Taxes & Entities

Section 382 and the NOL Limitation

Work out what a company's tax losses are actually worth to a buyer after the ownership-change rules bite — and how the deal you signed decides whether that number is large, small, or zero.

  • Expert
  • 14 min total
  • 12 chapters

What decision this helps you make: How much credit to give net operating losses in a purchase price, and how to structure the equity so the limitation you inherit is the one you modelled.

What this topic is

Section 382 of the Internal Revenue Code caps how much of a corporation's pre-change net operating losses it may use each year after its ownership changes hands. The cap is a formula: the value of the loss corporation immediately before the change, multiplied by a published interest rate. Everything else in the section is about measuring the change, measuring the value, and adjusting for built-in gains and losses.

Why it matters

Loss carryforwards are frequently the second-largest asset on a distressed target's balance sheet and the first thing a buyer over-credits. A company with $200M of federal NOLs may be able to use $4M a year — or none, if it fails a continuity test it did not know about. The limitation also fires on ordinary financings. A recapitalisation, a down round, or a bankruptcy emergence can trigger an ownership change without anyone selling anything, and a poorly sequenced capital raise can destroy an asset worth more than the money raised.

Who should learn it

M&A and corporate development teams pricing a loss company, CFOs of loss-making businesses raising equity, restructuring professionals, and tax practitioners who need the mechanism rather than the headline.

What you will understand

  • How an ownership change is measured — five-percent shareholders, public groups, the three-year testing period, and the segregation rules that create shareholders who do not exist
  • How the annual limitation is computed, and the value adjustments that shrink it
  • What built-in gains and losses do to the cap in the five years after a change, and why the two competing approaches to that question matter
  • The bankruptcy exceptions, the continuity-of-business requirement, and the interaction with the 80% taxable income limitation

Prerequisites

Common misconception

"The target has $200M of NOLs, so the buyer gets $42M of tax value." Almost never. After an ownership change, use of those losses is capped annually at the loss corporation's equity value times the long-term tax-exempt rate. A $60M company at a 3.5% rate can use about $2.1M a year. Over the remaining carryforward life that may be a fraction of the face amount — and if the business does not continue for two years after the change, or the corporation fails the continuity test, the answer drops to zero.