Why You Shouldn't Dabble in a 382 Tax Study
Michael Grant, senior manager in EisnerAmper’s Tax Practice, discusses the intricacies, benefits and misconceptions surrounding 382 Tax Studies.
Dave Plaskow: Hello and welcome to EisnerAmper’s Taxation Podcast Series, where we try to dig a little deeper on the issues facing tax professionals and their clients. Today’s topic is section 382 tax studies. I’m your host Dave Plaskow, and with us today is Michael Grant, Senior Manager in EisnerAmper’s Tax Practice. Michael, welcome, and thanks for being here.
Michael Grant: Great to be here Dave.
DP: So, talk to us about a 382 tax study. What is that?
MG: A 382 tax study is a detailed analysis of a loss company’s historical equity transactions to determine if they’ve undergone an ownership change of greater than 50% within a three-year period. The results of that study will have an impact on their ability to utilize Net Operating Losses (NOLs) going forward.
DP: And what kind of companies are we seeing utilizing the 382 studies?
MG:So a loss company is any company that has a historical NOL carryover. It could also be a capital loss carryover or an R&D credit carryover, for example. We see a lot of companies in the life science and tech industries where they’re generating a lot of losses in the development stage of the company.
DP: So let’s cut to the chase on the meat and potatoes of why a company would want to get a 382 tax study. What are the benefits to them?
MG:So any company with historical losses is going to need a 382 study at some point in their lifecycle, for a number of different reasons. The most obvious reason is that they’re expecting to generate taxable income in the future, and they’re going to want to use those NOLs going forward to offset the income. Often times, the net operating loss is one of, if not the largest deferred tax assets on, on the company’s balance sheet, and they’re going to want to determine if that’s accurately reported. Another reason to get a 382 study is if they’re thinking about selling the company, the buyer’s going to want to know if those NOLs have any value and if they’re going to be able to utilize those. So it’s definitely going to come up in the due diligence of a sales transaction. And finally, it can be used as a planning tool for the future. Once a 382 study has been performed, it can be updated periodically to plan for the impacts of future equity raises to help preserve the NOLs that the company has.
DP: Are there any misconceptions in the marketplace about 382 tax studies?
MG:I would say two of the most common misconceptions are, one, that you can just pick a point in time and start from that point. You really need to start from the first year in which the NOL was generated to have the full history of the company. The second one is that it’s a quick and easy process. That might be true in some cases, but most studies require an in-depth knowledge of the code and and substantial time. Section 382 is a very complex area and unless you deal with it on a regular basis, it’s easy to miss some of the finer points. Being proactive and not waiting until the last minute to have a study performed make a huge difference in the world of 382.
DP:Good point. So this isn’t something that a practitioner or a tax department should dabble in.
MG: Interestingly, a number of our engagements begin where companies try to prepare the study themselves in order to save on costs, and as a loss company you don’t want to be in a position where you’re looking to sell and the buyer can’t rely on your calculations. In that situation, they’re going to ask you to engage somebody to prepare the study anyway, and then you definitely don’t want to be in a position where you’re utilizing the NOLs against taxable income on your tax return, and the IRS comes in and tells you those NOLs weren’t available, and then hits you with a big tax bill.
DP:You certainly don’t want to get that phone call. And you were telling me earlier about business valuations. How do they factor into all of this?
MG:So the calculation of an ownership change is based on the relative value of the stock. For a public company, a lot of that information is out there in the public filings. For privately held companies, that information isn’t always readily available, and we can leverage our experienced, in house, valuation team here at EisnerAmper to help us determine the value of various classes of stock or even the company on, on a whole.
DP: Because this is such a complex area, perhaps you can illustrate it to our listeners with an example or a case study.
MG:Sure. We recently worked with a, a life science company, who is a public company. They had over $100 million in NOLs and they determined that, in the next few years, they planned on generating taxable income, and they wanted to make sure that the NOLs that they had available, they were actually going to be used to offset taxable income. So, we analyzed the public filings with them, we utilized their, their knowledge of the historical equity transactions, we ran our calculations, and we determined that they did undergo multiple changes of ownership, and the impact on the NOLs was that there was the potential that they would lose about 25% of those NOLs without ever being used. That wasn’t necessarily the best answer that they wanted to hear, but now they have a better picture going forward that will help them plan.
DP: Tell us about that planning. What did it mean for them in more of a long-term fashion?
MG: They need to continue to raise money, which they communicated to us and we told them that since the study has now been performed, we have a template in place where anytime they want to raise money, they can come to us, and we can run different scenarios for them to see the impact that that’s going to have on their NOLs, and it’ll help them better plan for the future.
DP:Thanks for this great insight Michael.
DP: And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and host of other topics. And join us for our next EisnerAmper podcast when we get down to business.