TAX NEWS - 2010

Measuring owner shifts of loss corporations where fluctuations in value are present

The Internal Revenue Service (IRS) on June 11 issued guidance (Notice 2010-50) regarding the accepted methodologies for measuring owner shifts of loss corporations for purposes of the loss limitation rules under section 382 when there are fluctuations in value among different classes of loss corporation stock.

Generally, section 382 limits the amount of income that may be offset by net operating losses if there has been a change in ownership of a loss corporation. In determining whether an ownership change has occurred, section 382(l)(3)(C) provides that any change in proportionate ownership of stock of a loss corporation that is attributable solely to fluctuations in the relative fair market values of different classes of stock is not taken into account. In the absence of IRS and Treasury guidance, taxpayers have employed a number of different methodologies to account for fluctuations in value when determining an ownership change.

Some taxpayers have interpreted section 382(l)(3)(C) narrowly, and as a result have determined the percentage of stock owned on the basis of the relative fair market value of the stock owned by such person to the total fair market value of the stock of the corporation, without making any attempt to adjust for fluctuations in the relative value of different classes of stock. Under this approach – referred to in the notice as the "Full Value Methodology" – changes in percentage ownership resulting from fluctuations in value are taken into account if an ownership change testing date occurs, regardless of whether a particular shareholder actively participates in or is otherwise a party to the transaction that causes the testing date to occur.

Other taxpayers have used methods that attempt to factor out fluctuations in value for purposes of determining the amount of stock held on a testing date. Under this approach – referred to in the notice as 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 the 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 occurred since the acquisition date of the tested share.

The notice provides that the IRS will not challenge any reasonable application of either a Full Value Methodology or the Hold Constant Principle, provided that a single methodology is applied consistently to the extent required by the notice. In addition, the notice provides some guidance on its view of what constitutes a "reasonable application."