The Tax Reform Act of 1984 (Public Law 98-369, 98 Stat. 494) amended section 1092(b) of the Internal Revenue Code (Code) to add, among other items, an election to establish a mixed straddle using straddle-by-straddle identification (a section 1092(b)(2) identified mixed straddle).

On January 24, 1985, the Treasury Department and the IRS published a notice of proposed rulemaking by cross-reference to temporary regulations (50 FR 3351, January 24, 1985). Included in the temporary regulations was §1.1092(b)-3T (TD 8008, 1985-1 C.B. 276), which describes how to account for a section 1092(b)(2) identified mixed straddle. In particular, §1.1092(b)-3T(b)(6) currently requires that unrealized gain or loss on a position that becomes a position in a section 1092(b)(2) identified mixed straddle be recognized on the day prior to establishing the section 1092(b)(2) identified mixed straddle. After filing of these temporary regulations in the Federal Register, §1.1092(b)-3T(b)(6) will apply to only those section 1092(b)(2) identified mixed straddles established on or before August 1, 2013.

The approach taken in §1.1092(b)-3T(b)(6) is suggested by the legislative history of section 1092, but it has come to the attention of the Treasury Department and the IRS that this paragraph arguably permits taxpayers to selectively recognize gains and losses in inappropriate circumstances and without market constraints. Thus, for example, a taxpayer could seek to use the identified mixed straddle rules in §1.1092(b)-3T(b)(6) to accelerate a loss on a position that could not be marked to market or easily disposed of. When taxpayers use the section 1092(b)(2) identified mixed straddle rules to serve as an alternative to selling or otherwise disposing of a position, the general rules governing when gain and loss are recognized are undermined. The Treasury Department and the IRS believe that it is appropriate to act promptly to prevent these types of transactions because they represent a use of section 1092 that was not intended. Accordingly, these temporary regulations add a new §1.1092(b)-6T and limit the application of §1.1092(b)-3T as described in this preamble. Section 1.1092(b)-6T will apply to all section 1092(b)(2) identified mixed straddles established after August 1, 2013.

Section 1.1092(b)-6T provides that unrealized gain or loss on a position held prior to establishing a section 1092(b)(2) identified mixed straddle is taken into account at the time, and has the character, provided by provisions of the Code that would apply if the section 1092(b)(2) identified mixed straddle had not been established, rather than on the day prior to establishing the section 1092(b)(2) identified mixed straddle as is required by §1.1092(b)-3T(b)(6). Section 1.1092(b)-6T does not, however, override other provisions that require the recognition of gain or loss. Thus, for example, if a taxpayer enters into a transaction that creates a constructive sale under section 1259, the rules of section 1259 continue to apply. Under §1.1092(b)-6T, the provisions of §1.1092(b)-3T, with the exception of §1.1092(b)-3T(b)(6), will also continue to apply to changes in the value of a position held after a section 1092(b)(2) identified mixed straddle is established. As a result, pre-straddle gain or loss will be accounted for under other provisions of the Code, while gain or loss incurred while the straddle is in place will be accounted for using the straddle rules in section 1092. Under §1.1092(b)-6T, the holding period of a position held prior to establishing a section 1092(b)(2) identified mixed straddle will continue to be determined using the rules in §1.1092(b)-2T.

It is important to account for pre-straddle gain and loss separately from gain and loss on positions while a straddle is in place. Therefore, §1.1092(b)-6T will continue to require the segregation of pre-straddle and straddle period gain and loss, but it will do so without requiring current recognition of unrealized gain and loss.

Section 1.1092(b)-6T will apply to all section 1092(b)(2) identified mixed straddles established after August 1, 2013, regardless of when any position that is a component of the section 1092(b)(2) identified mixed straddle was purchased or otherwise acquired.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. For the applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special Analyses section of the preamble to the cross-reference notice of proposed rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

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

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

Section 1.1092(b)-6T also issued under 26 U.S.C. 1092(b)(1).

Section 1.1092(b)-6T also issued under 26 U.S.C. 1092(b)(2).* * *

Par. 2. Section 1.1092(b)-3T is amended by:

1. Revising the paragraph heading of paragraph (b)(6).

2. Adding a new first sentence to paragraph (b)(6).

The revision and addition read as follows:

Temporary regulations in this issue of the Bulletin amend the Income Tax Regulations (26 CFR part 1) relating to section 1092(b). First, the temporary regulations limit the application of §1.1092(b)-3T(b)(6) to section 1092(b)(2) identified mixed straddles established on or before August 1, 2013. Second, a new §1.1092(b)-6T provides that unrealized gain and loss on a position held prior to establishing a section 1092(b)(2) identified mixed straddle is taken into account at the time and has the character provided by provisions of the Internal Revenue Code (Code) that would apply if the section 1092(b)(2) identified mixed straddle had not been established. Section 1.1092(b)-6T applies to section 1092(b)(2) identified mixed straddles established after August 1, 2013. The text of the temporary regulations also serves as the text of these proposed regulations.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in the preamble under the “Addresses” heading. The Treasury Department and the IRS welcome comments on this proposed regulation. All comments will be available at www.regulations.gov or upon request.

A public hearing has been scheduled for December 4, 2013, beginning at 10 a.m. in the Auditorium of the Internal Revenue Service Building, 1111 Constitution Avenue, NW., Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written comments and an outline of the topics to be discussed and the time to be devoted to each topic by October 31, 2013. Submit a signed paper original and eight (8) copies or an electronic copy. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

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

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

Section 1.1092(b)-6 also issued under 26 U.S.C. 1092(b)(1).

Section 1.1092(b)-6 also issued under 26 U.S.C. 1092(b)(2).* * *

Par. 2. Section 1.1092(b)-3 is added to read as follows:

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) relating to the application of the “controlled group” rules found in section 851(c) of the Internal Revenue Code of 1986, as amended (Code).

Section 851(b)(3)(B) provides that, to qualify as a RIC, a taxpayer must meet an asset diversification test pursuant to which not more than 25 percent of the value of the taxpayer’s total assets may be invested in (i) the securities (other than Government securities or the securities of other regulated investment companies) of any one issuer, (ii) the securities (other than the securities of other regulated investment companies) of two or more issuers which the taxpayer controls and which are determined, under regulations prescribed by the Secretary, to be engaged in the same or similar trades or businesses or related trades or businesses, or (iii) the securities of one or more qualified publicly traded partnerships (as defined in section 851(h)).

The controlled group rules in section 851(c) provide that, when ascertaining the value of a taxpayer’s investment in the securities of a particular issuer for purposes of determining whether the asset diversification test has been met, the proportion of any investment in the securities of such issuer by a member of the taxpayer’s “controlled group” should be aggregated with the taxpayer’s investment in such issuer, as determined under regulations. Section 851(c)(3) defines a controlled group as one or more chains of corporations connected through stock ownership with the taxpayer if—(i) 20 percent or more of the total combined voting power of all classes of stock entitled to vote of each of the corporations (except the taxpayer) is owned directly by one or more of the other corporations; and (ii) the taxpayer owns directly at least 20 percent or more of the total combined voting power of all classes of stock entitled to vote of at least one of the other corporations. Clarification is needed regarding whether a RIC and its controlled subsidiary are a controlled group if the subsidiary does not control (within the meaning of section 851(c)(2)) at least one other corporation.

The definition of a controlled group for purposes of the RIC rules was first enacted in 1942 and appears to have been modeled on the definition of an “affiliated group” in the predecessor to current section 1504(a). The predecessor to current section 1504(a) used language nearly identical, save for different ownership thresholds, to the definition of controlled group for purposes of the RIC rules. See HR Rep. No. 2333, 77^th Cong., 2^nd Sess. 122 (1942), 1942-2 C.B. 372, 462-63; see also The Revenue Act of 1928, ch. 852, sec. 141(d), 45 Stat. 791, 831 (1928) (enacting the predecessor to section 1504(a)). The current regulations under section 851 include a series of examples, two of which reproduce, nearly verbatim, examples contained in the 1942 legislative history. See §1.851-5, Examples 3 and 4. Some practitioners have interpreted section 851(c)(3) to require the presence of two levels of controlled entities for a controlled group to exist, and have relied on certain of the examples in the regulations, and the 1942 legislative history, to support this interpretation. The IRS and the Treasury Department believe that this interpretation is unwarranted. Accordingly, through revisions to the existing examples, these proposed regulations clarify that two corporations constitute a controlled group if the ownership requirements of section 851(c)(3) are met.

The IRS and the Treasury Department believe that the interpretation of the controlled group rules reflected in these proposed regulations is consistent both with the statutory language of section 851(c)(3) and the interpretation of analogous Code provisions. For example, for purposes of the consolidated return rules, the IRS has consistently treated a parent and its directly owned subsidiary as “affiliated” within the meaning of section 1504(a)(1) regardless of whether the subsidiary controlled another subsidiary. Likewise, in limiting certain tax benefits for affiliated corporations, the IRS treats a parent and its subsidiary as a “controlled group” under section 1563, which uses language similar to section 1504(a), regardless of whether the subsidiary controls another entity. See section 1563(a)(1) and §1.1563-1(a)(2)(ii), Example 1. The interpretation reflected in these proposed regulations is also consistent with the purpose of section 851(c)(3), which is to aggregate the investments of related corporations for purposes of the asset diversification test.

The IRS and the Treasury Department believe that the language in the examples in the existing regulations and in the 1942 legislative history was intended merely to simplify the description of certain fact patterns, and not to articulate a legal interpretation that is inconsistent with the construction of substantially similar language elsewhere in the Code and that is unsupported by practical or policy considerations grounded in the statutory scheme.

The proposed regulations update examples in existing §1.851-5. The controlled group rules of section 851(c) prevent a RIC from exceeding the limitations set forth in section 851(b)(3) by indirectly investing in the securities of an issuer through a subsidiary. This update clarifies the controlled group rules and confirms that they are applied in a manner consistent with sections 1504 and 1563.

First, the proposed changes to the regulations clarify the two examples that have caused confusion. In Example 1, additional language would clarify which entities in the example are members of a controlled group. Currently, the example states that none of the subsidiaries of the RIC in the example is a member of a controlled group. The IRS and the Treasury Department believe that this statement was intended merely to indicate that none of the wholly owned subsidiaries in the example controlled another subsidiary. Consistent with the statutory language of section 851(c)(3), the proposed regulations would clarify that each of the RIC’s wholly owned subsidiaries is a member of a controlled group with the RIC.

Example 4, which is derived from the legislative history of section 851(c)(3), is revised to remove references to ownership by controlled group members of greater than 20 percent interests in an issuer. The existing language has sometimes been misinterpreted to mean that in order for a subsidiary’s holdings in an issuer to be aggregated with the holdings of the parent RIC, the subsidiary must have a controlling interest in the issuer. The proposed revision to Example 4 would ensure that Example 4 is applied in a manner consistent with the statutory language of section 851(c)(3).

Second, the proposed changes would add a new example to illustrate both the mechanics of the controlled group rules as applied to wholly owned subsidiaries and the application of section 851(b)(3)(B)(iii)’s rule with respect to securities of qualified publicly traded partnerships.

Third, the proposed changes would update the dates used in the examples (1955) to the current year (2013 or 2014, where appropriate) and would update references from section 851(b)(4) to refer instead to section 851(b)(3). Section 1271(b)(1) of The Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788, 1063 (1997)), redesignated section 851(b)(4) as section 851(b)(3).

Finally, for additional clarity, these proposed regulations would add citations to section 851(d)(1) in Examples 5 and 6.

The proposed changes apply to quarters that begin at least 90 days after the date of publication in the Federal Register of a Treasury decision adopting these rules as final regulations.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation, and because the regulation does not impose a collection of information on small entitles, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before this proposed regulation is adopted as a final regulation, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted to the IRS. The IRS and the Treasury Department request comments on all aspects of the proposed examples. All comments will be available for public inspection and copying.

A public hearing has been scheduled for December 9, 2013, beginning at 10:00 a.m. in the IRS Auditorium, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC 20224. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 15 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit written or electronic comments by October 31, 2013 and an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by October 31, 2013. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

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

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

Section 1.851-5 also issued under 26 U.S.C. 851(c)

Par. 2. Section 1.851-5 is revised to read as follows:

The final regulations and removal of temporary regulations (TD 9622) that are the subject of this correction are under section 108(i) of the Internal Revenue Code.

As published, the final regulations and removal of temporary regulations (TD 9622) contains errors that may prove to be misleading and are in need of clarification.

* * * * *

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

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

Par. 2. Section 1.108(i)-0 is amended by revising paragraph (b) to read as follows:

* * * * *

(b) Effective/Applicability dates—(1) In general. The rules of this section, § 1.108(i)-1, and § 1.108(i)-2, apply on or after July 2, 2013, to reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. In addition, the rules of § 1.108(i)-3 apply on or after July 2, 2013, to debt instruments issued after December 31, 2008, in connection with reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008.

(2) Prior periods. For rules applying before July 2, 2013, see § 1.108(i)-0T, § 1.108(i)-1T, § 1.108(i)-2T, and § 1.108(i)-3T, as contained in 26 CFR part 1, revised April 1, 2013.

Par. 3. Section 1.108(i)-1 is amended by revising the third and fourth sentences of paragraph (b)(2)(iii)(D), and the fifth and seventh sentences of paragraph (c) Example 3 (ii) to read as follows:

* * * * *

(b) * * *

(2) * * *

(iii) * * *

(D) * * * Appropriate adjustments must be made to take into account any issuances or redemptions of stock, or similar transactions, occurring during the taxable year of distribution or any of the preceding three taxable years. If the electing corporation has a short taxable year for the year of the distribution or for any of the preceding three taxable years, the amounts are determined on an annualized basis. * **

* * * * *

(c) * * *

Example 3. * * *

(ii) * * * However, under paragraph (b)(2)(iii)(A) of this section, S’s distribution to P is an impairment transaction and the net value acceleration rule is applied with respect to the assets, liabilities, and deferred items of P (S’s successor). Immediately following the distribution, P’s gross asset value of $100 is less than the net value floor of $220 [110% x ($60 + $140)]. Accordingly, under the net value acceleration rule of paragraph (b)(2)(iii)(A) of this section, S is required to take into account its $400 of deferred COD income immediately before the distribution, unless value is restored to P pursuant to paragraph (b)(2)(iii)(C) of this section.

* * * * *