After a § 338(g) election, a subsidiary's pre-acquisition years are ignored for the worthless-stock gross-receipts test

Plain-English summary

When a company's stock in a subsidiary becomes worthless, the loss is normally a capital loss, but Section 165(g)(3) allows a more valuable ordinary loss if the subsidiary is an affiliated company and more than 90% of its gross receipts across "all taxable years" came from active business rather than passive sources like interest, dividends, rents, and royalties. This informal Chief Counsel email advice addresses how that test works after a Section 338(g) election. A U.S. C corporation bought all the stock of a foreign subsidiary in a qualified stock purchase and made a Section 338(g) election, which treats the target as if it sold all its assets and a brand-new corporation bought them the next day. The subsidiary's stock later became worthless and the parent claimed an ordinary worthless-stock deduction. The question was whether the parent must dig up and count the subsidiary's gross-receipts history from years before the acquisition. Chief Counsel advised no: because a Section 338 election creates a "new target" treated as unrelated to the "old target" for all purposes of subtitle A (and Section 165 is in subtitle A with no exception), "all taxable years" for the gross-receipts test includes only years beginning on or after the day after the acquisition. So pre-acquisition records are not required here. This is advice to the field, and Chief Counsel notes the gross-receipts test can still involve complex facts in other cases.

Ruling snapshot

• Question: After a § 338(g) election, must the taxpayer take into account the subsidiary's pre-acquisition gross receipts for the § 165(g)(3)(B) 90% gross-receipts test?
• Outcome: advice given (no; only post-election years count)
• Key authorities: IRC §§ 338(a), 165(g)(3)(B); Treas. Reg. § 1.338-1(a), (b)

Full text (IRS public release)

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ID: CCA_2024071008584113
UILC: 165.06-00, 338.00-00

Number: 202501010
Release Date: 1/3/2025
From: -----------------------
Sent: Wednesday, July 10, 2024 8:58:41 AM
To: -----------------
Cc: ----------------------------------------------------------------
Bcc:
Subject: POSTU-123139-22

--------,

You requested our advice on how § 338 applies to the facts described below.
Specifically, you asked whether, for purposes of the gross receipts test of §
165(g)(3)(B), Taxpayer must provide (and take into account) the gross receipts history
of Subsidiary from taxable years beginning on, or prior to, Date 1, the date on which
Taxpayer acquired Subsidiary in a qualified stock purchase. As explained in greater
detail below, Taxpayer should not be required to provide (or take into account) the gross
receipts history of Subsidiary for taxable years beginning prior to Date 2.

In this case, Taxpayer, a domestic Subchapter C corporation, acquired all the stock of
Subsidiary, a foreign entity treated as a corporation for U.S. tax purposes, in a qualified
stock purchase on Date 1. Taxpayer made a § 338(g) election with respect to the
acquisition. According to Taxpayer, the stock of Subsidiary subsequently became
worthless in Year 3, and Taxpayer claimed a worthless stock deduction under
§ 165(g)(3) with respect to such stock in Year 3.

Under § 165(g), a loss resulting from stock becoming worthless is generally a capital
loss if the stock itself is a capital asset. However, § 165(g)(3) provides for ordinary loss
treatment of worthless stock in “a corporation affiliated with a taxpayer” if over 90% of
the corporation’s gross receipts from “all taxable years” are, generally, not from
royalties, rents, dividends, interest, annuities, and gains from sales or exchanges of
stocks and securities. See section 165(g)(3)(B). Taxpayer argues that, as a result of
the § 338(g) election on Date 1, Subsidiary is treated as a new corporation formed on
Date 2 (the day after Date 1), and “all taxable years” in § 165(g)(3)(B) only include the
taxable years beginning on or after Date 2. Taxpayer concludes that it should not be
required to provide records relating to the gross receipts history of Subsidiary for
taxable years prior to Date 1. The field has requested advice on whether this treatment
is appropriate pursuant to § 338 and the regulations thereunder.

If the purchasing corporation in a qualified stock purchase makes an election under §
338, the target corporation is treated as selling all of its assets at the close of the
acquisition date at fair market value. Section 338(a)(1). The target is treated as a new
 2

corporation that purchased those assets as of the beginning of the day after the
acquisition date. Section 338(a)(2); see also Treas. Reg. § 1.338-1(a)(1) (“Although
target is a single corporation under corporate law, if a section 338 election is made, then
two separate corporations, old target and new target, generally are considered to exist
for purposes of subtitle A of the Internal Revenue Code.”). Unless a specific exception
in the regulations applies, new target is treated as a new corporation that is unrelated to
old target for all purposes of subtitle A. Treas. Reg. § 1.338-1(b)(1). The exceptions,
which are enumerated in Treas. Reg. § 1.338-1(b)(2) and (3), do not include § 165, a
provision in subtitle A. As a result, Subsidiary is treated as a new corporation as of
Date 2, and “all taxable years” of Subsidiary, for purposes of § 165(g)(3)(B), include
taxable years beginning on or after Date 2 and do not include taxable years beginning
before Date 2. Thus, documentation from years prior to Date 2 is not required in this
case.

Please contact CC:CORP if you encounter this issue in any future cases, as
determining whether any particular entity satisfies the gross receipts test may involve a
complex factual analysis. ----------------------------------------------------------------------------------

------------------------------------------------------- We would be happy to assist with factual
development and legal analysis in any other cases with section 165(g)(3) issues.

Please let us know if you have any questions.

Thank you,

Legend
Taxpayer = ----------------------------------------------
Subsidiary = ------------------------------
Date 1 = ------------------
Date 2 = --------------------
Year 3 = -------

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