IRC 382: Understanding Limitations on Net Operating Loss (NOL) Utilization

Under the Internal Revenue Code 382 (IRC 382), a C corporation is required to have a limit to offset historic losses. Essentially, a loss corporation is a firm that can use tax attributes like, for instance, NOL (Net Operating Loss). In contrast, “A Corporation” is a successful company that wants to acquire 100% of the stock of another company, “B Corporation”.

Basics of IRC 382

To understand the basics of section 382, we have the following details about B Corporation: It is a private company whose IP was funded with preferred financing and it has had net operating losses ever since it started. It is then considered a loss corporation. Once the acquisition is made, under Section 382, it limits the NOLs available to offset the taxable income of the company in the future.

There are two main components of this section – limitation and ownership change. Ownership change occurs when there is a shift in the owners or in the equity structure which is much more than 50%. Stock includes the following: convertible preferred stock, certain convertible debt instruments, common stock, and stock options/warrants.

Limitations of IRC 382

After the acquisition, the new company may deduct its losses in its taxable income following the Section 382 limitation.  There is a formula used in calculating the base limitation amount. It is calculated as follows:

Fair Market Value of the Old Loss Corporation Stock x Federal Long Term Tax Exempt Rate= Base Limitation Amount

To get the most of its NOLS, the company would calculate to get the biggest base amount that they can.

However, when calculating the amount, keep in mind that the fair market value depends on potential adjustments as set forth in the said regulations. The Internal Revenue Service publishes monthly the federal long-term tax-exempt rate.

Offsetting Taxable Income

Companies that are operating at losses can get use these to offset taxable income. Although companies may benefit from such, it does not mean that there are no limitations. The limitations are guided by the Internal Revenue Code Section 382. Then again, even the calculation of the base amount has become much more complicated, especially when the Chief Counsel Advice has issued a case that could affect loss corporations.

Learn more by reading a helpful guide on Internal Revenue Code 382 from Cornell Law School.

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