Thurs 345-515-mergersand acquisitions

© 2012 McGladrey LLP. All Rights Reserved.

© 2012 McGladrey LLP. All Rights Reserved.© 2012 McGladrey LLP. All Rights Reserved.

Mergers & Acquisitions

Nick Gruidl – McGladrey, Washington National Tax202.370.8242Ron Kolodkin – McGladrey, Los Angeles213.330.4642

49th Annual Bank & Capital MarketsTax Institute


Section 382: Loan loss reserves

- Notice 2003-65- §56(g)(4)(G) & § 111

M&A issues: Credit Union conversion to Mutual §355 & REITS – why and how? §368 boot allocation rules – don’t forget this

opportunity! Sale of a subsidiary: Unified loss rules

Topics

2


Section 382

3


In general, any built-in loss recognized by a net unrealized built-in loss (NUBIL) company during the 60 month period following an ownership change

Recognized built-in losses include OREO and bad debt deductions recognized on loans held at the time of an ownership change

Notice 2003-65 provides two safe harbor approaches for determining built-in gains and losses- Section 1374 method treats any bad debt deduction incurred

within the 12 month period following the ownership change as RBIL if the debt was owed to LossCo on the date of the ownership change

- Recognition period therefore shortened to 12 months on loans where taxpayer applies the Section 1374 method

- IRS confirmed in PLR 201105031

Loan Loss Reserves and Built-in Losses

4


Notice 2008-83 (Wells Fargo/Wachovia): short lived notice that provided bad debt following an ownership change did not represent RBIL - Basically expanding the Sec. 1374 method to bad debts within

12 months- Notice only applied until January 16, 2009

Taxpayer took the position that Notice 2008-83 allowed the taxpayer to remove the loans from the NUBIG/NUBIL calculation thereby causing the company to be a NUBIG- Eliminated § 56(g)(4)(G) – see next page

In the ILM (and two others almost identical) the IRS held that Notice 2008-83 had no impact on NUBIG/NUBIL as it only dealt with the treatment of bad debt and RBIL- RBIL & NUBIL are separate calculations and analyses

ILM 201326013: NUBIL & Notice 2008-83

5


Despite the 12 month bad debt safe-harbor provided in Notice 2003-65, significant AMT exposure may exist for a NUBIL company following an ownership change

Sec. 56(g) provides rules for determining adjusted current earnings (ACE), which is used in determining AMTI

Sec. 56(g)(4)(G) requires that if a NUBIL undergoes an ownership change, the asset basis for ACE is reduced to the assets proportionate of the FMV of total assets

As a result, despite the fact that a bad debt may not represent an RBIL, the loan generating the bad debt may be written down for ACE purposes thereby increasing AMTI

Could also impact E&P and treatment of future distributions as dividends versus return of capital

Built-in Losses & AMT: ILM 201326013

6


Lossco undergoes an ownership change at the time it is a NUBIL and has a loanwith a face of $100 and estimated FMV of $70

For ACE the loan is written down to $70 as of the change date As it turns out Loan A does not go bad and the entire $100 is

collected Lossco has a $30 positive adjustment resulting in an AMT tax

liability Would §111(a) allow for elimination of the adjustment or a

corresponding negative adjustment under the tax benefit rule? Tax benefit rule generally requires a previous deduction for

there to be a recovery Does Rev Rul 58-126 provide a position?

- Recovery of bad debt reserve not income when establishment of reserve occurred when taxpayer was non-taxable entity

Built-in Losses & AMT: Tax Benefit Rule?

7


What is the taxpayer is able to establish that the bad debt was not in fact a built in loss because:1. It was not a loan held at the date of the change, or2. It was performing at the date of the ownership?

Does excluding a bad debt on the second item above take you out of the section 1374 method? If so, what is the impact?

Loan Loss Reserves and Built-in Losses

8


Miscellaneous M&A Issues

9


Tax exempt Credit Union converts into a taxable Mutual- Generally an F or E reorganization for Fed tax- States may not recognize the CU as a corporation

for state law What is the impact on such a conversion for state

tax? - Tax deferred or taxable? - If taxable what is the result?

• How do rights of a CU vs a Mutual differ?- How does the likely conversion into a Stock Thrift

impact the analysis?

Credit Union conversion to Mutual Thrift

10


Prepayment of FHLB Advances High Interest Rates on Original Advances Pay off Original Advances with high interest rates

and enter into new advances with lower rates - Generally no change in creditor- Cash generally changes hands

Large prepayment penalties – GAAP vs. Tax treatment of penalties - Application of §1.163-7(c)?- Debt for debt exchange or extinguishment?

FHLB Prepayment Penalties

11


Recent section 355 distributions followed by REIT conversions include:- Windstream Communications- Penn National Gaming

Both involved distribution of real property followed by a lease back of the property to the operating entity

Rental activities would not satisfy the section 355 ATB requirement due to rental back to operating entity

To satisfy ATB each transferred a small business that would ultimately end up in a taxable REIT subsidiary (TRS)

In general ATB should represent at least 5% of the value of distributed and less that 25% of the value to meet REIT requirements

Built-in gain on REIT subject to corporate level tax under S corporation built-in gain tax rules, so potential to avoid corporate level tax on distributed assets

Section 355 & REIT Conversions

12


Are there real policy concerns with this transaction?- In an inversion crazed environment some commentators are

discussing 355/REIT conversions as a similar tax dodge- Rep. Camp’s proposals would limit the ability to elect REIT

following a section 355 transaction and would tax the built-in gain as opposed to allowing deferral

Income of the REIT does escape corporate taxation; however, dividends are often taxed at ordinary rates- However, the corporation no longer owns the assets or benefits

from the income/appreciation- Ultimately it benefits the shareholders

Like inversion, the argument is that these non-traditional REIT transactions are a way for large companies to avoid corporate tax

- Yet the Treasury recently issued regulations expanding the definition of real property expanding the opportunity to make a REIT election

Section 355 & REIT Conversions

13


Where basis in shares is relatively high as compared to the cash consideration received or shareholders have different bases/share specific allocation of boot may be favorable

Reg. §1.356-1(b) & §1.358-2(a)(2)(ii) provide rules for specific identification of shares exchanged in a reorganization

Ratable allocation if specific terms are not provided Terms of the exchange must be economically reasonable What is economically reasonable?

- Informal comments made by IRS/Treasury appear to support any allocation is reasonable so long as the buyer and seller agree to the allocation in the agreement

Boot allocation in tax-free reorganizations

14


Example 1: P acquires T in a §368(a)(1)(A) merger for 50/50 cash-stock Shareholder A holds 50 shares of common stock with a basis of

$10/share and 50 shares of preferred with a basis of $90/share Each shares is worth $100 A receives $100 in merger consideration ($50 in cash and $50 in

stock in total per share consideration) A wishes to specifically identify the cash to 50 shares of preferred

and stock to the 50 of common - 50 shares of common received tax-free- 50 shares of preferred received for cash in a fully taxable exchange- Total gain of $500 ($10/share gain x 50 shares) - Total gain of $3,000 without specific identification ($2,500 + $500)

P agrees to the allocation in the merger agreement- Is the allocation economically reasonable?


15


Example 2: P acquires T in a §368(a)(1)(A) merger for 50/50 cash-stock Shareholder A holds 100 shares of common stock with a basis

of $50/share and receives $100 in merger consideration ($50 in cash and $50 in stock in total per share consideration)

A wishes to specifically identify the cash to 50 shares and stock to the other 50 - 50 shares received tax-free- 50 shares received for cash in a fully taxable exchange- Total gain of $2,500 ($50/share gain x 50 shares) - Total gain of $5,000 without specific identification

P agrees to the allocation in the merger agreement- Is the allocation economically reasonable?


16


Reg. §1.1502-36 unified loss rules issued ≈ 6 years ago Replaced loss disallowance rule (LDR) Addresses three primary aspects:

1. Basis disparity: §1.1502-36(b) 2. Non-economic losses: §1.1502-36(c)3. Loss duplication: §1.1502-36(d)

Acquisition & Disposition of a Subsidiary:Unified Loss Rules

17


Reg. §1.1502-36(b): Basis disparity Example 1 P owns 100% of the 100 shares of S’s only class of stock Acquired 80 shares for $100/sh and 20 shares for $500/sh S Stock is worth $400/sh P sells the 20 shares with $500/sh basis for $400/sh incurring

a $100/sh loss Reg. §1.1502-36(b)(2) requires P to eliminate the gain by

reducing the basis in the shares sold by $100/sh and reallocating that basis to the remaining 80 shares

Remaining 80 shares have a basis of $125/sh

Acquisition & Disposition of a Subsidiary:Basis disparity rule

18


Reg. §1.1502-36(b): Basis disparity Example 2 P owns 100% of the 100 shares of S’s only class of stock Acquired 80 shares for $100/sh and 20 shares for $500/sh S Stock is worth $400/sh P sells all 100 shares for $400/sh No basis redetermination necessary; howevere a trap for the

unwary exists:- P’s loss on the sale of the 20 shares is subject to -36(c) & (d)

even though there is an overall gain P may elect to apply basis redetermination to eliminate the

loss on the 20 shares- Specific rules to provided for computing this

Acquisition & Disposition of a Subsidiary:Basis disparity rule

19


Reg. §1.1502-36(c) applies to eliminate nonecomic losses created via application of the investment adjustment rules

Example: P acquires S for $100 and S has 1 property with a FMV of

$100 and basis of $0 S sells the asset and recognizes $100 of gain and -32

adjustments bringing P’s basis in S to 200 S now has assets with a basis and FMV of $100 P sells the stock of S for $100 and realizes a $100 loss The $100 loss is a noneconomic loss -36(c) provides two methods to determine the basis reduction

necessary to address the non economic loss

Acquisition & Disposition of a Subsidiary:Noneconomic loss rules

20


Basis is reduced by the lesser of the:- Net Positive adjustment amount*

• In general the net -32 adjustments to the share excluding distributions

* If you can establish that the subsidiary is in a net negative adjustment position then -36(c) does not apply

• Basis disconformity amount• The difference between the outside basis and the net inside attribute

amount:- Tax basis of assets, plus- Net operating losses and capital loss carryovers, plus- Deferred deductions

• Limited stuffing opportunities available

In the prior example both the NPA and disconformity amount is $100

Acquisition & Disposition of a Subsidiary:Noneconomic loss rules

21


Assuming a loss remains after applying -36(b) & (c) the taxpayer must apply -36(d) to eliminate duplicated losses

Example: P purchased S for $200 S owns 1 property with a basis of $200 and a value of $100 P sells S for $100 and recognizes a $100 loss not subject to -

36(b) or (c) Following the sale S sells the asset for $100 and recognizes a

$100 loss – loss is duplicated -36(d) applies to eliminate loss duplication Query: Why is this a problem? It happens outside of

consolidation all the time and we have §§ 382 & 384 to address these situations. What about gain duplication?

Acquisition & Disposition of a Subsidiary:Duplicated losses

22


Query: Why is this a problem? It happens outside of consolidation all the time and we have §§ 382 & 384 to address these situations.

What about gain duplication?


23


Loss duplication exists and is eliminated under the attribute reduction if a stock loss remains after -36(b) & (c) and is limited to the lesser of:1. Net stock loss, or

• Aggregate basis over FMV of shares transferred2. Aggregate inside loss

• Net inside attribute amount over the FMV of all shares• Inside attribute amount is generally the same as -36(c) definition

Likely to occur where tax basis in assets is high but value is depressed- Prior §338(h)(10) or asset acquisitions- Significant loan loss reserves- Significant unutilized NOLs


24


Three methods to eliminate loss duplication:1. Reduce attributes of S*

1. Capital loss2. NOL3. Deferred deductions4. Asset basis (other than cash)* Buyer may be ok with some reduction depending upon §382 limitations

2. P elects to reduce basis in S to eliminate duplication• Partial reduction available

3. P elects to reattribute NOL (and other attributes other than asset basis) from S to eliminate duplication

• Converts capital loss to ordinary deductions• Partial reattribution available• Favorable if §382 limitation will be low


25


Thank you for your participation!

Questions?

26


DisclaimerThe information contained herein is general in nature and based on authorities that are subject to change. McGladrey LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. McGladrey LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations.

Circular 230 DisclosureThis analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

McGladrey LLP is the U.S. member of the RSM International (“RSMI”) network of independent accounting, tax and consulting firms. The member firms of RSMI collaborate to provide services to global clients, but are separate and distinct legal entities which cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party.

McGladrey, the McGladrey signature, The McGladrey Classic logo, The power of being understood, Power comes from being understood and Experience the power of being understood are trademarks of McGladrey LLP.


Documents

Thurs 345-515-mergersand acquisitions