On September 30, 2008, the IRS issued guidance impacting section 382(h) of the Internal Revenue Code for certain banks that have losses on loans or bad debts which either have undergone in the past, or will undergo in the future, a "section 382 ownership change." Banks included in the scope of this guidance generally are corporations that meet the definition of a bank in section 581 (this does not generally include investment banks, unregulated bank affiliates, and securities dealers) both immediately before and immediately after a section 382 ownership change. This guidance appears to have had a direct impact on Wells Fargo & Co.'s $15.1 billion offer to acquire Wachovia Corp.
The IRS, in Notice 2008-83, provides that a deduction allowed after a "section 382 ownership change" to a bank "with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) shall not be treated as a built-in loss or a deduction that is attributable to periods before the change date." If these losses were treated as a built-in loss or a deduction that is attributable to periods before the change date, the future utilization of such losses by banks may be limited under section 382. However, this Notice clarifies that such losses can generally be utilized by bank taxpayers on a go-forward basis without limitation. Banks may rely upon this IRS guidance unless and until there is additional guidance issued.
Section 382(h) provides rules for the treatment of built-in gains and losses with respect to assets owned by an entity that has tax attributes, such as net operating losses, at the time of a section 382 ownership change (a "LossCo"). The application of the rules under section 382(h) is mandatory, and not elective, for taxpayers. The rules under section 382(h) are very complex and there is a limited amount of guidance issued by the IRS with respect to these rules. Recognizing the complexity of these rules, in 2003, the IRS issued Notice 2003-65 to provide taxpayers with two alternative safe harbor approaches for applying these rules. In addition, a section 382(h) regulation project is currently underway by the IRS with additional guidance expected later in 2008/early 2009.
In general, for purposes of section 382(h), if a LossCo's aggregate fair market value of its assets exceeds the aggregate adjusted tax basis in its assets on the section 382 ownership change date (the amount of such excess is referred to as "NUBIG"), some or all of the built-in gain on such assets that is recognized over the five-year period ("RBIG") beginning on the section 382 ownership change date (the "recognition period") will increase the ability to utilize net operating losses (and certain other tax attributes) otherwise limited by section 382 (assuming satisfaction of certain other requirements). If a LossCo's aggregate fair market value of its assets is less than the aggregate adjusted tax basis in its assets on the section 382 ownership change date (the amount of such difference is referred to as "NUBIL"); however, some or all of the built-in loss that is recognized during the recognition period ("RBIL") will be subject to the same annual section 382 limitation as if it were a net operating loss generated prior to a section 382 ownership change (again, assuming satisfaction of certain other requirements).
Section 382(h)(6) provides that certain built-in income items are treated as RBIG and certain built-in deduction items are treated as RBIL to the extent such items are properly taken into account during the recognition period. Additionally, section 382(h)(6) also requires adjustments to the amount of NUBIG and NUBIL when these built-in items are taken into account. Prior to the issuance of Notice 2008-83, the built-in deduction items which were treated as RBIL under section 382(h)(6) could have included deductions allowed after a section 382 ownership change to a bank with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts). However, the IRS has now made it clear that, at least for the time being, such losses will not be treated as built-in deduction items.