To "net value" or not to "net value"? That is the question: A discussion of the proposed net value regulations - their purpose, utility, and future

In decisions dating back to the 1940s, courts have held that certain transactions in which property exchanged does not have net positive value do not rise to the level of tax-free exchanges. On the other hand, in decisions going back almost as far, courts have blessed the character of other transactions as tax-free, despite the absence of net value in these exchanges. Over the last few decades, these apparently inconsistent rulings have led to controversial questions: 1) When one or more parties to a reorganization is insolvent, does the reorganization fail to qualify as a tax-free transaction, despite meeting all mechanical requirements for such treatment under §368? 2) Does contribution of under-water property to a corporation by a shareholder qualify as a tax-free transaction under §351? 3) Does contribution of property to an insolvent corporation by a shareholder qualify as a tax-free transaction under §351? 4) Does the liquidation of an insolvent subsidiary qualify as a tax-free transaction under §332? The question as to whether a transaction in any of the above situations is nontaxable arises from the fact that the underlying property in the exchange is burdened by liabilities that exceed its fair market value. Nonrecognition transactions are premised on "exchanges" that leave the taxpayer in substantially the same position as before the exchange. Courts have addressed whether a transaction in which something of net positive value is not given or received qualifies as an "exchange." In 2005, through proposed regulations, the Department of the Treasury and the Internal Revenue Service (IRS) took the position that transactions that do not involve exchanges of property with net positive value are not "exchanges" and thus do not qualify under nonrecognition provisions. Twelve years later, the proposed regulations were suddenly withdrawn. This article explores court decisions on the application of corporate nonrecognition transactions involving insolvent entities and IRS rulings based on those decisions. More significantly, the article explores the proposed regulations on net value, their potential impact on various types of transactions, and the potential consequences of their withdrawal.