Companies engaging in mergers and acquisitions—particularly those with large losses—got some new clarity on how to calculate their tax write-offs when they come under new ownership.
The IRS proposal (REG-125710-18) released Sept. 9 outlines how the agency will integrate the 2017 tax overhaul’s numerous changes to the code into its treatment of so-called built-in gains and losses.
When one company buys a loss-laden one, the acquisition triggers a cap on how much of those losses the new, combined company can use to shrink its tax liabilities under tax code Section 382, to keep companies from trafficking in losses.
But the amount of losses the combined company is allowed to use may be affected by the target company’s built-in gains or losses, which in turn can depend on the company’s capital expenses. The 2017 law amended Section 168(k) to let businesses fully and immediately write off the cost of such expenses in the year they are incurred, instead of piecemeal over a number of years, leaving them with large tax deductions.
The Internal Revenue Service said in Notice 2018-30 in May 2018 that companies can disregard the 2017 law’s full expensing provision when tabulating built-in gains and losses that may alter the size of their losses following an acquisition.
The White House regulatory review office examined the proposed rules between April 11 and July 22.
The annual limit on the combined company’s use of net operating losses, which can be used to offset future taxes, under Section 382 is based on the market value of the target company right before the change in its ownership.
The company’s built-in gains, which are based on differences between the value of a company’s investment in its assets and the fair market value of those assets, can increase that limitation. Similarly, built-in losses can lower it.
In the new set of rules, the IRS proposed getting rid of one method of calculating built-in gains, using Section 338, or the so-called 338 approach, leaving companies’ tax advisers and CPAs with just one option: an approach using Section 1374. This may lessen the combined company’s use of the target company’s losses in some cases, according to tax professionals.
“Companies with built-in gains were all using the 338 approach, and companies with a built-in loss were using a 1374 approach,” said Lee Zimet, senior director at Alvarez & Marsal in Morristown, N.J. “It’s definitely going to reduce NOL usage and it may very well reduce the stock of NOL companies.”
While Zimet said this change could end up triggering litigation against the IRS if left unchanged, he added that “it’s hard to say” whether such legal action would be viable under current law. He disputed the notion that the elimination of the 338 approach would lead to simplification, which the IRS described in the proposed rules as its goal, given the much more onerous analysis required in its absence.
New York-based tax consultant Robert Willens praised the agency’s work in tying together pieces of disparate guidance on built-in gains and losses into a single comprehensive set of rules.
“It’s very useful to have one well-thought-out, coordinated document,” he said. “It was a good thing to do, because the guidance before had been contained in revenue rulings and notices.”