Advanced Corporate Tax

Corporate Exam ReviewQ1. Herb wanted to continue in business. Partial liquidation 302b4, complete redemption but need to avoid attribution issue. 355 a possibility, but have a shareholder business purpose not corporate business purpose.Q2. BigCo acquiring CookieCo. Issue here is can we do nonrecognition and get rid of dissidents. What can we carve out of reorg under relaxed business purpose rules. What can we hack out before picking a reorg type. Needed more 368 continuity rule discussions. Q3. Asset with FMV, net value exchange issue. Debt in excess of FMV triggers net value issue. If fail net value exchange fail 351.Q4. Rev Rule 2003-51. Can you recognize the fact pattern of the Rev Rule and apply it. Q5. This is a 355 question. Is there a business purpose or shareholder purpose, is this a device, will business purpose overcome device aspects. 302b3 partial interest possibility. Q6. 305a Stock dividend. Q7. Step transaction. Good essay had distinctions about turning on and off step transaction. Q8. Adjusted basis. 362e built in loss proposed regs., default rule vs election.

IntroductionOne issue of treating a loss corporation when the main asset of the target is their imbedded tax losses, another is bankruptcy tax. Also will be discussing § 382 NOL's and their interplay. Will have website for the course that contains the material.

Will have an exam, 3 hours, similar format.

I. Morris Trust Rules

Sec. 355Morris trust transactions, § 355(e), is a continuation of the repeal of General Utilities doctrine. In 1966 bank merger under A Reorg, National bank could not acquire State Bank Insurance Division. State Bank spun off insurance division under a § 355 transaction to shareholders with business purpose of facilitating merger, then a subsequent A Reorg to move all remaining assets to National Bank. Question is where does the transaction begin and end, as if § 355 transaction is stepped together there is no A Reorg. IRS said Ok, no step transaction, establishing Morris Trust as a planning tool.

How does this differ from a liquidation? Morris Trust raises two issues, does step get turned off to allow A Reorg, and can you ignore the § 355 transaction. § 355 does not address the step transaction as much as it addresses the spin-off. Under § 355(e) the distributing corporation will be taxed, § 355(e)(2)(A), not shareholder. (B) contains a rebuttable presumption that within a certain time period a plan will be considered conditional and as one transaction. Need to know what the plan is and how to rebut the presumption. IRS position is now there needs to be some manifest intention in addition to time period, and has added safe harbors.

Reg § 1.355-7Safe harbors have been in place less then one year. Fed Reg. Treasury Decision (TD 91-98) includes helpful preamble comparing current regs with 2002 temporary regs.

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Exam Question: Regs have extensive discussions of options and deemed exercise, question would be how one compares and contrasts the treatment of options between § 355 & § 382. Will find that the definitions and treatment are contextual between the code provisions.

§ 355(e) says that if this section is triggered the stock will not be qualified property, and will be triggered if part of a plan and a person acquires a greater then 50% interest. In § 1.355-7(b)(1) it states a facts and circumstances analysis will determine if a plan exists. Plan factors states the presumption of a plan, but a rebuttable presumption. Weight depends on "agreement, understanding, arrangement, or substantial negotiations" which can be found in the definitions in -7(h)(1) & (6). (h)(1)(A) goes into type of person such as controlling shareholder, which is odd as Board not controlling shareholder makes the decision, very broad reach of persons. Under (ii) again very broad reach of persons, (iii) says does not have to be a binding contract and all significant economic terms need to be agreed to. (9) Implicit permission is included to prevent defense that Board Approval corporate law requirements have not been met so § 355(e) has not been met. Very broad definitions of agreement and understanding.

Under § 1.355-7(a)(3)(i) we are told that an agreement or understanding within a two-year period will be given substantial weight. The nature, extent and timing matter in the weight. (iv) relates to discussions with an investment banker, (v) states that it is evidence if used to facilitate an acquisition, corporate business purpose needed. Timing can matter in the application of these factors.

Operating Rules, (c), help us use and understand safe harbors. (1) discussions with outside advisors can be used as evidence of a business purpose, (2) Takeover defense, may be addressing multiple acquirers, allowing the whole thing to allow defense against first takeover while allowing second company to acquire. (3) distribution will not even be considered, (4) seems to address a transaction which is undetermined, says they will aggregate.

Safe HarborExamples show that since a facts and circumstances analysis, not getting into a safe harbor will not automatically scuttle the deal. SHI: Will get sliced thin.SHII: Conjunctive "and" test. SHIII: If no agreement for a year after the distribution we are ok. SHIV: Disclosure event is in definitions, -7(h)(5). SHVI: If occurs as part of a public offering, places emphasis on disclosure event.SHVII: Acquisition not public offering if no member of coordinating group is acquired or controls acquired. Coordinating group is defined in -7(h)(4). SHVIII & IX: Employer, not going over.

Options, (e), in general need to know if options are considered deemed or exercised to determine whether to count them to the 50%. Look at option discussion for next week (e), and PLR and article assigned for this week.

General Utilities RepealPurpose of 355 is to keep general Utilities down and out. Issue is successive transfers, which allow tailoring transactions to spin off part of a company as a nonrecognition transaction. Trying to get the nonrecognition portion of the transaction as narrow as possible to allow for creating "designer" transactions. One aspect is that we may have a § 355 transaction with § 368 on either end.

Peter Canellos Article, 2004 TNT 144-332

He concludes § 355 is in need of simplification. Basis is how do we reconcile the loosening of § 368 with the rigidity of § 355, possibly hindering transactions that involve both. Rationale was the general utilities repeal, but transactions involve both transactions. Safe Harbors are one way to be safe.

§ 1.355-7(j) ExamplesExample 1: X wants to acquire D, but does not want C. 2 years matters as that is the period that creates a rebuttable presumption of a plan. X and D agree, D spins off C one month later and day after X acquires D. (§ 355(e)(1) has a trigger that makes the transaction taxable if in pursuance of a plan. Issue in examples is have we pulled the trigger regarding a plan, one of the first things to look at.) D shareholders owning less then 50% of X does not seem to be trigger as trigger looks at ownership by D shareholders in D. Example tells us that non-planned factors are a major bad fact in the transaction.Example 2: Meeting with investment bankers and no non-plan factors shows a fixed and firm intent to liquidate in accordance with a plan. Example points to Safe Harbor VII which is aimed at public offerings, this is not a public offering. Example 3: D spins off C, with a reasonable expectation that C will be acquired. Y acquires C subsequently within six months. Would be helpful to know what the definition of hot market is, is there more then one buyer? D has a separate business purpose for distributing C which is necessary. Considered not part of a plan. Example 4: Fits in the safe harbor. Does it help with example 3? Merger occurs before the actual distribution?Example 5: (Important example) Hard part of example is that there was a vote shift in transaction, leaving X shareholders in control of combined entity, but making it look like it was not pursuant to a plan. For purposes of looking at the acquisition there is a plan, under (ii). Under (iii) the example gets interesting as go into public trading safe harbor, however the voting shift attributable to the 30 day window pulls the entire transaction out of the safe harbor, Armageddon! Changes in capital structure can effect tax implications. Example 6: D splits off C to make it more desirable a target. Not considered part of a plan even though D was having separate negotiations. X and Y's truck business are not the same. § 1.355-7(h)(12) has definition of similar acquisition. The fact that different acquirers will not save us, but we are looking at D's planning not the acquirers planning. Example 7: Key is that here the acquirer is different but target changes. Can reconfigure assets to make the transaction happen as D creates a package of the assets that is sought to be acquired in a precise transaction. Example 8: Example 9: All part of a plan, 8 months after the spin-off a public offering. 8 months does not work.Example 10: Same example but now 14 months is ok. There still remains a grey area of law between 8 and 14 months.

II. Section 355

If on ABA task force cannot be specifically retained by a client on the issue under consideration.

ABA Report on Nonplan IssuesIssues that will need a regulatory hearing before we can give guidance to clients. FN7 is important. A § 355 opinion will almost never be a "will" opinion as it is an intensely fact based determination, will almost always be a could opinion. IRS stopped issuing § 355 PLR's, opinion letter can still protect client from penalty. Practitioner can make first draft at letter in hypo. Report states that stretching § 355 to other sections is not willful or necessarily harmful. When written did not have proposed regs on predecessors and successors.

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B. What constitutes an acquisition"B" highlights what are not stock acquisitions but what may still look like them. See NOTES diagram. Examples have discussion of actual knowledge and no actual knowledge. State that treasury could draft these regs. and treat them as an acquisition. Do not say inconsistent with regs, but argues that a narrower approach to § 355 is favorable. Advocating to get a tax-payer friendly rule. Trying to avoid situation where tax compels a certain business strategy. ABA seems to be grappling with the issue of how far to take retesting in determining what % of stock one has owned at a particular time. Trying to limit retesting to only when "bad shares" exist or pursuant to a plan to get acquisition treatment.

Example 2 (green): Conceding to retesting original. Z's share increases relatively even though total shares remains the same as outstanding was 100x and now it is 90x. A & B end up acquiring 45% together pursuant to a plan. ABA is showing treasury that this type of transaction would not trigger § 355(e). Highlighting that you will look back to consider original transaction.

Example 3 (magenta): Example states that original shareholders of "C" will not be tested, but new X Buyer will be.

Pursuant to a plan is a facts and circumstances test. Suggest factors that may work in determining a plan. Do not define what pursuant to a plan is though. Says will look at both how controlled and distributing are acquired.

Can assume that the connection between private corporations and entity can allow abuse so need tight controls, while public corporations are less centrally controlled and can have more flexible rules. The idea of closely held corporations abusing the General Utilities doctrine is a much more real threat.

Actual KnowledgeExample 1: Actual knowledge. Example shows how less then 50% shareholders will not trigger acquisition treatment, but 50% will. Example 2: No actual knowledge. In the absence of actual knowledge of who's shares are being redeemed there is no deemed acquisition, but is a device, so not a good § 355 transaction. Propose another anti-abuse rule as a possibility.

Treatment of Shifts in Different Classes of StockNumber 3 in ABA Berg report. Question is it the intent of increase in value to shift classes of stock. Rejecting mark to market accounting as a means of determining if there was an acquisition. Report states that an anti-abuse rule is a better method to prevent abuse. Report is a useful template for viewing possible approaches to rules. Exam: Take reasoning from report and apply to another issue such as § 382, or bankruptcy tax issue (Hill favorite) such as who gets the NOL?

Example: § 355 transaction followed by § 368(a)(1)(E). Business is spun off as common to shareholder X with 49% of voting and value. Growth in common lifts value to X of 60%. § 355 transaction was still ok as value does not equal voting. Question was has X acquired control under § 355(e). As a policy a shift in the value reasonably expected at time of acquisition.

If were going to have value shifts trigger § 355 or § 382 what do you do if the value shifts back.

Shifts in Voting Rights in Different Classes of Stock4

Example: Transaction is specifically prohibited by § 355(e)(3)(A). Recommendation is to retest the triggering event. Looking for a period of time in which a recap is considered a change of control. Refer to Example 5, § 1.355-7T(j) vote shift example, safe harbor.

Take away from reading is how far you can go with a recapitalization and what potential for abuse exists. What are the triggers for § 355 and § 368 and differentiate vote and value flip.

Proposed Reg. 1.355-8§ 355(e) provides generally that stock of a controlled corporation will not be treated as qualified property if distributed as part of a plan if one or more persons acquires greater then 50%, directly or indirectly.

Section where the IRS believes the rules do not work well at all. Question of whether more then one entity can be a successor, and when is an asset acquisition treated as a stock acquisition. Predecessor and successor rules in the regs do not answer all questions in the rules, but examples help understand the problems.

What constitutes a predecessor or successor corporation? § 355 Regs apply to both direct and indirect acquisition, problem is how do you define an indirect acquisition. In preamble saying it is about gain and how much will be recognized as taxable. Discussion about whether there can be a predecessor of controlled, or just a predecessor of distributing. IRS says that there is no need to have predecessor of controlled rules but are continuing to study. In Multiple Predecessors saying that there is a worry about the degree of complexity but that they continue to study. Allowing multiple predecessors of distributing and controlling. Discuss stock acquisitions even though rule is about asset acquisitions.

Example 1: Capping the gain recognized, a somewhat pro-taxpayer reg. § 368(a)(1)(A) followed by a § 368(a)(1)(D) transaction. D has largely divested of P assets. Could have doe under a post acquisition clean-up under (A), but do not know the relative value of the assets divested or the time frame, so are not sure if continuity rules are an issue. Value to taxpayer comes in the $60/$100 gain portion of the transaction. Y is deemed to make an acquisition of P, even though P does not exist any more in corporate form, so Y is considered to acquire P and becomes General Utilities problem. IRS is looking a Y's acquisition of P as taxed at 60 rather then 100, but anti-abuse as transaction is considered taxable.

Example 4:NOTES:

Example 5: NOTES:

III. Section 382

Definition of Stock for § 382 Purposes§ 382(k)(6)"Stock" does not include nonconvertible preferred. Determination of percentage of stock held shall be by value.

§ 382(e)Value of old loss corp includes nonconvertible preferred and is determined just before the ownership change.

Treas. Reg. § 1.382-2(a)(3)5

Preferred that receives voting rights due to dividend arrears is still not considered stock. Preferred stock is included in determining the value of the loss corporation under § 382(e).

Treas. Reg. § 1.382-2T(f)(18) - See Full SectionStock shall not be treated as stock if; 1) interest in future growth to 5% shareholder is disproportionately small, 2) treating as not stock would result in ownership change, and 3) pre-change loss value is more then twice the corp value*tax exempt rate formula. "Interests" will be treated as stock if; 1) interest offers significant participation in growth of corporation, 2) treating interest as stock results in ownership change, and 3) pre-change loss value is more then twice the corp value*tax exempt rate formula.

Treas. Reg. § 1.382-2T(h), with particular attention to (h)(4) (h) = Constructive ownership of stock. § 318 attribution rules will apply to § 382 stock. (h)(4) solely for determining ownership change on the testing date, stock of loss corporation subject to an option shall be treated as acquired on that date if deemed exercise results in ownership change, applied to each class of option and each 5% shareholder.

Treas. Reg. § 1.382-2T(k)(1)-(5)May rely on SEC filings to identify 5% stockholders. Loss corporation is required to determine stock ownership on testing date.

Treas. Reg. § 1.382-4Option is treated as exercised if; 1) meets ownership test, 2) meets control test, 3) meets income test.

Owner and Equity Structure ShiftsSee Reg § 1.382-2T(e). Owner shift includes: 1) purchase of loss corp by 5% shareholder, 2) § 351 exchange affecting percentage ownership of 5% shareholder, 3) redemption or recap affecting percentage owned by 5% shareholder, 4) issuance of loss corp. stock affecting percentage ownership of 5% shareholder, 5) equity structure shift affecting the percentage of stock owned by 5% shareholder.

Equity structure shift is any reorganization within the meaning of § 368 with respect to loss corporation, excluding § 368(F) and § 368 (D) or (G) that meet § 354(b)(1).

§ 382Purpose is to prevent companies from trafficking in losses. Old Reagan era leasing rules was that you could buy losses at a discount, not a bad idea but turned out to expensive to the treasury. Fair to say that some NOL provisions are expected never to be used for policy reasons. A loss corporation though, can acquire a profitable corporation and use its losses to shield income, but not visa versa. For planning purposes, do not have loss corporation be the target.

Current § 382 is a fairly current statute due to its checkered past, not much case law on recent § 382 regs. Statute does apply in bankruptcy, but if literally construed would make Ch. 11 unworkable. Without special § 382 rules there would be no Ch. 11 restructuring as future earnings can be sheltered by NOL's which otherwise would just disappear, making Ch. 7 more attractive. Statute plays out in restructurings and bankruptcies basically.

Trigger to § 3821. Trigger is ownership change, found in § 382(g), general rule in § 382(a). Ownership change has to be kind of inferred from the general rule, until mentioned in (g)(1)(A) & (B). (k)(7) defines what a 5% shareholder is, need to determine if referring to just one "person" or transitory shareholder. (B) uses the term "percentage points", not percentage, meaning a 10% shareholder need acquire 50%, for a flexible total of 60%.

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2. Other ownership change is an "equity structure shift", which does not include an F reorg but must comply with § 354(b)(1). § 382(g)(3)(B) includes taxable reorgs, so the statute includes these, bankruptcy and § 368 reorgs all together, so must go to the regs. Under (g)(4) you aggregate all less then 5% shareholders into one 5% group, creating the possibility of a 5% shareholder in a public corporation.

3. Owner shift occurs on the change date, § 382(j). § 382(a) limits the income that can be offset, not the losses themselves, of the new corporation. If the old loss corporation continues to exist as a sub, § 382 does not limit losses that can be used unless there is a consolidated return requirement.

4. Old loss and new loss corp. Limiting pre-change losses of the old loss corporation, in ownership change old loss and new loss become the same corporation with different capital structures. Want to use the pre change losses of the old corporation. new loss and old loss corp are defined in § 382(k)(2)&(3). (3) states that nothing in § 382 prevents old loss corp from being the new loss corp.

5. Calculation is in (b), the value of the old loss corporation multiplied by the long term tax exempt rate. § 382(e) says that the value of old is the value of stock, (k)(5) says value equals market value. § 1504(a)(4) counts preferred stock into the equation which is a good thing as increases the pool of "stuff" so that we can have a bigger § 382 limitation. For planning may wish to seek a narrower definition to easier meet the change of ownership requirement. Definition of long-term tax exempt rate is found in § 382(f). IRS puts out a monthly revenue rule giving the information necessary for figuring rate.

Date value is determined gets us back to § 382(j), the change date.

6. § 382(c)(1) puts severe limitations on continuity of business enterprise. If loss corporation acquires a gain corporation does this limitation apply? No, only if new loss corporation acquires a loss corporation wanting to use the targets losses. If for reasons the acquirer is not the loss corporation § 382 will control use of losses as more restrictive continuity regs then § 368. § 382 continuity seems to persist longer, and does continuity of enterprise have the same boundaries as in § 368? Is definition in regs?

7. § 382(l)(1) anti-stuffing rule. If corporation wishes to dump in capital must be made in the two years prior to the change date, or the planning option of certain contributions. Will a mere business purpose be sufficient? Large capital contribution under consideration here should be argued as A principle purpose, rather then THE principal purpose.

8. Look at § 382(l)(4) substantial nonbusiness assets such investment assets of at least 1/3 of the total assets of the corporation. Also § 382 regs contain a temporal 2 year limitation which needs to be considered.

9. Excess may be carried over to the next year under § 382(b)(2), but loss carry forward period can be carried forward for the loss limitation period in § 381.

Keep track of the worry list for § 382.

Definition of Stock for § 382 Purposes, § 382(k)(6)NOTES: Need concept of stock to determine if there has been an ownership change. § 382(k)(6) has the concept that for purposes of determining the value of the old loss corporation, § 1504(a)(4), except as provided in § 382(e). We want the § 382 limitation to include as much as possible, told here that preferred will count

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toward determining value, most advantageous rule. Do not want § 1504 stock to count because that increases the likelihood of change, but contrary, not counting decreases the ratio of stock change that will trigger ownership change. A nuanced change.

If we include § 1504 stock, in terms of value, we may have more 5% shareholders than otherwise. By basing change of ownership on value we are looking at the vote value.

§ 1504 stock does not vote, limited to dividends, not convertible. Has debt like properties. § 382(k)(6)(B) allows the commissioner to treat warrants, options and similar as stock as necessary, or stock as not stock. Specific to this code section, applies to § 382 only.

§ 382(e) Value of old loss corp includes nonconvertible preferred and is determined just before the ownership change.

Treas. Reg. § 1.382-2(a)(3)Reg. definition of stock. Preferred that receives voting rights due to dividend arrears is still not considered stock. Preferred stock is included in determining the value of the loss corporation under § 382(e). NOTES: Reg says we will use plain vanilla principles to prevent playing games with the capital structure. Control premium in closely held corporations, or blockage conditions, will not be factored into value of the stock.

Treas. Reg. § 1.382-2T(f)(18)Stock shall not be treated as stock if; 1) interest in future growth to 5% shareholder is disproportionately small, 2) treating as not stock would result in ownership change, and 3) pre-change loss value is more then twice the corp value*tax exempt rate formula. "Interests" will be treated as stock if; 1) interest offers significant participation in growth of corporation, 2) treating interest as stock results in ownership change, and 3) pre-change loss value is more then twice the corp value*tax exempt rate formula. NOTES: Temporary regs now sunset, even though temporary have force of law it is not quite as much as final regs. Cross-references to § 1.382-2(a)(3) providing comfort that the regs are consistent. States that indirect ownership interest may be treated as stock as well directly in the corporation. § 1.382-2T(f)(18)(i) stock shall not be treated as stock when (conjunctive); A) basically § 1504(a) preferred that pays dividends rather then participates in growth of corporation, worried about value, and B) if IRS treats as non-stock will likely trigger an ownership change, and C) have a huge pre-change loss compared to the value of the pre-change loss corporation. States that stock treated as not stock is for purposes of determining ownership change, not value of loss corporation triggering § 382 limitation. Comparing size of the prechange loss to the value of the old loss corporation. (f)(18)(iii) addresses ownership interests, again § 382 lets us have maximum value for old loss corp value purposes, but does not include in loss corp trigger.

Treas. Reg. § 1.382-2T(h)(4) (h) = Constructive ownership of stock. § 318 attribution rules will apply to § 382 stock. (h)(4) solely for determining ownership change on the testing date, stock of loss corporation subject to an option shall be treated as acquired on that date if deemed exercise results in ownership change, applied to each class of option and each 5% shareholder. NOTES: § 318 rules are something we need to worry about. Once we have options moving around we start having testing dates. It is the deemed exercise date that matters, but we only get to a deemed date if we have a testing date.

Example 1Because A grants the option the denominator does not change as A holds all shares, but what if L granted the option and issued additional stock? When option comes from shareholder, shareholder does not issue stock, so just change of ownership from stock sale. Pure deemed exercise example. Example will gave you a handle on how (h)(4) works. (vii)(C) points out that difference between shareholder and corporate distributed stock, does not allow for increase in value, interdicting tax games. Lean towards finding a testing date, use grid of which of the two main issues is being addressed.

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Example 2Trying to figure out the testing date, and if the option is deemed exercised. § 382 treats options as stock and stock as not stock, potentially. Stock being treated as not stock can be problematic because one wants to count it all.

In the room to find out; 1)how much income we can offset with the losses, 2) how much can we increase the losses is possible, and 3) to ensure a nonrecognition transaction.Trigger is change of ownership in corporation, § 382 is specifically concerned with the disaggregation of the tax attribute from the taxpayer and trafficking in those losses. Purpose of non-recognition is that a mere change in form should not be taxed. Continuity rules have been specifically eroded, so continuity for nonrecognition is going to be different from continuity for § 382 purposes. Purpose is to keep losses together with the income of the taxpayer that generated the losses. Can offset honest losses up to the amount of hypothetical income that would have been produced by the entity had it continued its hypothetical existence.

§ 382 then doesn't limit losses, but defines via formula how much income to target of the old corporation that will be the limit of the losses of the new corporation that can be used. Formula is value of old loss corp * long term tax exempt rate = § 382 limitation. Limitation is on the new loss corporation, post change income. Effectively this is a deemed income computation, not accurate, but the formula that is used either way.

Told by the IRS that stock will be treated as not stock if that will result in an ownership change, to prevent the manipulation of the capital structure to prevent an ownership change. Want denominator to be big and numerator small, so what we see in § 382 are two places where the definition of stock matters, for the purpose of determining the value of the old loss corporation for ownership changes. Is the definition specifically excluded from § 382(e) formula anywhere? § 382(k)(6) is definitional, so will be overridden by special purpose operational rules. Operation rules in § 1.382-2T.

Trick in § 382: That you cannot learn section through secondary rules, only through the primary materials in the code. Can only use secondary sources such as Hill & Mancino if you have mastered the primary sources. Nothing in exam can be answered by secondary materials.

Treas. Reg. § 1.382-2T(k)(1)-(5)May rely on SEC filings to identify 5% stockholders. Loss corporation is required to determine stock ownership on testing date.

Treas. Reg. § 1.382-4Option is treated as exercised if; 1) meets ownership test, 2) meets control test, 3) meets income test.

Owner and Equity Structure Shifts5% Shareholder Categories of complexity. § 1.382-2T(f)(10) also has a definition of 5% shareholder. § 1.382-2T(1)(A)&(B). 50 point increase of 100 is 50 to 75. What are the categories of issues arising in determination of who or what is a 5% shareholder? 1) who own indirectly vs directly, 2) what is this stuff that they are holding, stock, options, etc. 3) when did an individual acquire the stock to match up against testing period and date, 4) concept of aggregation and segregation into one 5% shareholder, 5) attribution rules of § 318 (can be different from direct/indirect constructive ownership), 6) loss corporation duties "know or have reason to know", 7) treatment of worthless stock, 8) if entity is first tier or higher tier, etc. Need to read the § 382 Regs.

Example 1 - Section (g) - Diagrams in Full Statute BookExample is identifying for us who are the 5% shareholders. Interesting facts: B is considered to own only 1.5% of L due to tier rules, so is considered to be part of Public L. Contrast though, we are told

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that P2 & P3 are not 5% shareholders, even though mathematically they do. Though we know about A&B, the example is still open as to treatment of P2&P3. Example 25% shareholder here are A, and C. B goes into Public L again. Trying to figure out if indirect interest through several tiers is applicable to public ownership as well as individual stock ownership. Interesting here is that B is now considered part of P1 for ownership purposes, while in Example 1 B was part of Public L. On its own P3 has only 1.4% of L, so what do we do about Public P4 as aggregated with P3 raises to over 5%.

Example 3Do not necessarily like P at 94% as means another 5% shareholder to keep track of.

Example 4 Another 5% shareholder is in the mix here.

Owner Shift Owner shift is a change in stock holding that affects the percentage ownership of a 5% shareholder. Outside factors can affect a 5% owners shareholder, cap A is direct, cap B is indirectly effecting 5% holder. Cap C can be indirect as well as cap D and cap E, all can indirectly effect 5% shareholders. Does 5% shareholder have to be a direct party to the transaction or just effected by it.

Example 1Will trigger § 382 limitation, but not ownership change. B goes form 0 to 30% shareholding. If had been 55% then would be an owner shift and ownership change. (g)(1) says more the 50 percentage points so could go up to 500 shares before ownership change.

Example 2C,D,AA each get 100 shares, total only 46.2% ownership change, so owner shift but no ownership change.

Example 3Key in this example is that buying and selling among Public L does not trigger any ownership changes as none within the group are 5% shareholders.

Example 4Same basic facts as example 2, but L redeems shares, which effects the 5% shareholders C, D and AA holdings, so owner shift and ownership change. Shifting capital structure will trigger ownership change, here to 54.6%. One needs to consider the § 382 consequences from a redemption, especially in closely held corporations. In closely held corp need to keep an eye on constructive ownership rules of § 318, can possibly use as a benefit here.

Example 5Public offering to new Public holders of 66.6% triggers equity shift and equity ownership change. If there were no losses in L then the company would be indifferent as no losses to traffic. Cautionary here as § 382 can appear in a completely publicly held company and offering without any 5% shareholders.

Example 6Trades between and among public shareholders are disregarded, but, A's purchase of 5% from the market is treated as proportionately bought from Public L and NPL, or 2/3 and 1/3 respectively. Does

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the proportional rule matter in this example? Proportional rule is important as you need to do the math as may change the result and create an ownership change, though it does not do so here. An allocation rule fiction as not possible to trace the trading on the market.

Example 7Same facts as example 6, but P always owned 5% of L. Trading among P is disregarded, but not sale of 5% to others. learning what trading is disregarded and what trading is not. Not turning off disposition even though all sales are on public exchanges. Also higher tier entity issue.Equity Structure Shift - § 1.382-2T(e)(2)Ownership and equity structure shift can be going on simultaneously. (ii) reserving the right to write the regs later regarding § 382(g)(3)(B), taxable reorganizations transactions including public offerings such as in previous examples 6 & 7. These in future may be considered Equity Structure Shift, at least taxable reorgs. and public offerings can be expected to be named in the reg. under (ii) as crossing § 382(g)(3)(B), question is what else will be included? Need to advise clients of this point of worry. Need to be sure IRS has not put out any guidance regarding taxable reorganizations. If no taxable reorg. and no 5% shareholder can argue that you are ok as regs are temporary and issue not completely addressed.

Example 1Here it is B's increased ownership in L that gets tested. Direction matters, as if L had acquired P, there would be no purchase of loss corp. and § 382 would not apply. Possible, depending on actual % owner shift, switching target may still trigger an equity/owner shift.

Example 2Pre-change losses are not limited as no ownership change due to the equity structure shift.

Example 3L1 survives, target shifts, example says that there is no change. Highlights the difference between equity structure shift and ownership shift.

IV. Bankruptcy Reorganization

What tax issues are raised in bankruptcy that are not raised outside bankruptcy?1) Tensions between the Bankruptcy code and Internal Revenue Code which seek different goals and operate under different theories.2) Reduction in Creditor Status of the IRS to shift a greater share of the burden from the unsecured creditor to the broader tax base.3) Whether cancellation of indebtedness income arising from debt discharges in bankruptcy is taxed.4) Limitations on the use of pre-bankruptcy tax attributes by the reorganized debtor.

How do G reorganizations attempt to accommodate these issues?By creating a special provision applicable to bankruptcy restructurings. If the corporation satisfies the continuity of shareholder interest requirement, the IRS treat the restructuring as a mere change in form and not a taxable event.

Do G reorganizations operate rationally in light of their objectives?Generally yes, but provision requiring that at least one-shareholder of debtor corporation remain not necessarily founded on either tax or bankruptcy objectives and can complicate restructurings. (Small Ch 11's?) Can be an issue of whether losses of a different taxpayer are being trafficked.

Why are special rules needed in § 382?

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To prevent losses being piled on in bankruptcy, then effectively trafficked to the new owners. § 382 limits loss carryforwards to what the corporation in bankruptcy could have used had it not declared bankruptcy.

Do these rules work rationally in light of their objectives?Probably if the goal is rehabilitation, no if the goal is maximizing revenue collection due to the subordination powers over tax claims of the bankruptcy court.

BankruptcyIf you're going to give a debtor protection from creditors, it makes no sense to then tax them and take away one of their main assets, the NOL. Role of Tax Lawyer in corporate bankruptcy is first and foremost to preserve the NOL. Bankruptcy courts main purpose is to keep the entity ongoing. Whether it makes good policy is a debatable issue as most bankruptcies end up in bankruptcy again.

Any plan you structure you need to make sure that it will pass muster with the Fed. Bankruptcy Judge. Ch 11 bankruptcy code has few rules, provides mainly for negotiation and ruling by the judge. Basically a statute without Regs. as there is no administrative agency, administered by the Bankruptcy court and then many appealed to the Supreme court. Probably historical that bankruptcy is conducted by courts, elimination of debtors prisons.

Mandatory credit counseling now required for individual bankruptcies, provided by a non-profit entity or course by US Credit Council. IRS has revoked many credit counseling organizations tax exempt status due to improprieties. Also, inherent conflict in credit card company funded non-profit credit counseling organizations even though incentive to keep debtor out of bankruptcy extending time to foreclose.

Corporate debtors, may make sense to have an administrative agency to make a report as to feasibility of restructuring plan.

Representation in BankruptcyWhat order do we get things done? In corporate bankruptcy what is the nature of the reorganization? File an automatic stay under § 362 of the bankruptcy code. We know there will be a reorganization of the company under § 368(a)(1)(G), or alternatively § 368(a)(1)(E) recapitalization. Creditors of the debtor are going to become the shareholders of the new corporation under discharge. May be more important to take care of trade creditors first to keep the company viable by keeping the necessary materials flowing. Trade creditors are more likely to want cash then unsecured creditors which are more willing to take ownership stakes.

Need to be cognizant of bottom-feeders that will buy stock and debt at a discount as they want a significant share of the restructured organization. Transaction always is that creditors will become shareholders. Will need a certain number of he creditors to buy in or will not have reorganization. Corp. bankruptcy tax two things that matter most; 1) satisfying creditors and continuity rules, and 2) making sure normal § 382 rules do not apply so that honestly earned NOL's can transfer. Not paying IRS proper tax prior to filing can trigger criminal time for executives and loss of license if attorney is found to collude.

§ 368(a)(1)(G)Statute says that bankruptcy court will create a new corporation. There is no continuity of business enterprise requirement under a (G) reorganization, so can be no objection that there is a divisive reorg. Can have a nonrecognition under § 355. Title 11 is defined in the § 368 statute, broader then just bankruptcy, such as receivership or foreclosure in addition. Transfer of assets says that you need

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to be under the jurisdiction of the court and need a plan of reorganization that is approved by the court to have a § 368(g) reorg. The plan would include both the restructure plan and tax plan. (C) talks about overlap between (G) reorganizations and other reorganizations. § 357(c)(1) liabilities in excess of basis has an overlap with (c)(1), can be an issue in (l)(5) and (l)(6) so need accountants to get numbers to see if overlap with § 351 or divisive (D).

(D) has an exception whereby a regulating agency can determine insolvency and be treated as the court.

§ 368(a)(1)(E) can also be used, but not as popular as (G) due to additional rigidities built in on types of stock that can be exchanged for value.

Net value exchange proposed regs. § 1.368-1(e)(6) transfer of no net value allows creditors to satisfy the exchange. Creditors can have proprietary interest even though they do not have control to satisfy continuity of interest rules.

§ 382 Intersection with (G) and (E)§ 382(l)(5) & (l)(6), necessary to preserve NOL's in order to preserve viability of new organization. (l)(5) says subsection (a)(1) does not apply. (l)(6) says subsection does not apply but can be finagled to increase value. Will not be tested on Hills theories of statutory intersection. Next week consolidated returns and -9 regs.

To get out of § 382(a)(1), if we want to use (l)(5) fist thing to do is make sure we satisfy the 50% benchmark which may be hard when people are buying up shares in bottom-feeding. Can have a conflict between tax lawyer and management who may wish to issue a new offering to improve cash flow. Can be the first point that needs to be addressed. § 382(l)(5) is the default position, need to determine if staying in (l)(5) or go to (l)(6). Qualified shareholders need to have held the debt for 18 months, or from the date of issue if issued in the ordinary course of business. (l)(5)(E) tells us what stock is taken into account, must not have been sold to another investor. (l)(5)(H) says you can elect not to have it apply, such as if you do not meet 50% rule, so try to go to (l)(6). Basically say here you are in (l)(5) unless you elect out or do not qualify.

(l)(6) simply says that if (l)(5) does not apply look at (l)(6).

Know you have to be in § 368(a)(1)(G) and satisfy continuity rules, then go for (l)(5) & (l)(6).

§ 269Anti abuse rule of the IRC. § 1.269-3(d)(1) could be a reason to prefer (l)(6) over (l)(5). Reg seems inconsistent with need to prevent overlap, here IRS thinks § 362(l)(5) may be abusive. Regulation is a continuity of active business enterprise continuity rule, vs § 368 which is just business continuity. Presumption is that (l)(5) is abuse and that taxpayer has burden to show that it is not being used in that manner. Very odd in that we have a reg stating that statute is presumptively abusive, when in front of a judge even.

§ 382(l)(5) & (l)(6)§ 382(l)(5) gets us out of § 382 if meet the conditions, fictional continuity rules. § 382(l)(6) says if (l)(5) does not apply (l)(6) may. (l)(5) says you need to meet the requirements of § 1504, and shareholders of the new loss corp must have been shareholders of the old loss corp. (l)(5)(E) says that a creditor, receiving stock in new corp, must have held the indebtedness for at least 18 months. Under (l)(5)(D) a new corp cannot be acquired within two years of looses the NOL carry forward, change

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date of the second ownership change.

§ 382(l)(6)§ 382(e) value is value of old loss corporation stock.

§ 1.382-9 Regulations-9(d) contains the definition of a qualified creditor, and -9(d)(2) qualified indebtedness. Need to be nervous of the qualified indebtedness definition. (iii) Requires a duty of inquiry from the attorney, who needs to figure out who has the debt. Can rely on a statement under perjury that the beneficial ownership is what it is.

Examples name debt as trade debt, ordinary and necessary business expenses etc., all of which is exchanged for stock will count. Need to be concerned about Cancellation of Indebtedness income? Now what happens is the value of the stock needs to be reasonably equal to the value of the debt given up. (l)(5)(C) says that there will not be any COD income for interest payments.

-9(d)(3) requires continuously owned beneficial interest. last line is a cryptic provision. 5% shareholders are persons who are thought to be able to exert influence. Rule seems to be preventing a person from gaining access to the tax attributes through the purchase of debt, then traded to become a new shareholder. Last line seems to be an anti-abuse rule. (l)(5) requires ordinary course holding, this part of the reg basically says you need to keep watching the structure even during bankruptcy.

-9(d)(3)(ii) contains operating rules. (A) is an actual knowledge rule. Cross reference to § 1.382-2T(k)(2). -9(d) Regs are basically cutting persons off from gaming the bankruptcy.

(l)(5) Tacking of ownership beneficial rules. Likely trying to preserve liquidity and keep from penalizing bankrupt company from regular business transactions prior to the bankruptcy, loans will be syndicated

-9(j) & (k) are trying in effect to balance out the rules on increasing value without giving up on all the § 382 anti-abuse rules, such as risk and anti-stuffing rules. (j) says (l)(6) will apply to title 11, and valuation of loss corps pre-change assets, which does not seem to have support in the § 382 statute, as pointing to assets rather then stock. Probably not challenged as choice of stock or assets can be beneficial to the debtor, but reg says you treat as the lesser of in effect placing a cap. Will need to talk to the accountants to get the values of tangible and intangible assets. Need to determine fast to decide if it is better to be in (l)(50 or (l)(6). If really trying to make statutes work together better should have used the anti abuse rules in § 382, then greater of the assets or stock rather then the lesser of. This makes § 382(l)(6) less useful, making (l)(5) the useful default. Exam question: Ask about what was just asked, apply the limitations and caps in § 382, then choose whether (l)(5) or (l)(6) are better. Know § 382 anti-abuse rules as they relate to bankruptcy. Follow issues through applicable statutes and regs. Bread-crumb trail through reg and statutory language is what is important, include citations. (l)(5) & (l)(6) are the heart of bankruptcy tax law. Does idea of statutory coordination have merit? Policy question is whether statutory coordination is being achieved through anti-abuse rules in § 382? Will test skill in parsing the provisions. Will ask pointed questions about the structure of the reasoning, and reading the code, as § 382 is considered a hard but pervasive question.

V. Consolidated Group Tax Liability

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Aspects of the Consolidated Group in Bankruptcy§ 108 provides that cancellation of debt income under Ch 11 or insolvency is not included in income but; 1) applied to reduce NOL's, certain tax credits and tax bases of property.

Problem is affiliated group filing a consolidated return, with P-S1-S2-S3. S2 files bankruptcy § 362, S3 has NOL's from being a start-up. Prudential Lines stands for the fact that you can move NOL's from S3 to S2 to be used by new loss corporation to help the restructure plan. Filing takes S2 out of the consolidated group, with the NOL's going out (even S2 NOL's). Theory is that once you have NOL's filing in a consolidated return, you have a Consolidated NOL, with S2 taking some of it when it leaves the group. The unanswered question is who gets to take out what?

In reality, everyone horse-trades over the issue which gets a stamp of approval from the court. Article tries to determine the value of the NOL to several members of the group, but this does not go to the policy issue, especially as relates to the party not in bankruptcy. Question is how much remaining tax should the other parties pay because the NOL left the group? Is bankruptcy to generous? Bankruptcy is tilted pro creditor, especially pro-secured creditors. Big question is who should bear the cost of bankruptcy, as determined by this technical tax question. May ask about logic and contours of the dispute. Testing can you read the code, regs and commentary.

To the extent the NOL goes out with the debtor, the remainder of the group pays more tax. Consolidated return rules are not helpful, need to look as special bankruptcy rules.

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