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TAX CLINIC

Under Sec. 165(g)(1), a loss related to a security that is a capital asset
and becomes worthless during a tax year is treated as from a sale or
exchange of a capital asset on the last day of that tax year.

domestic corporations. Specifically, a subsidiary was an investment or holding
Gains & Losses security in a corporation affiliated with company (see Rev. Rul. 88-65, citing S.
a taxpayer that is a domestic corpora- Rep’t No. 91-1530, 91st Cong., 2d Sess.
Determining gross receipts tion is not treated as a capital asset for 2 (1970), and S. Rep’t No. 77-1631,
under Sec. 165(g)(3) purposes of Sec. 165(g)(1). Therefore, 77th Cong., 2d Sess. 46 (1942)).
The IRS ruled in Letter Ruling a loss on a worthless security under The IRS has ruled that, for purposes
202140002 (released Oct. 8, 2021) that those circumstances is an ordinary loss. of computing the gross-receipts test, a
a corporation included the historic gross The definition of “security” for this corporation takes into account the his-
receipts of its liquidated subsidiary for purpose includes a share of stock in toric gross receipts of a transferor cor-
purposes of the gross-receipts test under a corporation. poration in a transaction to which Sec.
Sec. 165(g)(3). The letter ruling has a The test to determine whether a cor- 381(a) applied (e.g., a liquidating distri-
fact pattern similar to that of Rev. Rul. poration is affiliated with the taxpayer bution under Sec. 332); however, gross
2003-125, involving a corporation that requires that (1) the taxpayer directly receipts from intercompany transactions
becomes insolvent and elects a change owns stock in the corporation meeting under Regs. Sec. 1.1502-13 are elimi-
in entity classification under Regs. Sec. the requirements of Sec. 1504(a)(2) nated to prevent duplication (see IRS
301.7701-3 (an elective change). (possessing at least 80% of the stock’s Letter Rulings 201011003, 201524016,
While the letter ruling applies only total voting power and value); and (2) 201548003, and 201704003).
to the requesting taxpayer, it is con- the corporation meets a “gross receipts
sistent with prior rulings in which the test” that more than 90% of the corpo- An elective change with a
IRS ruled that a corporation takes into ration’s aggregate gross receipts for all single owner
account the gross receipts of a transferor tax years were from sources other than An eligible entity with a single owner
corporation after a transaction under certain specified passive sources. The that is classified as a corporation can
Sec. 381(a). Therefore, in the absence gross-receipts test is applied to the gross request an elective change to be disre-
of definitive guidance, the letter ruling receipts for all tax years combined (see garded as an entity separate from its
may further confirm the IRS’s view. The Rev. Rul. 75-186). direct owner (a disregarded entity), with
letter ruling is also noteworthy for con- Specifically, the gross-receipts test some limitations. Pursuant to Regs. Sec.
taining some planning considerations requires more than 90% of the corpora- 301.7701-3(g)(1)(iii), if such an eligible
for taxpayers in similar circumstances. tion’s aggregate gross receipts for all tax entity makes an elective change to a
This item first summarizes some of years to be from sources other than (1) disregarded entity, the corporation is
the relevant authorities and then covers royalties; (2) rents (except rents derived deemed to distribute all of its assets and
the facts and conclusion in Letter Rul- from rental of properties to employees liabilities to its owner in liquidation of
ing 202140002. of the corporation in the ordinary the corporation (a deemed liquidation).
course of its operating business); (3) The effective date of an elective change
Sec. 165(g) and worthless dividends; (4) interest (except interest generally cannot be more than 75 days
security losses received on the deferred purchase price prior to the date on which the election
Under Sec. 165(g)(1), a loss related of operating assets sold); (5) annuities; is filed. However, taxpayers may request
to a security that is a capital asset and and (6) gains from sales or exchanges of an elective change that is effective
becomes worthless during a tax year is stocks and securities. within three years and 75 days, under
treated as from a sale or exchange of a The legislative history of circumstances described in Rev. Proc.
capital asset on the last day of that tax Sec. 165(g)(3) indicates that Congress 2009-41.
year. Thus, a loss on such a worthless intended that an ordinary loss deduc- The Tax Court has held that an
security is a capital loss. tion for a worthless security was allow- elective change should be treated as if
However, Sec. 165(g)(3) provides able only when the subsidiary was an the deemed transactions actually oc-
an exception for taxpayers that are operating company and not when the curred (see Dover Corp., 122 T.C. 324

12 February 2023 The Tax Adviser