Corporate Taxation Chapter Twelve: Corporate Attributes

Presentation: Corporate Taxation Chapter Twelve: Corporate Attributes Professors Wells April 12, 2017

Chapter Twelve p.563 Basic Overview Fundamental provisions are as follows: 1) 381 target corporation s tax attributes follow its assets in a taxfree reorganization (other than B and E reorganizations) and taxfree liquidations of subsidiaries. 2) 382 & 383 restrict the carryforward of NOLs and other other losses and credits following a change of ownership. 3) 269 allows IRS authority to disallow deductions, credits, or other allowances where target corporation stock or assets are acquired with a principle purpose of obtaining tax attributes. 2

Section 381 Carryover Rules p.564 General Rule of 381(a): tax attributes of target carryover to acquierer in asset reorganizations and tax-free liquidations. Exception in 381(c)(2): hovering deficit rule. Target s acquired E&P deficit cannot be used to offset pre-acquisition positive E&P of Acquiring. 1. Target deficit can only offset post-acquisition Accumulated E&P. 2. Note that post-acquisition current E&P is not offset by Accumulated E&P and would have nimble dividend. Shareholder 100x Loss Co A Reorg. Profit Co E&P Deficit= <$100x> Pre-Acq. E&P = $100x 3

Section 381 Carryover Rules for NOLs p.565 381(c)(1) provides that Loss Target s NOLs generally carryover to the Acquiring Corporation. Exception #1: 381(b)(3) provides that the Acquiring Corporation cannot carryback Target Corporation s NOLs to the Acquiring Corporation s pre-acquisition years to get a refund of pre-acquisition tax amounts. Exception #2: 382 provides that the usage of NOLs are limited after an ownership change. 4

Problem 1(a) p.566 FACTS: P acquires Target assets in a C reorganization in Year 1. P has Acc. E&P of $30,000 and Current E&P of $20,000. T has an E&P Deficit of $50,000. P distributes $20,000 cash to its shareholders in Year 1. P Shares T S/Hs Liquidation T stock Target P Shares Exchange Target Assets E&P Deficit=($50,000) RESULT: 1. Dividend out of current E&P of $20,000 (nimble dividend). P S/Hs Year 1: $20,000 2. In Year 2, hovering deficit is still $50,000. This hovering deficit can only wipe out subsequent additions to accumulated E&P. P T Assets Pre-Acq. Acc. E&P= 30,000 Current E&P=20,000 5

Problem 1(b) p.566 FACTS: Same facts as (a) except P breaks even in Year 1 and Year 2. P distributes $20,000 in Year 2. RESULT: Dividend of $20,000 out of P s Acc. E&P. Hovering T deficit is not allowed to offset preacquisition accumulated E&P of P by reason of 381(c)(2). P Shares T S/Hs Liquidation T stock Target P Shares Exchange Target Assets E&P Deficit=($50,000) P S/Hs Year 2: $20,000 P T Assets Pre-Acq. Acc. E&P= 30,000 Year 1 E&P=0 Year 2 E&P=0 6

Problem 1(c) p.566 FACTS: Same facts (b) except P has current E&P deficit in Year 1 of $10,000 and and breaks-even in Year 2. P distributes $20,000 in Year 2. RESULT: Dividend of $20,000 out of P s Acc. E&P. P s Year 1 current E&P deficit reduces its accumulated E&P to $20,000 but the inherited T hovering E&P deficit is not allowed to offset pre-acquisition accumulated E&P of P by reason of 381(c)(2). P Shares T S/Hs Liquidation T stock Target E&P Deficit=($50,000) P Shares Exchange Target Assets P S/Hs Year 2: $20,000 P T Assets Pre-Acq. Acc. E&P= 30,000 Year 1 E&P Deficit=<10,000> Year 1 Acc. E&P 20,000 End of Year 1 E&P=0 7

Problem 1(d) p.566 FACTS: Same facts (b) [so, P has $10,000 of remaining pre-acquisition Acc. E&P after Year 2 distribution of $20,000] except P has a $10,000 current E&P deficit in Year 3 and makes a $20,000 distribution in Year 3. What is the result of the Year 3 distribution? RESULT: The inherited T hovering E&P deficit is not allowed to offset pre-acquisition accumulated E&P of P Shares T S/Hs Liquidation T stock Target P Shares Exchange Target Assets E&P Deficit=($50,000) P S/Hs Year 2: $20,000 Year 3: $20,000 P T Assets Pre-Acq. Acc. E&P= 30,000 Year 1 E&P=0 Year 2 E&P=0 Year 3 Acc. E&P=10,000 Year 3 E&P=<$10,000> P by reason of 381(c)(2). P has a $10,000 pre-acquisition accumulated E&P at the beginning of Year 3 and a Year 3 current year E&P deficit of $10,000. The current year E&P deficit is prorated per Rev. Rul. 74-164. Since last day of year, all $10,000 of Year 3 current E&P reduces Acc. E&P to zero. 8

Problem 1(e) p.566 FACTS: Same facts as in (d) except P has a $20,000 current E&P in Year 4 and makes another $20,000 distribution in Year 4. What is the result of the Year 4 distribution? RESULT: P has a $20,000 current E&P in Year 4 and thus has a nimble dividend in Year 4 by reason of 316(a)(2). P Shares T S/Hs Liquidation T stock Target P Shares Exchange Target Assets E&P Deficit=($50,000) P S/Hs Year 2: $20,000 Year 3: $20,000 Year 4: $20,000 P T Assets Pre-Acq. Acc. E&P= 30,000 Year 1 E&P=0 Year 2 E&P=0 Year 3 E&P=<10,000> End of Year 3 Acc. E&P = 0 Year 4 E&P=20,000 9

Problem 1(f) p.566 FACTS: Same facts as in (e) [P T S/Hs distributes $20,000 in Year 1 & 2 but no distribution in Year 4] and breaks-even in Year 4. P distributes $40,000 in 2014. What result for the 2014 distribution? Target P Shares Liquidation T stock P Shares Exchange Target Assets P S/Hs Year 1: $20,000 Year 2: $20,000 Year 3: 0 Year 5: $40,000 RESULT: P finally is going to be able to use some of the inherited T hovering E&P deficit. The Year 4 post-acquisition E&P of $20,000 is offset by $20,000 of the T hovering E&P deficit. So, in Year 5, there remains $30,000 of inherited T hovering deficit. In Year 5, P has no remaining accumulated E&P and no Year 5 current E&P, so the $40,000 distribution is not a dividend. It would be return of capital to the extent of basis per 301(c) (2) and thereafter creates capital gain by reason of 301(c)(3). E&P Deficit=($50,000) P T Assets Pre-Acq. Acc. E&P= 30,000 Year 1 & 2 E&P=0 Year 3 E&P=<10,000> End of Year 3 Acc. E&P=0 Year 4 E&P=20,000 Year 5 E&P=0 10

Problem 2(a) p.567 FACTS: T merges into P on August 31 (2/3 rd of year). P has <$30,000> current E&P deficit and T has Acc. E&P=$30,000. P distributes $20,000 next year and breaks-even next year. T Pre-Acq. E&P = $30x 2/3 rd of Year A Reorg. Shareholder P Next Year: 20x Cur. E&P Deficit <$30x> RESULT: P has $20,000 of its $30,000 of current E&P deficit that occurs pre-acquisition. This $20,000 portion of the pre-acquisition E&P deficit of P cannot be used to reduce T s pre-acquisition E&P, but the $10,000 current E&P deficit can be used per 381(c)(2)(B). As of the beginning of next year, P has Acc. E&P of $20,000 ($30,000 - $10,000 post-acquisition deficit) and P has a hovering deficit of $20,000. The P distribution is a dividend in full. 11

Problem 2(b) p.567 FACTS: Same as (a) except P has $30,000 current earnings and profits for the year and T has a $30,000 E&P deficit at the time of the acquisition. P distributes $20,000 next year and breaks-even next year. T 2/3 rd of Year A Reorg. Pre-Acq. E&P Deficit = <$30x> Shareholder P Next Year: 20x Current E&P E&P = $30x RESULT: Same result under 381(c)(2)(B). The direction of the merger parties (between loss co and profit co) does not change the result. 12

Problem 2(c) p.567 FACTS: Same as (b) except P distributes $30,000 on the last day of the year of the acquisition. T 2/3 rd of Year A Reorg. Pre-Acq. E&P Deficit = <$30x> Shareholder Same Year: 30x P Current E&P E&P = $30x RESULT: The full $30,000 would be a dividend. T has a prereorganization deficit which is subject to limitation by reason of 381(c) (2)(B). However, P has $30,000 of current E&P and that alone is sufficient to fund the dividend per 316(a)(2). As a result, P has a $30,000 hovering deficit that remains available at the beginning of the next year. 13

Problem 3(a) FACTS: T merges into P on Dec. 31 of Year T S/Hs 3 in an A reorganization. T shareholders receive 51% of the outstanding P stock. P & T T had been in existence for two years with T sustaining a $20,000 loss in Year 1 & 2 and P earning a profit of $30,000 in Year 1 & 2. 51% P Shares 12/31/2010 A Reorg. Pre-Acq. E&P Year 1: <$20x> Year 2: <$20x> P p.567 Pre-Acq. E&P Year 1: $30x Year 2: $30x Question: Can P carryback T s losses against P s profits for Year 1 and 2? Answer: No. T may carry back the losses to its own corporate structure under 172. Section 381(c)(1)(A) allows only a carryover to P. 14

Problem 3(b) p.567 FACTS: Determine combined net income for Year 4 assuming loss pattern continues. Answer: $10,000 per year from Year 1 through Year 4. T s pre-acquisition NOL can be used to offset the taxable income on carryforward basis. T S/Hs T 51% P Shares 12/31/2010 A Reorg. Pre-Acq. E&P Year 1: <$20x> Year 2: <$20x> P Pre-Acq. E&P Year 1: $30x Year 2: $30x 15

Problem 3(c) p.567 FACTS: Same as (b) except T is profitable with net income of $20,000 in each of the prior and current years but P sustained a $100,000 loss in Year 4 followed by a return to regular profitability in Year 5. T S/Hs T A Reorg. Pre-Acq. E&P Year 1: $20x Year 2: $20x 51% P Shares 12/31/2010 P Pre-Acq. E&P Year 1: $30x Year 2: $30x Year 4: <$100x> RESULTS: P loss can be carried back on P s prior returns but not for T s prior returns because 381(b)(3) precludes carryback to T. 16

Problem 3(d) p.567 FACTS: Same as (c) except T & P consolidate into new company C. C sustains $100,000 loss in Year 1 and $50,000 of profits in Year 2. P A Reorg. C A Reorg. T Pre-Acq. E&P Year 1: $20x Year 2: $20x Pre-Acq. E&P Year 1: $30x Year 2: $30x Year 4: <$100x> RESULTS: Now a carryback to both corporations is precluded by 381(b)(3) because both are transferor corporations. Thus the $100,000 loss carryover would only offset future income, i.e., the $50,000 of income in Year 2 and Year 3. 17

Section 382 Limitation on NOL Carryforwards p.568 Policy Concern: Congress does not want trafficking in Loss Companies or to have Profitable Companies to be overly motivated to buy the tax attributes of Loss Companies. Congressional Response: 382 limits the ongoing usage of net operating losses if the Loss Company has experienced an Ownership Change. 18

Section 382 Ownership Change p.571 382(g) provides that an ownership change occurs if there is either an owner shift involving 5% shareholders or an equity structure shift. A. Owner Shift of 5% Shareholders: The percentage ownership of a Loss Corporation by 5% or greater shareholders is increased by 50% over the lowest percentage of stock of the loss corporation owned by such shareholders. 1. Ownership shift can occur by reason of purchase, redemptions, 351 transfers, issuances of stock, and recapitalizations. 2. However, owner shifts by reason of gift, death, or divorce are not counted. See 382(l)(3)(B). B. Equity Structure Shift: Includes any reorganization including taxable acquisitions and public offerings that creates an owner shift See 382(g)(2) and (4)(B). 19

Section 382 p.574 Garber Industries Holding v. Commissioner Kenneth & Charles are brothers and so their stock is not attributed to each other under 318(a)(1) as they are siblings. Kenneth 26% 65% July 1996 0% April 1998 Charles 68% 19% 84% Charles purchase creates an ownership change because we take his lowest ownership (19%) in the testing period and compare it to his highest ownership (84%). This is more than a 50% owner shift. Kenneth had a similar 50% owner shift moving from 65% down to zero. Garber Industries 20

Section 382 NOL Poison Pill Plan If any shareholder acquires 4.9% or more stock without pre-approval by the board of directors of the company, then all other historic remaining shareholders have the right to acquire stock at 50% of its FMV to keep the new shareholder from becoming a 5% shareholder. Rationale: Prevent risk of creating an ownership change that would cause a Section 382 limitation on the NOLs of the company. Notable NOL Right Plans: Citibank, General Motors, Ford, JC Penny, AIG. Delaware Court of Chancery decision has upheld such rights plans was a reasonable means to defend the company s value. See Selectica, Inc. v. Versata, Inc., Civ. A. No. 4241, 2010 WL 703062 (Del. Ch. 2010). 21

Problem 1(a) p.585 FACTS: Loss has 100 shares of common stock owned equally by Shareholders 1 through 25 who are not related to one another. Loss has assets worth $1,000,000 and an NOL of $8,000,000. Will the Section 382 loss limitations apply if all shareholders sell their stock to J? Shareholders Loss Corp 100% L shares Julie RESULT: Ownership change under 382. None of the old L shareholders have an owner shift, but J increases her ownership from 0% to 100% and this represents more than a 50% owner shift per 382(g)(2). J is a 5% shareholder within the meaning of 382(k)(7). 22

Problem 1(b) p.585 FACTS: Same as (a) except only Shareholders 1-13 sell their shares to Julie. S/Hs (14-25) S/Hs (1-13) Julie 52% shares Loss Corp RESULT: Ownership change under 382. J s ownership has gone from zero to 52% and this represents more than a 50% owner shift per 382(g) (1). J is a 5% shareholder within the meaning of 382(k)(7). 23

Problem 1(c) p.585 FACTS: Same as (a) except only Shareholders 1-12 sell their shares to Julie. S/Hs (14-25) S/Hs (1-12) Julie 48% shares Loss Corp RESULT: No ownership change under 382. J s ownership has gone from zero to 48%. J is a 5% shareholder, but the change in 5% shareholders is less than the 50% owner shift threshold in 382(g)(1). J is a 5% shareholder within the meaning of 382(k)(7). 24

Problem 1(d) p.585 FACTS: Same as (c) except Loss Corp redeems Shareholders 13 & 14 two years later. S/Hs (13-14) S/Hs (15-25) S/Hs (1-12) Julie 48% shares Loss Corp RESULT: Ownership change under 382.. When shareholders 13 and 14 are redeemed, only 92 shares remain outstanding. Since J owns 48 of the 92 shares, her ownership at this point exceeds 50 percent. Because the stock purchases by J and the redemptions occurred within a single three year period, the "testing period" is the three year period ending on the date of the redemption. 382(i)(1). Even though the redemptions of the stock of Shareholders 13 and 14 directly involved only shareholders who were less than 5-percent shareholders, the redemptions resulted in an owner shift involving a 5-percent shareholder under 382(g)(1). 25

Problem 1(e) p.585 FACTS: Same as (c) except Shareholders 13 sells her stock to new Shareholder 26. S/H (26) S/Hs (13) S/Hs (14-25) S/Hs (1-12) Julie 48% shares Loss Corp RESULT: No ownership change under 382. Both Shareholder 13 and new Shareholder 26 are less than 5% shareholders. Any stock owned by them is therefore deemed to be owned by a single 5% shareholder comprised of the whole group of less than 5% shareholders. See 382(g) (4)(A). 26

Problem 1(f) p.585 FACTS: Same as (e) except Shareholders 13 & 14 sell their stock to new Shareholder 26. S/H (26) S/Hs (13-14) S/Hs (15-25) S/Hs (1-12) Julie 48% shares Loss Corp RESULT: An ownership change under 382. Both Shareholder 13 and new Shareholder 26 are less than 5% shareholders. Any stock owned by them is therefore deemed to be owned by a single 5% shareholder comprised of the whole group of less than 5% shareholders. See 382(g) (4)(A). 27

Problem 1(g) p.585 FACTS: Suppose Shareholders 1-25 sold their shares to Shareholders 26-50. S/Hs (1-25) 100% shares Loss Corp S/Hs (26-50) RESULT: No ownership change under 382 even though all of the stock has changed hands in this variation. All of the stock was owned by the less than 5-percent shareholders, who constitute a single 5-percent shareholder under 382(g)(4)(A). After the stock sales, all the stock is still owned by the single group of less than 5-percent shareholders. 28

Problem 2 p.585 FACTS: Loss Corp distributes 51% ownership to Gain Corp shareholders in a C reorganization. L Shares T S/Hs Liquidation G stock Gain Corp 51% L Shares Exchange Bill T S/Hs Loss Corp 51% Gain Corp Assets RESULT: An ownership change under 382. After the reorganization, the prior less-than-5-percent shareholders of Gain, as a group, own just over 50% of the stock of Loss Under 382(g)(4)(A) and (B), the group of less than 5-percent shareholders of Gain are treated as a single shareholder and the prior group of less than 5-percent shareholders of Loss are treated as a separate single shareholder. Reg. 1.382-2T(j)(2)(iii)(B)(1). The Gain group has increased its ownership from zero to more than 51% of Loss and an ownership change has occurred with the result that the 382 limitations become applicable. 29

FACTS: Whale purchases all of the stock of Minnow for cash. Problem 3 p.585 Minnow S/Hs Whale Minnow RESULT: An ownership change under 382. 382(g)(4)(B)(i) provides that in an equity structure shift the group of less than 5% shareholders of each corporation is treated as separate 5% shareholders. 382(g)(4)(C) provides that a rule similar to the segregation rules in 382(g)(4)(B) apply to acquisitions by groups of less-than-five-percent shareholders in this context. Thus, the group of less than 5% shareholders of Whale would be treated as separate from the group of less than 5% shareholders of Minnow Co which had its ownership of Minnow go from 0 to 100%. 30

Section 382 Results of an Ownership Change p.585 Policy Concern: Congress does not want trafficking in Loss Companies or to have Profitable Companies to be overly motivated to buy the tax attributes of Loss Companies. But, Congress wanted to allow the corporation to use its losses to offset the income from its own business. 382 does this through two limitations: Continuity of Business Enterprise Limit ( 382(c)): Disallows NOLs if the old loss corporation business is not continued for at least two years after the ownership change. 382 Limitation: NOLs can only be used in any post-change period only to the extent of the value of the Loss Corporation multiplied by the long-term tax-exempt rate. 31

Section 382 Limitation p.586 Carryforward of Unused Limitation. Just like NOLs can be carried forward, 382(b) allows unused 382 limitation in the current year to be carried forward to be added onto the limit in the next year. Mid-Year Ownership Changes (annual limit is proportionately reduced if the acquisition happens for part of the year. Long-Term Rate is published by IRS monthly. Value of Company is determined by appraisal. There are various antistuffing rules to prevent artificial inflation of the Loss Corp s value. Limit on Built-In Losses. Assets with unrealized built-in losses are also subject to 382 s limitation. The objective here is to prevent this excess depreciation from being able to be deducted post-ownership change. 32

Section 382 Limitation 382(h) s Built-In Gains & Losses p.590 Unrealized Built-In Gains (UBIG) that are recognized during the fiveyear recognition period (an RBIG) is allowed to increase the 382 limitation dollar-for-dollar to the extent that the Loss Corp had a net unrealized built-in loss (a NUBIG). Note: One would think that there must be an actual recognition of the built-in gain during the 5-year testing period when one reads the plain meaning of the statute, but the IRS in Notice 2003-65 identifies items of RBIG and RBIL by comparing the loss corporation's actual items with those that would have resulted if a section 338 election had been made with respect to a hypothetical purchase. As a result, under the 338 approach, built-in gain assets may be treated as generating RBIG even if they are not disposed of at a gain during the recognition period, and deductions for liabilities, in particular contingent liabilities, that exist on the change date may be treated as RBIL. 33

Problem 1(a) & (b) p.591 FACTS: Loss Corp has NOLs of $10 million. It has assets worth $10 million and liabilities of $2 million. L S/Hs $8.5 million of P Stock Loss A Reorg Profit (a) On January 1, Year 1, Profit Co acquires all of Loss assets in a merger of Loss into Profit where Loss shareholders receive Profit stock worth $8.5 million. The long-term taxexempt rate is 5%. Assuming the Loss Co business is continued, to what extent can Profit deduct Loss s loss carryforwards in 2011? (b) Does it matter if Profit buys Loss with cash? Result: (a) An ownership change as a result of an equity structure shift. 382(g)(1) and (3). The 382(b)(1) limitation is $425,000 (5% long-term tax-exempt rate x $8.5 million). See 382(c)(1). (b) No change. 34

Problem 1(c) p.591 FACTS: What result in (a) above if Profit s taxable incme, disregarding any loss carryforward, were $300,000 in Year 1? L S/Hs $8.5 million of P Stock Loss A Reorg Profit Result: The same $425,000 limitation of 382(b)(1) is applicable here. But, only $300,000 of losses are needed to offset all of the Year 1 income. So, 382(b)(2) allows a carryover of the $125,000 excess unused Year 1 382 limitation to be added to the limitation in Year 2 for any overall limitation of $550,000 (i.e., $425,000 + excess $125,000). 35

Problem 1(d) p.591 FACTS: What result in (a) above if Profit discontinues the Loss business and disposes of its assets? L S/Hs $8.5 million of P Stock Loss A Reorg Profit Result: Since the continuity of business enterprise requirements are not met, 382(c) would disallow any NOL carryover. Worse yet, the merger itself is a taxable event to all parties because the judicial doctrine of continuity of business enterprise requirement would not be satisfied. As a result, there would be no 381 carryover of Loss s net operating losses regardless of 382(c). 36

Problem 1(e) p.591 FACTS: What result in (a) above if the mergr occurs on June 30 in Year 1? Assume the June 30 date is halfway through each corporation s taxable year. L S/Hs $8.5 million of P Stock Loss A Reorg Profit Result: Under 382(b)(3)(B), the limitation for Year 1 would be reduced by 50% to $212,500 since only one-half of the days remain for the year to which the equity shift occurred. The limitation would be $425,000 for Year 2 and each subsequent year. 37

Problem 2(a) p.591 FACTS: Loss has $10 million NOL and the following assets: Basis FMV Equipment $2,000,000 $4,500,000 Land $6,000,000 $3,000,000 IBM Stock $2,000,000 $2,000,000 Cash $ 500,000 $ 500,000 $10,500,000 $10,000,000 L S/Hs Loss $8.5 million of P Stock Exchange Assets & Liabilities Profit On January 1 in Year 2, Loss transfers its assets and liabilities to Profit in exchange for Profit stock worth $8.5 million. The longterm tax-exempt rate is 5%. If the Loss business is continued, to what extent an profit deduct the Loss NOL in Year 1? Result: Loss s NOL carryforward can be deducted to the extent of 5% of $8.5 million (the assumed value of the Loss stock or $425,000 each year as it appears that no 382(h) adjustment applies. 382(b)(1).

Problem 2(b) p.591 FACTS: What result in (a) if the stock and cash had been contributed to the capital of Loss on November 1 of Year 1? L S/Hs $2.5 million Loss $8.5 million of P Stock Exchange Profit Assets & Liabilities Result: The 382(l)(1) anti-stuffing rule would apply. Any capital contribution by the Loss shareholders as part of a plan to increase the 382 limitation is not to be taken into account for purposes of determining the value of Loss Under 382(l)(1), any contribution within the two years prior to an ownership change is presumed to be pursuant to such a plan. Thus, Loss s value, for purposes of determining the usable loss carryforward would be reduced by $2.5 million to $6 million and the 382 limitation would be $300,000 per year. 39

Problem 2(c) p.591 FACTS: What result in (a) if the IBM stock had a value and basis of $5 million? L S/Hs $2.5 million Loss $8.5 million of P Stock Exchange Profit Result: Loss would have $5 Assets & Liabilities million of non-business assets (i.e., investment assets). See 382(l)(4)(C). In that case, the 382(l)(4) reduction in value rules would apply. Since $5 million out of a total of $13.5 million worth of assets are nonbusiness assets, at least 1/3 rd of the value of the total assets of Loss consists of nonbusiness assets. See 382(l)(4)(B)(i). As a result of the application of 382(l)(4), the value of the loss corporation for purposes of 382(b) computation is reduced by the value of the investment assets minus the liabilities attributable to those assets. 40

Problem 2(d) p.591 FACTS: What result in (c) if IBM were a wholly-owned subsidiary of Loss? Result: If the $5 million worth of IBM stock owned by Loss were stock of a wholly-owned subsidiary, L S/Hs $2.5 million Loss $8.5 million of P Stock Exchange Assets & Liabilities Profit 382(l)(4)(E) would apply. Under that section, if a parent owns at least 50% of the stock of a subsidiary then that stock is not treated as an investment asset for purposes of 382(l)(4) but the subsidiary corporate shell is pierced to determine the amount of the underlying investment assets. In this case, assuming the subsidiary is not filled with investment assets, the limit which applied in part (c) would no longer be applicable with the consequence that the 382(b) limit would be 5% of $11.5 million ($13.5 million value less $2 million liability or $575,000. 41

Problem 2(e) FACTS: What result in (a) if Profit acquires 70% of the Loss stock for Profit stock on January 1 and the IBM stock and the cash are distributed to Joe, a 30% shareholder of Loss on March 1 in redemption of his stock? L S/Hs $2.5 million Loss $8.5 million of P Stock Exchange Assets & Liabilities p.591 Profit Result: Under 382(e)(2), a redemption in connection with an ownership change (even if it were merely contemplated at the time of the change) is taken into account. In this case, the value of the Loss for purposes of applying the loss limitations is reduced by $2.5 million of assets that are distributed to Joe in redemption of his stock. Thus, the 382(b) limit is 5% of $6 million or $300,000. 42

Problem 2(f) FACTS: Will the result in (a) change if Profit sells the equipment in February? Would the answer be different if the land had a basis of zero? L S/Hs $2.5 million Loss $8.5 million of P Stock Exchange p.591 Profit Assets & Liabilities Result: Profit will have a $2.5 million recognized gain. However, Because there is no NUBIG as defined by 382(h)(3)(A), 382(h)(1)(A) does not apply. Thus, the gain is recognized and cannot be offset by any unused loss carryforwards other than those already allowed by 382(b). If the land had a basis of zero, then there would be a NUBIG in the Loss assets. Under 382(h)(1)(A), when Profit recognizes RBIB, it can increase its 382 limitation for the year by that amount and the recognized gain here is wiped out by the otherwise unused NOL carryover. 43

Problem 2(g) FACTS: Assume in (a) that the land had a basis of $8 million and that Profit sells the land for $3 million two years later. Is the loss deductible? What is Profit sells the land for $2.7 million? L S/Hs $2.5 million Loss $8.5 million of P Stock Exchange Assets & Liabilities p.591 Profit Result: Under 382(h)(3)(B)(ii), the cash and marketable securities whose value does not differ substantially from their adjusted basis are disregarded. The built-in loss (2.5 million) is greater than 15% of the net value of the relevant assets (i.e., $2.5 million is greater than $1,125,000 [15% of $7.5 million]). Thus, there is a NUBIL under 382(h)(3) and 382(h)(1) will apply. Since there is a NUBIL of $2.5 million, the RBIL on the asses of old Loss are treated as loss carryforwards and are subject to the 382 limitation. Thus, $2.5 million of the $5 million loss are subject to the 382(b) limit. See 382(h)(1)(B)(ii). 44

Other Limitation Regimes p.593 383: States that limitation regime of 382 that applies to NOLs should also apply to limit tax credits. 269: Applies a subjective test to deny the usage of tax attributes if it is determined that the the principal purpose of an acquisition of Loss Crop was evasion or avoidance of Federal income tax by acquiring the benefit of a deduction, credit, or other allowance. 384: Restricts an acquiring corporation from using its preacquisition losses to offset built-in gains of an acquired corporation. Example: L has $100,000 NOL and acquires T in an A reorganization. T s asset is sold for $100,000 of gain. 384 prevents Loss Corp from using its preacquisition NOL to offset the gain on the T asset that arose preacquisition. 45

Problem (a) p.597 FACTS: Gain has the following: Basis FMV Inventory $150,000 $300,000 Machinery $300,000 $200,000 Gainacre $100,000 $350,000 $550,000 $850,000 Loss has $500,000 NOL and sells Gainacre after the reorganization for $500,000. Result: Loss Corp. s acquisition of the Gain Corp assets in a Type A reorganization is a transaction described in 384(a)(1)(B) and Gain Corp. is a gain corporation under 384(c)(4). As a result, 384 applies. So, the income of Loss Corp. for any recognition period taxable year (see 382(h)(7)(B)) to the extent attributable to the recognized built-in gains (see 384(c)(1)(A)) may not be offset by any preacquisition loss other than a preacquisition loss of Gain Corp. 46 A Gain 20% Loss Stock A Reorg B Loss

Problem (b) p.597 FACTS: Same facts as (a) except that Loss Corp. acquired all of the Gain Corp. stock from A for cash (not making a 338 election) on January 1 after which it liquidated Gain Corp. under 332. Result: The result is the same as in (a). 384(a) applies if one corporation acquires control of another corporation and either corporation is a gain corporation. Control means ownership of stock satisfying the 80% vote and value test in 1504(a)(2). See 384(c)(5). Section 384(c)(7) provides that the 384(a) limitation applies to any successor corporation to the sae extent that it applied to its predecessor. Thus, 384 applies when Loss Corp. Sells an asset, such as Gainacre, that it acquired in a 332 liquidation. A Gain Stock Cash B Loss 47

Problem (c) p.597 FACTS: Gain has the following: Basis FMV Inventory $150,000 $300,000 Machinery $300,000 $200,000 Gainacre $100,000 $350,000 $550,000 $850,000 Gain Same as (a) except Loss Corp. sells the inventory for $400,000. Loss Result: Loss Corp. recognizes $250,000 gain. The RBIG appears to be $150,000 except 384(c)(1)(C) states that the RBIG shall not exceed the NUBIG (see 382(h)(3)(A)) reduced by the RBIG for prior years. Loss Corp. s NUBIG is $300,000 (see Problem (a)) and Loss Corp. had a $250,000 RBIG in Year 1. So, Loss Corp s RBIG in Year 2 cannot exceed $50,000 ($300,000 NUBIG less $250,000 Year 1 RBIG). Thus, Loss Corp. may not use its preacquisition NOLs to offset $50,000 of the recognized gain but the remaining $200,000 gain is not limited by 384. 48 A 20% Loss Stock A Reorg B

Problem (d) p.597 FACTS: Instead of (a) (c) above, assume Loss Corp. sells Gainacre for $900,000. A 20% Loss Stock B Result: The 384 limitation does not apply because Year 7 is not a recognition period taxable year. See 384(a). Recognition Gain A Reorg Loss period taxable year is defined by 382(h)(7) (see 384(c)(8)) as any portion of which is in the five-year recognition period beginning on the acquisition date. 49

Problem (e) FACTS: Same as (a) except that Loss Corp. has no NOL at the time of the acquisition but its only asset is Lossacre which had a fair value of $300,000 and an adjusted basis of $500,000. In Year 2, Loss Corp. sells Lossacre for $200,000 at the same time that it sells Gainacre for $500,000. A Gain 20% Loss Stock A Reorg p.597 B Loss Result: Although Loss Corp. has no NOLs, the term preacquisition loss incudes any RBIL in the case of a corporation with a NUBIL. See 384(c)(3)(B). Loss Corp. s NUBIL is $200,000. See 382(h)(3)(A)(i). Thus, $200,000 of the loss can only be used to offset the $150,000 of post-acquisition gain, not the $250,000 pre-acquisition gain. 50