Section 382 limits a loss corporation’s ability to use its Net Operating Losses (NOLs) carryforwards following an "ownership change."1 An ownership change is triggered if one or more "5-percent shareholders" of the loss corporation increase their ownership in the aggregate by more than 50 percentage points during a testing period. Following an ownership change, the "Section 382 limitation" generally reduces the ability to use NOLs to offset taxable income in any post-change year.2
A threshold question in examining if a loss company has undergone an ownership change is whether instruments issued by the corporation are treated as equity or "stock" in calculating the ownership shift. Although Section 382 defines "stock" as actual equity investments (except Section 1504(a)(4) stock), Treasury Regulations broaden the definition to include certain non-stock interests. For example, Treas. Reg. Sec. § 1.382-2T(f)(18)(iii) treats certain ownership interests as stock, regardless of title, if: (1) such interest, as of its issuance or transfer, offers potential to significantly participate in corporate growth; (2) treating the interest as stock would result in ownership change; and (3) the pre-change loss exceeds the product of the loss corporation’s value and the long-term tax-exempt rate. A loss corporation needs to evaluate all of its outstanding instruments in measuring whether or not they are stock, and thus must be included in an ownership change calculation.
IRS released PLR 2012280233 concerning the federal income tax consequences of the liquidation of a consolidated group ("Taxpayer Group"). Taxpayer Group had a consolidated NOL and subsequently, Taxpayer and several of its affiliates ("Debtors") filed for Chapter 11 bankruptcy. Under the final bankruptcy plan ("Plan"), a plan trust was created and all of Taxpayer’s stock was cancelled. The plan trust provided for the issuance of one share to be issued and held for the benefit of each former shareholder consistent with their former entitlements. After the Plan’s effective date, Taxpayer, as the plan administrator, was to wind down and liquidate Debtor assets. Though unlikely, the Plan preserved the Taxpayer’s shareholders’ right to receive a distribution in proportion to their previous stockholdings. The Debtors will ultimately be dissolved.
The IRS ruled that, under Section 382(g), there was no owner shift where the stock held in the plan trust stock replaced Taxpayer’s stock. Further, claims retained and interests received by the Debtors’ creditors are not "stock" for purposes of Section 382.4
Section 382(l)(5)(A) is an exception to the Section 382 limitation on using NOLs and applies where a loss corporation is under jurisdiction of a court in a "title 11 or similar case" and when the loss corporation’s shareholders and "qualified creditors" (as a result of their status as shareholders and qualified creditors) after the ownership change own at least 50 percent of the loss corporation’s stock (measured by both voting power and value).
Although Section 382(l)(5)(A) preserves the use of NOLs after an ownership change, there are several significant drawbacks. First, the pre-change losses and excess credits are recalculated as if no deduction was permitted for interest paid or accrued by the old loss corporation on debt that was converted into stock under a title 11 case for the part-year in which the change occurs and the three prior years.5 Second, usually when determining cancellation of indebtedness income, where corporations transfer stock to creditors to satisfy the debt, the corporation is treated as satisfying the debt to the extent of the stock’s fair market value. However, where the Section 382(l)(5) bankruptcy exception applies, the corporation does not account for indebtedness for interest paid or accrued during the year of change and the three prior years.6 Third, if there is a second ownership change during the following two-year period, the second change does not qualify for the Section 382(l)(5)(A) exception and the Section 382 limit is zero.7 Last, the stock must be transferred to a creditor in satisfaction of indebtedness, which was either held by the creditor for 18 months before the title 11 proceedings or are ordinary-business-trade creditors.8
The Taxpayer in this PLR seems to have received a unique result because it arguably received the benefits of the Section 382(l)(5) bankruptcy exception without any of the associated drawbacks. Under the PLR, the Taxpayer was allowed to avoid the Section 382 limitation because the IRS found there was no ownership change as a result of the IRS determination that the interests the creditors might receive are not "stock" for Section 382 purposes.
We note that bankruptcy scenarios are typically analyzed under Section 382(l)(5). Here, however, because of the complex litigation present in the Taxpayer’s facts, the nature of the assets held, and the depressed financial markets that the Taxpayer is subject to, it was apparently sufficiently unclear as to the exact interest in the Taxpayer that the creditors were receiving when the Plan was confirmed. Thus, the IRS may have assumed that, since the interest was unclear, no stock was conveyed and therefore, a traditional Section 382(l)(5) analysis was not required.
1 Unless otherwise stated, all references to "Section" are to the Internal Revenue Code of 1986, and all references to "Treas. Reg. Sec." are to the Treasury Regulations promulgated thereunder.
2 The Section 382 limitation is a formulaic calculation that is basically equal to the product of the value of the loss corporation (subject to certain adjustments) and the long-term tax-exempt rate. The long-term tax-exempt rate is published on a monthly basis by the IRS and can be found in IRS publications, including the Internal Revenue Bulletin. Taxpayers are required to use the long-term tax-exempt rare for the month in which the ownership change occurs when calculating their Section 382 limitation for any ownership change.
3 IRS released PLR 201228023 on July 13, 2012.
4 Treas. Reg. Sec. 1.382-2T(f)(18)(iii).
5 Section 382(l)(5)(B).
6 Section 382(l)(5)(C).
7 Section 382(l)(5)(D).
8 Section 382(l)(5)(E).
Todd Reinstein and Joshua Goldstein
Joshua Goldstein is a law clerk, resident in Pepper’s Washington, D.C. office. He is not admitted to practice law.
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