Technical Advice Memorandum 202116012 Released April 23, 2021 Advice

Insolvent subsidiary may deduct assumed product liabilities on liquidation

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This page covers one taxpayer's ruling from 2021, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.

Not precedent. Under 26 U.S.C. § 6110(k)(3), this written determination may not be used or cited as precedent. It resolved one taxpayer's situation on its specific facts, and identifying details were redacted by the IRS before release. The official IRS release (linked on this page as a PDF) is the authoritative source.

About this page: The plain-English summary and ruling snapshot below were written by Ezel based on the official IRS release. The full text is the IRS's own document.

View official IRS release (PDF)

Plain-English summary

A consolidated group had acquired a manufacturer facing product-liability claims that were later resolved through master settlement agreements. Before the subsidiary became a disregarded entity in a planned liquidation, it included the settlement liabilities in its amount realized and claimed deductions under Treasury Regulation Section 1.461-4(d)(5). The IRS reasoned that the insolvent subsidiary's deemed asset transfer could not be an exchange for its stock and instead was treated as a purchase in which the parent assumed, or took assets subject to, the liabilities. It concluded that the subsidiary could deduct the product liabilities under Section 162 because economic performance was satisfied when the liabilities were included in the amount realized. A second issue and its conclusion are redacted in the public release.

Ruling snapshot

Question: Could the subsidiary deduct settled product-liability obligations when its parent assumed them in the subsidiary's check-the-box liquidation?
Outcome: Advice given: yes, economic performance was satisfied under Treasury Regulation Section 1.461-4(d)(5); the second issue is redacted.
Key authorities: IRC §§ 162 and 461; Treas. Reg. §§ 1.461-4(d)(5), 1.1001-2, and 301.7701-3; Rev. Rul. 2003-125

Full text (IRS public release)

                        INTERNAL REVENUE SERVICE
              NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

                                         December 31, 2020

                                                  Third Party Communication: None
                                                  Date of Communication: Not Applicable

Number: 202116012
Release Date: 4/23/2021

Index (UIL) No.: 461.06-00
CASE-MIS No.: TAM-107814-20

Michael Corrado
Area Counsel (Philadelphia)
(Large Business & International)

      Taxpayer's Name:                             ----------------------------
      Taxpayer's Address:                          --------------------------
                                                   -----------------------------
      Taxpayer's Identification No                 ----------------
      Year(s) Involved:                            -------
      Date of Conference:                          ------------------

LEGEND:

Taxpayer = ----------------------------

Business 1 = ----------------------------------------------------

Business 2 = ------------------------------------------------------------------

Business 3 = --------------------------------

Product 1 = ----------------------

Product 2 = -------------------------------------------------

Clause 1 = -----------------------------------------------------------------------------------------------------

TAM-107814-20 2

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Clause 2 = -----------------------------------------------------------------------------------------------------

Government Agency = ----------------------------------------

MSA 1 = -------------------------------

MSA 2 = -------------------------

MSA 3 = ---------------

Order 1 = ---------------------------------------------

Order 2 = ------------------------------------------------

Year 1 = -------

Year 2 = -------

Date 1 = -------------------

Date 2 = ------------------------

Date 3 = -----------------

Date 4 = --------------------------

Date 5 = --------------------------

Date 6 = -------------------

Date 7 = --------------------

Date 8 = ------------------

Month 1 = -------------

A = ---------------------------------------------
TAM-107814-20 3

B = ----------------------------------------------------------

C = ----------------------------------------------------------------------

D = ------

E = ---------------------------------------------------------------------------------------------------------------

F = -----------------------------------------------

G = ----------------------------------------

H = --------------------------------------------------

J = --------------------

K = ---------------

L = ---------------------------

M = ----------------------

N = --------------

O = --------------------------------------------------

P = -----------------------------------------------------------

Q = ----------------------------------------------------------------------

R = --------------------------------------------

S = -------------

T = -------------

U = --------------

V = ------------

W = ---------

X = ---
TAM-107814-20 4

Y = -----------------

Z = ---

ZZ = ---

ISSUES:

1. May H (the subsidiary of A) deduct the amount of the Product 2 product liability
   under § 162 of the Internal Revenue Code (“Code”) ---------------------------------------
   ---------------------------------------------, satisfying economic performance under
   Treas. Reg. § 1.461-4(d)(5), ---------------------------------------------------------------------
   ------------------------------------------------------------------------------------------------------------
   -----------------------------------------------------------------------------------------------?

2. ------------------------------------------------------------------------------------------------------------
   ------------------------------------------------------------------------------------------------------------
   ----------------------------------------------------------------------------------

CONCLUSIONS:

1. H may deduct the amount of Product 2 liabilities ---------------------------------in Year
   2 under § 162 of the Code because economic performance is satisfied under
   Treas. Reg. § 1.461-4(d)(5).

2. ----------------------------------------------------------------------------------------------------------------
   ----------------------------------------------------------------------------------------------------------------
   ----------------------------------------------------------------------------------------------------------------
   ------------------------------------------------------------

FACTS:

B, a publicly-traded --------- corporation, is the parent corporation of a worldwide
corporate group engaged in Business 1, including Business 2 and Business 3. Taxpayer
is engaged in Business 1. A is a second-tier subsidiary of Taxpayer. Taxpayer is the
common parent of B’s U.S. group and files a consolidated tax return with, among other
members, A, C, E, and F.

On Date 1, A acquired all of the outstanding shares of C, a publicly-traded manufacturer
of Product 1 -------------------------. Within C’s corporate structure at the time, D was the
operating entity that manufactured and sold products -------------------------through
Business 2 and Business 3. After the acquisition, D was owned partially by A, and
partially by E, another member of Taxpayer’s consolidated group.
TAM-107814-20 5

D’s Business 3 manufactured and sold Product 2. As of the date of A’s acquisition of D,
approximately V product liability suits had been filed against D. As a result of --------------
--------------------------------------, and as of Date 4, over W product liability claims for
Product 2 had been asserted against A, F, C, and D. Claims against A included
allegations of both product liability------------------------------------------------------------------------

On Date 2, the Judicial Panel on Multidistrict Litigation created a multidistrict litigation
(“MDL”) proceeding to coordinate all pending federal claims asserted against A, F, C,
and D. As part of the MDL, A, F, and C negotiated an agreement with plaintiffs’ -----------
counsel, ------------------------------------------------------------in D’s MDLs. ---------------------------

-------------------------------------------------------This agreement was reduced to an agreed
upon draft order, which the MDL Court approved, adopted, and entered as Order 1 on
Date 3.

Order 1 ----------------------------------------------------------------------------------------------------------

-------------------------------------------------------------------------------------------------------------.

In compliance with Order 1, to resolve the claims against D efficiently, X Master
Settlement Agreements (“MSAs”) were entered into with various groups of claimants. All
Z of the MSAs at issue in this TAM (totaling $Y of the liabilities assumed) were fully
executed prior to Date 4. Taxpayer has agreed that the remaining ZZ MSAs executed
after Date 4 are not included in this TAM request.

The MSAs set forth the terms for the settlement of Product 2 product liability claims
under the MDL. This settlement process was described in Order 2. ---------------------------

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The MSAs generally provide that a specified payment be made --------------------------------
All Z of the MSAs at issue in this TAM state that they are between D, C, A, and F,
collectively referred to in the MSAs as G and the respective claimants. The MSAs state
that G will pay certain amounts to the claimants, and that entities other than D are
intended third party beneficiaries of the MSAs.
TAM-107814-20 6

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Three of the MSAs at issue in this TAM, MSA 1, MSA 2, and MSA 3, contain additional
language. These three MSAs contain Clause 2 as to the parties thereto.

Finally, all of the MSAs provide that they do not constitute an admission of liability or
wrongdoing or of any position whatsoever in connection with any matters in any pending
or potential litigation, and contain an express denial of such liability or wrongdoing.

This disclaimer prohibits claimants, including those parties to the particular MSAs in the
event of a failure of G to make payments --------------, from asserting that the MSAs
amount to an admission of liability by A, F, and C.

As the MSAs became final, the MDL court issued orders regarding the MSAs. -------------

------------------------------------------. D did, in fact, make payments pursuant to the MSAs.

---------------------------------------------------------------------------------------------------------------------

-------------------------------------------------------, three C subsidiaries – J, K, and D –
converted from ------------- corporations to-------------- LLCs (the “Conversions”) to
become L, M, and N, respectively. Subsequently, L, M, and N were classified for U.S.
federal income tax purposes as disregarded entities owned by C.

D checked the box to become a disregarded entity, and all of D’s assets and liabilities
were transferred to C for Federal income tax purposes.

---------------------------------------------------------------------------------------------------------------------

-----------------------------------------------------------, on Date 8, -----------------------------------------

---------------------------------------------------------------------------------------------------------------------

TAM-107814-20 7

Throughout Month 1, C contributed Business 3 operations to a newly created --------------

limited liability company, P, which was classified from its formation as a disregarded
entity for U.S. federal income tax purposes. C also changed its name ------------------------
---- to H.

Liquidation of H

As part of a plan of liquidation, on Date 4, H converted from a--------------corporation into
a ------------- LLC ----------------------------------------------, resulting in it becoming a
disregarded entity owned by A, for federal income tax purposes, and changed its name
---------------------------to Q. As a result of the --------------------------conversion, A assumed
all remaining assets and liabilities of H for federal income tax purposes.
Also on Date 4, ----------------------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

Filing Positions

A, E, and H all filed as part of Taxpayer’s consolidated group for the Year 2 tax year. H
included the amounts of the liabilities incurred through the MSAs in its amount realized
on the liquidation for federal income tax purposes and deducted these amounts under
§ 1.461-4(d)(5). -----------------------------------------------------------------------------------------------

---------------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------The
consolidated net operating loss was reported as $U, -----------------------------------------------

LAW AND ANALYSIS:

Issue 1: May H (the subsidiary of A) deduct under § 1.461-4(d)(5) the amount of
Product 2 liability ---------------------------------------------------------------------------------------------

TAM-107814-20 8

Section 461 provides that the amount of any deduction or credit allowed by this subtitle
shall be taken for the taxable year which is the proper taxable year under the method of
accounting used in computing taxable income.

Section 1.461-1(a)(2)(i) of the Income Tax Regulations provides that under an accrual
method of accounting, a liability (as defined in §1.446-1(c)(1)(ii)(B)) is incurred, and
generally taken into account for Federal income tax purposes, in the taxable year in
which all the events have occurred that establish the fact of the liability, the amount of
the liability can be determined with reasonable accuracy, and economic performance
has occurred with respect to the liability.

Section 1.461-4(d)(5)(i) provides that in general, if, in connection with the sale or
exchange of a trade or business by a taxpayer, the purchaser expressly assumes a
liability arising out of the trade or business that the taxpayer but for the economic
performance requirement would have been entitled to incur as of the date of the sale,
economic performance with respect to that liability occurs as the amount of the liability
is properly included in the amount realized on the transaction by the taxpayer. See
§1.1001-2 for rules relating to the inclusion in amount realized from a discharge of
liabilities resulting from a sale or exchange.

The sole question under Issue 1 is whether A can assume H’s MSA liabilities in
satisfaction of the economic performance requirement in connection with the sale of a
trade or business under § 1.461-4(d)(5) ---------------------------------------------------------------
-----------.1

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Therefore, when H made a “check the box election” under § 301.7701- 3(c)(1) on Date
4 to become a disregarded entity, under § 301.7701- 3(g)(1)(iii), H was deemed to
distribute all of its assets and liabilities to A. Further, because H was insolvent at the
time of the check-the-box election, Rev. Rul. 2003-125, 2003-2 C.B. 1243, clarifies that
the deemed distribution of H’s assets and liabilities to A cannot be in exchange for H’s
stock because the amount of H’s liabilities is greater than the fair market value of H’s
assets. Because the acquisition was not in exchange for stock (per Rev. Rul. 2003-
125), the shareholder must be treated as purchasing the assets and either assuming
the liabilities (the case if the shareholder is directly liable to the claimants) or taking the
assets subject to the liabilities (where the shareholder is not directly liable to the
claimants). -----------------------------------------------------------------------------------------------------

1 Exam has not challenged the taxpayer’s position that the other requirements of § 1.461-4(d)(5) have

been satisfied.
TAM-107814-20 9

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-----------------------Therefore, H may deduct the amount of Product 2 liabilities --------------
-------------------------------- under § 162 because economic performance is satisfied under
§ 1.461-4(d)(5).2

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  a. --------------------------------------------------

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----------.3

2 Exam has not challenged Taxpayer’s position that these deductions qualify as ----------------------------------

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3 -----------------------------------------------------------------------------------------------------------------------------------------

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TAM-107814-20 10

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  b. ------------------------

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  c. Caselaw and Definitions

Deductions are a matter of legislative grace and are “strictly construed”.7 INDOPCO,
Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292
U.S. 435, 440 (1934).

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TAM-107814-20 13

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  d. -----------

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       ii.    -------------------------------------------------------------------------

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TAM-107814-20 19

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CAVEAT(S):

A copy of this technical advice memorandum is to be given to the taxpayer(s). Section
6110(k)(3) of the Code provides that it may not be used or cited as precedent.

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Apply this to your situation

This page covers one taxpayer's ruling from 2021, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.

On this page

Document type

Technical Advice Memorandum

IRS subject

Incurred Liabilities

Topics

Accounting methods and periods

Code sections

§ 162, § 461, § 1001, § 7701, § 6110

Ruling dated

December 31, 2020

Publicly released

April 23, 2021

View Official PDF