[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1042-1T]

[Page 168-171]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1042-1T  Questions and answers relating to the sales of stock 
to employee stock ownership plans or certain cooperatives (temporary).

    Q-1: What does section 1042 provide?
    A-1: (a) Section 1042 provides rules under which a taxpayer may 
elect not to recognize gain in certain cases where qualified securities 
are sold to a qualifying employee stock ownership plan or worker-owned 
cooperative in taxable years of the seller beginning after July 18, 
1984, and qualified replacement property is purchased by the taxpayer 
within the replacement period. If the requirements of Q&A-2 of this 
section are met, and if the taxpayer makes an election under section 
1042(a) in accordance with Q&A-3 of this section, the gain realized by 
the taxpayer on the sale of the qualified securities is recognized only 
to the extent that the amount realized on such sale exceeds the cost to 
the taxpayer of the qualified replacement property.
    (b) Under section 1042, the term qualified securities means employer 
securities (as defined in section 409(l)) with respect to which each of 
the following requirements is satisfied: (1) The employer securities 
were issued by a domestic corporation; (2) for at least one year before 
and immediately after the sale, the domestic corporation that issued the 
employer securities (and each corporation that is a member of a 
controlled group of corporations with such corporation for purposes of 
section 409(l)) has no stock outstanding that is readily tradeable on an 
established market; (3) as of the time of the sale, the employer 
securities have been held by the taxpayer for more than 1 year; and (4) 
the employer securities were not received by the taxpayer in a 
distribution from a plan described in section 401(a) or in a transfer 
pursuant to an option or other right to acquire stock to which section 
83, 422, 422A, 423, or 424 applies.
    (c) The term replacement period means the period which begins 3 
months before the date on which the sale of qualified securities occurs 
and which ends 12 months after the date of such sale. A replacement 
period may include any period which occurs prior to July 19, 1984.
    (d) The term qualified replacement property means any securities (as 
defined in section 165(g)(2)) issued by a domestic corporation which 
does not, for the taxable year of such corporation in which the 
securities are purchased by the taxpayer, have passive investment income 
(as defined in section 1362(d)(3)(D)) that exceeds 25 percent of the 
gross receipts of such corporation for the taxable year preceding the 
taxable year of purchase. In addition, securities of the domestic 
corporation that issued the employer securities qualifying under section 
1042 (and of any corporation that is a member of a controlled group of 
corporations with such corporation for purposes of section 409(l)) will 
not qualify as qualified replacement property.
    (e) For purposes of section 1042(a), there is a purchase of 
qualified replacement property only if the basis of such property is 
determined by reference to its cost to the taxpayer. If the basis of the 
qualified replacement property is determined by reference to its basis 
in the hands of the transferor thereof or another person, or by 
reference to the basis of property (other than cash or its equivalent) 
exchanged for such property, then the basis of such property is not 
determined solely by reference to its cost to the taxpayer.
    Q-2: What is a sale of qualified securities for purposes of section 
1042(b)?
    A-2: (a) Under section 1042(b), a sale of qualified securities is 
one under which all of the following requirements are met:
    (1) The qualified securities are sold to an employee stock ownership 
plan (as defined in section 4975(e)(7)) maintained by the corporation 
that issued the qualified securities (or by a member of the controlled 
group of corporations with such corporation for purposes of section 
409(l)) or to an eligible worker-owned cooperative (as defined in 
section 1042(c)(2));
    (2) The employee stock ownership plan or eligible worker-owned 
cooperative owns, immediately after the sale, 30 percent or more of the 
total value of the employer securities (within the meaning of section 
409(l) outstanding as of such time;
    (3) No portion of the assets of the employee stock ownership plan or 
eligible

[[Page 169]]

worker-owned cooperative attributable to qualified securities that are 
sold to the plan or cooperative by the taxpayer or by any other person 
in a sale with respect to which an election under section 1042(a) is 
made accrue under the plan or are allocated by the cooperative, either 
directly or indirectly and either concurrently with or at any time 
thereafter, for the benefit of (i) the taxpayer; (ii) any person who is 
a member of the family of the taxpayer (within the meaning of section 
267(c)(4)); or (iii) any person who owns (after the application of 
section 318(a)), at any time after July 18, 1984, and until immediately 
after the sale, more than 25 percent of in value of the outstanding 
portion of any class of stock of the corporation that issued the 
qualified securities (or of any member of the controlled group of 
corporations with such corporation for purposes of section 409(l)). For 
purposes of this calculation, stock that is owned, directly or 
indirectly, by or for a qualified plan shall not be treated as 
outstanding.
    (4) The taxpayer files with the Secretary (as part of the required 
election described in Q&A-3 of this section) a verified written 
statement of the domestic corporation (or corporations) whose employees 
are covered by the plan acquiring the qualified securities or of any 
authorized officer of the eligible workerowned cooperative, consenting 
to the application of section 4978(a) with respect to such corporation 
or cooperative.
    (b) For purposes of determining whether paragraph (a)(2) of this 
section is satisfied, sales of qualified securities by two or more 
taxpayers may be treated as a single sale if such sales are made as part 
of a single, integrated transaction under a prearranged agreement 
between the taxpayers.
    (c) For purposes of determining whether paragraph (a)(3) of this 
section is satisfied with respect to the prohibition against an accrual 
or allocation of qualified securities, the accrual or allocation of any 
benefits or contributions or other assets that are not attributable to 
qualified securities sold to the employee stock ownership plan or 
eligible worker-owned cooperative in a sale with respect to which an 
election under section 1042(a) is made (including any accrual or 
allocation under any other plan or arrangement maintained by the 
corporation or any member of the controlled group of corporations with 
such corporation for purposes of section 409(l)) must be made without 
regard to the allocation of such qualified securities. Paragraph (a)(3) 
of this section above may be illustrated in part by the following 
example: Individuals A, B, and C own 50, 25, and 25, respectively, of 
the 100 outstanding shares of common stock of Corporation X. Such shares 
constitute qualified securities as defined in Q&A-1 of this section. A 
and B, but not C, are employees of Corporation X. For the benefit of all 
its employees, Corporation X establishes an employee stock ownership 
plan that obtains a loan meeting the exemption requirements of section 
4975(d)(3). The loan proceeds are used by the plan to purchase the 100 
shares of qualified securities from A, B, and C, all of whom elect 
nonrecognition treatment under section 1042(a) with respect to the gain 
realized on their sale of such securities. Under the requirements of 
paragraph (a)(3) of this section, no part of the assets of the plan 
attributable to the 100 shares of qualified securities may accrue under 
the plan (or under any other plan or arrangement maintained by 
Corporation X) for the benefit of A or B or any person who is a member 
of the family of A or B (as determined under section 267(c)(4)). 
Furthermore, no other assets of the plan or assets of the employer may 
accrue for the benefit of such individuals in lieu of the receipt of 
assets attributable to such qualified securities.
    (d) A sale under section 1042(a) shall not include any sale of 
securities by a dealer or underwriter in the ordinary course of its 
trade or business as a dealer or underwriter, whether or not guaranteed.
    Q-3: What is the time and manner for making the election under 
section 1042(a)?
    A-3: (a) The election not to recognize the gain realized upon the 
sale of qualified securities to the extent provided under section 
1042(a) shall be made in a statement of election attached to the 
taxpayer's income tax return filed on or before the due date (including 
extensions of time) for the taxable year in

[[Page 170]]

which the sale occurs. If a taxpayer does not make a timely election 
under this section to obtain section 1042(a) nonrecognition treatment 
with respect to the sale of qualified securities, it may not 
subsequently make an election on an amended return or otherwise. Also, 
an election once made is irrevocable.
    (b) The statement of election shall provide that the taxpayer elects 
to treat the sale of securities as a sale of qualified securities under 
section 1042(a), and shall contain the following information:
    (1) A description of the qualified securities sold, including the 
type and number of shares;
    (2) The date of the sale of the qualified securities;
    (3) The adjusted basis of the qualified securities;
    (4) The amount realized upon the sale of the qualified securities;
    (5) The identity of the employee stock ownership plan or eligible 
worker-owned cooperative to which the qualified securities were sold; 
and
    (6) If the sale was part of a single, interrelated transaction under 
a prearranged agreement between taxpayers involving other sales of 
qualified securities, the names and taxpayer identification numbers of 
the other taxpayers under the agreement and the number of shares sold by 
the other taxpayers. See Q&A-2 of this section.

If the taxpayer has purchased qualified replacement property at the time 
of the election, the taxpayer must attach as part of the statement of 
election a statement of purchase describing the qualified replacement 
property, the date of the purchase, and the cost of the property, and 
declaring such property to be the qualified replacement property with 
respect to the sale of qualified securities. Such statement of purchase 
must be notarized by the later of thirty days after the purchase or 
March 6, 1986. In addition, the statement of election must be 
accompanied by the verified written statement of consent required under 
Q&A-2 of this section with respect to the qualified securities sold.
    (c) If the taxpayer has not purchased qualified replacement property 
at the time of the filing of the statement of election, a timely 
election under this Q&A shall not be considered to have been made unless 
the taxpayer attaches the notarized statement of purchase described 
above to the taxpayer's income tax return filed for the taxable year 
following the year for which the election under section 1042(a) was 
made. Such notarized statement of purchase shall be filed with the 
district director or the director of the regional service center with 
whom such election was originally filed, if the return is not filed with 
such director.
    Q-4: What is the basis of qualified replacement property?
    A-4: If a taxpayer makes an election under section 1042(a), the 
basis of the qualified replacement property purchased by the taxpayer 
during the replacement period shall be reduced by an amount equal to the 
amount of gain which was not recognized. If more than one item of 
qualified replacement property is purchased, the basis of each of such 
items shall be reduced by an amount determined by multiplying the total 
gain not recognized by reason of the application of section 1042(a) by a 
fraction, the numerator of which is the cost of such item of property 
and the denominator of which is the total cost of all such items of 
property. For the rule regarding the holding period of qualified 
replacement property, see section 1223(13).
    Q-5: What is the statute of limitations for the assessment of a 
deficiency relating to the gain on the sale of qualified securities?
    A-5: (a) If any gain is realized by the taxpayer on the sale of any 
qualified securities and such gain has not been recognized under section 
1042(a) in accordance with the requirements of this section, the 
statutory period provided in section 6501(a) for the assessment of any 
deficiency with respect to such gain shall not expire prior to the 
expiration of 3 years from the date of receipt, by the district director 
or director of regional service center with whom the statement of 
election under 1042(a) was originally filed, of:
    (1) A notarized statement of purchase as described in Q&A-3;
    (2) A written statement of the taxpayer's intention not to purchase

[[Page 171]]

qualified replacement property within the replacement period; or
    (3) A written statement of the taxpayer's failure to purchase 
qualified replacement property within the replacement period.

In those situations when a taxpayer is providing a written statement of 
an intention not to purchase or of a failure to purchase qualified 
replacement property, the statement shall be accompanied, where 
appropriate, by an amended return for the taxable year in which the gain 
from the sale of the qualified securities was realized, in order to 
reflect the inclusion in gross income for that year of gain required to 
be recognized in connection with such sale.
    (b) Any gain from the sale of qualified securities which is required 
to be recognized due to a failure to meet the requirements under section 
1042 shall be included in the gross income for the taxable year in which 
the gain was realized. If any gain from the sale of qualified securities 
is not recognized under section 1042(a) in accordance with the 
requirements of this section, any deficiency attributable to any portion 
of such gain may be assessed at any time before the expiration of the 3-
year period described in this Q&A, notwithstanding the provision of any 
law or rule of law which would otherwise prevent such assessment.
    Q-6: When does section 1042 become effective?
    A-6: Section 1042 applies to sales of qualified securities in 
taxable years of sellers beginning after July 18, 1984.

[T.D. 8073, 51 FR 4333, Feb. 4, 1986]