Originally published October 2003

TABLE OF CONTENTS

I. OVERVIEW OF SECTION 382

A. Required Change in Ownership

B. Consequences of an Ownership Change

C. Losses Subject to Limitation

D. Example

E. Effective Dates

II. CONSOLIDATED RETURN ISSUES -- OVERVIEW

III. RULES PERTAINING TO LOSS GROUPS

A. Definition of Loss Group

B. Determining if a Loss Group Has an Ownership Change

C. Effect of an Ownership Change

IV. WHAT HAPPENS WHEN MULTIPLE CORPORATIONS JOIN A GROUP? -THE LOSS SUBGROUP RULES

A. Definition of Loss Subgroup

B. Determining if a Loss Subgroup Has an Ownership Change

C. Effect of an Ownership Change

V. WHAT HAPPENS WHEN CORPORATIONS JOIN A GROUP AND SUBGROUPING DOES NOT APPLY?

A. Definition of New Loss Member

B. Determining if a New Loss Member Has an Ownership Change.

C. Effect of an Ownership Change

D. Illustrations

VI. OWNERSHIP CHANGE OF SUBSIDIARY ON A SEPARATE ENTITY BASIS

A. Ownership Change Determination

B. Effect of the Ownership Change

C. Relationship to General Ownership Change Rules

VII. END OF SEPARATE TRACKING (THE "FOLD IN RULES") AND SUBSEQUENT OWNERSHIP CHANGES

A. End of Separate Tracking

B. Subsequent Ownership Changes

VIII. BUILT-IN GAINS AND LOSSES -- SPECIAL RULES

A. Determining if a Consolidated Group Has a Net Unrealized Built-in Gain or Loss

B. Intercompany Transactions

C. Exchanged Basis Property

D. Determination of Whether a Loss Subgroup Has a Net Unrealized Built-In Loss

E. Special Problems

IX. WHAT HAPPENS WHEN A CORPORATION LEAVES A GROUP OR SUBGROUP?

A. Leaving a Loss Group

B. Leaving or Ceasing to be a Member of a Loss Subgroup

C. Filing the Election to Apportion

D. Coordination with Loss Disallowance Rules

X. TITLE 11 OR SIMILAR CASES

XI. COORDINATION WITH SECTION 383

XII. CONTROLLED GROUP RULES

A. Background

B. Section 382 Limitation with Respect to Controlled Group Loss

C. Restoration of Value

D. Disposal and Reacquisition of Controlled Group Stock

E. Rules Preventing Double Reduction

F. Coordination with Consolidated Section 382 Regulations

XIII. REVISED SEPARATE RETURN LIMITATION YEAR RULES

A. Overview

B. Revision of SRLY Computation

C. SRLY Limitation Computed on Cumulative Basis

D. SRLY Subgroups

E. Built-In Gain and Loss

F. Overlap Rule

I. OVERVIEW OF SECTION 382

A key element in planning many transactions is the survival and subsequent use of net operating loss ("NOL") carryovers. The Tax Reform Act of 1986, P.L. 99-514, made sweeping changes in the rules governing the use and availability of NOL carryovers following certain changes in the stock ownership of a loss corporation. In particular, section 382 was substantially altered.

A. Required Change in Ownership

1. Section 382 ("section 382") applies only after a change, however effected, in ownership of more than 50 percent of the stock (by value) in a loss corporation over a prescribed period of time. See section 382(g).

a. Such a change is referred to as an "ownership change." The date on which an ownership change occurs is referred to as the "change date." See section 382(j).

b. An ownership change may occur either through an "owner shift involving a 5-percent shareholder," an "equity structure shift," or a combination of the two. See section 382(g).

c. In general, a "loss corporation" is a corporation entitled to use NOL carryovers, having an NOL in the year of the ownership change, or having a net unrealized built-in loss. See section 382(k)(1).

2. In general, the change in ownership of the loss corporation must occur within a three-year testing period ending on the day of any owner shift or equity structure shift. Section 382(i)(1).

3. Under the statute, the loss corporation must track the stock ownership of 5-percent shareholders.

a. To determine who the 5-percent shareholders are, the corporation must determine which ownership interests in the corporation constitute "stock." See section 382(k)(6); Treas. Reg. § 1.382-2(f)(18).

b. The corporation must then determine who owns the stock. For purposes of determining stock ownership, the constructive ownership rules of section 318 apply with certain modifications. See section 382(l)(3)(A); Treas. Reg. § 1.382-2(h).

c. Finally, once the constructive ownership rules have been applied, the corporation can determine its 5-percent shareholders based on the percentage of stock that they own.

(1) A 5-percent shareholder is any person holding 5-percent or more (by value) of the loss corporation stock at any time during the testing period. See section 382(k)(6)(C) and (7); Treas. Reg. § 1.382-2(g).

(2) Shareholders who own less than 5 percent are aggregated and treated as one 5-percent shareholder. See section 382(g)(4); Treas. Reg. § 1.382-2(j).

d. If the aggregate stock ownership of one or more of the 5-percent shareholders has increased by more than 50 percentage points during the testing period, then an ownership change has occurred. See section 382(g)(1); Treas. Reg. § 1.382-2(a)(1) and (c).

B. Consequences of an Ownership Change

1. If an ownership change occurs, section 382 places an annual limit on the amount of post-change taxable income which may be offset by the loss corporation's pre-change NOL carryovers.

a. This limitation -- known as the section 382 limitation -- is an amount equal to the product of a prescribed rate of return and the value of the loss corporation. Section 382(b)(1).

(1) The prescribed rate of return is the long-term tax-exempt rate of return. Section 382(f).

(2) The value of the loss corporation, in general, is measured by the value of the corporation's stock immediately before the ownership change. Section 382(e)(1).

b. If the loss corporation has a net unrealized built-in gain the annual limitation may be increased by recognized built-in gains of the loss corporation. Section 382(h)(1)(A).

c. If income is less than the section 382 limitation, the unused section 382 limitation amount may be carried forward to subsequent years. Section 382(b)(2).

2. If an ownership change occurs, the loss corporation must satisfy the continuity of business enterprise requirement applicable to reorganizations throughout the two-year period beginning on the change date. Otherwise, its loss carryovers, in effect, will be eliminated. Section 382(c)(1).

C. Losses Subject to Limitation

1. In general, losses incurred prior to the ownership change are subject to the section 382 limitations. That is, loss carried forward from previous years to the year of change, certain built-in losses and losses incurred during the year of change are subject to section 382. These losses are referred to as "pre-change losses." See sections 382(d)(1) and (h)(1)(B).

2. Losses generated in the year of change are allocated to the periods before and after the change. That portion allocated to the period after the ownership change is not subject to limitation; that portion allocated to the period prior to the ownership change is subject to the section 382 limitations, i.e., those losses may only offset income to the extent of the section 382 limitation. See section 382(d)(1)(B).

To view this article in its entirety (and any footnotes/diagrams), please click or enter the following link into a fresh browser:
http://www.steptoe.com/publications/1145702_v4.pdf

Copyright © Steptoe & Johnson LLP. All Rights Reserved.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.