382 Limits on NOL Usage an Ownership...

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Presenting a live 110‐minute teleconference with interactive Q&A

Section 382 Limits on NOL Usage Following an Ownership Change Following an Ownership Change Navigating Restrictions on Loss Carryforwards to Maximize Tax Benefits

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, SEPTEMBER 21, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Jeffrey Kelson Partner-In-Charge Domestic Tax EisnerAmper Edison N JJeffrey Kelson, Partner In Charge, Domestic Tax, EisnerAmper, Edison, N.J.

Todd Reinstein, Tax Partner, Pepper Hamilton, Washington, D.C.

Robert Liquerman, Principal, KPMG LLP, Washington, D.C.

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Section 382 Limits on NOL Usage F ll i O hi Ch Following an Ownership Change Seminar

Sept. 21, 2011

Robert Liquerman, KPMGrliquerman@kpmg.com

Todd Reinstein, Pepper Hamiltonreinsteint@pepperlaw.com

Jeffrey Kelson, EisnerAmper jeffrey.kelson@eisneramper.com

Today’s ProgramWhat Causes An Ownership Change[T dd R i t i ]

Slide 14[Todd Reinstein]

Calculating The Limitation[Robert Liquerman]

Slide 23

Notice 2003-65 And Built-in Gains[Jeffrey Kelson]

Notice 2010-50 And Fluctuations In Value Slide 34 – Slide 39

Slide 33

[Todd Reinstein]

Notice 2010-49 And Treatment Of Non-5% Shareholders

[Robert Liquerman]

Slide 45

Investment Advisors[Jeffrey Kelson]

Slide 48

WHAT CAUSES AN Todd Reinstein, Pepper Hamilton

WHAT CAUSES AN OWNERSHIP CHANGE

Wh S 8 MWhy Sec. 382 Matters

• Purchase price modeling should account for limits on NOLs.

• Equity transactions should be monitored to make sure ownership changes do not inadvertently trip Sec. 382.

• Cumulative annual limitations may be less than the NOL carryforward.y

― Deferred tax asset

S 8 B iSec. 382 Basics

• Limits a “loss corporation”• Limits a loss corporation

• That undergoes an “ownership change”

― An ownership change occurs if immediately after an owner shift or an equity structure shift; the percentage by value of stock of the loss corporation owned by one or more 5 % shareholders has increased by more than 50 ypercentage points over the lowest percentage ownership of such shareholders.

• During a three-year “testing period”During a three year testing period

• From utilizing “pre-change losses” or other tax attributes

• Against “post-change” income

S 8 D fi i iSec. 382 Definitions• Loss corporation

― NOL, tax credit, capital loss or other attribute carryforward

Net unrealized built in loss ― Net unrealized built-in loss

• 5% shareholders

― Any person holding 5% or more during the testing period

• Testing period

― Begins on the first day of the tax year in which carryforward beginscarryforward begins

― Three-year “rolling” period, unless change occurs

― Shorter period when an ownership change occurs

E iEquity

• Common stock• Common stock

• Convertible preferred stock

• Voting preferred stock

N E iNot Equity

• Plain vanilla preferred stock [Sec 1504(a)(4) stock]• Plain vanilla preferred stock [Sec. 1504(a)(4) stock]

― Not entitled to vote

― Not convertible

― Limited and preferred as to dividends

― Does not participate in corporate growth

Redemption and liquidation rights do not exceed issue ― Redemption and liquidation rights do not exceed issue price

• Most stock options

― But, must test under the option attribution rules

• Debt, including most convertible debt

The convertibility feature creates an option to acquire

― The convertibility feature creates an option to acquire stock.

D t i i % Sh h ldDetermining 5% Shareholders•• Any individual who owns directly or indirectly an amount of the loss corporation stock that aggregates to a 5% ownership interest by value •• Include indirect 5% shareholders

― Trying to get to “arms and legs”

A is indirect 5% shareholder of LossCo

A sells 30% of X stock to C

24% shift in LossCo (30% multiplied by

A C30%

( p y80%) even though shareholder X still owns 80%

LossCo

SEC FilSEC Filers• “Reliance” on the existence or absence of Schedules 13D &

― What about Schedule 13F?

No obligation to inquire or to determine whether actual facts • No obligation to inquire or to determine whether actual facts are consistent with the ownership

― IRS has moved away from this view in recent PLRs and is now requiring more inquiry.

• “Actual knowledge” can always be taken into account.

• Other SEC information: Other SEC information:

― Forms 3 and 4

― DEF 14A – Proxy Statement

― 10-Qs

― 10-Ks

CALCULATION THE Robert Liquerman, KPMG

CALCULATION THE LIMITATION

A l Li i iAnnual Limitation

In general,

Equity value immediately before ownership change

(Special adjustments)(Special adjustments)

Adjusted equity valuex AFR for ownership changes in given monthx AFR for ownership changes in given month

Basic annual limitation

Direct adjustments to annual Sec. 382 limitation under certain conditions

Determining Value Of Loss Corporation• Value of loss corporation is the value of the stock of such

corporation immediately before the ownership change. Sec. 382(e)(1)

• TAM 200513027TAM 200513027

• Taxpayer hired an accounting firm to value P and T in lieu of using a market capitalization approach.

• Average high/low trading prices on the ownership change date (market capitalization)

• An adjustment for control premium may be appropriate.An adjustment for control premium may be appropriate.

• No control premium was added to the market capitalization approach for acquisition of T.

• A control premium for the P market capitalization approach may be appropriate.

S 8 Li i iSec. 382 Limitation

• Redemptions or other corporation contractions [Sec 382(e)(2)][Sec. 382(e)(2)]

• Certain capital contributions [Sec. 382(l)(1)] p [ ( )( )]

• Extent of non-business assets [Sec. 382(l)(4)]

• Continuity of business enterprise [Sec. 382(c)]

C i l C ib iCapital Contributions

C it l t ib ti ithi t [S 382(l)(1)]• Capital contributions within two years [Sec. 382(l)(1)]

• Part of a plan a principal purpose of which is to avoid or • Part of a plan, a principal purpose of which is to avoid or increase a Sec. 382 limitation

C i l C ib i (C )Capital Contributions (Cont.)

• Received by LossCo within two years of ownership change

• “Irrebutably” presumed to be part of a plan to increase LossCo value for computing limitationp g

• Relief from “irrebutable presumption” under certain conditions, based on committee reports and private letter rulings

C i l C ib i (C )Capital Contributions (Cont.)

“Exceptions” to irrebutable presumption

• Contributions in connection with LossCo formation

• Contributions prior to LossCo becoming a loss corporationp g p

• Working capital expenditures

― Meeting daily operating expenditures

If t ib ti i th lt f it li d d bt t i ― If a contribution is the result of capitalized debt, certain PLRs have supported treating debt under the working capital exception, based on (i) debt proceeds used for working capital, (ii) proximity of incurring debt and working capital, (ii) proximity of incurring debt and capitalizing debt, and (iii) intent to convert debt to equity or to raise equity to repay debt.

Capital Contributions (Notice 2008‐78)• Turns off the irrebutable presumption of Sec. 382(l)(1)(B)

― Facts-and-circumstances test

― Effective date: Ownership changes in tax years ending on or after Sept. 26, 2008,

― Safe harbors – A capital contribution will not be considered part of a plan if:

― Made by person that is not a controlling shareholder or related Made by person that is not a controlling shareholder or related party; no more than 20% of the value of the stock issued; no contemplated ownership change transaction; no ownership change within six months

― Made by a related party or other person; no more than 10% of the value of the stock issued; no contemplated ownership change transaction; no ownership change within one year

― Made in exchange for services

― Received on formation or before it becomes a loss corporation22

S b i l N B i ASubstantial Non‐Business Assets

• Substantial non-business assets [Sec 382(l)(4)]• Substantial non-business assets [Sec. 382(l)(4)]

• Value of old LossCo is reduced by the value of its non-business assets (adjusted for their indebtedness), but only if the new LossCo has substantial non-business assets immediately after the ownership change.

• Substantial non-business assets threshold is met if Substantial non business assets threshold is met if at least one-third of the value of the total assets of the new LossCo are non-business assets.

• Berry Petroleum

• Notice 2008-78: No double-reduction under Sec. 382(l)(1) and Sec. 382(l)(4)Sec. 382(l)(4)

NOTICE 2003 65 AND BUILT IN Jeffrey Kelson, EisnerAmper

NOTICE 2003‐65 AND BUILT‐IN GAINS

O h Si ifi AdjOther Significant Adjustments

NUBIG/RBIG• NUBIG/RBIG

• NUBIL/RBIL• NUBIL/RBIL

B il I G i /LBuilt‐In Gains/Losses

• After ownership change

• Must determine whether it has net unrealized built-in gain (NUBIG) or net unrealized built-in-loss (NUBIL)(NU G) o et u eal ed bu lt loss (NU )

• Stand-alone loss corporation either has NUBIG or NUBIL, but not both.

Th h ld t• Threshold amount

• $10 Million or, if less than $10 Million, 15% of the value of the assets

B il I G i /L (C )Built‐In Gains/Losses (Cont.)

• FMV of assets minus tax basis = NUBIG/NUBIL (subject to de minimis rules)s ules)

Recognition period

• Recognized built-in losses (RBILs) or recognized built-in gains (RBIGs) during the five-year recognition, period beginning on the change date

I Of RBIG /RBILImpact Of RBIGs/RBILs

- Increase or decrease Annual 382 Limit for recognition period (beyond, in certain cases)

- If NUBIG-RBILs are ignored NU G s a e g o ed

If NUBIL-RBIGs are ignored

Different than S corporation treatment

- Items of income and items of deduction are treated as RBIGs or RBILs if the item is “properly taken into account during the recognition period” and is attributable to periods before the change date.

• Deduction items: Depreciation, amortization

• Income items: Sec 481 adjustments COD income• Income items: Sec. 481 adjustments, COD income

Oth I t Of B ilt i G iOther Impacts Of Built‐in Gains

- AMT taxpayers need to take into account NUBIL rules in calculating ACE.

- Pre-paid income is not RBIG; any amounts received prior to Pre paid income is not RBIG; any amounts received prior to change date that are attributable to performance occurring on or after change - final regulations.

- Planning: Reduce NUBIL (built-in income items)

- Sec. 384

Appraisals- Appraisals

N i 6Notice 2003‐65

• Much confusion regarding calculating NUBIL/RBIL, NUBIG/RBIG

• IRS issued notice as stopgap and safe harbor.

• Notice is effective until temporary or final regulations are issued• Notice is effective until temporary or final regulations are issued.

• Adopt one of two possible alternatives in determining RBIGs/RBILs

338 approach: RBIGs take into account “deemed” amortization and depreciation deduction, based on a deemed 338 election.

• Best for NUBIGs

Sec 1374 approachSec. 1374 approach

COD and bad debts reduced to 12-month recognition period

• Best for NUBILs

N i 6 E lNotice 2003‐65: Example

• Hypothetical Sec. 338 purchase of the company under IRS Notice 2003-65― Company value $1,820p y $ ,

― Company liabilities $600

― Hypothetical ADSP $2,420

E t t b i i t $2 270― Est. tax basis in assets $2,270

― NUBIG $150

N i 6 E l (C )Notice 2003‐65: Example (Cont.)

H th ti l S 338 h f th d IRS • Hypothetical Sec. 338 purchase of the company under IRS Notice 2003-65 (Cont.)

― NUBIG (from prior slide): $150( p ) $

― RBIG attributable to Asset 1: $30

― RBIG attributable to goodwill: $120

― Hypothetical amortization on goodwill

― RBIG attributable to goodwill: $120

― Amortization period: 15 years

― Hypothetical amortization: $8 per year

N i 6 E l (C )Notice 2003‐65: Example (Cont.)

Adjustments to Section 382 Limitation in 5 Year Recognition Period

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Gain on Disposition of Asset 1 - 30 - - - -

Hypothetical Amortization (5 years) 8 8 8 8 8 -

T t l R i d B ilt I G i 8 38 8 8 8 0Total Recognized Built-In Gain 8 38 8 8 8 0

PLUS: Annual NOL Limitation 81 81 81 81 81 81

EQUALS: Adjusted Limitation 89 119 89 89 89 81j

NOTICE 2010 50 AND Todd Reinstein, Pepper Hamilton

NOTICE 2010‐50 AND FLUCTUATIONS IN VALUE

M i ShifMeasuring Shifts

• The determination of the percentage of stock owned by a The determination of the percentage of stock owned by a person shall be made on the basis of the relative fair market value of the stock owned by such person to the total fair market value of the corporation’s outstanding stockmarket value of the corporation s outstanding stock.

Fl i I V lFluctuations In Value

• Any change in proportionate ownership that is attributable solely to fluctuations in relative FMV of different classes of stock is not taken into account [Sec. 382(l)(3)(C)]

Fl i I V l E lFluctuations In Value: Example

P f $20 ( t 1504) C $80

Year 2 common sale $5

At LossCo formation A has 20% of FMV and B has 80% FMV

Pref $20 (not 1504) Common $80

LossCoAt LossCo formation, A has 20% of FMV and B has 80% FMV.Year 1: LossCo has NOLYear 2: LossCo overall value drops to $25; A still has 80% of FMV, and B drops to 20% FMV Year 2: B sells all LossCo stock to unrelated C for $5

Is the sale treated as an 80% shift [A increases from 20% to 80% (60% difference) + C increases from 0% to 20% (20% difference)]? Or

difference) + C increases from 0% to 20% (20% difference)]? Or,Is the sale treated as a 20% shift (C’s increase to 20%)?

N i Notice 2010‐50• Issued June 11, 2010

• Full-value methodology

― Mark-to-market shares

H ld i i l• Hold-constant principle

― The equity shift is calculated by factoring out fluctuations in the relative values of classes.

― Alternative 1

― Look-back method

Al i 2 b li d i ― Alternative 2 can be applied in two separate ways:

― Proportionate reduction method

― Purchase reduction method

Issues To Resolve Under Notice 2010‐50

• Designation of 5% percent shareholders (FMV% or HCP%)

• Issuances and redemptions could have different results under all three.

• Application to small and cash-issuance exceptions

• Applies to closed years

― Can’t change tax liability

NOTICE 2010 49 AND Robert Liquerman, KPMG

NOTICE 2010‐49 AND TREATMENT OF NON‐5% SHAREHOLDERS

N i SNotice 2010‐49: Summary

• IRS invites comments relating to potential modifications to the treatment of “small shareholders,” for Sec. 382 purposes

― “Small shareholders” are defined as those who are not 5% shareholders (very generally, shareholders that do not own directly or indirectly 5% or more of the loss corporation).

• The notice sets forth two approaches to the proper treatment of small shareholders, both of which recognize that one of the primary abuses Sec. 382 seeks to prevent is the acquisition of l ti t k f ll d b t ib ti f iloss corporation stock, followed by contribution of income-producing assets or diversion of income-producing opportunities.

N i T A hNotice 2010‐49: Two Approaches• Ownership tracking approachp g pp

― Approach primarily taken by the current regulations

― Public tracking exception: Temp. Treasury Reg. 1.382-2T(e)(1)(ii)

― It is generally of no significance whether the shareholders who increase their ownership (to count toward the 50% threshold) are small or 5% shareholders, when they purchase from a 5% shareholder.

― For example, if a 5% shareholder sells stock to small shareholders, such small shareholders are segregated into a separate public group, resulting in a shift in ownership counted toward the 50% threshold

Temp. Treasury Reg. 1.352-2T(j)(3)p y g (j)( )

Notice 2010‐49: Two Approaches (Cont.)

• Ownership tracking approach

Public Group4% L Stock

Public Public Group2

Mr. A$

20%80%

• Purposive approachPurposive approach

― Seeks to indentify more specifically the circumstances in which abuses of Sec. 382’s underlying purpose are likely to

iarise

― Reflects the view that it is unnecessary to take into account all acquisitions of stock by small shareholders, q y ,because they generally are not in a position to abuse Sec. 382 by acquiring loss corporation stock and then contributing income-producing assets (or diverting contributing income producing assets (or diverting income-producing opportunities)

― Typically would result in fewer owner shifts, because hif b imany shifts are not abusive

• Original public group (OPG) owns 100% of LossCo (L).

― New investor 1 (NI1) buys 10% of L stock and sells to small shareholders.

C t bli 1 (NPG1)― Creates new public group 1 (NPG1)

― New investor 2 (NI2) buys 10% of L stock and then sells to small shareholders.

Purchase deemed made from OPG and NPG1― Purchase deemed made from OPG and NPG1

― Creates NPG2

― New investor 3 (NI3) buys 10% of L stock and then sells to small shareholdersshareholders.― Purchase deemed made from OPG, NPG1 and NPG2

― Ownership tracking approach: 27.1% shift

Purpose approach: 10% or possibly 0% shift― Purpose approach: 10%, or possibly 0%, shift

INVESTMENT ADVISORSJeffrey Kelson, EisnerAmper

INVESTMENT ADVISORS

I Ad iInvestment Advisors

• Investment advisors may not count at 5% shareholders.

― PLRs distinguish between a person who has the right to the dividends and proceeds from the sale of a loss corporation’s t k (th “ i ”) d th i t t d i stock (the “economic owner”); and the investment advisor,

who holds the power to vote and/or dispose of such stock (the “reporting owner”).

Right to dividends― Right to dividends

― Right to proceeds upon the sale of stock

― PLR 9533024, PLR 9725039, PLR 200806008 and PLR 200902007200902007

― If not a separate 5% shareholder, the stock is treated as held by the public group

I Ad i (C )Investment Advisors (Cont.)

PLR 200747016 provides guidance on how to interpret information on Schedules 13D and 13G.

• SEC filers who do not provide additional information and SEC filers who do not provide additional information, and taxpayer has no actual knowledge

• SEC filers who provide additional information

• SEC filers who do not provide additional information, but taxpayer has actual knowledge

PLR20110006• PLR20110006

• Actual knowledge

• Not obligated to pursue for all shareholders• Not obligated to pursue for all shareholders

382 Limits on NOL Usage an Ownership...

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