The section 382 limitation restricts how much of a company’s net operating losses (NOLs) and certain tax credits generated before an ownership change can be used to offset taxable income after that change. The limitation does not necessarily eliminate those tax attributes. Instead, it can spread their use over a longer period.
A Section 382 study typically reviews changes in stock ownership to determine whether an ownership change occurred and then calculates the resulting annual limitation. This can matter for tax returns, financial statement reporting, and transactions where the future value of NOLs or credits may affect the economics of a deal.
An ownership change generally occurs when one or more 5% shareholders increase their combined ownership by more than 50 percentage points compared with their lowest ownership levels during the testing period, generally three years.
It does not require one investor to acquire control of the business. Multiple financing rounds can create enough cumulative movement to trigger the test. The rules also look at ownership based on value, not simply the number of shares outstanding. Certain groups of shareholders owning less than 5% individually may also be combined when applying the rules, making ownership changes easier to miss than many companies expect.
Once a corporation experiences an ownership change of more than 50%, Section 382 generally limits how much of its pre-change NOLs can be used each year.
Example:
If Loss Corporation earns $700,000 of taxable income from July 1 through December 31, 2023, it could generally use up to $320,000 of NOLs. The unused NOLs may carry forward, subject to the annual Section 382 limitation and other applicable rules.
At the ownership-change date, a company may need to compare the value of its assets with their tax basis to determine whether it has a net unrealized built-in gain, or NUBIG, or a net unrealized built-in loss, or NUBIL.
If a company has a NUBIG, a recognized built in gain during the following five years may increase the amount of NOLs or credits that can be used. If the company instead has a NUBIL, certain recognized built-in losses during that period are treated similarly to pre-change NOLs and may be subject to the annual limitation.
Companies with meaningful NOLs should evaluate Section 382 before a financing, stock sale, recapitalization, or similar transaction closes. Start by reviewing historical stock issuances, transfers, repurchases, and financing rounds to identify whether an earlier ownership change has already occurred.
Next, model how the proposed transaction could affect ownership percentages and the company’s equity value immediately before closing. Companies should also evaluate potential NUBIG or NUBIL and maintain supporting ownership records.
Transaction structure can matter as well. For example, an F Reorganization may raise separate tax considerations that should be evaluated as part of the broader transaction planning process.
Does Section 382 limit tax credits as well as NOLs?
Yes. When an ownership change occurs, Section 382 can limit the use of certain tax credits and NOLs generated before the ownership-change date. Therefore, a Section 382 study may be important for companies with significant tax attributes, including accumulated NOLs or tax credits.
Can Section 382 eliminate a company’s NOLs entirely?
Not necessarily. Section 382 generally limits how quickly pre-change NOLs can be used rather than automatically eliminating them. If the annual limitation is not fully used in one year, the unused limitation may carry forward and increase the amount available in a later year.
How does Section 382 interact with bankruptcy reorganizations?
During a bankruptcy reorganization, a company may face limits on using tax losses from before the change in ownership. However, those limits may not apply if certain owners and creditors keep at least half of the company. Otherwise, a different limit may apply.
Can a 382 ownership change occur without a credit default?
Yes. An ownership change is based on shifts in stock ownership, not whether a company has defaulted on debt. Multiple rounds of financing, stock issuances, transfers, or repurchases can create a qualifying ownership shift even when the business has experienced no credit default.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Vijay Vaswani, partner and leader of Bennett Thrasher’s Mergers & Acquisitions Transaction Advisory practice, or call us at 770.396.2200.
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