United States

Failed bank acquisition tax accounting addressed in subsequent period

Taxpayer argument for carryover basis in acquisition denied by IRS

TAX ALERT  | 

There is a special set of tax rules that should be analyzed whenever a financial institution is acquired with assistance from the Federal Deposit Insurance Corporation (FDIC). These are the rules of section 597 of the Tax Code, which affect asset basis, attribute carryovers, and income recognition of the parties to this type of acquisition. Section 597 provides a completely different method of allocating the deemed purchase price on an FDIC-assisted transaction, including the treatment of the transaction as an asset acquisition regardless of the legal form of the transaction. The IRS has released a Chief Counsel Advice email, CCA 201733014, illustrating that if the section 597 rules aren’t applied correctly the IRS may make subsequent tax adjustments to properly reflect the application of the section 597 regulations. The IRS may make such adjustments even if the time period for assessing tax with respect to the acquisition year has closed. 

Section 597 rules

In general, the section 597 rules aim to offset a failed financial institution’s net operating losses and built-in losses with income from Federal financial assistance (FFA) provided to it. Detailed regulations generally: (1) treat FFA as taxable ordinary income; (2) prevent institutions from receiving tax benefits for losses that form the basis for FFA compensation; (3) seek to match the timing of FFA and loss recognition; (4) decouple certain aspects of an affected financial institution’s acquisition from the form of the acquisition (e.g., stock or asset acquisition); and (5) treat loans as Class II assets for purposes of allocating the deemed purchase price of the assets.

The section 597 regulations are complex and in some respects, unclear. The section 597 regulations were derived from Notice 89-102, which was issued during the savings and loan crisis of the early 1990’s. In 2015, new section 597 regulations were proposed to clarify the earlier rules. The proposed regulations (REG-140991-09), however, generally are not effective until they are finalized.

Case addressed in CCA 201733014

The taxpayer addressed in CCA 201733014 had not applied the section 597 rules correctly in prior years and sought to make corrections. The CCA also states that the taxpayer had proposed a carryover basis – a tax basis that immediately after the acquisition in question would be the same as the pre-acquisition tax basis. This type of proposal, however, would appear contrary to the section 597 rules. The section 597 rules do not permit for a carryover of tax basis in the assets acquired, nor do they permit any of the tax attributes of the target corporation to survive.    

The CCA does not state the IRS’ proposal for resolving the taxpayer’s case. Instead, Chief Counsel’s recommendations for resolution are completely redacted. The CCA does not provide the necessary details to be useful in the application of any of section 597’s unclear provisions.

Although the recommended method of resolution was not published, the CCA quoted the section 597 regulations’ anti-abuse provision. That provision states that the IRS can make corrective adjustments in situations evidencing a principal purpose of avoiding the purposes of section 597. The IRS’ view in the CCA thus appears to be that adjustments could still be made even though the acquisition year was closed to tax assessment.  

Conclusion

Even though it is brief and provided limited discussion of the facts, CCA 201733014 illustrates that the section 597 rules need to be applied whenever a financial institution is acquired with assistance from the FDIC and that improper application of the section 597 rules may be addressed by the IRS at a later date, perhaps even after the general statute of limitations for tax assessments has run. 

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