Sections 332 does not apply if the subsidiary is insolvent since the parent corporation does not receive any distribution in exchange for its subsidiary’s stock. A subsidiary is considered by the IRS to be insolvent if its liabilities exceed the fair market value of its assets. In this case, the parent corporation’s loss on its subsidiary’s securities is treated as a loss from worthless securities under Code Sec. 165(g).
Ordinary Loss Treatment
Although the resulting loss is generally a capital loss, the parent will actually receive ordinary loss treated if:
1. The parent corporation owns at least 80 percent of the voting power and at least 80 percent of each class of nonvoting stock; and
2. More than 90 percent of the subsidiary’s gross receipts for all taxable years were derived from sources other than royalties, rents, dividends, interest, annuities, and gains from sales or exchanges of stocks and securities.
Any subsidiary debt obligation that does not qualify as a security under Code Sec. 165(g)(2) will be deductible by the parent corporation as a business bad debt.