NOL Treatment on Federal Corporate and Individual Tax Returns: Challenges for Preparers

Transcription

1 NOL Treatment on Federal Corporate and Individual Tax Returns: Challenges for Preparers Navigating Computation, Sect. 382 Limitation, Carryback/Carryforward and Other Rules FRIDAY, NOVEMBER 16, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 registered tax return preparer (RTRP) credit hours (other federal tax law/federal tax related). Based on the IRS rules, to earn credit you must: Participate in the program on your own computer connection or phone line (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Respond to polling questions presented throughout the seminar. If you have not printed out the Official Record of Attendance for Continuing Education Credits, please print it now. (see Handouts tab in Conference Materials box on left-hand side of your computer screen). To earn Continuing Education credits, you must write down your answers to polling questions, as well as the verification code, on the Official Record of Attendance form. Complete and submit the Official Record of Attendance for Continuing Education Credits included with the presentation materials. That record must include your PTIN ID #. Instructions on how to return it are included on the form. To earn full credit, you must remain on the line for the entire program. WHOM TO CONTACT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Program: - On the web, use the chat box at the bottom left of the screen - On the phone, press *0 ( star zero) If you get disconnected during the program, you can simply call or log in using your original instructions and PIN.

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4 NOL Treatment on Federal Corporate and Individual Returns: Challenges for Preparers Seminar Nov. 16, 2012 Robert Liquerman, KPMG Rebecca Holtje, KPMG Connor Lewis, McGladrey LLP Amy Chapman, KPMG

5 Today s Program Corporate Equity Reduction Transactions (CERT) [Robert Liquerman and Rebecca Holtje] Sect. 382 Ownership Change Provisions [Connor Lewis] Impact Of An Ownership Change [Robert Liquerman and Amy Chapman] Issues Related To Sect. 384 [Connor Lewis] Applications Of Alternative Minimum Tax With NOLs [Connor Lewis] Particular Issues With NOLs For Individual Taxpayers [Connor Lewis] Slide 7 Slide 18 Slide 19 Slide 32 Slide 33 Slide 54 Slide 55 Slide 63 Slide 64 Slide 67 Slide 68 Slide 71

6 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

7 Robert Liquerman, KPMG Rebecca Holtje, KPMG CORPORATE EQUITY REDUCTION TRANSACTIONS (CERT)

8 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

9 Rules Applicable To Corporate Equity Reduction Transactions (CERTs) Sect. 172(b)(1)(A) allows an NOL incurred by a taxpayer to be carried back or carried forward to taxable years of that taxpayer. Carrybacks are limited to the two years prior to the year of the NOL, and Carry forwards are limited to the 20 years after the year of the NOL. Sect. 172(b)(1)(E) prohibits an applicable corporation from carrying back a portion of an NOL (the CERIL) incurred in any loss limitation year (a LLY) to those taxable years that precede the taxable year in which a CERT occurs. The purpose of the CERT limitation is to prevent taxpayers from claiming a refund of a prior-year tax payment for the purpose of funding the cost of post-cert year interest expense allocable to certain corporate acquisitions and distributions. See H.R. Rep. No (1989) 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 9

10 What Is A CERT (Corporate Equity Reduction Transaction)? As provided in 172(h)(3) a CERT is defined as either a major stock acquisition or an excess distribution. Major stock acquisition (MSA): An acquisition by a corporation of 50% or more (by vote or value) of the stock in another corporation A stock acquisition for which a 338 election is made is not an MSA. Excess distribution (ED): A current-year corporate distribution (including redemptions, regardless of whether they are dividend equivalents), provided the amount exceeds the greater of: 150% of the average of such distributions during the three taxable years immediately preceding the taxable year of the potential ED, or 10% of the fair market value of the stock of such distributing corporation, measured at the beginning of such current year Adjustments are made for certain stock issuances and certain contributions for, distributions on, and redemptions of plain vanilla preferred stock KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 10

11 Examples Of A CERT MSA ED P T stock $ SH $ SH T T X 172(h)(3) Note: Distribution must exceed both the 150% (three-year lookback) and 10% (fair market value) thresholds in 172(h)(3)(C), to constitute an ED KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 11

12 What Is An Applicable Corporation? An applicable corporation is: An acquiring C corporation in an MSA A target C corporation in an MSA The C corporation making the distribution in an ED A successor to an applicable corporation 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 12

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14 Identifying Applicable Corporation In A CERT MSA ED P $ T stock SH $ SH T T X = Applicable corporation 172(b)(1)(E)(iii) 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 14

15 What Taxable Years Are The LLYs (Loss Limitation Years)? The LLYs are the tax years in which the CERT occurred and, generally, each of the two following tax years. LLYs CERT Corporation T engages in a CERT during its taxable year ending Dec. 31, Year 4. T s LLYs are Year 4, Year 5 and Year (b)(1)(E)(ii) 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 15

16 How Is The CERIL Computed? The applicable corporation s CERIL (corporate equity reduction interest loss) is the difference between its NOL for the taxable year and the NOL for the taxable year reduced by its allocable interest deduction (AID). The applicable corporation s AID is the portion of its NOL that is generated by interest deductions allocable to a CERT. Interest deductions are allocable to a CERT based on the UNICAP model (Treas. Reg A-9), but subject to certain limitations: AID cannot exceed the three-year base period amount, and AID under $1 million is disregarded under a de minimis rule. Sect. 172(h)(2)(B) prohibits direct allocation of interest expense to non-cert activity KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 16

17 Proposed CERT Rules On Sept. 13, 2012, the IRS and Treasury issued proposed regulations addressing CERTs. The proposed regulations are prospective only. The proposed regulations address: General CERT rules: Identification of CERT costs Application to tax-free transactions Interaction of EDs and MSAs Calculation of lookback period items Successor rules Consolidated CERT rules: Guidance on single vs. separate entity Treatment of intercompany transactions CERT status Allocation of CERT attributes Carryback waivers: Avoidance of CERT taint 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 17

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19 Connor Lewis, McGladrey LLP SECT. 382 OWNERSHIP CHANGE PROVISIONS

20 IRC 382 Ownership Change Ownership change Occurs when new owners acquire control of a loss corporation Five sub-elements, which must occur together: If the major shareholders, As a result of a triggering event, And measuring backwards from the date of that transaction, For a specified period of time, Increase their ownership in a loss corporation by more than 50 percentage points. 20

21 Major, Or 5%, Shareholders Sect. 382(k)(7) defines a 5% shareholder as any person holding 5% or more of the loss corporation s stock at any time during the testing period. Person includes individual, public groups, first-tier and highertier entities. Emphasis is on the determination of ultimate owners of the corporation stock. Ownership percentage is based on value. Changes that occur solely by reason of fluctuations in stock value are ignored. Public groups Owners of less than 5% of stock are treated as a single 5% shareholder, and all of their individual stock ownership is aggregated. Segregation public groups 21

22 Major, Or 5%, Shareholders (Cont.) Publicly held corporations Reliance on SEC filings Schedules 13D and 13G Beneficial vs. economic ownership Beneficial ownership = Voting power and/or investment power Economic ownership = The right to receive or direct dividends and/or the proceeds of the sale of the stock Economic owners are counted toward the determination of 5% shareholders. Reliance on actual knowledge 22

23 The Triggering Event, Or Transaction Owner shift Broad term encompassing nearly every kind of transaction in corporate stock Equity structure shift Taxable purchase and disposition, tax-free exchanges, redemptions, debt conversions, stock issuances Exclusions (i.e., certain related party transactions) Any tax-free reorganization except divisive D and G reorganizations and any F reorganizations Publicly held companies 23 Day-to-day trading in stock should not be affected by 382. Only transactions involving a 5% shareholder are counted as owner shifts.

24 Testing Date A loss corporation is required to determine whether there has been an ownership change after each owner shift. Each date on which this determination is made is called a testing date. The computation of the percentage points of the ownership change must be made as of the close of the testing date. All transactions that occur on the testing date are to be treated as though they occur simultaneously at the close of that testing date. Avoidance of anything that might require a testing date is the philosophical basis for the adoption of an NOL poison pill or charter amendment. Information statement on federal income tax return 24

25 Testing Period Generally, a three-year period ending on the testing date Exceptions 25 Testing period ends regardless of whether the owner shift or equity structure shift triggers an ownership change. There is no testing period until there is an owner shift involving a 5% shareholder. Testing period is counted backward from the time of the transaction. Testing period cannot begin prior to May 6, Testing period begins on the day after a prior ownership change date, in the case of successive ownership changes. Testing period cannot begin earlier than the first taxable year in which the corporation is a loss corporation.

26 Ownership Increase 5% shareholder s increase is measured against the lowest percentage of loss corporation stock owned by that shareholder during the testing period. Each 5% shareholder s increase is computed separately, and then all increases during testing period are added to determine whether the 50-percentage-point threshold has been surpassed. Increase must be more than 50 percentage points. 26

27 Ownership Increase Example LossCo stock ownership Testing date: 1/1/20x7 Shareholder Percentage Owned Minimum Percentage Increase Public Groups PG1 100% 100% 0% Total 100% 100% 0% 27

28 Ownership Increase Example (Cont.) LossCo stock ownership Testing date: 1/2/20x7 Shareholder 1 purchases 20% of LossCo stock in open market. Shareholder Percentage Owned Minimum Percentage Increase Shareholder 1 20% 0% 20% Public Groups PG1 80% 80% 0% Total 100% 80% 20% 28

29 Ownership Increase Example (Cont.) LossCo stock ownership Testing date: 1/1/20x8 Shareholder 1 disposes 10% of LossCo stock in open market. Shareholder Percentage Owned Minimum Percentage Increase Shareholder 1 10% 0% 10% Public Groups PG1 80% 80% 0% PG2 10% 0% 10% Total 100% 80% 20% 29

30 Ownership Increase Example (Cont.) LossCo stock ownership Testing date: 7/1/20x8 Shareholder 2 buys 18% of LossCo stock in open market. Shareholder Percentage Owned Minimum Percentage Increase Shareholder 1 10% 0% 10% Shareholder 2 18% 0% 18% Public Groups PG1 64% 64% 0% PG2 8% 0% 8% Total 100% 64% 36% 30

31 Ownership Increase Example (Cont.) LossCo stock ownership Testing Date: 1/1/20x9 Shareholder 2 disposes 18% of LossCo stock in open market. Shareholder Percentage Owned Minimum Percentage Increase Shareholder 1 10% 0% 10% Shareholder 2 0% 0% 0% Public Groups PG1 64%% 64%% 0% PG2 8% 0% 8% PG3 18% 0% 18% Total 100% 64% 36% 31

32 Ownership Increase Example (Cont.) LossCo stock ownership Testing date: 7/1/20x9 Shareholder 3 buys 20% of LossCo stock in open market. Shareholder Percentage Owned Minimum Percentage Increase Shareholder 1 10% 0% 10% Shareholder 2 0% 0% 0% Shareholder 3 20% 0% 20% Public Groups PG % 49.78% 0% PG2 6.22% 0% 6.22% PG3 14% 0% 14% Total 100% 49.78% 50.22% 32

33 Robert Liquerman, KPMG Amy Chapman, KPMG IMPACT OF AN OWNERSHIP CHANGE

34 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

35 Impact Of An Ownership Change Limitation on pre-change losses/credits Offsetting post-change income 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 35

36 Annual Limitation In general, Equity value immediately before ownership change Adjustments for: (1) Capital contributions within two years [ 382(l)(1)] (2) Redemptions or other corporation contractions [ 382(e)(2)] (3) Extent of nonbusiness assets [ 382(l)(4)] (4) Controlled group adjustment [Reg ] Adjusted equity value x AFR for ownership changes in given month Basic annual limitation Annual limitation may become zero if continuity of business enterprise is broken within two years of an ownership change. Certain exceptions for ownership changes pursuant to court-approved plan of reorganization in bankruptcy case 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 36

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38 Determining Value Of Stock Of Loss Corporation For the purposes of 382, the value of a loss corporation is based on the fair market value of the stock of such corporation immediately before the ownership change. Stock includes any stock described in 1504(a)(4). Warrants, options, contracts to acquire stock, convertible debt interests and other similar interests may be treated as stock if so treated under rules applicable to ownership shifts KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 38

39 Determining Value Of Stock Of Loss Corporation (Cont.) Publicly traded corporation: Generally treat average price at which the stock is trading on an established exchange on the ownership change date as the value of the corporation, for purposes of 382 BUT, in appropriate exceptional circumstances, departure from the trading price may be permissible in determining fair market value. See, Amerada Hess Corp., Moore-McCormack Lines, Inc. v. Comm r, TAM , TAM KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 39

40 Determining Value Of Stock Of Loss Corporation (Cont.) When might value not be determined by trading price? May be a control premium on the stock Restrictions or additional rights (e.g., on voting rights) on stock may cause variation in and from the trading price. The stock price on the ownership change date is aberrational compared with its price on the exchange throughout the rest of the year. Trading price only reflects sales of small lots, forced sales or sales in a restricted market KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 40

41 Adjustments: 382(l)(1) Capital Contributions Any capital contribution received by LossCo as part of a plan a principal purpose of which is to avoid or increase any limitation under this [ 382] is not taken into account (i.e., the annual limit is reduced). Any capital contribution received by LossCo during the two-year period ending on the date of the ownership change irrebutably is presumed to be part of a plan to increase LossCo value for computing limitation. Relief from irrebutable presumption under certain conditions is based on committee reports and private letter rulings KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 41

42 Capital Contributions (Notice ) Turns off the irrebutable presumption of 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 who 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 corporation 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 42

43 Available Limitation In Given Tax Year Annual limitation [in year of ownership change; annual limitation proportionately scaled back for post-change period] + Carryforward of unused limitation + Built-in gains recognized in recognition period for loss companies in a net unrealized built-in gain position on change date Available limitation in given tax year 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 43

44 Built-In Gains And Losses 382(h) provides rules for the treatment of built-in gain or loss recognized with respect to assets owned by the loss corporation at the time of its ownership change. Two primary goals: (1) Built-in gain should not be limited by 382, because if the gain had been recognized before the ownership change, it could have been offset without limitation by the loss corporation s losses. (2) Built-in loss should not escape the 382 limitation, because if it had been recognized before the ownership change, it would have been subject to KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 44

45 Built-In Gains And Losses (Cont.) 382(h)(1) and (2) Recognition rules Recognized built-in gains (RBIGs): If a loss corporation has a net unrealized built-in gain (NUBIG), any BIG recognized during the five-year recognition period following the ownership change increases the 382 limitation for that year. Recognized built-in losses (RBILs): If a loss corporation has a net unrealized built-in loss (NUBIL), any BIL recognized during the five-year recognition period following the ownership change is treated as a prechange loss subject to the 382 limitation. Depreciation, amortization or depletion deductions are treated as RBIL, except to the extent the loss corporation establishes that the deduction is not attributable to an asset s built-in loss. Burden is on the taxpayer: A loss corporation with a NUBIG must establish that any gain recognized is RBIG. Conversely, a loss corporation with a NUBIL must establish that any loss recognized is not RBIL 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 45

46 Built-In Gains And Losses (Cont.) 382(h)(3) NUBIG/NUBIL NUBIG: A loss corporation s NUBIG generally equals the excess, if any, of the aggregate fair market value of its assets immediately before an ownership change over the assets aggregate adjusted basis at that time. NUBIL: A loss corporation s NUBIL generally equals the excess, if any, of the aggregate adjusted basis of its assets immediately before an ownership change over the assets aggregate fair market value at that time (see also 382(h)(8)). Threshold rule: If a loss corporation s NUBIG or NUBIL does not exceed the lesser of $10 million or 15% of the aggregate fair market value of its assets immediately before the ownership change, then the loss corporation s NUBIG or NUBIL is deemed to be zero KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 46

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48 Built-In Gains And Losses (Cont.) 382(h)(6) Income and deductions Income items: Any item of income properly taken into account during the recognition period is treated as RBIG, if the item is attributable to periods before the change date. Deduction items: Any item of deduction allowable as a deduction during the recognition period is treated as RBIL, if the item is attributable to periods before the change date. 382(h)(6) items also affect the determination of NUBIG/NUBIL. Until the release of Notice , there was very little guidance on how to apply 382(h)(6) KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 48

49 Built-In Gains And Losses (Cont.) Notice Notice (Sept. 12, 2003) provides guidance on the identification of built-in items under 382(h). Alternative approaches: Two alternative safe harbors for the identification of built-in items, for purposes of 382(h): (1) The 1374 approach (2) The 338 approach 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 49

50 Built-In Gains And Losses (Cont.) NUBIG/NUBIL under Notice (both approaches) Calculation of NUBIG or NUBIL: Amount realized if, immediately before the ownership change, the loss corporation (L) had sold all of its assets, including goodwill, at fair market value to a third party that assumed all of its liabilities: Decreased by the deductible liabilities (including contingent liabilities) of L that would be included in the amount realized on the hypothetical sale and L s aggregate basis in all of its assets Increased or decreased by the L s 481 adjustments that would be taken into account on the sale Increased by any RBIL that would be disallowed as a deduction under 382/383 or 384 on the sale (as a result of prior transactions) If this amount is positive, L has a NUBIG. If the amount is negative, L has a NUBIL. Both are subject to the threshold limitation KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 50

51 Built-In Gains And Losses (Cont.) 1374 approach overview Identifies built-in items using 1374 rules (net realized built-in gains of subchapter S corporations) Generally treats items as attributable to pre-change period, if they accrue prior to the ownership change However, for purposes of determining whether an item is RBIL, 461(h)(2)(C) and Treas. Reg (g) (concerning certain liabilities for which payment is economic performance) do not apply. Generally best for taxpayers who want to avoid characterization of deductions as built-in losses 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 51

52 Built-In Gains And Losses (Cont.) 338 Approach overview Identifies built-in items by comparing L s actual items with those that would have resulted from a 338 transaction Generally allows some items (e.g., income from foregone depreciation, deduction for contingent liabilities) not accrued prior to OC to be treated as built-in gain or loss Generally best for taxpayers who want to treat income from wasting (i.e., depreciable or amortizable) assets as recognized built-in gain 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 52

53 Built-In Gains And Losses (Cont.) 338 Approach wasting asset RBIGs If LossCo has a NUBIG, certain of LossCo s built-in gain assets are treated as generating RBIG, even if such assets are not disposed of during the recognition period. The amount treated as RBIG (regardless of L s gross income in any year during the recognition period) equals the excess of the cost recovery deduction that would have been allowable with respect to a built-in gain asset, had an election under 38 been made for the hypothetical purchase over L s actual allowable cost recovery deduction for the asset. The deduction allowable had a 338 election been made is determined based on the fair market value of the asset on the change date and a cost recovery period that begins on the change date KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 53

54 Built-In Gains And Losses (Cont.) Example 338 wasting asset RBIGs LossCo has a NUBIG of $300 attributable to goodwill with a value of $300, and a basis of $0. The cost recovery deduction that would have been allowable with respect to the goodwill had an election under 338 been made for the hypothetical purchase would be $20, because LossCo could amortize 1/15th of the $300 basis in the goodwill. The actual allowable cost recovery deduction would be $0, because the goodwill has $0 basis. Therefore, LossCo is treated as having $20 of RBIG ($20 hypothetical cost recovery deduction - $0 actual cost recovery deduction) and may increase its 382 limitation by $ KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity. 54

55 Connor Lewis, McGladrey LLP ISSUES RELATED TO SECT. 384

56 IRC Sect. 384 Overview IRC Sect. 384 limits the use of certain tax attributes of one corporation against certain recognized built-in gains of another. Initially created to limit acquisitions of unrealized gains by loss corporations Sect. 384 denies the use of NOLs, excess credits and capital losses and certain gains recognized within a fiveyear recognition period following the acquisition. Applies both to stock and asset acquisitions Sect. 382 is keyed to the acquisition of a loss corporation, whereby Sect. 382 generally applies to acquisitions by a corporation with NOLs, excess credits or capital losses. 56

57 Gain Corporation In order for 384 to apply, either the acquired, acquiring or surviving corporation must be a gain corporation. A gain corporation is a corporation with a net unrealized built-in gain (NUBIG) at the time of the acquisition. 384 prevents the other corporation from using its tax attributes to offset or reduce the tax on recognition of certain of those NUBIGs. 57

58 Recognized Built-In Gains The 384 definition of recognized built-in gain (RBIG) treats gain recognized during the five-year period following the acquisition date as RBIG, unless the corporation can prove otherwise. RBIG is the gain recognized during the five-year recognition period on disposition of any asset of the gain corporation. Exceptions are: Income items Assets not owned by gain corporation on acquisition date Any realized gain that exceeds the asset s unrealized built-in gain as of the acquisition date Items of income earned in prior years but not taken into income until a recognition period taxable year are treated as RBIGs, for purposes of

59 Limitation For any recognition period taxable year, the RBIGs cannot exceed the remainder of the original net unrealized built-in gain (NUBIG) in the assets of the gain corporation on the acquisition date. Calculated by subtracting the RBIGs of prior years from the original amount of the NUBIG RBIGs of prior years are the amounts of RBIGs that would have been offset by pre-acquisition losses, if it were not for the rule of

60 Pre-Acquisition Losses Pre-acquisition loss includes all of the pre-acquisition NOLs incurred by that corporation, Pre-acquisition NOLs are composed of both NOL carryovers to the acquisition year and the portion of the acquisition year NOL that is incurred on or before the acquisition date. If a corporation has NUBIL, then its pre-acquisition loss also includes any RBIL it might suffer during the recognition period. Excess credits and net capital losses are also limited by the provisions of 384. Limitation applies to pre-acquisition losses of the other corporation, but not the pre-acquisition losses of the gain corporation. Sect. 384 does not apply to post-acquisition losses. 60

61 Recognition Period Limitation of 384 applies to every recognition period taxable year. Generally means every taxable year that includes the portion of the five-year period which follows the acquisition date A gain on a sale that occurs after the recognition period would not be subject to 384, since it would not be a recognized built-in gain. 61

62 Sect. 384 Example LossCo purchases GainCo for $1,000. LossCo has NOLs of $200 on date of acquisition. GainCo has NUBIG of $500 on date of acquisition. Included in NUBIG is appreciated land: FMV of land: $100 Adjusted basis of land: $50 Built-in gain of land: $50 62

63 Sect. 384 Example (Cont.) In Year 2 after acquisition, LossCo sells land for $150. Realized gain on sale: Proceeds: $150 Adjusted basis of land: $ 50 Gain on sale: $100 RBIG from sale of land was $50 ($100 FMV - $50 basis) Pre-acquisition NOLs of LossCo are only available to offset the additional $50 of gain over and above RBIG amount. 63

64 Connor Lewis, McGladrey LLP APPLICATIONS OF ALTERNATIVE MINIMUM TAX WITH NOLs

65 Alternative Tax Net Operating Loss Deduction AMT net operating loss deduction is used only to compute a taxpayer s alternative minimum taxable income. Equal to the regular tax net operating loss deduction, modified in three respects: 65 The AMT NOL deduction is limited to the lesser of the amount of the deduction attributable to NOLs, or 90% of the AMTI determined without regard to the NOL deduction and the manufacturing deduction under 199. The AMT net operating losses are modified for certain AMT preference items from the year in which the net operating losses are generated. The AMT NOL deduction, to the extent determined to be an NOL carryback, is limited to the 90% rule in the same manner as is the NOL carryforward.

66 AMT NOL Example Assume company has sufficient NOLs to offset taxable income. Regular Tax Alternative Minimum Tax Taxable income $100 $100 Preference items $10 AMTI $110 NOL deduction ($100) ($99) Taxable income post-nol $0 $11 Tax liability $0 $2.20 AMT credit carryforward generated $

67 AMT NOL Carryback Considerations If a taxpayer carries back a regular NOL to a previous tax year, then it must also carry back any AMT NOL generated in the same year to that previous tax year, to the extent there is AMTI. Carryback of AMT NOL is limited to the 90% of AMTI rule. To the extent an NOL carryback generates AMT liability owed by the taxpayer, in the year to which it is carried back, that taxpayer generates a minimum tax credit carryforward that can be used in subsequent tax years. A minimum tax NOL is offset by AMTI income of a carryback or carryover year, even if the taxpayer had no minimum liability for such taxable year. An election to waive the carryback period with respect to a NOL will be valid for AMT NOL as well. Cannot elect to waive carryback solely for AMT purposes 67

68 Connor Lewis, McGladrey LLP PARTICULAR ISSUES WITH NOLs FOR INDIVIDUAL TAXPAYERS

69 Individual NOL Considerations Negative taxable income does not always result in an NOL. The following are added back to taxable income when computing the NOL generated in a tax year: Personal exemptions NOL carryover from another year Excess of non-business capital losses over non-business capital gains Sect exclusion on the sale of qualified small business stock Excess of non-business deductions over non-business income Excess of business capital losses over the total of (a) business capital gains and (b) any non-business capital gains remaining after reducing for non-business capital losses and other non-business deductions The Sect. 199 domestic production activities deduction 69

70 Recomputations In NOL Carryback Years Two instances when a taxpayer s prior year AGI-based income and deductions are recomputed when dealing with NOL carrybacks: When NOL is deducted in a carryback year, tax for that year is refigured by claiming the NOL as a deduction in arriving at AGI. AGI-based items of income and deduction, as well as credits, are then recomputed based on this lower amount of AGI and tax. After the NOL is deducted in a carryback year, the amount left for use in other tax years is determined by computing modified taxable income for the carryback year. Modified taxable income for the carryback year is essentially the taxable income as reported for that year before the current NOL carryback. 70

71 Passive Activity Considerations Suspended passive activity losses are fully deductible in the year in which the taxpayer disposes of his/her entire interest in the passive activity, in a fully taxable transaction to an unrelated party. Partial disposition 71 A partial disposition of the passive activity can be treated as a complete disposition, if substantially all of the activity is disposed of and the taxpayer can establish with reasonable certainty the items of income, deductions and credits allocable to the disposed part of the activity. Taxpayers must keep separate books and records for the disposed part. How passive activities are grouped by the taxpayer can determine whether a complete or partial disposition has occurred.