Mergers and Acquisitions Tax Services

Past losses, future gains

Tax attributes such as net operating losses and

built-in losses (assets with a tax basis higher

than value) can provide a tax shield against

future taxable income. These tax attributes

will be referred to as NOLs in this discussion.

Whether you are a strategic or financial buyer,

protecting and maximizing the value of those

NOLs is a key consideration in the economics

of any transaction. Even if you don’t plan on

utilizing NOLs currently, your ability to utilize the

tax benefits of an NOL is an important part of

financial reporting, and your failure to properly

determine the benefit could result in negative

financial statement consequences.

Even companies not involved with traditional

change-in-control transactions may find their

NOLs at risk through ownership changes

triggered by day-to-day stock trading or

fundraising activity. S corporations changing to

C corporation status also need to be aware of the

impact of an equity issuance or change in control.

Why? Congress enacted Internal Revenue Code

section 382 to prevent trafficking in losses. But

the rules surrounding section 382 are quite

complex, often misunderstood, and driven by the

unique facts and circumstance surrounding each

particular company and transaction.

Complex rules require careful analysis

If you are acquiring a company with NOLs, annual

utilization of that company’s NOLs is generally

limited to the value of the loss corporation

multiplied by the adjusted federal long-term

tax-exempt rate. But the analysis does not

stop there.

Having a full understanding of a company’s status

as a Net Unrealized Built-in Gain (NUBIG) or Net

Unrealized Built-in Loss (NUBIL) corporation is

critical. The annual utilization of NOLs can be

increased significantly if the acquired company

is a NUBIG corporation. But, if the company is a

NUBIL corporation, even post-ownership change

losses may be treated as if they were recognized

prior to the ownership change, thereby further

limiting the ability to utilize NOLs.

Determining the annual utilization is further

complicated by bargain sales, distressed

transactions and leveraged buy-outs.

In acquisitions, it is not only the acquiring party

that will need to understand the target’s NOLs.

Sellers wishing to be compensated for the

value of the loss corporation’s NOLs should also

understand and document future availability

of NOLs. acquirers leave that assessment and

documentation up to the seller.

Section 382 Analyses

Preserving NOLs and credit carryovers in an M&A transaction or other equity transaction

Do you know if any of your

tax attributes are subject

to limitation?

Do you know if your

company has undergone an

ownership change?

Do you understand the

complexities of section 382?

Acquisitions are not the only concern

Companies thinking that the section 382

rules are only a concern during acquisitions

are incorrect. Stock trading, capital raising

and even recapitalizations can trigger

ownership changes under section 382 – and

companies with multiple classes of stock face

particularly complex concerns.

Not all the news is bad, nor is a change in

ownership always a negative event. Companies

often overlook planning opportunities as well

as risks. Companies that are highly leveraged or

have significant self-created intangible assets

at the date of an ownership change may have

built-in gains that can lead to enhanced NOL

utilization. As a result, incurring a change in

ownership does not necessarily mean that you

are unable to fully offset current taxable income

or that a reserve must be booked for financial

statement purposes.

Multiple classes of stock

The application of section 382 is further

complicated when the company has multiple

classes of stock outstanding. Ownership under

section 382 is based upon stock value, and

therefore, when there are multiple classes of

stock involved, determining value becomes a

more complicated exercise than when there

is only a single class. Further, a shareholder’s

ownership may change over time merely due

to value fluctuation. This fluctuation may

cause ownership shifts unrelated to any stock

purchases, sales or other transactions.

Because of value fluctuation, taxpayers are

permitted to apply one of two methods when

performing a section 382 analysis– either, the

full value methodology or the hold constant

principle. Understanding which method to

apply can be of great benefit to taxpayers, as one

method may yield a more favorable outcome

than the other.

Section 382 is not new to us

Whether your company is considering an

acquisition or other equity transaction, section

382 concerns may be new to you. They are not

new to McGladrey. Our national M&A tax group

has helped companies across all industries

plan for and address NOL concerns involved

in acquisitions and other ownership changes.

We are experienced, in deals of all sizes, from

strategic trasactions by large publicly held

companies to portfolio deals for private equity

firms to acquisitions involving privately held

start-up companies. Based on our knowledge

and experience, we can help you examine the

specifics of your situation and work with you to

plan for and structure transactions ranging from

acquisitions to stock offerings in ways that best fit

your strategic goals while still helping to maintain

the tax benefits associated with your losses or

those of a target company.

888.811.1023 www.mcgladrey.com

Disclaimer This document contains general information, may be based on authorities that are subject to change, and is not a substitute for professional advice or services. This document does not constitute assurance, tax, consulting, business, financial, investment, legal or other professional advice, and you should consult a qualified professional advisor before taking any action based on the information herein. McGladrey LLP, its affiliates and related entities are not responsible for any loss resulting from or relating to reliance on this document by any person.

McGladrey LLP is an Iowa limited liability partnership and the U.S. member firm of RSM International, a global network of independent accounting, tax and consulting firms. The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party.

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