g)(2)(C) applies, if issued by a political party or similar organization, see section 271 . (3) For special rule for losses on stock in a small business investment company, see section 1242 . (4) For special rule for losses of a small business investment company, see section 1243 . (5) For special rule for losses on small business stock, see section 1244 .