The Treasury Department and the IRS recently issued proposed regulations ( REG-100400-14) under Treas. Reg. Sec. 1.1502-76(b) that would modify the application of the existing "end of day rule" and the "next day rule."
The current regulations under Treas. Reg. Sec. 1.1502-76(b) address the treatment of a corporation's tax items that accrue on the day the corporation ceases to be a member of an affiliated group that has elected to file a consolidated tax return (a consolidated group) or becomes a member of a different consolidated group. The end-of-day rule under the current regulations provides that a Subchapter C corporation is treated as becoming or ceasing to be a member of a consolidated group at the end of the day of the corporation's change in status. Accordingly, the corporation's tax items reportable on that day are generally included in the tax return for the taxable year that ends as a result of the corporation's change in status.
The next-day rule, however, is an exception to the end-of-day rule under the current regulations. Under the current next-day rule, if a transaction that occurs on the day of a corporation's change in status can be properly allocated to the portion of the corporation's day after the event that resulted in the corporation's change in status, the corporation must treat the transaction as occurring at the beginning of the following day. The current regulations set forth certain factors for determining whether an item can be properly allocated to the portion of the corporation's day after the event that resulted in the corporation's change in status. The proper allocation of items under the current version of the next-day rule using these factors has led to controversy between the IRS and taxpayers.
The proposed regulations modify and narrow the next-day rule. Under the proposed regulations, the modified version of the next-day rule applies only to "extraordinary items" as defined in the current and proposed regulations, which result from transactions that occur on the day of the corporation's change in status but after the event causing such change in status. The proposed next-day rule doesn't apply to any extraordinary item that arises "simultaneously" with the event that causes the corporation's change in status. Extraordinary items under the proposed regulations are intended to include compensation-related deductions incurred in connection with the corporation's change in status. This includes such items as fees for services rendered in connection with the corporation's change in status (for example, investment banking success-based fees) and severance, bonus and option cancellation payments.
In addition to modifying the next-day rule, the proposed regulations address various related matters, including applying the anti-abuse rule, special rules for Subchapter S corporations and related issues under Sections 382 and 1374.
The proposed regulations, if finalized in their current form, are expected to substantially narrow the application of the next-day rule. Taxpayers should consider the proposed regulations and other IRS guidance, like generic legal advice memorandum 2012-10, when they contemplate transactions within the scope of the current and proposed regulations.
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