CARRYOVER OF TAX ATTRIBUTES

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CARRYOVER OF TAX ATTRIBUTES

• The statutory scheme is found in 382, governing
  net operating losses( NOLs), 383, carry over of
  credits (no longer of much application) and 384,
  Built in losses (BILs) and Built in gains (BIGs)
• In addition,269 prohibits the use of an NOL
  where tax avoidance is the principal motive of an
  acquisition.
• A third set of rules not found in the code but
  present in the regulations applies to
  parent-subsidiary corporations filing
  consolidated returns.

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LIBSON SHOPS

• 17 brother sister corps merged some had NOLs,
  and the surviving corporation reduced its post
  merger income by the NOLs IRS challenges that
  deduction.
• The court bought the IRS argument that the NOLs
  can only be used against the future income of the
  corporations that produced the loss.
• The congressional committee reports issued when
  the last revisions to 382 were enacted state
  that Libson Shops has been overruled, and that is
  true except its theory still exists in the
  consolidated return area.

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STANGE COMPANY V CIR

• There was no ownership change here, but merely a
  tax avoidance scheme. For that reason only 269
  applies.
• MGI corporation (with NOLs) and April,
  brother-sister corporations, were merged each
  had substantially the same stockholders. IRS
  said the motive was tax avoidance, but the tax
  court found some business reasons. Looks weak to
  me.
• Court found that tax avoidance, while present,
  was not the principal motive. Other motives
  included supplying capital to MGI, economy of
  administration and serving as an acquisition
  vehicle.

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382 LIMITATIONS

• There are two type of changes that trigger the
  limits on NOLs of 382.
• Ownership changes, that is, purchases, which
  includes
• Purchase for cash from target stockholders
• 351 contributions for stock when the new
  stockholders have 80 control
• Exercise of stock conversion rights, or,
• Redemptions

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382 LIMITS, CONT

• The other kind of change of ownership is called
  equity structure shifts, i.e.,acquisitive
  reorganizations
• Equity structure shifts are any one of the
  following
• Mergers, that is A reorganizations
• Stock for stock acquisitions, that is B
  reorganizations
• Assets for stock, that is C reorganizations.
• Non-divisive D reorganizations, as in Ringwalt
  and Berghash, p. 757.

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EXAMPLES OF THE UTILIZATION OF NOLs

• A loss corporation acquires profitable assets
  and uses its losses against future income. There
  is no limit on the use of the net operating
  losses.
• Brother and Sister corps merge Harry owns all
  the stock of each. One has an NOL. Could be a
  problem under 269 which requires a business
  purpose for the merger. This is the fact
  situation of the Stange case.
• A loss corporation acquires a profitable
  corporation and uses its NOL against future
  income of the group no matter how organized.
  There is no limit on the use of the NOL by the
  Loss corporation.
• A profitable corporation acquires a loss
  corporation in a B reorg, and pumps profitable
  assets into Loss. 382 will limit the amount of
  the yearly NOL.

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EXAMPLES CONTINUED

• A profitable corporation acquires a loss
  corporation and they file a consolidated return.
  The consolidated return regulations limit the use
  of the NOL in much the same manner as the court
  held in Libson Shops.
• The change in ownership, be it a cash purchase
  or a reorganization, must exceed 50 or there is
  no 382 adjustment.
• To make the adjustment, you simply value the loss
  corporation and then multiply that value by the
  IRS announced tax exempt interest rate the
  result is the yearly limit on the use of the NOL.
  Unused amounts carry over to future years until
  the NOL expires.

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PROBLEM 13-1, 2 AND 3, p. 635,636

• 13-1 a Yes, if the sale occurs within 3 years.
  b no, the sale to a third party is ignored.
• 13-2 no, if it was a failed reorganization it
  would be treated like a cash acquisition.
  However, any gain could be offset by the NOL.
• 13-3 no, Greggs interest shrinks from 100 to
  40 so there has been an ownership change.

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Ltr. Rul. 9226030 AND 200245006

• The first letter ruling not in this edition
  holds that a father and son are a single person
  for ownership shift status so no change occurs
  when dads stock is all redeemed and son becomes
  the sole shareholder. Accordingly there is no
  limit on any NOL.
• The second ruling announces that an ownership
  shift occurs when a brother sells all his stock
  to another brother because there is no family
  attribution between siblings in 318. The area
  is not without confusion, for if one of their
  parents were alive there probably would be
  attribution and the brothers would be treated as
  a single person.

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PROBLEM 13-5 p. 642

• Answers are as follows
• a.1. Yes, there is an ownership change
• 2. a peculiar rule everyone
  has less than 5.
• 3. No there is no ownership
  change nobody has more than 5 of the stock so
  they are all a single stockholder.
• b.1. i. Yes there is an
  ownership change Jay goes from 100 to 20 Kay
  now has 80
• ii. No, Jay goes from
  100 to 60, Kay has 40.
• 2. i. No.
• ii. No. The form of the reorg is
  immaterial.

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PROBLEM 13-5 CONT

• 3. i. Yes, there is an ownership change Jay
  goes from 100 to 20 Kay has 80
• ii. No Jay goes from 100 to 60 Kay has
  40.
• 4. Jay and Kay, father and son, would be treated
  as a single person and there would be no
  ownership change in any of these examples.
• c Gratuitous transfers are ignored, such
  as gifts, inheritances and divorce awards.

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PROBLEM 13-6,7 p 644

• In year 6 the limit is the total earnings,
  100,000 so only that amount can be used. In
  year 7, the disallowed from year 6 amount is
  carried over, so the total allowed in year 7 is
  200,000100,000300,000
• Problem 13-7 Assume the NOL is from year 19.
• (a) 1 2 none the acquiring corporation must
  use the acquired assets for 2 years. 3.
  210,000, i.e. the full allowable amount the 2
  years have elapsed since the acquisition. (b)
  none, in year 23, as the NOL has expired.

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PUBLIC GROUPS AND THE 5 RULE

• Few problems arise in this area, as virtually all
  such acquisitions involve closely held
  corporations.
• Say a publicly held corporation has an NOL, and
  merges with Loss corporation and no shareholder
  has 5 or more of the stock.
• Still, there will be an ownership change unless
  the stockholders of the loss corporation have 50
  or more of the surviving corporation. All loss
  shareholders are treated as a single person.

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Footnote 1, page 645

• 382 does largely eliminate trafficking in loss
  carry forwards. Think of it this way the target
  is worth 1,000,000 and the published rate for
  the NOL carry forward limitation is 5. Unless
  the Acquiring company can make a good return on
  the assets acquired, all it can expect is to
  reduce taxes each year by 50,000. That is not a
  good return on equity for a successful business.

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BUILT IN GAINS LOSSES p. 645

• The amount of any built-in-gain BIG increases
  the yearly net operating loss limitation when the
  BIG asset is sold.
• If a company acquires a loss corp with a BIG, it
  cannot use the NOL against the BIG for 5 years.
  An appraisal of the assets at the time a target
  is acquired is important.
• The amount of any BIL is allowed only up to the
  value of the corporation. See also, Canaveral v
  CIR, 61 TC 520 (1974) In that case a corporation
  owned a yacht with a basis of 769,000 the
  corporation was acquired in a B reorg. by a
  Canaveral, Inc. for stock worth about 170,000.
  \Canaveral later sold the yacht for 250,000 and
  claimed a loss of 519,000. The tax court held
  that the basis of the yacht for sale purposes was
  limited to the value of the Canaverals stock
  used to acquire the yacht corporation. The case
  was decided before the 384 limits were enacted.

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CONSOLITATED RETURNS p. 647

• If a parent owns a subsidiary corporation that
  has an NOL, the parent could liquidate the
  subsidiary tax free (332) and the loss, subject
  to any 382 limits, will inure to the parent
  corporation.
• Another way to use the loss is to file
  consolidated returns, an election available when
  the parent has 80 control of the subsidiary
  brothersister corporations cannot file
  consolidated returns.
• Each of the parent-subsidiary corporations must
  elect to file consolidated returns the parents
  taxable year becomes the taxable year for the
  group.

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CONSOLIDATED RETURNS

• Intercompany transactions, like sales, rents, and
  dividends are eliminated in calculating the
  income of the consolidated group. Essentially
  the entire group is treated like a single
  corporation. One result of consolidated returns
  is a 100 dividend received deduction.
  Actually, the dividends are eliminated from the
  parent's income.
• The parents basis in the stock of the subsidiary
  will increase with the subsidiarys income, and
  decrease with the subsidiarys losses.
• Most eligible Parent-Subsidiary groups elect
  consolidated return reporting.

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CONSOLIDATED RETURNS, NOL LIMITS

• There are two kinds of limits on the use of NOLs
  following the formation of a consolidated group.
  These limitations are known as Consolidated
  Return Change of Ownership (CRCOs) and Separate
  Return Year Limitation (SRYLs).
• Say a parent acquires a sub on August 1 the sub
  had losses from January 1 to August 1. The parent
  and subsidiary elect to file consolidated
  Returns on August 1 the loss up to August 1 can
  only be used against the subs income for that
  year and future years, like in Libson Shops.
  This is a CRCO.

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SEPARATE RETURN YEAR LIMITATION (SRYL)

• A 100 controlled subsidiary corporation filed a
  separate return for last year reporting a loss of
  1 million.
• On January 1 of this year consolidated return
  filing is elected the NOL from last year is
  only allowed against the subsidiarys future
  income. Again this is identical to the Libson
  Shops doctrine which Congress said it repealed.
• These rules (CRCOs SRYLs) do not come from the
  statute, but from IRS regulations concerning
  consolidated return reporting that predate the
  enactment of 382.

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BERCY INDUSTRIES

• Bercy, Inc. is the target, to be acquired by
  Beverly corp. Beverly forms a subsidiary and the
  subsidiary merges with Bercy on April 23. The
  subsidiary is the surviving corporation in the
  merger it is called New Bercy. From that date
  to the end of the year the subsidiary incurs a
  loss on the Bercy assets, and carries the loss
  back to Old Bercys pre-merger income despite a
  statute to the contrary, the court allows the
  carryback.

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BERCY CONTINUED

• Had Old Bercy survived the merger, the loss would
  have been allowed by the code i.e., it would
  have been a reverse triangular merger. Perhaps
  the court had this in mind when it refused to
  follow the literal language of the statute.
• Note the reference to disallowing a carryback in
  a CERT acquisition, footnote 5, p.651. This is
  Congress's response to junk bond acquisitions.
  Corporate Equity Reduction Transaction CERT
  means that junk bonds were used to buy out the
  stockholders, like in the RJR Nabisco example I
  used. The interest on those bonds cannot create
  a carry back loss, but can create a carry forward
  loss.

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ACQUISITION OF AN S OR OTHER ENTITY

• Can a taxpayer save on his taxes by acquiring an
  S corporation or a partnership with a history
  of losses? Why not?
• What if Larry Loser enters into matrimony with
  Mary Moneybags, and he brings an NOL into the
  marriage. Can Mary deduct Larrys NOL against
  her post-marriage income on their joint income
  tax return?

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