Income Taxes

3 Months Ended

Mar. 31, 2024

Income Tax Disclosure [Abstract]

Income Taxes

Income Taxes

As discussed in Note 1, Organization and Business, we deconsolidated UpHealth Holdings and its subsidiaries as of September 30, 2023; accordingly, the financial results of UpHealth Holdings and its subsidiaries for the three month ended March 31, 2023 are included in our unaudited condensed consolidated financial statements and the financial position of UpHealth Holdings as of March 31, 2024 and December 31, 2023 and the financial results of UpHealth Holdings and its subsidiaries for the three months ended March 31, 2024 are not included in our unaudited condensed consolidated financial statements.

Also, as discussed in Note 3 Discontinued Operations, on November 16, 2023 we agreed to sell 100% of the equity interest in Cloudbreak to Forest Buyer, LLC. The Sale closed on March 15, 2024. Accordingly, we have presented the financial position of Cloudbreak as of December 31, 2023 as held for sale and the results of operations of Cloudbreak for the period from January 1, 2024 to March 15, 2024 and for the three months ended March 31, 2023, as well as the gain on Sale of Cloudbreak, as discontinued operations in the accompanying unaudited condensed consolidated financial statements. For the three months ended March 31, 2024, the net income from discontinued operations is net of $19.9 million of income tax expense, which consists of $1.2 million of tax expense related to the operations of Cloudbreak prior to the Sale, and $18.7 million of tax expense from the Sale of Cloudbreak.

The income tax expense from continuing operations was $4.5 million and zero in the three months ended March 31, 2024 and 2023, respectively. For the three months ended March 31, 2024, $4.5 million of tax expense was recorded related to the recognition of prior period liabilities for uncertain tax positions that were previously recognized in accordance with ASC 740 as contra-balances in the deferred tax asset account because the Company had net operating loss carryforwards against which these uncertain tax positions could be settled. Since the deferred tax assets had a full valuation allowance against them, there was no net impact to income tax expense when the liabilities for uncertain tax positions were reported in the prior year. In the current year, the gain on Sale of Cloudbreak will cause the net operating losses to be utilized and the liability for uncertain tax positions is now recognized as a liability on our balance sheet.

We evaluate our deferred tax assets periodically to determine if valuation allowances are required. Ultimately, the realization of deferred tax assets is dependent upon generation of future taxable income during those periods in which temporary differences become deductible and/or tax attributes can be utilized. To this end, we consider the level of historical taxable income, the scheduled reversal of deferred tax liabilities, tax-planning strategies, and projected future taxable income. Based on these above considerations, and consistent with our conclusion as of December 31, 2023, we continue to believe it is more likely than not that a portion of the benefit from the deferred tax assets will not be realized, and as such have recorded a valuation allowance of $42.8 million against our deferred tax assets as of March 31, 2024. The net change in the valuation allowance for the three months ended March 31, 2024 was a reduction of $6.0 million.

The total amount of liabilities for uncertain tax positions as of March 31, 2024 and December 31, 2023 was $4.5 million.

The Internal Revenue Service (“IRS”) audited the 2008 and 2009 tax returns for Thrasys, a business that was since made a part of our Integrated Care Management segment, for the proper year of inclusion in income of an approximately $15 million payment on the license of certain intellectual property rights. Thrasys originally included the $15 million payment in income on its 2010 S Corporation tax return, matching the year of inclusion for financial accounting purposes. The corporate level tax was paid to California and the business passed the gain through to its shareholders. The IRS has asserted that Thrasys owes an entity-level tax of approximately $5 million for 2008, or in the alternative, the business owes C Corporation tax of approximately $5 million for 2009 as a built-in gain. In addition, Thrasys could be assessed additional California franchise tax of approximately $1.3 million; and if additional income taxes are imposed, interest will be charged at approximately 4% to 10% per year, compounded annually, resulting in potential interest of approximate $4 million. The IRS has not asked that penalties be imposed.

The matter is currently pending before the U.S. Tax Court, Docket 11565-15. There are related tax cases for some of the former shareholders of Thrasys for additional income taxes due if the gain is shifted to 2009 without triggering the entity-level tax on the business as an S corporation. On December 4, 2018, the IRS filed a motion for summary judgment; however, Thrasys prevailed, and the motion was denied by the U.S. Tax court. In January 2020, Thrasys filed a motion for summary judgment arguing that either the gain was properly reported in 2010 and all taxes have been paid or in the alternative it should have been taxable in 2009 with no built-in gains tax. In both cases, there would be no additional income tax due for 2008 or 2009 to be paid by the business. The IRS filed an objection to the business’ motion. On March 3, 2021, the U.S. Tax Court, without consideration of the merits of the case, issued a very brief court order dismissing Thrasys’ motion. Had the motion been granted, the need for a trial would have been obviated.

When we acquired Thrasys in November 2020, all of the former shareholders of the business agreed to indemnify us for any losses as a result of this dispute with the IRS.

Thrasys filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code commencing a Chapter 11 case in the Bankruptcy Court on October 20, 2023. As a result, the automatic stay imposed by section 362(a) of the Bankruptcy Code became immediately effective, and, on October 30, 2023, the U.S. Tax Court entered an order staying all proceedings in the case. On November 17, 2023, the IRS filed before the Bankruptcy Court an amended proof of claim asserting a priority claim under section 507(a)(8) of the Bankruptcy Code in the amount of $17,282,914.83 (the “IRS Proof of Claim”) based on both of the IRS’s alternative positions. On March 14, 2024, the Thrasys filed a motion in the Bankruptcy Court to estimate the IRS Proof of Claim pursuant to sections 502(c) and 105 (a) of the Bankruptcy Code, or, alternatively pursuant to section 505 of the Bankruptcy Code, and believe that it should be substantially reduced to an amount between $0 to approximately $166,835. The Debtors withdrew without prejudice the estimation motion with respect to the IRS Proof of Claim. On April 23, 2024, the Debtors filed an objection to the IRS Proof of Claim, seeking to disallow the IRS Proof of Claim in its entirety or reduce it to approximately $161,000. The ultimate outcome of this matter is unknown at this time.

On March 21, 2024, the California Franchise Tax Board (the “FTB”) filed before the Bankruptcy Court a proof of claim arising out of the same facts described above against Thrasys asserting a claim of $6,983,089.81, with $6,226,194.94 of the claim allegedly entitled to priority under section 507(a)(8) of the Bankruptcy Code (the “FTB Proof of Claim”). According to the FTB Proof of Claim, the basis of the asserted liability is the FTB's “understanding that [Thrasys] and the IRS are in the process of resolving disputes concerning tax years 2008, 2009, and 2010.” The FTB states that the claim was submitted to “protect its interests” and that it “will amend the claim when issues are resolved between the IRS and” Thrasys. While Thrasys disputes any such liability, the ultimate outcome of this matter is unknown at this time.

Thrasys is a subsidiary of UpHealth Holdings, which we deconsolidated as of September 30, 2023 (as discussed in Note 1, Organization and Business).