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We are happy to provide you with another edition of M&A Spotlight. Many variables can effect the ultimate outcome of any corporate transaction. One of the most misunderstood variables is the effect of taxes on a corporate structure in all transactions. With over 100 tax professionals at SC&H, we can provide you or your clients with tax compliance or consulting on almost any aspect of the business cycle (M&A, State and Local, Income, etc).

We are especially grateful to our clients and referral sources as it is because of these strong relationships that we are able to advise so many companies in their business transactions.

As always, our SC&H Capital team is prepared to invest time getting to know your business. For more information on our services or to schedule a complimentary advisory session, please call me at (410) 785-8049.

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Christopher Helmrath, Managing Director

Maintaining the Value of Corporate Tax Attributes through the Corporate Growth Cycle

By Jennifer Nolan, Senior Manager, SC&H Corporate Tax Services

Most corporations, as they progress through the various stages of growth, typically incur substantial net operating losses ("NOLs") and may accumulate tax credit and other carryforwards on their quest to become profitable. These NOLs and tax credit carryforwards - referred to as tax attributes, are valuable to a corporation because they will be available to offset taxable income once the corporation turns profitable, thereby reducing future cash tax payments.

Tax attributes are valuable assets of a corporation which, in the past, led to the trafficking of corporate NOL and tax credit carryovers. For instance, a corporation generating taxable income would acquire the stock of a corporation that had a large NOL carryforward ("Loss Corporation") and then utilize the Loss Corporation's NOLs. Congress effectively put an end to this practice with the adoption of Section 382 in 1986. The legislative approach to end trafficking in corporate tax attributes is rather broad and includes all Loss Corporations whether or not the corporation ever intended to traffic tax attributes.

Generally, Section 382 imposes an annual limitation on the amount of tax attributes that can be used to offset the taxable income of a Loss Corporation when it experiences an ownership change. An ownership change occurs when there has been a greater than fifty percent change in the stock ownership of the Loss Corporation within a three year period. Following an ownership change, the Loss Corporation's NOLs and other tax attributes are subject to an annual limitation which is an amount determined by multiplying the value of the old Loss Corporation's stock by the applicable federal long-term tax-exempt rate.  This limitation can be increased by built-in gains recognized during the five years after an ownership change.

Many companies with NOL and other tax attribute carryforwards may receive multiple rounds of equity from various sources over a period of time. Consequently, it is highly likely that growing corporations will have one, if not multiple, ownership changes during their growth cycle. As such, the value of the corporation's tax attributes could be reduced and in some cases significantly impacted. Whether the impact of Section 382 will be detrimental to the value of a corporation's tax attributes depends on many factors including the value of the corporation at the time of the ownership change; the magnitude of their tax attributes; the impact of previous ownership changes; and the length of time until the corporation generates taxable income.

With proper tax planning, it's possible for a corporation to manage the impact of Section 382 on the value of its tax attributes. Most corporations don't have the resources to deal with potential Section 382 limitations while growing; however, even simple measures can help mitigate the impact of this provision. For example, a general awareness of the impact that new equity may have on the value of tax attributes is important. Also, maintaining key documents such as stock ledgers; stock purchase agreements; valuations; and Board minutes supporting the value of the corporation at the time of an equity raise, is critical.

Expert tax advice and consideration of Section 382 while structuring an equity raise could alleviate or mitigate entirely the impact of a potential ownership change. For example, if a corporation issued convertible debt instead of preferred stock in an equity raise, a potential Section 382 ownership change could be avoided.

For more information about Corporate Tax, contact Jennifer Nolan: 703-852-5610 or jnolan@scandh.com.

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