A has owned 90 of the 100 shares of CFCT stock since CFCT was organized on March 13, 1989. P has owned the remaining 10 shares since organization, and those 10 shares constitute nonrecently purchased stock in P’s hands within the meaning of section 338(b)(6)(B). On November 1, 1994, P purchases A’s 90 shares of CFCT stock for $90,000 and makes a section 338 election for CFCT. P does not make a gain recognition election under section 338(b)(3)(A) and § 1.338-5(d).
CFCT’s earnings and profits for its short taxable year ending November 1, 1994, are $50,000, determined without taking into account the deemed asset sale. A recognizes gain of $81,000 on the sale of the CFCT stock, and CFCT recognizes gain of $40,000 by reason of its deemed sale of assets under section 338(a)(1).
A’s sale of CFCT stock to P is a transfer to which section 1248 applies. For purposes of section 1248(a), CFCT’s earnings and profits for the short year are $90,000 (the $50,000 determined under § 1.1248-2(e) plus the $40,000 from the deemed sale). A’s entire gain is therefore characterized as a dividend under section 1248 (but see section 338(h)(16)).
The 10 shares of nonrecently purchased CFCT stock held by P are carryover FT stock under paragraph (b)(3). The earnings and profits (and attributable foreign taxes) of old CFCT carry over to new CFCT solely for that block of 10 shares. The carryover amount equals the section 1248 dividend P would have recognized on that block had it made a gain recognition election — $9,000 ($90,000 × 10/100).
Even without a gain recognition election, A’s entire gain on the sale of its 90 shares is recharacterized as a dividend under section 1248.
P’s 10 nonrecently purchased shares are carryover FT stock under paragraph (b)(3), so old CFCT’s earnings and profits and foreign taxes carry over to new CFCT solely for that block.
P recognizes no current section 1248 dividend on its block, but the carried-over earnings surface later — for example, on a distribution by new CFCT with respect to those shares.
The carryover for the 10-share block equals the section 1248 dividend P would have recognized had it made a gain recognition election, $90,000 × 10/100 = $9,000.
