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Actual Knowledge Exception: IRS Issues New Section 382 PLR

Section 382 of the Internal Revenue Code, which governs the use of net operating losses (NOLs) among other attributes including excess interest carryovers, is critical for taxpayers who want to use NOLs.

One of the key provisions of Section 382 mandates corporations to limit the amount of NOLs they are eligible to use to offset their federal taxable income in future years once they undergo a “ownership change.” In order to assess if an ownership change happened on a testing date, Section 382 and the Treasury Regulations require a loss business to calculate the percentage of stock ownership of its five percent shareholders. If one or more 5 percent shareholders increase their ownership by more than 50% points within a testing period, an ownership change will occur.

Section 382 requires that you first identify the shareholders you want to follow. A losing corporation can identify its 5 percent shareholders and the percentage of ownership each 5 percent shareholder holds after reviewing documentation such as capitalization tables and SEC filings. Afterwards, it examines the percentage ownership of each 5% shareholder’s lost firm shares on every testing date to see if an ownership shift of 50% points or more has occurred on each testing day.

The loss corporation is ultimately responsible for keeping track of the ownership changes of its 5% shareholders. SEC filings (or lack thereof) can be used by public loss firms to identify their 5 percent stockholders, as long as they are made in accordance with a rule of convenience. When a shareholder acquires more than 5% of a publicly traded company’s shares, the Securities and Exchange Commission (SEC) requires the shareholder to file either a Schedule 13D or Schedule 13G.

To determine if an ownership shift has occurred, regardless of whether SEC filings exist or not, the loss corporation may be compelled to take its “actual knowledge” into account if it already knows or later discovers certain ownership facts. The Treasury regulations dictate that a loss corporation utilise actual knowledge to identify its 5% shareholder, but the IRS has guidelines on other scenarios where a loss corporation must take actual knowledge into account to assess if an ownership change has happened.

Loss corporations recently received PLR 202146003 from the IRS, which allowed them to utilise real knowledge to identify overlapping ownership between shareholders of a target corporation and the loss corporation in order to avoid the creation of a new public group in the course of an acquisition.. [3] Historically, the issuing of shares by a losing corporation to the shareholders of a target corporation is known as a “equity structure transfer.” Because there is a presumption that there is no overlapping shareholder ownership, the lost corporation would have to organise a new public group if it issued shares to non-5 percent shareholders in an equity structure move. By engaging in written correspondence with non-5% shareholders before to the merger, the loss corporation sought genuine knowledge of its overlapping non-5% shareholders in order to avert the formation of a new public group. As a result of IRS’s decision, the lost corporation was not obligated to apply the presumption that there was no overlapping ownership between the combined entities. For Section 382 purposes, it is likely that this method of obtaining actual knowledge might be used in other situations.

Use the actual knowledge exception to reduce the ownership shift in PLR 202146003 as an excellent example. Analyzing company financial data in this way is time consuming because of the need to speak with many different people at once. Loss corporation tax preparers should use extreme caution when acquiring this information from a publicly traded firm, as it is a communication between the company and a single shareholder and must comply with SEC guidelines. An intermediary or tax advisor could help taxpayers who find themselves in this predicament.

“Section” refers to the Internal Revenue Code of 1986, while “Regulation” or “Treas. Reg.” refers to the Treasury Regulations issued under that code.

If the corporation’s worth is more than the “long-term tax-exempt rate” before an ownership change, a loss can be used to offset that value, subject to other possible adjustments. [2]