X and Y, both U.S. corporations, have each owned 50% of the CFCT stock since 1986. Among CFCT’s assets are assets the sale of which would generate subpart F income. On December 31, 1994, X sells its CFCT stock to P. On June 30, 1995, Y sells its CFCT stock to P, and P makes a section 338 election for CFCT. In both 1994 and 1995, CFCT has subpart F income resulting from operations.
For taxable year 1994, X and Y are United States shareholders on the last day of CFCT’s taxable year, so each must include in income its pro rata share of CFCT’s subpart F income for 1994 under section 951(a)(1)(A). Because P’s holding period in the CFCT stock acquired from X does not begin until January 1, 1995, P is not a United States shareholder on the last day of 1994 (see § 1.951-1(f)). X must then determine the extent to which section 1248 recharacterizes its gain on the sale as a dividend.
For the short taxable year ending June 30, 1995, Y is considered to own the CFCT stock sold to P at the close of CFCT’s acquisition date. Because the acquisition date is the last day of CFCT’s taxable year, both Y and P are United States shareholders on the last day of that year and each must include its pro rata share of CFCT’s subpart F income for the short year — including any income generated on the deemed sale of CFCT’s assets.
Y must then determine the extent to which section 1248 recharacterizes its gain on the sale of the CFCT stock as a dividend, taking into account any increase in CFCT’s earnings and profits due to the deemed sale of assets under the section 338 election.
P acquires 50% from X and then 50% from Y; the second purchase completes a qualified stock purchase, and P makes a section 338 election for CFCT.
Because P’s holding period in X’s shares does not begin until January 1, 1995, P is not a United States shareholder on the last day of 1994 — only X and Y are.
X (for 1994) and Y (for the short year ending June 30, 1995) each determine the extent to which section 1248 recharacterizes its gain on the sale as a dividend.
For the short year, the section 338 deemed asset sale increases CFCT’s subpart F income and earnings and profits, which Y takes into account in its section 1248 computation.
