The IRS yesterday released a Coordinated Issue Paper (CIP) to instruct agents how to identify and audit prohibited contingent liability transactions. Here are the three conclusions:

1. The basis of the stock received in the transaction is either limited to its fair market value, or reduced by the amount of the liabilities assumed in the transaction with the result that the taxpayer recognizes no loss on the sale of the stock.
2. The transferee liability management company may not deduct amounts paid for liabilities in subsequent years if the transferor retains the benefit of the deduction.
3. The accuracy related penalty should be asserted in all applicable cases.

Below the fold are the ten issues to be considered by agents:

1. Whether the taxpayer satisfies the technical requirements of I.R.C. § 351.
2. Whether the transaction took place on or after October 19, 1999, such that I.R.C. § 358(h) applies.
3. Whether the contingent liability is a liability that gives rise to a deduction within the meaning of I.R.C. § 357(c)(3) and whether the taxpayer’s basis in its stock is determined by reference to I.R.C. § 358(d)(1) or I.R.C. § 358(d)(2).
4. Whether the liability assumption should be treated as money received under I.R.C. § 357(b).
5. Whether the liability assumption should be treated as a promise to pay, rather than as a legal obligation, such that the promise constitutes “other property” within the meaning of I.R.C. § 358(a).
6. Whether preferred stock issued in connection with the 351 transaction is nonqualified preferred stock within the meaning of I.R.C. § 351(g), or whether the sale of stock should be recharacterized.
7. Whether the stock loss should be disallowed or recharacterized under applicable judicial principles, including step transaction, economic sham, or sham in fact.
8. Whether the liability assumption has been properly valued.
9. Whether the transferor or the transferee is entitled to subsequent tax benefits associated with the subsequent deduction of the contingent liabilities.
10. Whether the Service should assert the negligence or disregard of rules or regulations and/or the substantial understatement of income tax portions of I.R.C. § 6662 against a taxpayer for engaging in a contingent liability transaction.