Other Tax Compliance
Internal Revenue Code (“IRC”) 409A states that deferrals of compensation under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. Compensation is deferrable on stock options that are issued at an exercise price greater than or equal to the fair market value of the stock on the grant date. ASC Topic 718 relates to the treatment of accounting transactions in which an entity exchanges equity instruments for goods or services. For purposes of determining the cost of equity based compensation, the Statement no longer allows for the use of the intrinsic value method and requires the use of the fair value method for most transactions. After the fair value as of the grant date of the equity compensation is determined, the cost is recognized over the period during which an employee is required to provide services in exchange for the award.
An independent valuation of the operating unit and/or its underlying assets is beneficial when profitable subsidiaries and divisions of companies are sold or when unprofitable divisions are liquidated. In addition to establishing a sound basis for negotiating the sale price, a valuation will assist in tax, accounting and financing matters. If, for example, the assets of a division are being bought or sold, the value of the tangible and intangible assets must be calculated to determine a basis for allocation under Reg. Section 1.1060-1T(d)(2)(ii) of the IRC.
Under Section 382, the amount of taxable income which a corporation may offset with net operating losses (NOLs) arising before the ownership change may be subject to a limitation which is determined, in part, by the value of the stock prior to the change in ownership. Certain ownership or equity changes limit NOL carryforwards. A valuation is often required to determine the fair market value of corporations prior to ownership or equity changes and the fair market value of assets for unrealized built-in capital gains purposes, both of which affect NOL limitations.
Under Section 501(c)(3), none of a tax-exempt organization’s net earnings may inure to the benefit of any private shareholder or individual. Otherwise, it risks losing its exempt status. With all the merger and acquisition activity occurring in the healthcare industry, for example, this issue has drawn the scrutiny of the IRS and the Department of Health and Human Services. The IRS requires that a nonprofit organization not pay more than fair market value for a physician practice. As a result, a formal appraisal is required to ensure that a practice is not acquired by an exempt organization for more than fair market value to prove that there is no private benefit.
Passive Foreign Investment Company
There may be significant tax consequences to a US company due to its foreign subsidiary’s high levels of cash and equivalents. The benefit of the deferral of income for tax purposes that is typically allowed a foreign corporation is eliminated once the entity is classified as a PFIC. One characteristic of a PFIC is if 50% or more of the average value of its assets consists of assets that produce, or are held for the production of, passive income. If a corporation is in danger of being classified as a PFIC, a formal appraisal would help determine the threshold and allow the company to plan accordingly.