NOL Treatment on Federal Corporate and Individual Tax ...media.straffordpub.com/products/nol-treatment-on... · 6/6/2017 · To convert the taxpayer's taxable income per return (usually

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NOL Treatment on Federal Corporate and

Individual Tax Returns: Challenges for Preparers

TUESDAY, JUNE 6, 2017, 1:00-2:50 pm Eastern

FOR LIVE PROGRAM ONLY

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June 6, 2017

NOL Treatment on Federal Corporate and Individual Tax Returns

Amy Chapman, Senior Manager

KPMG, Washington, D.C.

[email protected]

Timothy M. Nichols, Esq.

KPMG, Washington, D.C.

[email protected]

John R. Dundon, II, EA, President

Taxpayer Advocacy Services, Englewood, Colo.

[email protected]




4 © 2017 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.

Notice

The following information is not intended to be “written advice concerning one or more

Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury

Department Circular 230.

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.

5

NOL’s For Individual Taxpayers

This portion of the presentation is taught by:

John R. Dundon II, EA

President, Taxpayer Advocacy Services, Inc. Fellow, National Tax Practice Institute

Direct contact information http://JohnRDundon.com [email protected] (720) 234-1177

http://johnrdundon.com/





6

NOL’s for Individual Taxpayers 4 subtopics include

• Basic Rules

• Restrictions and Allowances in Calculating

and Using NOLs

• Pass-through allocations

• Calculation of NOL carryback and carryover

periods, AND NOLD

7

Basic Rules

• In principle, a NOL generally results when a

taxpayer's business expenses exceed

income from all sources.

• Per IRC section 172, a taxpayer who

sustains this type of loss in one year can

spread the loss over several years. This may

generate refunds which can provide

additional capital.

8

To have a NOL, the loss must be caused by:

1. Deductions from a trade or business

2. Deductions for business-related expenses as

an employee

3. Deductions for casualty and theft losses,

4. Losses from a partnership or S corporation

which flow-through to the partners or

shareholders.

9

Losses from a partnership or S corporation

Partners or shareholders may be able to use

their separate shares of the partnership's or S

corporation's business income and business

deductions to figure their individual NOL.

The amount of the loss passed though to the

individual’s tax return is contingent upon the

individual’s basis in the entity.

Without basis losses are suspended.

10

STATUTE OF LIMITATIONS ON CLAIMS A claim for refund relating to a NOL carryback

generally must be filed within the later of:

3 years after the due date of the return

(including filing extensions) for the loss year; or

the period set forth in IRC section 6511(c) as to

the loss year (that is, 6 months after the

extended date for assessment set forth in an

IRC section 6501(c)(4) agreement concerning

the loss year). IRC sections 6511(d)(2)(A) and

6511(c).

11

Example A 2015 return shows a NOL of $540,000.

The due date for filing the 2015 tax return is October 15,

2016, including extensions.

The 3-year period for filing a claim for refund expires

October 15, 2018.

Remember that the 2015 return is a loss year due to the

NOL.

A claim for refund for the year 2012 (relating to a

carryback from 2015) filed after October 15, 2016, would

normally be untimely.

However, there is an exception to the general rule.

12

Exception to the general rule

Rev. Rul. 65-281, 1965-2 C.B. 444 states that

the special limitations provisions of IRC section

6511(d)(2)(A) apply in addition to the regular

limitations periods of IRC section 6511(a).

So, even if the special claims statute of IRC

section 6511(d)(2)(A) has expired, the IRC

section 6511(a) claim statute may still be open

on one or more of the carryback (gain) years.

13

Rule Exception in Plain Terms The claim statute under IRC section 6511(a) for

the carryback (gain) year expires either:

3 years from the date of filing of the carryback

year return, or

2 years after the tax is paid, whichever is later.

This claim period can be extended by an IRC

section 6501(c)(4) agreement as to the

carryback year.

14

Be Aware

1. IRC section 6511(a) or 6511(c) period as to

the carryback year, will not allow a refund if the

carryback year has already been disposed of by

a Tax Court decision.

2. However, the special limitations provisions of

IRC section 6501(c)(4) will allow such a refund

as long as the carryback issue was not raised in

the Tax Court proceeding.

15

STATUTE OF LIMITATIONS ON ASSESSMENT 1. IRC section 6501(h) provides that for deficiencies attributable to

the tentative or erroneous allowance of a NOL carryback, the

statute for assessment of such deficiencies for the carryback

year is determined by the statute of limitations on assessment

for the loss year.

But, IRC section 6501(h) covers the carryback year ONLY TO THE

EXTENT OF THE REFUND generated from the NOL carryback.

It does not protect the statute of the carryback year for any other

purpose.

However, if the refund is attributable to a tentative carryback

adjustment under IRC section 6411(a), an assessment (to the

extent of the refund) may be based not only on the disallowance of

the NOL carryback, but also on other items of income or deduction

affecting the taxpayer's tax liability for the carryback year.

IRC section 6501(k).

16

STATUTE OF LIMITATIONS ON ASSESSMENT 2. If the IRC section 6501(h) statute for the carryback

year has expired, the deficiency attributable to a NOL

carryback, as well as any other deficiencies, can be

assessed if the regular statute of limitation for the

carryback year is still open

For example, as in the case of:

1. a late filed return, IRC section 6501(c)(4)(A)

extension by agreement, or

2. IRC section 6501(c)(1) unlimited statute of limitations

for false or fraudulent return.

Calumet Industries Inc. v Commissioner., 95 T.C. 257,

279-280 (1990).

17

STATUTE OF LIMITATIONS ON ASSESSMENT

3. The statute of limitations on an assessment of

a tentatively or erroneously allowed carryback of

a General Business Credit is governed by the

year in which the unused credit originated or the

year of the net operating loss, the carryback of

which released a previously used credit.

IRC section 6501(j).

18

OVERVIEW OF NOL When a taxpayer incurs a NOL, the loss may be

carried back to reduce the tax in prior years.

Any excess amounts may be carried forward.

Based on the carryback, a taxpayer may

request a refund by filing:

a. Tentative Carryback Application (Form 1045),

or

b. Amended U.S. Individual Income Tax Return

(Form 1040X).

19

OVERVIEW OF NOL Form 1045 differs from Form 1040X:

1. Concerning the time to file,

2. Whether verification is before or after the

issuance of the refund, and

3. The method of making audit adjustments.

The background, documentation, research, and

computations are the same.

20

IRS Form 1045 1) Form 1045 must be filed within one year of the loss

year (IRC section 6411(a)).

2) Refunds based on filing Form 1045 are considered

“tentative refunds” per IRC section 6411.

After verifying the release of the refund to the taxpayer

using the Integrated Data Retrieval System (IDRS), any

adjustments can be made using regular audit Report

Writing Procedures.

The deficiency procedure in IRC section 6213(a) does

not apply to assessments arising out of tentative

carryback allowances. (IRC section 6213(b)(3)).

21

IRS Form 1040X 1. Form 1040X may be filed anytime within the later of:

3 years after the due date (including extensions) of

the loss year; or, the date as extended by an IRC

section 6501(c)(4) extension agreement for the loss

year return; or other periods referred to in Rev. Rul.

65-281. (IRC sections 6511(c) and (d)(2).

2. Refunds based on Form 1040X generally are not

released to taxpayers before the Form 1040X enters

the audit stream. Any adjustments would be made

using the claim processing procedures outlined in

IRM 4510.

22

*****IMPORTANT**** For both the Form 1045 and the Form 1040X

refund requests, the loss year and the

carryback/carryover year(s) MUST be kept

together.

RECORD RETNETION IS PARAMOUNT

KEEP ALL RECORDS BACK TO THE

ORIGINAL NOL YEAR – EVEN IF IT WAS 20

YEARS AGO!

23

CALCULATION OF NOL STEP 1: Compute Negative Taxable income

To convert the taxpayer's taxable income per return

(usually stated at zero) to true negative taxable income:

1. Subtract the standard deduction or the itemized

deductions from adjusted gross income.

2. Subtract the exemptions claimed.

3. The net result is negative taxable income. This

amount is also referred to as the “statutory” loss.

This step is necessary since the tax return will generally

not show negative taxable income.

24

CALCULATION OF NOL

Negative Taxable Income Computation

START: Adjusted Gross Income (AGI)

MINUS: Standard/itemized deductions

MINUS: Exemptions

EQUALS Negative Taxable Income

25

CALCULATION OF NOL STEP 2: Add Modifications—IRC Section 172(d)

Make modifications to arrive at the NOL.

These modifications eliminate personal

deductions.

The net result is a loss resulting solely from

business, casualty or theft.

IRC section 172(d) requires that certain items

be added back to the negative taxable income.

26

CALCULATION OF NOL Add back the following items:

1. IRC section 172(d)(1) NOLD—No NOLD

carried over or back from another year is

allowed when NOLD computing the NOL.

The NOLD is shown as an adjustment to

income on the tax return. A NOLD is the total of

any carrybacks and carryovers of NOLs from

other years. Since the computation of the net

operating loss is for the current year, it is logical

to modify items attributable to another year.

27


2. IRC section 172(d)(2)—capital gains and losses of taxpayers other than

corporations.

For purposes of the IRC section 172(c) modifications for the loss year, read

IRC section 172(d)(2) in conjunction with IRC section 172(d)(4).

Business and nonbusiness capital gains must be identified and two

separately applied limitations must be considered.

a. The nonbusiness capital losses cannot exceed the nonbusiness capital

gains, that is, any excess nonbusiness capital loss cannot offset business

capital gain.

b. The business capital losses cannot exceed:

1) The sum of the business capital gains and

2) The amount, if any, of the taxpayer's remaining excess nonbusiness

capital gains (after offset by nonbusiness capital losses and excess

nonbusiness deductions)

28

CALCULATION OF NOL

Add back the following items:

3. IRC section 172(d)(3) Deduction for Personal

Exemptions, as defined by IRC section 151,

including those for age and blindness.

29


4. IRC section 172(d)(4) Nonbusiness Deductions of Taxpayers Other Than

Corporations.

a. Nonbusiness deductions are allowable to the extent of nonbusiness

income.

b. Nonbusiness capital gains are used to offset excess nonbusiness

deductions.

1) Nonbusiness capital gains are first offset against nonbusiness capital

losses.

2) Any net nonbusiness capital gain is then used to reduce the excess of

the ordinary nonbusiness deductions over ordinary nonbusiness gross

income.

3) Any remaining nonbusiness capital gains after the reductions of 1 and 2

are used to offset business capital losses.

30

Carryback and Carryover Periods Loss Year

After the NOL has been computed, the next step is to

determine which year to carry the loss to. For tax years

beginning on or before August 5, 1997, IRC section

172(b)(1)(A)(i) provides that the NOL can be carried

back 3 years. IRC section 172(b)(1)(A)(ii) provides that

any unabsorbed NOL can be carried forward 15 years.

For tax years beginning after August 5, 1997, the

carryback period is lowered to 2 years and the carryover

period is extended to 20 years.

31

Carryback and Carryover Periods However, the change from the 3 to 2 year

carryback period does not apply to:

a. Specific liability losses. IRC section 172(f)

b. Casualty on theft losses of individuals. IRC

section 172(b)(F)(ii)

c. Losses attributable to federally declared

disasters for taxpayers engaged in a farming

business or small business. IRC section

172(b)(1)(F)(ii)

32

Carryback and Carryover Periods

IRC section 172(b)(1)(A)(i) requires that the loss be

carried to the earliest year first.

Any amount not absorbed should be carried to the

subsequent year and thereafter until fully absorbed.

In addition, a taxpayer may file claims resulting from

several carryback loss years to the same gain year.

***UNLESS AN ELECTION IS MADE IN THE YEAR OF

THE NOL TO PERMANENTLY FOREGO THE

CARRYBACK***

33

Important election under IRC172d(b)(3) If the taxpayer fails to assert the election under

IRC 172(b)(3) to permanently forego carrying

back the NOL, the IRS’ default position

procedurally is that the taxpayer is disallowed

from carrying the NOL forward in any regard.

***MANY GOOD TAX PRACTITIONERS HAVE

FAILED TO PROPERLY MAKE THIS

ELECTION – A VERY COSTLY OVERSIGHT

AND ONE REASON TO CARRY INSURANCE

34

Election to Forego the Carryback Period IRC section 172(b)(3) provides the taxpayer with an option.

The taxpayer may elect to forego the carryback period.

The NOL can be carried forward for 15 years or 20 years, depending on the

tax year in question.

The taxpayer elects to forgo the entire carryback period by filing a written

notice attached to a timely filed loss year return (including extensions).

This election cannot be revoked; however, for elections with due dates

(excluding extensions) that fall on or after October 1, 1992, a special rule

applies.

For such elections, Rev. Proc. 92-85, section 4.02, 1992-2 C.B. 490, grants

an extension of 6 months from the due date of the return (excluding

extensions) to make the election.

This includes situations in which a taxpayer files the return without making

the election, but takes corrective action within the 6-month period.

Corrective action is amending the filed return to perfect the election.

35

Election to Forego the Carryback Period If no election to waive the carryback years is made, check IDRS for

the carryback years' statutes.

If the refunds are barred by the statute of limitations, calculate the

amount of NOL which WOULD HAVE BEEN absorbed by the

carryback years.

No refund can be given to these years due to the barred statutes;

however, the amount of NOL available for carryover is reduced by

the carryback amount not taken.

If the carryback years are open under the refund statute, pick up the

available carryback years, and allow any refund which the taxpayer

failed to claim.

If the taxpayer asserts the election on the return, I usually accept

the NOL carryforward without further research.

36

Carryback and Carryover Periods MULTIPLE LOSSES.

If a NOL occurs in more than one year, the loss

occurring in the earlier year is deducted from

the income of the other years before the later

loss.

Although the NOLD is the sum of all carrybacks

and carryovers to that year, the earliest loss is

used first.

If a taxpayer incurs net operating losses in both

2014 and 2015, the 2014 loss is applied first.

37

Carryback and Carryover Periods

Under certain circumstances, an alternate carryback or carryover

period may apply instead of the 3-year/15-year or 2-year/20-year

periods as specified under the normal rule.

For example, a special 10 year carryback period applies in the case

of product liability losses and deferred statutory or tort liability

losses. IRC section 172(b)(1)(C).

However, the normal 15 or 20-year carryover period applies to such

losses.

Note: Many taxpayers have filed refund claims based on ten year

carrybacks or purported specified liability losses, described in IRC

section 172(f)(1)(B), that the Service considers to be invalid. Such

refund claims require special attention.

39

The NOL Deduction

When an NOL is carried to another year, two

possibilities exist.

The NOL can either be:

1. fully absorbed or

2. not fully absorbed.

40

Fully Absorbed Losses When a NOL is carried back to an earlier year, it

is compared to the taxable income.

If the taxable income is large enough, the NOL

is allowed in full as a deduction from gross

income to arrive at adjusted gross income.

Remember that the reduction of adjusted gross

income by a net operating loss deduction may

cause certain deductions or exclusions to

change because they are based upon, or limited

by, adjusted gross income.

41

Fully Absorbed Losses The deductions or exclusions, which may need to be recomputed because of the

decreased adjusted gross income, include the following:

1) Deduction up to $25,000 of passive activity losses from rental activities as per IRC

section 469(i)

2) Exclusion of social security and Tier 1 railroad retirement benefits as per IRC section 86

3) Deductions for individual retirement accounts as per IRC section 219(g)

4) Exclusion of U.S. Saving Bond interest used for educational purposes as per IRC

section 135(b)

5) Medical expense deductions as per IRC section 213(a)

6 Casualty loss deduction as per IRC section 165(h)

7) Miscellaneous itemized deductions as per IRC section 67(a)

8) Total itemized deductions as per IRC section 68(a)

9) Phase out of exemptions as per IRC section 151(d)(3)

Regarding items (1) through (4), above, if more than one applies, you re-compute them in

the order listed above, using the recomputed AGI after applying the NOL deduction and

any previous items on the list above.

42

Fully Absorbed Losses

The reduction in AGI due to a NOL carryback

has no effect on the individual's deduction for

charitable contributions.

IRC section 170(b)(1)(F) provides that the

contribution base for determining percentage

limitations is the AGI without regard to any NOL

carrybacks.

43

LOSS NOT FULLY ABSORBED

LOSS NOT FULLY ABSORBED REQUIRES

INTERVENING YEAR MODIFICATIONS.

44

LOSS NOT FULLY ABSORBED

IRC section 172(b)(2) requires that

modifications be made to taxable income to

determine how much of the NOL is used up in

that year, and how much can be carried to the

preceding year.

The steps to compute the carryover to the

second preceding year are as follows:

45

Loss Not Fully Absorbed

1) Start with the taxable income for the 2nd or

3rd preceding tax depending on whether the

tax year (loss year) began after August 15,

1997.

For this purpose such taxable income takes into

account the NOLDs (carryforwards or

carrybacks) from all years prior to the loss year.

IRC section 172(b)(2)(B)

46

Loss Not Fully Absorbed 2) Ad back the following modifications. IRC section 172(b)(2)(A)

a) Personal exemptions

b) Net capital loss deduction. Unlike the modifications of IRC

section 172(c) which takes into account IRC sections 172(d)(2) and

172(d)(4), the modifications of IRC section 172(b)(2) only take into

account IRC section 172(d)(2). Thus, the separate limitations

discussed earlier (in the NOL computation for the loss year) do not

apply. For purposes of IRC section 172(b)(2), it is simply the net

capital loss deduction that is added back.

c) Modifications relating to Real Estate Investment Trusts, if they

apply. See IRC section 172(d)(6)

47

Loss Not Fully Absorbed 3) Make the adjustments to items which are based upon, or limited by, a

modified AGI.

a) Adjustments to exclusions or deductions based on or adjusted by AGI

(rental loss passive activity exclusion, taxable social security and Tier 1

retirement benefits, deductions for contribution to an IRA exclusion of

savings bond interest discussed earlier).

b) Itemized deductions

(1) The following itemized deductions will need to be recomputed based

upon the modified AGI computed above: medical expenses (10 percent

floor), casualty and theft loss (10 percent floor), miscellaneous itemized

deductions (2 percent floor) and total itemized deductions (phaseout).

(2) Charitable contributions may also need to be adjusted but this involves

some special rules. The percentage limitations for charitable contributions

are based upon a “contribution base” which is defined as the AGI computed

without regard to any NOL carrybacks to the taxable year. IRC section

170(b)(1)(F).

48

Loss Not Fully Absorbed Any NOL carryback deduction would not be taken into account for

the purpose of computing the charitable contribution deduction.

In contracts, to determine modified taxable income for purposes of

absorbing an NOL in a carryover year, the charitable contribution

deduction must be recomputed based on what AGI would have

been without the NOL (or any NOLs from taxable years subsequent

to the loss year).

IRC section 170(d)(1)(B) provides a special rule for determining the

contribution carryover where NOLs are involved.

The computation that is required in such instances is quite

complicated and is beyond the scope of this class. See Treas.

Regs. Sections 1.172-5(a)(2)(ii) and 1.170A-10(d)(2).

49

Loss Not Fully Absorbed 4) The result is the modified taxable income of the 3rd

preceding year.

5) The modified taxable income is subtracted from the

NOL calculated for the loss year. The balance, if any, is

the NOL carryover to the 2nd preceding year.

6) The above process is again applied to determine the

modified taxable income of the 2nd preceding year and

such amount is subtracted from the NOL carryover to

see if there is any excess to be carried to the 1st

preceding year.

7) This process is repeated until there is no remaining

NOL carryover.

50

Loss Not Fully Absorbed Example

Jan Smith runs a small clothing store. In 2015, she has a NOL of $36,000 that she chooses to carryback to 2012.

She has no other carrybacks to 2012. Jane's original 2012 return contained the following income and deductions:

Wages $30,000

Capital loss ($1,000)

Adjusted gross inccome $29,000

Itemized deductions

Medical Expenses $ 550

Charitable contributions $ 1,450

Total taxes $ 1,650

Home mortgage interest $ 1,125

TOTAL ($ 4,775)

Exemption ($ 2,300)

TAXABLE INCOME $21,925

Jane's $36,000 carryback NOL will eliminate her positive 2012 taxable income.

She uses Form 1045 Schedule B to calculate the amount of the NOL absorbed in 2012, and the amount that

should be carried over to 2013.

51

John R. Dundon II, EA http://JohnRDundon.com President, Taxpayer Advocacy Services, Inc. Fellow, National Tax Practice Institute

(720) 234-1177


http://www.johnrdundon.com/

https://www.facebook.com/ThatTaxGuy/

https://www.linkedin.com/in/john-r-dundon-ii-ea-b265408

https://twitter.com/JohnRDundon

https://www.youtube.com/channel/UCtmdzTIPXZbCa8mSso8jESg

Corporations



Overview of Presentation

• NOL Carryovers for C Corporation Taxpayers

• Basic Rules

• Corporate Equity Reduction Transactions

(the “CERT” Rules)

• Section 382 Ownership Change

Calculation

• Impact of an Ownership Change

• Not Covered – Consolidated Return Issues

NOL Basics



Carryback and Carryforward Rules • Section 172(a): “There shall be allowed as a deduction for the

taxable year and amount equal to the aggregate of (1) the net

operating loss carryovers to such year, plus (2) the net operating

loss carrybacks to such year.”

• Section 172(c): “the term “net operating loss” means the excess

of the deductions allowed by this chapter over the gross income.”

• General Rule: NOL is carried back to the 2 taxable years

preceding the loss year and carried forward to the 20 taxable

years following the loss year. The NOL is utilized in the earliest

taxable year with any unused portion carried forward. Section

172(b)(1)(A).

• Example: An NOL from Year 3 is carried back to Year 1; any

unused portion is utilized in Year 2; any unused portion is

utilized in Year 4, etc.

• Section 172(b)(3): Can elect to waive carryback period.



Section 381 Transactions

• When Applicable: acquisition of the assets of a corporation

(“Target”) by a corporation (“Acquirer”) in (i) a tax-free section

332 subsidiary liquidation or (ii) a section 361 transfer as part of

a tax-free asset reorganization. Section 381(a).

• If Applicable: Acquirer succeeds to NOLs of the Target, subject to

certain limitations. Section 381(a).

• Section 381(b)(3): Except for “F Reorganizations,” cannot

carry back an NOL for a taxable year ending after the date

of distribution or transfer to a taxable year of the Target.

• Can carry back post-acquisition NOLs against pre-

acquisition Acquirer taxable years.



Section 381 Transactions

361 Reorganization

P T

T

SH

S

Section 368(a)(1)(A)

332 Liquidation

Merger

P

Liquidation

Corporate Equity Reduction Transactions (“CERTs”)



Overview of Rules Applicable to a Corporate Equity Reduction Transaction (“CERT”)

Section 172(b)(1)(A) allows an NOL incurred by a taxpayer in a taxable year to

be carried back or carried forward to other taxable years of that taxpayer.

Carry backs are limited to the 2 years prior to the year of the NOL; and

Carry forwards are limited to the 20 years after the year of the NOL.

Section 172(b)(1)(D) 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. 101-247 (1989).



What is a CERT (corporate equity reduction transaction)? As provided in § 172(g)(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.



What is a CERT? (cont.) Excess Distribution (“ED”):

Current year corporate distributions (including

redemptions – whether or not dividend equivalent),

provided the amount exceeds the greater of –

150% of the average of such distributions during the 3

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.



Examples of a CERT

MSA

P

T T

SH

X

SH

T stock $ $

Note: distribution must exceed both

the 150% (3-year look-back) and 10%

(fair market value) thresholds in §

172(g)(3)(C) to constitute an ED. Section 172(g)(3)(B)

ED



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.



Identifying the Applicable Corporation in a CERT

MSA ED

P

T T

SH

X

SH T stock

$

Section 172(b)(1)(D)(iii)

= applicable corporation

$



What taxable years are the LLYs (Loss Limitation Years)? The LLYs are the tax year in which the CERT occurred and, generally, each of

the two following tax years.

Corporation T engages in a CERT during its taxable year ending December

31, Year 4.

T’s LLYs are Year 4, Year 5, and Year 6.

LLYs

CERT

Section 172(b)(1)(D)(ii)



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. § 1.263A-9, but subject to certain limitations:

Section 172(g)(2)(B) prohibits direct allocation of interest expense to non-CERT activity.

AID cannot exceed the excess (if any) of (i) the interest deductions in the year at issue minus (ii) average interest deductions for the three years preceding the CERT (the “Interest Cap”).

AID under $1 million is disregarded under a de minimis rule.



How is the CERIL Computed? (cont.) Rules in Treas. Reg. § 1.263A-9 regarding measurement dates, computation

periods, etc. for purposes of the avoided cost method.

(Very) Simplified CERIL Computation Steps

Step 1 – Calculate CERT costs

MSA CERT costs – FMV of the stock acquired and other related costs

ED CERT costs – FMV of excess distributions and other related costs

The Proposed Regulations include borrowing costs that facilitate a

CERT as CERT costs.

Step 2 – Calculate the Weighted Average Interest Rate (“WAIR”) (see

Treas. Reg. § 1.263A-9)

Step 3 – Multiply WAIR by CERT costs to calculate AID

If this amount is less than $1 million, CERT rules do not apply

Step 4 – Calculate Interest Cap

Step 5 – CERIL is the lesser of the AID or the Interest Cap



CERIL Calculation – Simplified Example Assume –

CERT on first day of Year 5

CERT costs of $1,000

Weighted average interest rate (WAIR) of 4%

Year 5 interest deductions of $65

Prior interest payments of $10 (Year 2), $20 (Year 3), and $60 (Year

4)

Calculation

CERT costs of $1,000 * 4% WAIR = $40 AID for Year 5

Prior three-year interest average of (10 + 20 + 60)/3 = $30

Year 5 Interest Cap = $65 – $30 = $35

CERIL is the lesser of AID ($40) or the Interest Cap ($35) – CERIL of

$35 for Year 5.

Taxpayer cannot carryback $35 of Year 5 NOL to tax years preceding

the year of the CERT.



Proposed CERT Rules On September 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

Section 382 Ownership Change Calculation



Section 382 Section 382 provides that if a Loss Corporation

experiences an Ownership Change, then the amount of

the Loss Corporation’s taxable income for any

postchange year (or period) that can be offset by its

prechange losses cannot exceed the Section 382

Limitation for that year



Section 382 – Ownership Change A Loss Corporation is any corporation having an NOL carryover, capital loss

carryover, net unrealized built-in loss, general business credit carryover, AMT

carryover, foreign tax credit carryover

A Loss Corporation has an Ownership Change if, on a testing date, the percentage

by value of stock of the Loss Corporation owned by one or more 5 percent

shareholders has increased by more than 50 percentage points over the lowest

ownership percentage of such shareholders at any time during the testing period.

A testing date is any date on which the percentage ownership of a 5 percent

shareholder changes or on which an equity structure shift, such as a merger,

occurs. (See exceptions in Notices 2008-76 and 2008-84.)

The testing period is generally a rolling three-year period

ending on the testing date.



5-percent shareholders Type

Individuals

Corporations

Partnerships

Trusts

ESOPs

Governments

Investment advisors

If ownership % > 5%

5% shareholder

Attribute ownership to shareholder

Attribute ownership to partners

Attribute ownership to trustee/beneficiary

5% shareholder (some exceptions)

5% shareholder (some exceptions)

Treatment depends on “economic owner”



Aggregation

LossCo

VC Corp. A

K

30%

8% 62%

40% 40%

20%

J

B E

F

D C

LossCo

Public B

H

E

F

D C

I G

B E

F

D C

VC Corp.

Public T

R

O

P

N M

S Q



Coordinated Acquisitions • A group of persons who have a formal or informal

understanding among themselves to make a coordinated

acquisition of stock are treated as an “entity”;

• A principal element in determining if such an understanding

exists is whether the investment decision of each member of a

group is based on the investment decision of one or more other

members



Segregation • Segregation rules treats certain groups of shareholders as a new

public group, separate from any pre-existing public group

• These typically include:

o Issuances by Loss Corp to public

o Redemptions by Loss Corp from public

o Acquisitions/dispositions of Loss Corp stock by 5-percent

shareholders from or to public

o Reorganizations qualifying as equity structure shifts

o First or higher-tier transactions



Segregation Rule Example: Issuance

Beginning of

testing period

LossCo

LossCo

Public A

33% 67%

LossCo

LossCo

Public A

~16% ~32%

LossCo Seg.

Public

~53%

Issuance of stock to public

in exchange for debt

Example:

• LossCo (calendar year taxpayer) was formed in Year 1 by Individual A (300

shares) and a number of less-than-5-percent shareholders (600 shares).

• In Year 2, LossCo issued 1000 shares of common stock to less-than-5-

percent shareholders in exchange for debt.



Segregation Rule Example: Redemption

Beginning of

testing period

LossCo

LossCo

Public

100%

LossCo

LossCo

Public

40%

100%

LossCo Seg.

Public

60%

Redemption of 60% of the stock of

LossCo

Example:

• LossCo was formed in Year 1 by a number of less-than-5-percent shareholders.

• In Year 2, LossCo redeems 60% of its outstanding stock.



Segregation Rules – Exceptions These exceptions may allow a Loss Corp to issue shares with no or a

reduced corresponding increase in cumulative owner shift

• Small issuance exception – Reg. § 1.382-3(j)(2)

- Generally treats “small issuances” by Loss Corp as issued to existing

direct public groups on a pro-rata basis

• Cash issuance exception – Reg. § 1.382-3(j)(3)

- Generally treats a portion of shares issued by Loss Corp “solely for

cash” as issued to existing direct public groups



Cash Issuance Exception Example

Beginning of

testing period

LossCo

LossCo

Public A

5% 95%

LossCo

LossCo

Public A

<1% ~9%

LossCo Seg.

Public

~91%


in exchange for cash

Example:




percent shareholders in exchange for cash. Segregation Rule if there were no

Cash Issuance Exception



Cash Issuance Exception Example (continued)

Beginning of

testing period

LossCo

LossCo

Public A

5% 95%

LossCo

LossCo

Public A

<1% ~52%

LossCo Seg.

Public

~48%


in exchange for cash

Example:




percent shareholders in exchange for cash.

Under the Cash Issuance Exception



• New Small Shareholder Regulations apply to testing dates

occurring on or after October 22, 2013 (with some flexibility for

testing periods that begin before October 22 and end after)

• “Secondary transfer” exception to segregation rules for sales by

5-percent shareholders to public

• “Small redemption” exception to segregation rules (similar to

current small issuance exception)

• Exception for certain transactions involving the stock of first tier

entities or higher tier entities

• Anti-avoidance rule

Small Shareholder Exceptions to the Segregation Rules



Notice 2010-2 • Between 2008 and 2010, the Service issued a number of

Notices, including Notice 2010-2 to address certain federal

income tax implications of the issuance of instruments by

loss corporations to Treasury under the Emergency

Economic Stabilization Act of 2008 (“EESA”).

• Notice 2010-2 provides guidance to corporate issuers with

respect to the treatment of stock issued to Treasury (either

directly or upon the exercise of a warrant) pursuant to

specified EESA programs (“TARP Stock”).



Notice 2010-2: The Rules

• TARP Stock (other than Section 1504(a)(4) Stock) issued to Treasury is not considered to cause Treasury’s ownership in the issuing corporation to have increased over the lowest percentage that it owned on any earlier date.

• TARP Stock is considered to be outstanding for purposes of computing the percentage of stock owned by other 5-percent shareholders on any testing date.

• TARP Stock that is redeemed will be treated as if it had never been outstanding.

• If Treasury sells TARP Stock (other than Section 1504(a)(4) Stock) and the sale creates a segregated public group (a “TARP Public Group”), the TARP Public Group’s ownership in the issuing corporation will not be considered to have increased solely as a result of such a sale.

• The TARP Public Group’s ownership is treated as having increased to the extent the TARP Public Group increases its ownership pursuant to any transaction other than a sale of stock by Treasury, including an increase attributable to the Small Issuance Exception or the Cash Issuance Exception.

Impact of an Ownership Change



Impact of an Ownership Change Limitation on

Pre-change

Losses/credits

Offsetting

Post-change Income



Annual Limitation In general,

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. § 1.382-8]

Equity value immediately before ownership change

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



Determining the Value of the Stock of the 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

(including any stock described in § 1504(a)(4)) immediately before

the ownership change.

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.



Determining the Value of the Stock of the Loss Corporation

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 the

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., 517 F.2d 75 (3rd. Cir. 1975);

Moore-McCormack Lines, Inc. v. Comm’r, 44 T.C. 745 (1965); TAM

9332004; TAM 200513027.



Determining the Value of the Stock of the Loss Corporation (continued) 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 to 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.



Available Limitation in Given Tax Year

[In year of ownership change, annual limitation

proportionately scaled back for postchange period]

Annual limitation

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

+

+



Built-in Gains and Losses • Objective of built-in gain/loss rules is to promote neutrality

• Pre-change NOLs could have offset built-in gains recognized

before an ownership change

• Built-in losses should not escape the section 382 limitation

• If a loss corporation has a net unrealized built-in gain (“NUBIG”):

• Built-in gains recognized during the 5 year recognition period

(“RBIG”) increase the base section 382 limitation applicable to

NOLs to the extent of the NUBIG

• If a loss corporation has a net unrealized built-in loss (“NUBIL”)

• Built-in losses recognized during the 5 year recognition period

(“RBIL”) are treated as pre-change losses to the extent of the

NUBIL, subject to the base section 382 limitation along with any

pre-change NOLs



Notice 2003-65 Notice 2003-65:

• Notice 2003-65 (September 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”



NUBIG/NUBIL Calculation NUBIG / NUBIL under Notice 2003-65 (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 (the

lesser of $10 million or 15 percent of the fair market value of certain

assets immediately before the ownership change)



Example NUBIG/NUBIL Calculation o Assets

- $1000 FMV

- $100 adjusted tax basis

o Non-Deductible Liabilities

- $200 (undiscounted pre-discharge)



Example NUBIG/NUBIL Calculation (continued) o Assets

- $100 FMV

- $100 adjusted tax basis

o Non-Deductible Liabilities

- $200 (undiscounted pre-discharge)

See PLR 201051019



The 1374 Approach § 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. §1.461-4(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



The 338 Approach § 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



Wasting Assets § 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 §

338 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



Wasting Assets (continued) 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 annual 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.

• 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 $20.



Amy K. Chapman Professional and Industry Experience

Amy is a senior manager with KPMG’s Washington National Tax practice, specializing in corporate

taxation, with a particular emphasis on mergers & acquisitions, dispositions, reorganizations, debt

restructurings, and bankruptcy and nonbankruptcy workouts. Amy’s broad range of clients include global

leaders in the banking and insurance industries.

Prior to joining KPMG, Amy was an associate in the tax department of the international law firm Dewey &

LeBoeuf LLP, based in New York.

Publications and Speaking Engagements

Amy has written numerous articles for tax publications, including the Journal of Corporate Taxation and

The Tax Adviser.

Amy lectures on corporate tax matters, and serves as a panelist for various groups. She also teaches

internal and external continuing professional education courses.

Amy K. Chapman

Senior Manager, Corporate

Washington National Tax

KPMG LLP

1801 K Street, NW

Washington, DC 20006

Tel 202-533-4742

Fax 202- 403 3421

[email protected]

Function and Specialization

Restructurings, Mergers, Acquisitions, Spin-offs

and other Divisive Strategies

Education, Licenses & Certifications

• J.D., Washington & Lee School of Law

• B.A., St. Mary’s College of Maryland



Timothy M. Nichols Professional and Industry Experience

Tim Nichols is a manager in KPMG’s Washington National Tax Corporate Group. Tim consults on a

variety of corporate tax transactions, including mergers, acquisitions, corporate restructurings, spin-offs,

recapitalizations and redemptions.

Prior to joining KPMG Tim practiced law with a private firm and represented closely held businesses and

other clients on tax and other matters.

Timothy M. Nichols

Manager

KPMG LLP

Suite 12000

Washington, DC 20002

Tel 202-533-4033

Fax 202-379-4941

Cell 414-617-5480

[email protected]

Function and Specialization

Mergers, acquisitions, spin-offs, divestitures,

liquidating and non-liquidating corporate

distributions, and corporate reorganizations.

Education, Licenses & Certifications

LL.M., Georgetown University Law School

J.D., Marquette University

B.A., Marquette University

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All rights reserved.

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