D-1-Mergers-&-Acquisitions

NOVEMBER 7-9, 2012 DISNEY CONTEMPORARY HOTEL | ORLANDO

47th

annualBANK & CAPITAL MARKETSTAX INSTITUTE

47th

annualBANK & CAPITAL MARKETS TAX INSTITUTE

WWW.BANKTAXINSTITUTE.COM

D-1: MERGERS & ACQUISITIONSNutcracker Ballroom November 9th, 1:45pm – 3:15pm

47th ANNUAL BANK & CAPITAL MARKETS TAX INSTITUTE DISNEY CONTEMPORARY HOTEL

Speakers:

JOHN KINSELLA

KEVIN POWERS, CPA

MELISSA REINBOLD

1

The Unique Alternative to the Big Four®

Bank & Capital Markets Tax Institute 2012Mergers & Acquisitions

Kevin Powers, Partner – Crowe Horwath LLPMelissa Reinbold, Senior Manager – Crowe Horwath LLPJohn Kinsella, Director of Tax – U.S. Bancorp

November 9, 2012


© 2012 Crowe Horwath LLP 2Audit | Tax | Advisory | Risk | Performance

Disclaimers

These slides are for educational purposes only and are not intended, and should

not be relied upon, as legal, tax or accounting advice.

Pursuant to Circular 230 promulgated by the Internal Revenue Service, please

be advised that these slides were not intended or written to be used, and that

they cannot be used, for the purpose of avoiding federal tax penalties unless

otherwise expressly indicated.



Agenda

2012 Year in Review

Due Diligence Process

S Corporation Acquisitions

Recapitalizations & Sec. 382 Ownership Change Rules

Other Current Issues

2



2012 Year in Review



2012 Year in Review

See separate hand-out




3




Acquisition structure

Target review

Post-acquisition integration



Acquisition Structure



Due Diligence – Structure

What questions should you be asking?

Stock or asset acquisition?

Tax-free or taxable?

C Corp or S Corp?

Holding Company or Bank?

Type and amount of consideration?

What are the post-closing plans for target corporation?

4




Stock or asset acquisition?

This is not always a simple question

You could have a stock acquisition for legal purposes which may be treated as an asset acquisition for tax purposes

If asset acquisition for legal purposes, then it should always be treated as an asset acquisition for tax purposes

The legal form of the acquisition will also dictate which pre- and post-acquisition liabilities (including income taxes) are the responsibility of the acquirer

Stock sale avoids title transfers/re-titlements, transfer taxes, consents and other legal entity issues (dissolution, etc.)

Joint and several liability for subsidiaries of an affiliated/consolidated group





We are asking this question with respect to the target corporation and acquirer

The acquisition can be taxable to the shareholders, but tax-free to the corporations

During pre-acquisition planning, this is an important question to ask, as legal documents will have to be drafted specific to the expected results

During post-acquisition implementation, the structure will impact the purchase accounting entries, tax return preparation, etc.




C Corp or S Corp?

C Corp acquisitions are typically structured as tax-free deals

Many S Corp acquisitions are structured to be treated as asset purchases, but can also qualify as tax-free

Question: What is the reason for this?

Answer: No double taxation for S Corp target shareholders (however, BIG Tax can still apply to the target corporation)

5




Holding Company or Bank?

In many cases, the target holding company stock will be acquired

However, the target Bank stock could be purchased from a holding company

Question: Why purchase the Bank stock instead of the holding company stock?

Answer:

Non-tax reasons – Unwanted H/C assets or liabilities

Tax reasons – To facilitate an asset purchase




Type and amount of consideration?

Target shareholders may receive some combination of cash and acquirer’s stock

Even if target shareholders receive all cash, the transaction can still be tax-free to the corporations

In some cases, even if the acquisition is structured such that it could qualify as tax-free, an election can be made to treat the acquisition as a purchase of assets

Any contingent consideration?




What are the post-closing plans for target corporation?

In many cases, the target corporation will be merged with the acquirer

Target corporation could be the holding company, in which case the target Bank subsidiary might be merged with the acquirer’s Bank subsidiary

Assets of target corporation and its subsidiaries may be contributed to other entities within acquirer’s affiliated group

Is acquirer filing a consolidated tax return?

Consideration should be given to how these plans impact the structure of the deal (e.g., state taxes)

6





Forward triangular merger - Target shareholders exchange stock of Target for stock of Acquirer and Cash (at least 40/60 split)

Treated as asset purchase if all cash consideration

TargetC CorpTargetC Corp

New SubNew Sub

AcquirerAcquirer

Merge





Reverse triangular merger - Target shareholders exchange stock of Target for stock of Acquirer and Cash (at least 80/20 split)

Treated as a “qualified stock purchase” if all cash consideration


New SubNew SubMerge

AcquirerAcquirer





Qualified stock purchase – Can make §338(h)(10) election to treat as asset purchase for tax purposes


AcquirerAcquirerTarget StockParentParent

7



Target Review



Due Diligence – Target

What questions should you be asking?

What is the target corporation’s structure?

What tax returns are being filed?

Have there been any IRS or state audits?

What are the target corporation’s accounting methods?

Has the target corporation engaged in any prior acquisitions or other significant transactions?




What questions should you be asking? (cont.)

Does the target corporation have any NOLs or other carryforwardattributes?

Has the target corporation engaged in any tax planning strategies?

Are there any change-in-control agreements?

Have all non-income taxes been considered?

8




What is the target corporation’s structure?

Obtain a copy of the organizational chart, including states (or countries) in which the corporation does business

Obtain a schedule of partnerships in which the corporation has invested, including a description of the nature of the investments

Obtain a copy of any intercompany agreements, including tax allocation

S Corps – Obtain a copy of the following:

Shareholder list

Executed shareholder agreements




What tax returns are being filed?

Obtain a copy of all federal and state tax returns filed for the past 3 years

Obtain a copy of related tax workpapers for these same returns, including:

Deferred inventory schedules

Rollforward of all balance sheet tax accounts

Calculation of book taxable income and expense

State apportionment schedules

“FIN 48” analysis / Sch. UTP details

S Corps – Obtain a copy of the following:

IRS approval letter for S election and QSub elections (if any)

Any required state approval letters/applications

Schedule of net unrealized built-in gains




Have there been any IRS or state audits?

Obtain a summary of IRS and/or state examinations for the 5 most recent tax years

Obtain a copy of any revenue agent reports, settlements or closing agreements for the 5 most recent tax years

Obtain a copy of any tax notices received within the last 5 years, including any correspondence sent and a description of the resolution/current status

Obtain a copy of any notices and correspondence related to information reporting infractions, including penalties paid within the past 5 years

9




What are the target corporation’s accounting methods?

Review tax return and workpapers for applicable accounting methods

Obtain a copy of any Form 3115’s filed within the past 5 years, including a copy of the executed IRS consent letters (if applicable)

Obtain a copy of the following documents:

Sec. 475 mark-to-market identification policy

Hedge identification policy/statements

Express determination letter (if bad debt conformity election in place)




Has the target corporation engaged in any prior acquisitions or other significant transactions?

Obtain a description of the transactions, including a copy of any tax opinions issued

Obtain a copy of any IRS private letter rulings, or state rulings, issued in conjunction with the transactions

Obtain a copy of any purchase accounting schedules or any other book-tax reconciliation schedules

Obtain a copy of the “FIN 48” assessments and Sch. UTP details completed with respect to the transactions (if available)

BOLI policies – Consider impact based on structure of transaction




Does the target corporation have any NOLs or other carryforwardattributes?

Obtain a copy of any carryforward schedules

The tax returns can also be reviewed to identify any carryforward attributes

Remember – The form of the transaction will dictate the availability of these tax attributes

For example, if the acquisition is to be treated as an asset purchase for tax purposes, any carryforward items remain with the “old” target

Acquisition of target subsidiary – Consolidated regulations will dictate availability of carryforward items

S Corps – Any carryforward items from pre-S Corp years?

10




Has the target corporation engaged in any tax planning strategies?

Obtain a description of the strategies

Obtain a copy of any pending IRS private letter ruling requests, or state ruling requests, with respect to proposed transactions

Obtain a copy of any executed IRS consent letters with respect to strategies implemented in prior years

Obtain a copy of the “FIN 48” assessments and Sch. UTP details completed with respect to the strategies (if available)




Are there any change-in-control agreements?

Obtain a copy of executive employment agreements or any supplemental change-in-control agreements

Obtain a copy of any Code §280G calculations that may have been completed

For public companies – Review the executive compensation summary table from the most recent proxy filing

Note – Certain exceptions apply for non-public companies; in particular, S Corps (or companies otherwise qualifying as S Corps, even if an election has not been made) are exempt from the provisions of Code §280G




Have all non-income taxes been considered?

Non-income taxes can include:

Payroll taxes

Back-up withholding

Personal property taxes

There can often be hidden liabilities in these taxes

Confirm as to who will be responsible for reviewing these areas

11



Post-Acquisition Integration



Due Diligence – Integration

What should you do now?

Address tax treatment of acquisition costs

Address tax treatment of severance payments

Review purchase accounting entries

Consider impact on book accounting for taxes

Consider impact on federal tax return

Consider impact on state tax returns

Consider need to prepare final short-period tax returns for target corporation

Consider impact on information reporting




Acquisition costs

Prepare/obtain an analysis of the following:

Investment banker fees (Note: 70/30 election now available)

Legal & accounting fees

Other integration costs

Analysis should be prepared for costs incurred by both target and acquirer

Determine impact on book purchase accounting and target/acquirer tax returns

12




Severance payments

Update Code §280G calculations for final pay-outs

Determine amount of payments treated as “excess parachute payments” – no tax deduction for this amount

Review timing/deductibility of other compensation related payments, such as:

Deferred compensation

Stock option “cash out”

Determine impact on book purchase accounting and target/acquirer tax returns




Purchase accounting entries

Review purchase accounting entries

Tax-free acquisitions – Deferred tax assets/liabilities will have to be established

What tax rate should be used (including states)?

Any “FIN 48” reserves required?

Taxable acquisitions – Generally no net deferred tax implications

Book ALLL does not carry over

What about PAA entries related to liabilities?




Book accounting for taxes

Update ASC 740 schedules

Target book-tax basis differences

Carryforward attributes

Purchase accounting entries

Determine impact on book expense for income taxes

Higher tax bracket?

Changes in state apportionment?

New state filing requirements?

Discuss need for valuation allowances

13




Federal tax return

Determine where inconsistencies may exist between target and acquirer accounting methods

Consider filing of Form 3115, where necessary

Consider need for bad debt reserve recapture

Prepare any necessary statements related to tax-free acquisitions (e.g., Sec. 368 statements)

Coordinate preparation of Form 8594 or Form 8883 (if applicable)

Update Form 851 for new subsidiaries

Also report post-acquisition liquidations of subsidiaries




Federal tax return (cont.)

Coordinate revisions to Sec. 475 and hedge identification policies

Update carryforward schedules (e.g., NOLs)

Determine applicability of Code §382 to carryforward items, such as:

Net operating losses

General business credits

AMT credits

Capital losses

Consider impact of Sec. 56(g)(4)(G) “ACE” basis adjustments

Determine impact to estimated tax calculations




State tax returns

Determine impact to state apportionment factors

Determine if any new state or local tax returns will have to be filed

Consider timing of estimated tax payments

Consider need to file tax registration documents

Update carryforward schedules (e.g., NOLs)

Determine impact of any federal accounting method changes to specific states

Do all states conform to Internal Revenue Code?

14




Final short-period tax returns

Coordinate preparation of tax returns

When are the tax returns due?

Coordinate payment of final estimated tax and extension payments

Determine if NOLs should be carried back

If taxpayer chooses to carry forward, election must be made on tax return

Remember – Credits and capital losses must be carried back if they can be used in a prior tax year (no election to C/F)




Information reporting

Consider the various requirements related to information reporting for the target’s pre-acquisition activities

For example, consider the reporting requirements for the following:

Form W-2

Form 1099 series, including 1099-INT & 1099-MISC

Form 1098



S Corporation Acquisitions

15



S Corp Acquisitions – Considerations

Is the purchase price more or less than the seller’s income tax basis in its assets?

Is the purchase price more or less than the selling shareholders’ income tax basis in their shares?

Should the transaction be a sale of stock or a sale of assets?



S Corp Acquisitions – Options

1. Purchase of holding company stock

2. Purchase of holding company stock with a Sec. 338(h)(10) election

3. Purchase of bank stock from a holding company

4. Purchase of assets and assumption of liabilities from a bank



Purchase of Holding Company Stock

Can be structured as a Sec. 368 reorganization

Consideration can be a combination of cash and stock of Acquirer

BankQSubBankQSub

AcquirerAcquirerParent Stock

ParentParent

TargetS/H’sTargetS/H’s

16




Impact on Selling Corporation

No corporate-level tax implications

All holding company and bank assets transfer

All holding company and bank liabilities are assumed




Impact on Selling Shareholders

For tax-free reorganizations, gain recognized up to amount of “boot” (e.g., cash) received

No loss recognition, unless all cash consideration received by shareholder

Any gain/loss deferral reflected in basis of acquiring stock received

Full gain or loss recognition for taxable acquisitions




Impact on Acquiring Corporation

No corporate-level tax imposed

Carryover basis in assets and liabilities

Section 382 could limit use of recognized built-in losses or prior years’ C Corp carryover attributes

Built-in loss recognition period for bad debt deductions is generally 1 year

For acquiring S corporations, built-in gains attributable to selling corporation’s assets tracked for remainder of recognition period

17




Reporting Requirements

For tax-free reorganizations, information statements included with returns of all parties to the reorganization

See Reg. Sec. 1.368-3

Consider Sec. 6045B reporting of “organizational actions”

See IRS Form 8937, Report of Organizational Actions Affecting Basis of Securities




Planning Considerations

If acquiring corporation is also an S corporation, acquisition unlikely to be structured as a Sec. 368 reorganization

Limitations on number of shareholders

Ownership by closely-held family groups

S Corp acquirer should consider filing QSub election for target holding company and/or bank



Purchase of Holding Company Stock w/ Sec. 338(h)(10) Election

Consideration can be a combination of cash and stock of Acquirer

Target shareholders and Acquirer must all agree to the election

BankQSubBankQSub

AcquirerAcquirerParent Stock

ParentParent


18



Tax Transaction – Step 1:“Old Target” Sells Assets to “New Target”

Old target is treated as selling assets to new target

New target is treated as assuming liabilities of old target

OldTarget

OldTarget

NewTargetNew

TargetAssets/Liabilities

Consideration



Tax Transaction – Step 2:Old Target Liquidates

Target shareholders receive liquidating distribution from old target

OldTarget

OldTarget


Consideration(cash, acquiring stock,

other properties)



Tax Transaction – Step 3:New Target Gets Fair Market Value Basis in Assets

New target may remain in existence or merge with acquirer (or a subsidiary of acquirer)

NewTargetNew

Target

AcquirerAcquirer

Asset Tax Basis = Fair Market Value

19





Taxable sale of all holding company and bank assets

All holding company and bank liabilities are assumed

Consider impact of cash-basis adjustments

Ordinary income “recapture” for net accrued income

Built-in gains tax could apply





Gains and losses from deemed sale of assets pass through to shareholders

Shareholders adjust stock basis for these gains/losses

Certain assets will generate ordinary (versus capital) gains/losses

Acquirer may indemnify shareholders for additional tax resulting from ordinary gains

Shareholders recognize gain or loss upon deemed liquidation of holding company shares (or bank shares, if no holding company)

See separate hand-out for sample analysis of tax implications to shareholders





Step up (or step down) in tax basis

Deductible Sec. 197 intangible asset

No Section 382 limitations

No carryover of built-in losses or prior years’ C Corp attributes

S Corp acquirer should consider filing QSub election for target holding company and/or bank

20





Joint election required

See IRS Form 8023, Elections Under Section 338 for Corporations Making Qualified Stock Purchases

IRS Form 8883, Asset Allocation Statement Under Section 338, included with return of both selling and acquiring corporations





A single dissenting shareholder can disrupt the process

Various transactions can be used to “squeeze out” the dissenting shareholder

Forward cash merger can be used in lieu of a Section 338(h)(10) election

Invalid holding company S election or bank QSub election could pose potential tax risks to the acquirer

Acquiring corporation assumes certain tax liabilities



Purchase of Bank Stock from Holding Company

Automatically treated as an asset purchase

Unwanted assets and liabilities can be transferred from bank to holding company (or vice versa) immediately before the sale

BankQSubBankQSub

AcquirerAcquirerBank StockParentParent

21





Taxable sale of all bank assets (not holding company assets)

Remember, the Bank is a QSub, and thus was treated as having been completely liquidated in a prior tax year

Bank, but not holding company, liabilities are assumed

Consider impact of cash-basis adjustments

Ordinary income “recapture” for net accrued income






Gains and losses from deemed sale of bank assets pass through to shareholders



Acquirer may indemnify shareholders for additional tax resulting from ordinary gains

No deemed liquidation of shares

Gain or loss recognized if holding company subsequently liquidates






Deductible Sec. 197 intangible



S Corp acquirer should consider filing QSub election for target bank

22





No special elections required

Mitigates objections of dissenting shareholders

IRS Form 8594, Asset Acquisition Statement Under Section 1060, included with return of both selling and acquiring corporations





Invalid holding company S election or bank QSub election could pose potential tax risks to the acquirer

Built-in gains tax or potential state-level corporate income taxes from the deemed sale of the bank’s assets remains a liability of the selling corporation



Purchase of Assets and Assumption of Liabilities from a Bank

Tax consequences essentially mirror those of a purchase of bank stock from a holding company

Advantageous if target Bank is under regulatory enforcement or other significant legal exposures exist

BankQSubBankQSub

AcquirerAcquirerBank Assets/Liabilities

ParentParent

23





Taxable sale of specifically identified bank assets

Specifically identified bank liabilities are assumed






Gains and losses from sale of assets pass through to shareholders



Acquirer may indemnify shareholders for additional tax resulting from ordinary gains (although perhaps not as common w/ this structure)

No deemed liquidation of shares

Gain or loss recognized if holding company (or bank, if no holding company) subsequently liquidates






Deductible Sec. 197 intangible



24





No special elections required

IRS Form 8594, Asset Acquisition Statement Under Section 1060, included with return of both selling and acquiring corporations





Invalid holding company S election or bank QSub election would not pose any risks to acquirer

Built-in gains tax or potential state-level corporate income taxes from the deemed sale of the bank’s assets remains a liability of the selling corporation



Recapitalizations &

Sec. 382 Ownership Change Rules

25



Recapitalizations & Sec. 382 Ownership Change Rules

Banks seeking capital

Private equity/other investors seeking investment opportunities

Recent economic downturn resulted in large deferred tax assets (DTA)

DTA indicative of pre-change tax attributes

Net operating losses (NOLs), tax credit carry forwards, built-in losses (BILs)

Banks and potential investors want to preserve DTA

Challenge is how to structure recapitalization to preserve DTA by avoiding Section 382 ownership change (OC)



Recapitalizations & Section 382 – Agenda

Background on Section 382

Exceptions to Segregation Rules

Aggregation into single “entity”

TARP

Proposed Regulations on Segregation Rules for Small Shareholders

Tax benefit preservation plans

OC implications and BILs




Purpose to prevent abuses

trafficking in NOLs

infusion of income-producing assets or opportunities

If loss corporation has OC, Sec. 382 limits amount of pre-change losses available to offset post-change income

Sec. 382 limit = FMV of loss corporation’s stock immediately before OC x applicable long term tax-exempt rate

Accounting implications – may result in write off of DTA under U.S. GAAP to extent losses limited by Sec. 382 cannot be utilized

Complex rules to determine if OC triggered

26




Generally, OC occurs with respect to a loss corporation on any testing date where there is a greater than 50 percentage point increase in percentage by value of equity ownership by one or more 5-percent shareholders over each such shareholder’s lowest ownership percentage during the testing period

Sub-elements:

Loss corporation

Testing date

Transaction

Testing period

5-percent shareholder



Sub-elements Defined, Generally

Loss corporation – corporation with tax loss, credit carry-forwards, or BILs

Testing date – any date on which the loss corporation must determine whether an OC has occurred due to a transaction

Transaction – an owner shift (e.g., percentage ownership of a 5-percent shareholder changes) or equity structure shift (e.g., merger)

Testing period – generally, the 3-year rolling period looking backwards from a testing date

5-percent shareholder – person holding 5 percent or more of the loss corporation’s stock at any time during the testing period (directly, indirectly or constructively), or a group of less than 5-percent shareholders treated as a public group by virtue of the aggregation or segregation rules



Transactions Causing Testing Dates

Owner shift

Stock issuance (to new or existing shareholder, public offering, private placement)

Stock redemptions

Exercise of stock options or lapse of restrictions on stock awards

5-percent shareholder/higher-tier entity buys or sells stock from/to other shareholders

Equity structure shift

Most reorganizations under Code Section 368(a)(1)

A “failed” reorganization may also qualify

An equity structure shift cannot occur unless the former shareholders of the loss corporation receive or retain less than 50 percentage points in the reorganization survivor

27



Public Group

Public Group – group of individuals, entities or other persons each of whom owns, directly or constructively, less than five percent of the loss corporation

5-percent shareholder definition includes

Public group of first tier entity or higher tier entity under aggregation rules (§1.382-2T(j)(1)(iv)(A) or (B))

Public group of loss corp. under aggregation rules (§1.382-2T(j)(1)(iv)(C))

Public group of loss corp., first tier entity or higher tier entity under segregation rules (§1.382-2T(j)(2) or (3))



Tiered Entities

First Tier Entity – owns 5% or more direct ownership interest in the loss corp. during the testing period

Higher Tier Entity – owns 5% or more direct ownership interest in a first tier entity or higher tier entity during the testing period

Highest Tier Entity – a first or higher tier entity NOT owned by a higher tier entity during the testing period

Next Lower Tier Entity – with respect to a first tier entity = Loss corp.



Example of Aggregation Rule Analysis of Tiered Entities

E1E 3

E 2

LC

B

E 4

C

A

5% 95%

10%

36%

90%

56%4%

4%

90%

F G

5% 5%

D E

28



E1E 3

E 2

LC

B

E 4

C

A

5% 95%

10%

36%

90%

56%

5%

4%4%

5%90%

2.52% 47.88%

3.6% 32.4% 2.8%2.8%

D E

F G



E1E 3

E 2

LC

B

E 4

C

A

5% 95%

10%

36%

90%

56%

5%

4%4%

5%90%

2.52% 47.88%

3.6% 32.4% 2.8%2.8%

D E

F G

5% S/H DIRECT PUBLIC GROUP OF LOSS CO

5% S/H PUBLIC GROUP OF FIRST TIER ENTITY

5% S/H

5% S/H

5% S/H



Direct Public Group

Defined in §1.382-2T(j)(2)(ii)

Any Public Group of the loss corp.

under aggregation rule §1.382-2T(j)(1)(iv)(C)

under segregation rule §1.382-2T(j)(2)(iii), including

Certain equity structure shifts

Redemption-type transactions

under segregation rule §1.382-2T(j)(3)(i) on dispositions

Significance of direct public group vs. public group

29



Aggregation/Segregation Rules Result in Distinct Public Groups

Equity structure shifts – new less-than-5-percent shareholders segregated as a result of the reorganization

Stock issuances (e.g., public offering) – segregate new less-than-5-percent shareholders

Redemption of shares from public – redeemed shares treated as owned by a different public group

Sale to public by 5-percent shareholder or tiered entity – Segregate purchasing public group

Stock option exercises by public – Segregate exercising into new public group



Exceptions to Segregation Rules

Small issuance exception – issuance itself does not exceed small issue limitation as of the beginning of the year of either

1. 10% of the value of the stock outstanding on a corporation-wide basis, OR

2. 10% of the number of shares on class-by-class basis…

…Up to the small issue limitation when the shares issues are considered with all other small issuances previously made in the same taxable year

Cash issuance exception – stock issued solely for cash up to an amount equal to one-half of the stock held (before the issuance) by the small shareholders

Limit: amount of stock excepted cannot exceed the total amount of stock issued in the issuance less the amount of that stock owned by a 5-percent shareholder (other than a direct public group) immediately after the issuance

Treated as issued on a pro-rata basis to the aggregated public groups existing immediately prior to the issuance



Maximize Recapitalization Cash Issuance Exception

Absent exceptions, new investors may only own up to 50% of total post-issuance shares

If less than 5-percent shareholders comprise a majority of the new investors, the cash issuance exception would generally allow for a larger capital raise

Beware of the coordinated acquisition rule under §1.382-3(a) that can treat a coordinated effort to acquire stock as a deemed entity to which the cash issuance exception does not apply

Entity defined

Corporation, estate, trust, association, company, partnership or similar organization

Includes group of persons who have formal understanding among themselves to make a coordinated acquisition of stock

Is investment decision of each member of group based on the investment decision of one or more members?

30



2010 Notices

Notice 2010-2 provides for a favorable exception for certain sales by the U.S. government to the public (less than 5-percent shareholders)

Notice 2010-49 explores the purposive approach vs. the ownership approach; contemplated some taxpayer favorable exceptions for small shareholders that are not currently in effect; sought comments; and was the precursor to Prop. Regs. §1.382-3



Proposed Regulations §1.382-3

“Taxpayer-friendly” exceptions to segregation rules for Small Shareholders

Reduces percentage owner shift in measuring an OC

Reduces administrative burden

Builds on purposive approach in Notice 2010-49, utilizing objective criteria

Purposive approach – identify circumstances where abuse would likely occur; acquisitions by Small Shareholders generally not determined to be abusive

Small Shareholders – shareholders who are not 5-percent shareholders



Exceptions under the Proposed Regulations

Secondary transfer exception

Small redemption exception

Exception for first tier and higher tier entities

31



Secondary Transfer Exception – Prop. Reg. §1.382-3(j)(13)

Segregation rules of §1.382-2T(j)(3)(i) would not apply to:

The transfer of a direct ownership interest in the loss corporation to public shareholders by

A first tier entity or

An individual that owns 5 percent or more of the loss corporation

The transfer of an interest in a tiered entity that owns 5% or more in the loss corporation to either:

a public owner, or

a 5-percent owner who is not a 5-percent shareholder

BY:

A 5-percent owner that is a 5-percent shareholder, or

A higher tier entity owning 5 percent or more of the loss corporation

Exempted stock will be treated as acquired proportionately by each public group existing at the time of the transfer



Small Redemption Exception – Prop. Reg. §1.382-3(j)(14)

Segregation rules do not apply to “small redemptions”

Rule applies similar to the small issuance exception

Small redemption – redemption of public shareholders by the loss corporation up to the small redemption limitation (each redemption and on an aggregate year-to-date basis)

Small redemption limitation for each taxable year of either:

1. 10% of the value of the stock outstanding as of the beginning of the year on a corporation-wide basis, OR

2. 10% of the number of shares of the class redeemed that were outstanding at the beginning of the taxable year

Exempted stock will be treated as being redeemed proportionately by each public group existing at the time of the redemption



Exception for Tiered Entities – Prop. Reg. §1.382-3(j)(15)

Segregation rules do not apply if:

1. First tier or higher tier entity owns 10% or less (by value) of all the outstanding stock of the loss corporation, AND

2. Entity’s direct or indirect investment in the loss corporation does not exceed 25% of the entity’s gross assets (excluding cash or cash items)

Entity’s ownership in the loss corporation will be determined without regard to §1.382-2T(h)(2), but considers attribution under Code Sec. 318(a) with an exception for options not treated as exercised

If the exception applies to combine one or more public groups, the continuing public group must combine its increase in the percentage of stock ownership, as well as its lowest percentage ownership, with the respective proportionate share of each of the former public groups

32



Proposed Regulations Seeking Comments

Small issuance and cash issuance exception

Coordinated acquisition



Tax Attribute Preservation Plans

Tax preservation plans seek to protect taxpayers from an inadvertent ownership change by letting existing shareholders purchase at highly discounted rates

May discourage, but do not actually prevent, an OC

Discourage from becoming 5-percent shareholder

Discourage existing 5-percent shareholder from acquiring more shares

Mechanisms used may include:

Rights to existing shareholders that may be exercised at a below-market price

Voiding shares that would have otherwise contributed to an OC



Built-in Losses

BILs recognized within five years of OC subject to 382 limitation up to NUBIL

Notice 2003-65 provides 2 safe harbor approaches:

1. The 1374 approach

Depreciation/amortization is not RBIL up to the amount of such deduction that would have been allowed had the loss corporation purchased the asset for its FMV on the change date

Bad debt deductions taken during the first 12 months of the recognition period for debts owed at the beginning of that recognition period are RBILs

2. The 338 approach

Under the 338 approach, built-in gain assets may be treated as generating RBIG even if they are not disposed of at a gain during the recognition period, and deductions for liabilities, particularly contingent liabilities, that exist on the change date may be treated as RBILs

Hypothetical depreciation/amortization of an asset with change-date built-in gain over the actual depreciation/amortization deduction claimed during the recognition period is treated as RBIG –the so-called “wasting asset”

May use either approach, but may not mix

33



ACE Basis

See Code Sec. 56(g)(4)(G)

Adjusted asset basis deemed equal to proportionate share of the FMV of the assets of the corporation immediately before OC

Permanent reduction in bases of assets for ACE, including depreciation and any gain or loss on disposition

For the life of the asset, not just the 5-year BIL recognition period, and will require separate record keeping

Result – no deduction for losses that occurred pre-change in computing ACE adjustments; could result in unexpected AMT liability



Other Current Issues



Other Current Issues Agenda

Reporting of organizational actions

Revenue Procedure 2012-39

Deductibility of success-based fee – Background and recent CCAs

Section 597 observations

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Section 6045 Reporting Requirements

Form 1099-B has historically required those acting in the capacity of a broker to report the gross proceeds from sales of stock or securities to the seller

New laws now require the broker to report the tax basis of certain covered securities and indicate whether the resulting gain/loss is short-term or long-term

Covered securities

Shares of stock (other than mutual fund and dividend reinvestment plan shares) acquired for cash on or after 1/1/2011

Mutual fund and dividend reinvestment plan shares acquired for cash on or after 1/1/2012

Debt securities acquired for cash on or after 1/1/2013, or such later date determined by the Treasury

Other securities as the Treasury may designate in future years

Unless the bank acts as a broker/custodian of its own stock, it is not likely required to file Form 1099-B



Transfer Statement Requirements

Generally requires that brokers and professional custodians who effect transfers of stock to other brokers/custodians issue a “transfer statement” to the receiving broker/custodian within 15 days of the transfer

Contains various identification and other information about the transferred securities, including a designation regarding whether the transferred securities are covered securities

If the transferred securities are covered securities, the transfer statement must contain the original acquisition date and tax basis of those securities

If the bank acts as its own transfer agent, it will likely be required to comply with the transfer statement provisions of §6045A

Those banks who employ professional transfer agents to handle transfers of their stock will not likely be impacted by the transfer statement or basis reporting requirements



Organizational Actions

Enacted in tandem with the new Form 1099-B basis reporting and transfer statement requirements

All banks are potentially subject to the organizational action reporting requirements of §6045B if they undertake an action that affects their shareholders’ stock basis

Requires issuers of stock and securities to report actions undertaken by the issuer that affect a holder’s per-share basis in such securities

Reporting is made to the owners of the applicable securities and to the IRS

The ultimate goal is to provide owners of such securities with information needed to calculate the impact of the action on the basis of their securities

Any organizational action that impacts the basis of the securities must be reported, including (but not necessarily limited to): Mergers and tax-free reorganizations

Stock dividends

Stock splits

Non-dividend distributions

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Organizational Actions

Reporting required on two fronts: 1) Reporting to each holder of record by January 15th of the year following the calendar

year in which the organizational action was executed; and

2) Reporting to the IRS within 45 days following the organizational action or, if earlier, January 15th of the year following the calendar year in which the organizational action was executed

Both reporting requirements can be satisfied by timely posting the required information on the taxpayer’s public website within 45 days of the organizational action and keeping it available there for 10 years

Reporting must include identification of the affected securities and a detailed description of the impact the organizational action has on the basis of the securities

Reporting requirement first applicable to organizational actions on or after 1/1/2011

See Notice 2012-11 for transitional relief for 2011 actions



Form 8937, Report of Organizational Actions Affecting Basis of Securities

Describe the OA and the date of the action, or the date against which shareholders’ ownership is measured for the action

Describe the quantitative effect of the OA on the basis of the security in the hands of a U.S. taxpayer as an adjustment per share, or as a percentage of old basis

Describe the calculation of the change in basis and the data that supports the calculation, such as the market values of securities and the valuation dates

List the applicable IRC section(s) and subsection(s) upon which the tax treatment is based

Discuss if any resulting loss be recognized

Provide any other information necessary to implement the adjustment, such as the reportable tax year

See separate hand-outs for sampling of completed forms



Revenue Procedure 2012-39 Change in Method of Accounting

Provides for automatic accounting method change for taxpayers engaging in corporate reorganizations or tax-free liquidations under Section 381(a) for the taxable year of transaction

Previously, automatic consent procedures were not available

Policy changes related to August 2011 final rules (T.D. 9534) on accounting method changes in corporate acquisitions – See §§1.381(c)(4)-1 and 1.381(c)(5)-1

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Deducting Success-Based Fees in M&A Transactions

Deductions for success-based investment banking and other fees have been the source of significant disagreement between taxpayers and the IRS

The issue centers largely on the documentation requirements required by regulation and the fact that conforming documentation is often not available The IRS wants timesheet documentation (or something similar) and many investment

bankers do not keep or provide

Documentation is often subjective and relies on service provider

To eliminate much of the disagreement in this area going forward, the IRS issued Revenue Procedure 2011-29 in April 2011

Applies to transactions described in §1.263(a)-5(e)(3) – most merger and acquisition transactions

Provides an elective safe harbor to treat 70% of the success-based fee as non-facilitative (deductible) and 30% as facilitative (capitalized) without the need to gather any supporting documentation

Available (separately) to both the buyer and the seller



2012 Chief Counsel Advice on Success-Based Fees

CCA 201234027 provides that non-refundable amounts paid to an investment banker upon reaching specified deal milestones, even when those payments are credited toward the success-based fees, are not eligible for the 70/30 safe harbor split

CCA 201234026 provides that the “bright-line” date is not impacted or extended by the time period allowed in the deal for the target to shop itself to other buyers



Section 597 Observations

Typical acquisition of a failed bank from the FDIC

Structured as a direct purchase and assumption of failed bank’s assets and liabilities (including deposit liabilities)

Failed bank charter not acquired

Subsidiaries of failed bank often acquired in the transaction

Transaction may or may not contain loss share coverage (i.e., negotiated amount of guarantees) on acquired loans and OREO to be provided by FDIC for a set period of time

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Tax Treatment of the Transaction

Considered to be a taxable asset purchase

Purchase price paid (failed bank liabilities assumed plus any cash paid by the purchaser) is allocated to classes of assets acquired under general rules of §338 / §1060, with some modification

Covered assets are Class II

Any resulting allocation of purchase price to intangible assets (Classes VI and VII) constitutes a §197 intangible to be amortized over 15 years

No carry-forward tax attributes (e.g., NOLs, tax credits) of failed bank are available to purchaser

If the purchaser receives financial assistance from the FDIC in the form of a cash payment or loss share coverage, then the transaction is governed by §597



Application of §597

§597 contains special rules:

Forces particular approach to determining purchaser’s basis in certain categories of acquired assets

May result in a bargain purchase gain for tax purposes (excess of assigned tax basis over the actual purchase price paid) required to be recognized evenly over 6 tax years, beginning with year of acquisition

Requires taxable asset purchase treatment within acquired subsidiaries, similar to a §338(h)(10) election

If §597 applies to transaction due to presence of a loss sharing agreement, may be significant differences between purchase price assigned to loans and OREO for book and tax purposes



Discrepancies in Book vs. Tax Purchase Price Allocations

Under §597, tax basis of loans and OREO covered by loss share agreement are recorded at FMV, but not in an amount less than the guaranteed balance

For book purposes, loans are recorded at GAAP FMV, which is generally the discounted amount of the anticipated cash flows from the loans

May result in a significant difference between recorded book value of acquired loans and OREO and tax basis of these assets (i.e., tax basis is likely to be much greater than book basis)

GAAP requires recording of a “FDIC indemnification asset” which represents the value of anticipated indemnification payments to be received from FDIC under loss sharing agreement

No tax basis assigned to FDIC indemnification asset, resulting in a potentially significant book vs. tax difference

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Discrepancies in Book vs. Tax Purchase Price Allocations

Forced allocation of purchase price to loans and OREO under §597 can lead to little or no tax basis assigned to other types of miscellaneous assets (e.g., fixed assets, certain securities, prepaid expenses, loans and accounts receivable not covered under the loss sharing agreement)

Can cause significant book v. tax differences in the allocation of purchase price

All of these differences require recording and tracking of deferred tax assets and liabilities for GAAP purposes



Tracking Issues Going Forward – the “Day-2 Dilemma”

Once significant book-tax basis differences in loans are established at acquisition, proper tracking of correct taxable income from these loans going forward becomes challenging

Book accounting systems and reports used for financial reporting purposes will no longer provide correct taxable income for loans

For book, interest accrued is likely being calculated on loan’s recorded balance, not on contractual loan terms as required for tax purposes

Rate used to accrue interest on the discounted loan for GAAP purposes may not comport with loan’s stated interest rate

Differences in the amount and methodology employed to calculate the accretion of the loan purchase discount may exist as this amount is calculated on a different loan basis for book and tax purposes and may not be accreted on some loans for book purposes



How Are the Tracking Issues Being Addressed?

A variety of approaches are being used in the marketplace

Specialized software Benefits: Precision

Automatic calculations

Detailed support for the “M” adjustments

Drawbacks: Price

Output is only as good / reliable as data input

Manual calculations (i.e., spreadsheets) Benefits: No additional software to purchase

Complete control over the calculations / assumptions

Drawbacks: Time consuming

Calculations are complex

May not be possible if there are too many loans to track

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How Are the Tracking Issues Being Addressed?

Deferred Tax Asset / Liability Approach Benefits: No additional software to purchase

Often tied to movements in the associated GAAP purchase accounting adjustments or MTM calculations of loans remaining at year end, so calculations are simpler (macro)

Drawbacks: Precision is lower than with other methods

Often lacks detailed support for “M” calculations (i.e., relies more on a conceptual process than upon raw data)



Questions??



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For more information, contact:

Kevin Powers, Partner – Crowe Horwath LLP

Direct 630.586.5140

[email protected]

Melissa Reinbold, Senior Manager – Crowe Horwath LLP

Direct 630.586.5244

[email protected]

John Kinsella, Director of Tax – U.S. Bancorp

Direct 612.303.0990

[email protected]

D-1-Mergers-&-Acquisitions

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