IRS concludes no disaster loss for CFC stock


The IRS has concluded in an internal legal memorandum (ILM 202325007) that a taxpayer’s loss arising from stock in controlled foreign corporations (CFCs) did not occur in a federally declared disaster area and did not qualify as a disaster loss under Section 165(i). The case has important implications for the scope of losses that can be considered disaster related under the sweeping disaster declaration arising from COVID-19.


The taxpayer addressed by the ILM was the common parent of a consolidated group with a subsidiary that owned three CFCs. Each CFC underwent a change in entity classification that resulted in a deemed liquidation under Treas. Reg. Sec 301.7701-3(g)(1)(iii). The taxpayer determined that each CFC was insolvent at the time of each deemed liquidation, and the subsidiary therefore claimed a worthless securities deduction for the stock under Sections 165(a) and (g).


Section 165(i) provides that any loss occurring in a disaster area and attributable to a federal declared disaster may, at the election of the taxpayer, be taken into account for the taxable year immediately preceding the taxable year in which the disaster occurred. At the time of the transactions, the president had designated all 50 states and all U.S. territories as federal declared disaster areas pursuant to the Robert T. Stafford Relief and Emergency Assistance Act.


Based on the sweeping disaster designation and a largely redacted argument, the subsidiary claimed the CFC losses under Section 165(i), which allowed the taxpayer to carry back the losses for beneficial tax results.


The IRS concluded that the CFC losses did not qualify under Section 165(i) because they did not actually occur in a federal declared disaster area. In making this determination, the IRS took an approach that looked at business metrics to reflect the location of each loss. The IRS stated that such business metrics could include: income producing assets, customers, employees, or revenue streams. Using a “substantially all” standard, the IRS concluded that none of the CFCs derived substantially all of their revenues from U.S. customers, and that other metrics were located outside the U.S. 


The IRS dismissed alternative approaches that would locate the losses based on location of residence of the shareholder or location of the place of sale or disposition. The IRS also stated that an approach based on the location of where a foreign corporation is headquartered would not necessarily be appropriate.


Grant Thornton Insight

The IRS did not address whether the CFC losses were “attributable to” the COVID-19 disaster for purposes of Section 165(i), which has become an important issue for many taxpayers due to the unprecedented scope of the disaster area and the widespread economic disruption caused by COVID-19. While the taxpayer’s specific argument is redacted, the facts provided that the taxpayer had decreased cash flow that impacted the taxpayer’s financial support of the CFCs.



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