Tax Issue Relating Patriot Inc Accounting Essay

Ed Harris requested our revenue enhancement advice for Patriot Inc. , how to cover with the issues originating from registering for Chapter 11 Bankruptcy, and best method in covering with the intervention of cancellation of debt and continuing the NOL carryovers. After much deliberation I have provided a recommendation for the revenue enhancement intervention of these issues.

Facts

During April of 2012 Patriot, Inc. a filed for Chapter 11 bankruptcy protection and worked out a re-organization program that was accepted by the Bankruptcy Court and the creditors ‘ commission. Under the program, the note holders ( a venture capital house that financed the concern ) with notes collectible of $ 105,000,000 will have new common stock ; the old common stock will be cancelled. The new Whaoo, Inc emerged from bankruptcy on October 31, 2012.

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Ed Harries will go on as the CEO and will have 2 % of the stock which came from a transition of liabilities that corporation owed him.

The corporation had debt cancelled under chapter 11 Bankruptcy of $ 105,000,000. It had Net Operating Loss ( NOL ) carryfowards of $ 65,000,000 from 2009, $ 45,000,000 in 2010, and $ 30,000,000 from 2011.

The just market value of Patriot, Inc. at day of the month of outgrowth from bankruptcy $ 150,000,000. Its Property and equipment had a value of $ 450,000,000 and accrued depreciation on these assets of $ 200,000,000. The adjusted footing for the assets was $ 250,000,000. Patriot Inc. , had intangible assets deserving $ 250,000,000 with accrued amortisation of $ 100,000,000, giving it an adjusted footing of $ 150,000,000.

Ed Harris anticaptes the new corporation doing an acquisition withing six months which will increase gross 15 % and net incomes by 12 % .

Issues:

The first issue relates to Section 382 of the Internal Revenue codification and its impact on the company ‘s future usage of NOL carryfowards.

The 2nd issue relates to “ cancellation of debt income ” and decrease of revenue enhancement properties under the Internal Revenue code 108. Some consideration for this issue are the company being in a chapter 11 bankruptcy, and that Wahoo, Inc. would wish to be able to maintain their NOL carryovers to countervail hereafter nonexempt income

Analysis:

Section 382

Internal Revenue Code sets forth a restriction of NOL carryforward for a company that goes through an ownership alteration. Patriot, Inc. harmonizing the Internal Revenue Code did hold an ownership alteration, which would give the company an NOL restriction equal to the value of the ‘old loss corporation ‘ . This value is equal to the just market value of Patrio, Inc. at the day of the month of outgrowth from bankruptcy ( $ 150,000,000 )

The NOL loss restriction per twelvemonth for the company is $ 4,515,000. Which is computed utilizing the long-run tax-free rate of 3.01 % ( Revenue Ruling 2012-28 ) , multiplied by the $ 150,000,000 ( old loss corporation ) . The NOL loss restriction for 2012 is $ 754,562 ( ( 61/365 ) *4,515,000 ) , due to restriction merely covering November and December.

Assuming that Wahoo, Inc has nonexempt income above NOL restriction sum each twelvemonth, there will be about $ 53,462,500 of fresh NOL carryforward. For the following 20 old ages the sum NOL restrictions is $ 86,538,000, after 2011.

Section 382 ( I ) ( 5 ) gives the company the option to elect non to hold the loss restriction apply because Wahoo, Inc. ( new loss corporation ) was involved in a rubric 11 bankruptcy instance and the creditors of Patriot, Inc. ( old loss corporation ) own the at least 50 % of the entire value of Whoo, Inc. ( new loss corporation ) stock. This is computed by taking debt canceled under chapter 11 bankruptcy divided by the just market value of nationalist, Inc. at day of the month of outgrowth from bankruptcy ( $ 105,000,000/ $ 150,000,000 ) . We are presuming that the debt arose in the normal class of the concern or that the creditors had held the debt for at least 18 months before the bankruptcy proceeding.

The company may elect non to hold the NOL loss restrictions apply by cut downing the NOL carry forwards by the involvement tax write-offs in the current and three anterior old ages related to the debt that was converted into equity. Further information is needed from the company to cipher what the decrease in the NOL would be.

The company should besides see the effects of the proposed acquisition and how it will increase grosss and net incomes in the hereafter, every bit good as the negative effect of altering ownership. Section 283 ( I ) ( 5 ) ( D ) says “ if, during the biennial period instantly following an ownership alteration to which this paragraph applies subdivision 382 ( I ) ( 5 ) , an ownership alteration of the new loss corporation occurs, this paragraph shall non use and the subdivision 382 restriction with regard to the 2nd ownership alteration for any post-change twelvemonth stoping after the alteration day of the month of the 2nd ownership alteration shall be zero ” . If Wahoo, Inc acquisition causes another ownership alteration for the corporation in the following two old ages predating the bankruptcy the NOL carryforward will be reduced to zero.

Section 108

Internal Revenue Code subdivision 108 helps put out the options for companies for the cancellation of debt income of the company. Harmonizing to subdivision 108 ( a ) ( 1 ) ( A ) , “ gross income does non include any saddle horse which would be includible in gross income by ground of the discharge of liability of the taxpayer if the discharge occurs in a rubric 11 instance ” . The company $ 105,000,000 should non be included in calculation of gross income because the company filed for chapter 11 bankruptcy.

There are two options confronting the corporation which include utilizing the cancellation of debt income to cut down the footing in its depreciable belongings or utilize the cancellation of debt income to cut down the NOL carryforward. The Internal Revenue Code subdivisions 108 ( B ) ( 1 ) , 108 ( 2 ) ( A ) , 108 ( B ) ( 3 ) ( A ) , and 108 ( B ) ( 4 ) ( B ) says that if the company take the option to cut down their NOL, they foremost must cut down the NOL for the current twelvemonth and work back from oldest to newest NOL carryover. The decrease should be applied dollar for dollar with an exclusion for the $ 105,000,000 ( off debt ) .

To wholly measure this job more expeditiously we would necessitate more information, specially the current twelvemonth NOL. With out a current twelvemonth NOL, the decrease would travel as follows: the NOL from 2009 ( $ 65,000,000 ) would be wholly eliminated, it would so cut down the 2010 NOL by $ 40,000,000. This would go forth $ 5,000,000 NOL for 2010, and would let the company to maintain its full 2011 NOL ( $ 30,000,000 ) .

Section 108 ( B ) ( 5 ) , a company may elect to cut down the footing in its depreciable belongings, but it may non cut down any other properties. By taking this option the company will cut down the depreciable assets footing from $ 250,000,000 to $ 145,000,000.

Decision:

To supply a more complete analysis of this state of affairs we require Ed Harris supply information that includes whether or non the proposed acquisition will ensue in an ownership alteration, the sum of the involvement tax write-off related to the debt transition into equity, the plus lives of the depreciable assets.

Based on the current information, and the fact that Mr. Harris would wish to continue the NOL ‘s, we recommend that the company take to cut down the footing of the depreciable belongings alternatively of cut downing the NOL ‘s. If the assets are comprised of durable assets and the company expects to be profitable over the following 20 old ages, this is the best option available.

The profitableness of the company, the dollar for dollar sum of involvement tax write-off related to the debt transition into equity, and whether or non an ownership alteration will happen within two twelvemonth window will finally consequence the best option for the company. If the company chooses to utilize its NOL ‘s it will be limited to $ 86,538,000 of the $ 140,000,000 NOL carryforwads.

If the the difference between NOL ( $ 140,000,000 ) and the maximal aggregative NOL restriction of ( 486,500,000 ) is less than the involvement tax write-off so the company should take non utilize the NOL restrictions, which is contingent on the company being able to supply a clause in the bankruptcy program that would necessitate creditors and shareholder to keep ownership for the needed two twelvemonth keeping period lineation in the Internal Revenue Code. The other option would be for the company to utilize the current NOL restrictions and lose a part of the NOL carryovers alternatively of the full sum.