Update - Built-In Gains and Losses Under Section 382(h)

The IRS and Treasury Department recently released final regulations under Section 382(h). These regulations became effective on June 11, 2010 and provide guidance about the treatment of prepaid income -- a thorny issue for loss corporations that have triggered Section 382.

Why? Under the temporary regulations, the IRS and Treasury took the position that prepaid income was not considered attributable to the period before a loss corporation triggered Section 382. Therefore, it was not considered recognized built-in gain or (RBIG). Conversely, a loss corporation with prepaid income that triggered Section 382 would take the opposite view, as such income would increase the Section 382 Limitation.

The temporary regulations are now final. Thus, the issue appears to be settled for loss corporations that have ownership changes on or after June 11, 2010. A copy of the final regulations is available here.

Apparently, a few errors were made when the final regulations were published in June. Specifically, the errors are with regard to the headings of paragraph (h)(4)(vii)(A) and paragraph (h)(4)(x)(J) under paragraph 2 of Section 1.382-2T.

Today, the IRS and Treasury issued a correction. A copy of the corrections to the final regulations is available here.

NOL Protective Measures Gaining Momentum

Increasingly, companies are adopting Stockholder Rights Plans or NOL Protective Amendments to protect and preserve their NOLs. In fact, last week, both LiveWire Mobile, Inc. and TMNG Global announced plans to adopt and amend their plans, respectively.

This trend is quite interesting. It also presents a range of issues to consider, from both the company's and the shareholder's perspective.

Certainly, from the company's perspective, the bigger issue is the ability to protect NOLs that would otherwise be impaired, if Section 382 were triggered. Thus, a plan is put in place to prevent that from happening. Conversely, from the shareholder's perspective, the issues range from concerns about how such measures impact stock price, offers from potential acquirers, the duration of the plan, etc...

In fact, CMC Master Fund LP, a significant shareholder in Heska Corporation described its opposition to the company's plan. Read more!

Section 382 Rates for August 2010

Adjusted federal long-term tax-exempt rate for August 2010 is 3.98%

Long-term tax-exempt rate for ownership changes during August is 4.01%

See Rev. Rul. 2010-19 for more details

To Protect and Preserve

Extreme Networks, Inc. recently joined the growing list of public companies that have adopted Tax Benefit Preservation Plans. On July 1, the company's Board of Directors adopted a plan to protect its $260M of net operating losses. Similar to other plans, the Extreme Networks plan prevents certain shareholders ("Acquiring Persons") from acquiring 4.95% of the company's outstanding stock.

Why? Management must have reason to believe the company is within a gnat's eyelash of triggering Section 382. Stated another way, future acquisitions, when combined with market activity and other equity transactions, would likely result in an ownership change, which would limit the company's use of its tax assets.

Thus, a Tax Benefit Preservation Plan puts an end to the Section 382 anxiety -- at least temporarily. The plan of Extreme Networks expires on April 27, 2011.

What's up with Section 382?

Unless you've been hiding under a rock, you are well aware that there's been a lot of activity regarding Section 382 over the past several months.

In addition to 6 Written Determinations, IRS and Treasury have issued 3 Notices.  For the most part, this guidance pertains to Section 382(l)(3)(C) and the litany of questions raised by the provision.



So what does this mean?  For starters, it does mean that for the time being, there is more clarity in determining how to apply Section 382 to loss corporations that have multiple classes of stock.


Specifically, in Notice 2010-50, the IRS provides two acceptable methodologies for applying Section 382(l)(3)(C) -- Full Value Methodology and Hold Constant Principle.


However, there is still more work to be done.  Notice 2010-50 is interim guidance.  And until the comment period expires, it is unclear what, if anything, will change.


What else does it mean?


More companies are likely to review and maybe even redo their Section 382 Studies.  Because of Notice 2010-50, companies now know there are 2 methodologies to use for determining whether they have triggered Section 382.  I don't know about you, but I think a comparative analysis is certainly worth considering. How else do you truly know where your company stands?