In an effort to limit loss trafficking, Congress enacted IRC § 382 to limit the use of corporate net operating losses (NOLs) following an ownership change, which is defined generally as a greater than 50% change in stock ownership among certain 5% shareholders over a three-year period. In the event of an ownership change, use of the loss corporation’s NOLs and certain built-in losses is limited to the value of the loss corporation multiplied by the adjusted federal long-term tax-exempt rate.
For purposes of determining whether an ownership change has occurred, section 382(l)(3)(C) addresses the issue of fluctuations in stock price for corporations with multiple classes of stock, stating that, “Except as provided in regulations, any change in proportionate ownership which is attributable solely to fluctuations in the relative fair market values of different classes of stock shall not be taken into account.” However, the regulations do not specifically address how to apply section 382(l)(3)(C) and have therefore left both taxpayers and practitioners to struggle with this issue.
Recently, the IRS sought to clarify its position by issuing Notice 2010-50. This is the first guidance from the service to provide acceptable methodologies to account for fluctuations in the value of one class of stock relative to another class of stock for purposes of section 382. The notice outlines two general applications of section 382(l)(3)(C): the full value methodology (FVM) and the hold constant principle (HCP).
Under the FVM, the determination of the ownership percentage of stock owned by a shareholder is based on the fair market value of the stock owned by the shareholder relative to the total fair market value of the corporation’s outstanding stock on a testing date. Essentially, under the FVM all shares are marked to market regardless of whether the shareholder actively participates in or is otherwise a party to the transaction.
The HCP, on the other hand, gives effect to the statutory language of section 382(l)(3)(C) by factoring out fluctuations in the value of stock held by passive shareholders across multiple testing dates. According to the IRS notice:
Broadly stated, under the Hold Constant Principle, the value of a share, relative to the value of all other stock of the corporation, is established on the date that share is acquired by a particular shareholder. On subsequent testing dates, the percentage interest represented by that share (the “tested share”) is then determined by factoring out fluctuations in the relative values of the loss corporation’s share classes that have occurred since the acquisition date of the tested share.
While Notice 2010-50 is welcome guidance for many practitioners, the IRS is looking for further assistance in a number of areas related to section 382(l)(3)(C) before it issues regulations. It is requesting comments, particularly on the application of the HCP and whether the regulations should interpret section 382(l)(3)(C) to require rules for factoring out fluctuations in value. In the meantime, taxpayers and their advisers should continue to use their judgment in applying section 382(l)(3)(C) as outlined in Notice 2010-50.
For a detailed discussion of the issues in this area, see “Sec. 382 and the Hold Constant Principle,” by Trudie Duan, CPA, and Chan- Yu Wang, CPA, in the September 2010 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
Also in the September Tax Adviser:
- A discussion of expenses incurred by temporarily out-of-work individuals;
- An examination of taxation of LLC members.
The Tax Adviser is the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or e-mail email@example.com for a subscription to the magazine or to become a member of the Tax Section.
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