Tax 4022/5022 Tax 4022/5022 Federal Income Tax II Federal Income Tax II

Tax Attributes Tax Attributes Chapter: NoneChapter: None

Dr. Robert R. OlivaDr. Robert R. Oliva

Professor and ChairpersonProfessor and Chairperson

Department of AccountingDepartment of Accounting

University of Arkansas at Little RockUniversity of Arkansas at Little Rock

Tax Attributes: Tax Attributes:

Copyright, 1996 © Dale Carnegie & Associates, Inc.

TIP For additional advice seeDale Carnegie Training® Presentation Guidelines

IntroductionIntroduction

• T is merged into A (calendar year T is merged into A (calendar year corporations) a/o 6/30/99. T has corporations) a/o 6/30/99. T has $200,000 NOL from 1997 and $200,000 NOL from 1997 and reports taxable income of $60,000 reports taxable income of $60,000 through end of June 1999. A reports through end of June 1999. A reports $146,000 for 1999. How much of T’s $146,000 for 1999. How much of T’s NOL balance that could be used by NOL balance that could be used by A in 2000? A in 2000?

Tax attributesTax attributes

• ABAB

• HPHP

• EPEP

• DepreciationDepreciation

• Accounting methodsAccounting methods

• Net operating lossesNet operating losses

• Capital loss carryforwardsCapital loss carryforwards

Tax attributes and Tax attributes and reorganizations reorganizations

• In types A, C, and acquisitive D (as well as F, and In types A, C, and acquisitive D (as well as F, and acquisitive G reorganizations)acquisitive G reorganizations)– Acquiring Corp Acquiring Corp inheritsinherits the Target’s attributes and the Target’s attributes and

assetsassets

• In types In types BB (as well as E) reorganizations the tax (as well as E) reorganizations the tax attributes remain as they wereattributes remain as they were because there is because there is no transfer of assets; Target survives. no transfer of assets; Target survives.

• In divisive D (as well as G) reorganizations, In divisive D (as well as G) reorganizations, only only the transferor’s EPthe transferor’s EP is allocated. is allocated. – 1.312-10 1.312-10

Relevant IRC provisionsRelevant IRC provisions

• IRC 381IRC 381– it requires that that tax attributes be assumedit requires that that tax attributes be assumed

• from the acquired to the acquiring corporationfrom the acquired to the acquiring corporation

• from the transferor to the transferee from the transferor to the transferee corporation corporation

• However, IRC 269, 381, 382, and 384 However, IRC 269, 381, 382, and 384 restricts it. restricts it.

Current restrictionsCurrent restrictions

• IRC 269: IRS may disallow deductions, credits, IRC 269: IRS may disallow deductions, credits, ect., in some acquisitions ect., in some acquisitions

• IRC 381: Target’s attributes follow its assets IRC 381: Target’s attributes follow its assets – Except B and E b/c there is no transfer of assetsExcept B and E b/c there is no transfer of assets

• IRC 382; 383: Restrict c/o of NOLs and creditsIRC 382; 383: Restrict c/o of NOLs and credits

• IRC 384: Restricts use of loss carryforwardsIRC 384: Restricts use of loss carryforwards

Tax free reorganization Tax free reorganization involving involving asset acquisitionasset acquisition

• AssetsAssets– AB: c/o; same as beforeAB: c/o; same as before

– HP: c/o; same as beforeHP: c/o; same as before

Other tax attributesOther tax attributes

• EPEP

• DepreciationDepreciation

• Accounting methodsAccounting methods

• Net operating lossesNet operating losses

• Capital loss carryforwardsCapital loss carryforwards

InterpretationsInterpretations

• Case law prior to the 1954 IRCCase law prior to the 1954 IRC

• Statutory law: 1954 IRC Statutory law: 1954 IRC

Case law historyCase law history

• First: Negative attributes surviveFirst: Negative attributes survive– Profit Corp bought Loss Corp for their negative Profit Corp bought Loss Corp for their negative

EPEP

• Then: Negative attributes did not surviveThen: Negative attributes did not survive– Loss Corp bought Profit Corp. Loss Corp bought Profit Corp.

• Now: Negative attributes can be used only Now: Negative attributes can be used only by Loss Corp (or substantially same by Loss Corp (or substantially same business) that generated them business) that generated them

Statutory law has Statutory law has replaced case lawreplaced case law

• IRC 381: Target’s attributes follow its assets IRC 381: Target’s attributes follow its assets – Except B and E b/c there is no transfer of assetsExcept B and E b/c there is no transfer of assets

• IRC 382; 383: Restrict c/o of NOLs and creditsIRC 382; 383: Restrict c/o of NOLs and credits

• IRC 384: Restricts use of loss carryforwardsIRC 384: Restricts use of loss carryforwards

• IRC 269: IRS may disallow deductions, credits, IRC 269: IRS may disallow deductions, credits, ect., in some acquisitions ect., in some acquisitions

IRC 381(a)(2)IRC 381(a)(2)

• Which reorganizations?Which reorganizations?

• What does it require?What does it require?

• When does it take effect?When does it take effect?

• What items are affected?What items are affected?

• What conditions and limitations?What conditions and limitations?

Which reorganizations?Which reorganizations?

• All types except B and EAll types except B and E– B: Target remains intact and retains its B: Target remains intact and retains its

attributes attributes

What does it require?What does it require?

• Acquiring corporation shall inherit Acquiring corporation shall inherit various tax attributes of the various tax attributes of the distributor or transferor corporationdistributor or transferor corporation

When does it take effect?When does it take effect?

• At the close of the day of the At the close of the day of the distribution or transfer.distribution or transfer.

What items are affected?What items are affected?

• Items in IRC 381( c): Items in IRC 381( c): – NOL c/o; EP; Capital loss c/oNOL c/o; EP; Capital loss c/o

– Method of accounting; Inventories; Method of accounting; Inventories; Depreciation methods; charitable Depreciation methods; charitable contributions excess c/ocontributions excess c/o

– and many othersand many others

What conditions and What conditions and limitations?limitations?

• IRC 381(b) IRC 381(b)

• IRC 381 (c) IRC 381 (c)

IRC 381(b)(1); (2) IRC 381(b)(1); (2)

• O/T F type, O/T F type,

• Transferor’s Y/E = day of distribution Transferor’s Y/E = day of distribution or transfer = day transaction or transfer = day transaction completed completed – May be day when “substantially all” the May be day when “substantially all” the

property transferred if transferor ceases property transferred if transferor ceases operations, except for liquidating operations, except for liquidating transactionstransactions

IRC 381(b)(3)IRC 381(b)(3)

• Transferor’s Transferor’s pastpast years are years are not not affectedaffected by Acquiring corp’s by Acquiring corp’s futurefuture NOL or CL. NOL or CL. – Prohibits Loss Corp to buy and use Prohibits Loss Corp to buy and use

Profit Corp’s positive past attributes.Profit Corp’s positive past attributes.

Should Should post-acquisition post-acquisition losseslosses be permitted to be permitted to offset offset pre-acquisition pre-acquisition gainsgains? ? • IRC 381(b)(3)IRC 381(b)(3)

• BercyBercy: :

BercyBercy: 640 F2d 1058 (9th : 640 F2d 1058 (9th Cir. 1981)Cir. 1981)

• Should post-acquisition losses be Should post-acquisition losses be permitted to offset pre-acquisition gains?permitted to offset pre-acquisition gains?

– Is prohibition in IRC 381(b)(3) to be applied Is prohibition in IRC 381(b)(3) to be applied in all cases?in all cases?

• Congressional intent was to limit the Congressional intent was to limit the trafficking to only those cases where the trafficking to only those cases where the carryback would entail carryback would entail complex complex problemsproblems of post-reorg loss allocation. of post-reorg loss allocation.

Was there a Was there a complex complex problemproblem of post- of post-acquisition loss allocation acquisition loss allocation in in BercyBercy??• Complexity does not exists whenComplexity does not exists when

– Same business generates the same Same business generates the same income and lossincome and loss

– There is only one set of operating There is only one set of operating assets; one set of books, one tax assets; one set of books, one tax history.history.

• For T/P For T/P

Should Should pre-acquisitionpre-acquisition losseslosses be permitted to be permitted to offset offset post-acquisition post-acquisition gainsgains?? • IRC 381( c)IRC 381( c)

• First year’s use of the Target’s NOL First year’s use of the Target’s NOL by the Acquiring Corp is limited to by the Acquiring Corp is limited to the Acquiring corporation’s allocable the Acquiring corporation’s allocable daily post acquisition 1st year daily post acquisition 1st year income. income.

Example from the Example from the beginning: beginning:

• T is merged into A (calendar year T is merged into A (calendar year corporations) a/o 6/30/99. T has corporations) a/o 6/30/99. T has $200,000 NOL from 1997 and $200,000 NOL from 1997 and reports taxable income of $60,000 reports taxable income of $60,000 through end of June 1999. A reports through end of June 1999. A reports $146,000 for 1999. How much of T’s $146,000 for 1999. How much of T’s NOL balance that could be used by NOL balance that could be used by A in 2000?A in 2000?

Answer: How much of its Answer: How much of its NOLs does T use?NOLs does T use?

• T’s final tax return runs from 1/1/99 T’s final tax return runs from 1/1/99 to 6/30/99. to 6/30/99. – T’s NOL= 200K - 60K = $140K NOLs T’s NOL= 200K - 60K = $140K NOLs

balancebalance

Answer: How much of T’s Answer: How much of T’s NOLs could A use before NOLs could A use before any limitations?any limitations?

• 7/1/99-12/31/99 = 184 days7/1/99-12/31/99 = 184 days

• How much did A earned after merger?How much did A earned after merger?– [184/365 ($146K)] = $73,600[184/365 ($146K)] = $73,600

– T’s NOLs usable by A: $73,600T’s NOLs usable by A: $73,600

– Remaining of T’s NOL to be used by A after Remaining of T’s NOL to be used by A after 1999 = $140,000 - $73,600 = $66,400 1999 = $140,000 - $73,600 = $66,400

However there are However there are additionaladditional limitations on limitations on the use of tax attributes: the use of tax attributes:

• IRC 382 and IRC 269IRC 382 and IRC 269

• IRC 383IRC 383

• IRC 384IRC 384

IRC 382 and IRC 269 IRC 382 and IRC 269 prevents prevents

• acquisition of assets or stock of a acquisition of assets or stock of a corporation with NOL C/O primarily to corporation with NOL C/O primarily to acquire its tax attributes.acquire its tax attributes.

• Profit Corp buying Loss CorpProfit Corp buying Loss Corp

• a corporation with NOL C/O to acquire a corporation with NOL C/O to acquire the assets or stock of a corporation the assets or stock of a corporation primarily to use its tax attributes primarily to use its tax attributes

• Loss Corp buying Profit CorpLoss Corp buying Profit Corp

IRC 382 IRC 382

• Limits NOL C/O and built-in losses after Limits NOL C/O and built-in losses after some some ownership changesownership changes

• IRC 382 imposes limits on the amount IRC 382 imposes limits on the amount that pre-acquisition losses may offset that pre-acquisition losses may offset post acquisition TI.post acquisition TI.– Thus it limits the use of a Loss (Target) Thus it limits the use of a Loss (Target)

Corporation’s NOL carryforwards by the Corporation’s NOL carryforwards by the Acquiring CorporationAcquiring Corporation

IRC 382 issuesIRC 382 issues

• When does it take effect?When does it take effect?

• What items are affected?What items are affected?

• What conditions and limitations?What conditions and limitations?

When does the limitation When does the limitation take effect?take effect?

• Only whenOnly when there is a there is a substantial substantial “ownership change” in the LOSS (TARGET) “ownership change” in the LOSS (TARGET) CORPORATION.CORPORATION.

• Rationale: Those who bore the burden Rationale: Those who bore the burden should benefit from their deduction against should benefit from their deduction against future gain, e.g., if there is no ownership future gain, e.g., if there is no ownership change, losses should offset gains freely. change, losses should offset gains freely. But if there is an ownership change, the But if there is an ownership change, the use of the NOLs is limited. use of the NOLs is limited.

There is a “There is a “substantial substantial ownership change” in the ownership change” in the LOSS Target LOSS Target when there is when there is eithereither • an an ownership shiftownership shift involving a 5%or involving a 5%or

more shareholdermore shareholder– Ownership: use modified IRC 318 [IRC Ownership: use modified IRC 318 [IRC

382(l)(3)] 382(l)(3)]

• oror, an equity structure shift: tax free , an equity structure shift: tax free reorganization reorganization

Who is a “Who is a “5% 5% shareholdershareholder”?”?

• A 5% shareholder A 5% shareholder

• AllAll shareholders that own < 5% are shareholders that own < 5% are treated, in the aggregate, as treated, in the aggregate, as oneone 5% 5% shareholdershareholder

• Note: “stock” is defined by exclusion: Note: “stock” is defined by exclusion: IRC 382(k)(6): Nonvoting preferred IRC 382(k)(6): Nonvoting preferred stock is excluded form calculations.stock is excluded form calculations.

What is an What is an ownership ownership shiftshift? ?

• % of stock owned by any“5% % of stock owned by any“5% shareholders” has shareholders” has increasedincreased by by more than 50%more than 50% from the lowest % from the lowest % of stock owned during the preceding of stock owned during the preceding 3-year or shorter “testing period” 3-year or shorter “testing period” – from 11% to 61.1% is a >50% from 11% to 61.1% is a >50%

ownership change ownership change

Ownership shift may be Ownership shift may be triggered bytriggered by

• purchasespurchases

• issuances of stockissuances of stock

• recapitalizationsrecapitalizations

• 351351

• 302 transactions. 302 transactions.

• Excepted: changes due to death, divorce, or Excepted: changes due to death, divorce, or gift. IRC 382(l)(3)(B)gift. IRC 382(l)(3)(B)

Old Loss Corporation [IRC Old Loss Corporation [IRC 382(k)(2)] v. New Loss 382(k)(2)] v. New Loss Corporation [IRC 382(k)Corporation [IRC 382(k)(3)](3)]• Old Loss Corporation (Target): Old Loss Corporation (Target):

entitled to use the NOL in the year entitled to use the NOL in the year ofof the ownership change. the ownership change.

• New Loss Corporation (Acquiring): New Loss Corporation (Acquiring): entitled to use the NOL in the year entitled to use the NOL in the year afterafter the ownership change. the ownership change.

ExampleExample

• Each of T’s 600 shareholders own Each of T’s 600 shareholders own <5% of T. T is merged into A. Each <5% of T. T is merged into A. Each of A’s 1000 shareholders own <5% of A’s 1000 shareholders own <5% of A, and none owns any T. After the of A, and none owns any T. After the merger, T’s shareholders own 40% merger, T’s shareholders own 40% of A. Is T’s NOLs subject to the IRC of A. Is T’s NOLs subject to the IRC 382 limitations?382 limitations?

AnswerAnswer

• All of A’s shareholders = one (1) 5% shareholderAll of A’s shareholders = one (1) 5% shareholder

• How many shares of Loss Target did A’s “single” How many shares of Loss Target did A’s “single” 5% shareholder own before (0%) v. after (40%)? 5% shareholder own before (0%) v. after (40%)?

• No ownership change because <50%.No ownership change because <50%.

• $48,000 = $252,000] may be used by Pebble’s $48,000 = $252,000] may be used by Pebble’s the following year. the following year.

• $50,000$50,000

What items are affected? What items are affected? NOLs C/ONOLs C/O

• Yearly IRC 382 limit: NOL is limited to the Yearly IRC 382 limit: NOL is limited to the valuevalue of the Old Loss Corp immediately of the Old Loss Corp immediately before before the ownership changethe ownership change multiplied by the multiplied by the LT LT tax-exempt federal ratetax-exempt federal rate. IRC 382(b)(1). IRC 382(b)(1)

• Rationale: Supposedly, it is the yearly rate at Rationale: Supposedly, it is the yearly rate at which the Old Loss Corp would have used up which the Old Loss Corp would have used up its NOLs. its NOLs.

• The greater the value to the NOL C/O, the The greater the value to the NOL C/O, the lesser the limitation. lesser the limitation.

““Value” of the Old Loss Value” of the Old Loss Corp: Corp:

• IRC 382(e)(1); includes nonvoting IRC 382(e)(1); includes nonvoting preferred stock.preferred stock.

Restricting “value” Restricting “value” manipulationsmanipulations

• Anti-stuffing rule; IRC 382(l)(1)Anti-stuffing rule; IRC 382(l)(1)– Ignore capital contributions made prior Ignore capital contributions made prior

to change which were part of a planto change which were part of a plan

– Capital contributions made during the Capital contributions made during the 2 year period prior to the change 2 year period prior to the change considered part of a plan.considered part of a plan.

IRC 382(l)(4): too much IRC 382(l)(4): too much passive assets passive assets

• If at least 1/3 of assets consists of If at least 1/3 of assets consists of investment assets, “value” includes investment assets, “value” includes only net value represented by its only net value represented by its business assets. business assets.

LT tax-exempt federal LT tax-exempt federal rate: IRC 382(f)rate: IRC 382(f)

• highest highest of the adjusted fed LT rates in of the adjusted fed LT rates in effect for any month in the effect for any month in the 3-calendar 3-calendar monthmonth period period ending in the monthending in the month of the of the stock ownership change.stock ownership change.

• Assume change took place in December Assume change took place in December 1998: 1998: – RR 98-57: 12/98 = 4.67, but the highest for RR 98-57: 12/98 = 4.67, but the highest for

Oct, Nov, and Dec period = 4.80%Oct, Nov, and Dec period = 4.80%

What conditions and What conditions and limitations?limitations?

• IRC 382(c): New Loss must continue Old IRC 382(c): New Loss must continue Old Loss business for two years after Loss business for two years after ownership change. ownership change. – Otherwise no NOLs can be use. Otherwise no NOLs can be use.

• If loss limitation is not used up in a If loss limitation is not used up in a given year, it increases the loss given year, it increases the loss limitation in the following year. IRC limitation in the following year. IRC 382(b)(2)382(b)(2)

Other limitations and Other limitations and conditions (Not covered in conditions (Not covered in Tax 6935)Tax 6935)

• IRC 383IRC 383

• IRC 384IRC 384

• IRC 269IRC 269

IRC 383: prevents IRC 383: prevents acquisitions primarily with acquisitions primarily with the view to use capital the view to use capital loss and tax credit loss and tax credit carryovers. carryovers. • restricts the use of tax credits and restricts the use of tax credits and

CL C/O when there are ownership CL C/O when there are ownership changes. changes.

IRC 384: prevents the use IRC 384: prevents the use of pre-acquisition losses of pre-acquisition losses to offset built-in gains. to offset built-in gains.

• prevents Loss Corp’s pre-acquisition prevents Loss Corp’s pre-acquisition losses from offsetting Gain Corp’s losses from offsetting Gain Corp’s built-in gains (BIG) recognized built-in gains (BIG) recognized during the 5 year period after the during the 5 year period after the ownership change. ownership change. – OK to offset pre-acquisition Gain Corp’s OK to offset pre-acquisition Gain Corp’s

losses with Gain Corp’s post-losses with Gain Corp’s post-acquisitions recognized BIGs. acquisitions recognized BIGs.

IRC 269: IRC 269:

• applied where control is obtained applied where control is obtained and principal purpose of acquisition and principal purpose of acquisition is evasion or avoidance through the is evasion or avoidance through the use of deductions.use of deductions.

• control: 50% VP or valuecontrol: 50% VP or value

• too subjective; instead IRS prefers IRC too subjective; instead IRS prefers IRC 382-384 382-384