Effective NOL Planning in Light of Tax Reform
Can your company unlock the value of net operating loss carryforwards to reduce future taxable income?

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Under current tax rules, a corporation can generally carry back a net operating loss (NOL) to the two preceding taxable years and carry it forward up to the twenty taxable years following the loss to offset 100 percent of federal taxable income and ninety percent of the alternative taxable income. Section 13302 of H.R. 1 changes the NOL rules.1 Section 13302 eliminates the ability to carry back NOLs generated in taxable years beginning after December 31, 2017, except for certain farming NOLs.

The NOL carryforward period for new NOLs would also change from the current twenty succeeding taxable years to an indefinite period. With the elimination of the alternative minimum tax, NOLs for taxable years beginning after December 31, 2017, can offset 80 percent of federal taxable income with no reduction for the alternative minimum tax.2 Since several other parts of the legislation limit or eliminate traditional deductions for corporate income taxpayers, such as interest expense, Section 199 deductions, and entertainment expenses, corporate taxpayers will likely look to NOLs to potentially offset future taxable income. Corporate taxpayers may also look to NOLs to offset income arising from the deemed transition tax under the new Section 965 for tax year 2017.

Taxpayers planning to use NOLs in either the current tax regime or new regime should be aware of the rules that could limit or eliminate the ability to use NOLs. The primary provision that governs the use of NOLs is Section 382.3 Whether you are a loss corporation calculating your own limitation or your company is acquiring a corporation with NOLs or built-in losses, there are a number of practical tips for applying the rules. However, an introduction to the rules is needed to understand those practical tips. Section 382 generally requires a corporation to limit the amount of its income in future years that can be offset by historic NOLs once the corporation has undergone an “ownership change.”

A loss corporation as defined in Section 382 is a corporation entitled to use an NOL carryforward (among other tax attributes) or having NOLs for the taxable year in which the ownership change occurs. In addition, a loss corporation includes any corporation with a net unrealized built-in loss. Taxpayers often miss this last rule, particularly when they look to apply these rules only when there is an NOL carryover. The consequences as discussed below could be dire, because post-change losses could be subject to the Section 382 limitation, thereby increasing tax liability in post-change years.

Section 382 requires that a loss corporation determine whether an ownership change occurred as of a certain “testing date.” Generally, a testing date is any date in which there is any owner shift, issuance of stock, or issuance or transfer of an option with respect to the stock of the loss corporation. Pursuant to Treas. Reg. Section 1.382-2(a)(4)(i), a loss corporation is required to determine whether an ownership change has occurred immediately after any owner shift, stock issuance, or transfer. Generally, the “testing period” for any testing date is the three-year period ending on the testing date. Once an ownership change occurs, the three-year testing period is reset and a new testing period begins.

With the elimination of the alternative minimum tax, NOLs for taxable years beginning after December 31, 2017, can offset 80 percent of federal taxable income with no reduction for the alternative minimum tax.

Identifying Five-Percent Shareholders

The first step to applying Section 382 rules is to determine which shareholders to track and to determine ownership percentages on each testing date for these shareholders or groups of shareholders known as “public groups.” Section 382 and the Treasury Regulations promulgated under it require that a loss corporation calculate increases in the percentage of stock ownership of its five-percent shareholders to determine whether an ownership change occurred on a testing date. A loss corporation is thus required to identify and determine the percentage ownership of each five-percent shareholder on each testing date.

The ownership of each five-percent shareholder on that date is compared with such shareholder’s lowest percentage of ownership on any previous testing date during the testing period (which is generally the shorter of (i) the three-year period ending on the current testing date or (ii) the period of time since the last ownership change and the current testing date). An ownership change will occur if one or more five-percent shareholders increase their ownership, in the aggregate, by more than fifty percentage points during a testing period. The key is a fifty-percentage-point shift rather than a fifty-percent increase in ownership. Under Section 382(g)(2), the shift is determined by looking at all the shareholders who own at least five percent of the corporation based on the value of their stock and certain other groups of shareholders that are treated as five-percent shareholders under these rules. However, to the extent that there is a decrease in the ownership by a five-percent shareholder, Section 382 does not take such decreases into account. The percentage ownership on a given testing date has been determined based on the fair market value of the stock issued and outstanding on such date. The computation of the owner shift with respect to any five-percent shareholder on the testing date is based on a comparison of the percentage ownership on the testing date and the lowest percentage ownership of the five-percent shareholder during the testing period.

In order to identify five-percent shareholders under these rules, a loss corporation reviews documents including capitalization tables and SEC filings and determines the percentage ownership of each five-percent shareholder of the company on each testing date, and then compares each five-percent shareholder’s percentage ownership of company stock on each testing date to determine if an ownership shift of more than fifty percentage points has occurred. This test uses a “cliff” approach.

A loss corporation’s “five-percent shareholders” include individuals or public groups that own, directly or indirectly, five percent or more of the stock of the loss corporation. Two or more persons can be combined into a deemed “entity” for Section 382 purposes when such persons have a formal or informal understanding among themselves to make a “coordinated acquisition” of stock. In addition, two or more persons that are the economic owners of stock in a loss corporation may join together to report their combined beneficial interest on a single Schedule 13D or Schedule 13G filing with the SEC. If the Schedule 13D or Schedule 13G filing does not affirm the existence of a “group” for SEC purposes under Section 13(d)(3) of the Exchange Act, then the two or more economic owners do not constitute an “entity” making a coordinated acquisition of stock for Section 382 purposes.

Two or more economic owners should not be treated as an entity or as a shareholder making a coordinated acquisition for Section 382 purposes merely because they share the same officers, directors, or investment advisors. Thus, two or more economic owners should be treated as separate and independent shareholders in the loss corporation unless such owners affirm the existence of a “group” for SEC purposes or unless the loss corporation has actual knowledge that such owners joined together in a coordinated acquisition.

Based on the above principles, a loss corporation must interpret the company’s SEC Schedule 13D or Schedule 13G filings based on the following key disclosures in each respective Schedule 13D or Schedule 13G filing, including (1) whether the filer indicated that it is an investment advisor and specifically disclaimed “economic” ownership of the reported shares; (2) whether the filer indicated that any other person is the five-percent shareholder of an “economic” interest in the company through the filer’s reported interest; and (3) whether the filer affirmed the existence of a group under Section 13(d)(3) of the Exchange Act.

In addition to identifying direct five-percent shareholders, a loss corporation also must identify higher-tier entities and their five-percent shareholders who indirectly own, at any time during the testing period, five percent or more of the loss corporation through the ownership interest in the highest tier entity. A shareholder who indirectly owns five percent or more of the loss corporation through a higher-tier entity is considered a five-percent shareholder for determining the impact of an owner shift on any testing date. Each person who has an ownership interest in any highest-tier entity and is not treated as a five-percent shareholder of the loss corporation is a member of the public group of the highest-tier entity. A public group that indirectly owns five percent or more of the loss corporation on the testing date is treated as a five-percent shareholder. If the identified public group owns less than five percent of the loss corporation on the testing date, this public group is treated as part of the public group of the next lower tier entity.

As you can see, this is a very fact-intensive analysis and often requires reaching out to individual shareholders, funds, corporate shareholders, and others who are not direct owners of the loss corporation stock. In the case of a public company, we strongly advise the loss corporation tax preparers to use caution in gathering this information, as it is a communication between the company and one shareholder. Taxpayers in this situation may want to seek SEC counsel or have an intermediary contact the SEC filer.

Identifying these shareholders in the context of an acquisition can also be difficult, because the shareholder records may be difficult to construct once the transaction is closed. In a private company context, the historical shareholder information and background may be held by the target stakeholders, and getting in touch with them following the transaction may be difficult. One practical tip might be including a cooperation clause in the stock purchase agreement to make sure that the buyer receives all the necessary data to make the Section 382 calculations at a later date.

Public Groups and Relief From the Segregation Rules

Shareholders who own less than five percent of the loss corporation on a testing date are aggregated and treated as a single five-percent shareholder, referred to as a “public group.” Subject to certain exceptions, each public group that existed prior to a testing date is segregated from the direct public group that acquires the loss corporation’s stock on a testing date. Under the general segregation rules, direct public groups can be treated as acquiring additional shares in certain transactions, if for example, a direct five-percent shareholder sells their shares. In that type of case, a new public group is created to hold the shares sold by the five-percent shareholder. However, if the sale is a sale on the open market to shareholders who are not themselves five-percent shareholders, the sold shares can be allocated to existing public groups. Thus, the owner shift impact of certain stock issuances and sales may be reduced to the extent that the shares are treated as being issued to one or more public groups that are already in existence.

Treas. Reg. Section 1.382-3(j)(2)(iii) provides that the loss corporation may apply the small issuance limitation either on a corporation-wide basis or on a class-by-class basis. Furthermore, the small issuance exception does not apply to any portion of a single issuance that exceeds the ten-percent limit, or to any portion of a series of separate issuances that are pursuant to a single plan in which the shares issued under that plan exceed the ten-percent limit.

In instances in which the issuance of stock was solely for cash, a loss corporation can use the “solely for cash” exception. Under the solely for cash exception, a portion of the shares issued for cash are exempt from segregation and the remaining portion that is not exempt is treated as having been acquired by a new public group. The exempt portion is equal to one half of the percentage ownership of public groups existing immediately before the issuance.

Each public group existing immediately before the issuance is treated as having acquired its proportionate number of shares that are exempt from segregation under the solely for cash exception. If both the cash issuance exception and the small issuance exception might apply to an issuance, the application of the small issuance exception takes priority over that of the cash issuance exception, and the cash issuance exception applies only to the portion of the issuance (if any) not exempted under the small issuance exception. The practical impact of this exception is that if public groups hold a significant amount of a loss corporation’s stock, a significant number of newly issued shares will be allocated to those public groups. In contrast, if the stock of the loss corporation is owned primarily by individual five-percent shareholders, the cash issuance exception will provide very limited benefits in reducing an owner shift resulting from the issuance of new stock.

Calculating a Section 382 Limitation

If a loss corporation undergoes an ownership change, the new loss corporation may deduct only its pre-change losses against taxable income in an amount equal to the Section 382 limitation amount. The Section 382 limitation has two components: (1) the base limitation, calculated using the value of the stock, and (2) the net unrealized built-in gain/loss, calculated using the value of the assets (NUBIG and NUBIL).

The value of a loss corporation equals the value of all classes of stock outstanding on the change date immediately before the ownership change, including stock described in Section 1504(a)(4), adjusted as required by Section 382 and the Treasury Regulations thereunder. Examples of required adjustments include: adjustments for redemptions and corporate contractions pursuant to Section 382(e)(2); adjustments for foreign corporation investments pursuant to Section 382(e)(3); adjustments for certain capital contributions received as part of a plan, a principal purpose of which is to avoid/increase the Section 382 limitation, pursuant to Section 382 (l)(1); and adjustments for substantial nonbusiness assets pursuant to Section 382(l)(4), including assets held for investment.

Although a Section 382 limitation may be reduced for certain capital contributions made to a loss corporation within two years of an ownership change under Section 382(l)(1) if it is determined to be part of a plan a principal purpose of which is to avoid or increase any limitation, taxpayers can argue that if the contributions were made to fund the working capital requirements of the loss corporation, they were not made with a principal purpose of increasing a limitation, and thus an adjustment is unnecessary. This type of analysis can be used to defeat the elimination of capital contributions when calculating the loss corporation’s equity value.

One issue that buyers often misunderstand is the need for a Section 382 analysis and the pressures on the timing of knowing if a loss corporation has undergone an ownership change prior to the current transaction. The acquisition of 100 percent of the stock of a loss corporation does create an ownership change. What is often overlooked by acquirers is the impact of multiple ownership changes of a loss corporation. A separate Section 382 limitation applies independently to each change which potentially results in a lower limitation on significant NOLs accumulated from earlier years. As a result, the buyer needs to know if the NOLs are trapped at lower limitation levels prior to factoring in the loss corporation’s NOLs and their availability to any buyer going forward.

This can be equally important for financial statement reporting purposes. Under GAAP, a loss corporation is typically required to record a deferred tax asset for the value of the NOL carryforward. If the annual limitation from preceding changes is low enough, the loss corporation will be unable to use the NOLs prior to their expiration, which under current law is twenty years. If an acquirer later determines that the deferred tax asset is overstated because of this, the acquirer will have to reduce the deferred tax asset on its books. It may be better to write down the asset through purchase accounting entries if possible, which requires identifying earlier any changes. The proposed legislation mentioned above will change the carryforward period for NOLs incurred after December 31, 2017, to an indefinite period. This will alleviate the tension on this issue for future NOLs but that tension may still exist on older NOLs that remain subject to the twenty-year carryforward.4

In the year during which an ownership change occurs, the Section 382 limitation is reduced by a percentage based on the number of days in that year after the change date divided by the total number of days in that year. Similarly, in the change year, a loss corporation must allocate income and loss for the year ratably to each day in the year (unless a “closing of the books election” is made pursuant to Treas. Reg. Section 1.382-6). Only NOLs attributed to the pre-change portion of the year of the ownership change are subject to the Section 382 limitation. For a loss corporation that undergoes an ownership change midyear, this may help alleviate a potential tax burden in the year of the change. In addition, the amount of NOLs incurred in the change year can be calculated only after the tax year ends.

Built-In Gains and Losses

In addition to the Section 382 limitation, taxpayers who are in a NUBIG position may be allowed to increase their Section 382 limitation for the first five years after the change date by applying the relevant rules outlined in Notice 2003-65. As a general rule, to determine if a taxpayer is in a NUBIG or in a NUBIL position as of the change date, the loss corporation must compare the fair market value of all its assets to its tax basis, and if the fair market value of the assets exceeds the tax basis by a statutory amount (generally the lesser of fifteen percent of the total asset value or $10,000,000), the loss corporation is said to be in a NUBIG position. If instead the tax basis exceeds the fair market value of the assets on such date by the statutory amount, the loss corporation is in a NUBIL position.

Pursuant to Notice 2003-65, a loss corporation is allowed to presume a hypothetical sale of all its assets immediately prior to the change date and to “gross up the hypothetical purchase price” by liabilities in order to determine the fair market value of all the assets on the change date. This hypothetical calculation does not affect the tax basis of the assets. Rather, the calculation is to determine if the loss corporation can increase its Section 382 limitation for the post-change period by an additional amount of “deemed amortization,” and thus loss corporations in a NUBIG position may be able to alleviate somewhat the burden of undergoing an ownership change, during the five-year period after the ownership change date.


Although applying Section 382 may seem daunting, not to mention formulistic and documentation driven, these practical tips may help to reduce the burden on taxpayers as they learn to apply the rules of Section 382. Companies in the process of transaction evaluation or becoming profitable after years of losses will be particularly interested to know their Section 382 posture. In addition, your company may look to unlock the value of net operating loss carryforwards as an offset to reduce taxable income imposed under the Tax Reform Act.

Todd Reinstein is a partner in the Washington, D.C., office of Pepper Hamilton LLP, and Annette Ahlers is of counsel in the Los Angeles office of Pepper Hamilton LLP. The opinions expressed in this article are those of the authors and are not necessarily those of Pepper Hamilton LLP or its clients.


  1. “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” (PL 115-97) (“Tax Reform Act”) limits the NOL deduction to 80% of taxable income, effective with respect to losses arising in taxable years beginning after December 31, 2017.
  2. Id.
  3. Unless otherwise stated, all references to “Section” are to the Internal Revenue Code of 1986, and all references to “Regulation” or “Treas. Reg.” are to the Treasury Regulations promulgated thereunder. Additionally, taxpayers should also keep in mind other NOL limitation provisions such as Section 269, SRLY, and other similar provisions. Nothing in either the House or Senate versions of the tax bill repeals these limitation provisions.
  4. Of note, the new carryforward period for NOLs in the Tax Reform Act could result in some interesting financial statement reporting issues. Under GAAP, a corporation may be required to record a contra asset, a valuation allowance, to offset its deferred tax asset if the future utilization of the NOL is uncertain. One significant factor in making this determination is the twenty-year carryforward. If the carryforward is changed to an indefinite period, companies may have to continue to record a valuation allowance on the NOLs generated prior to December 31, 2017, and not on the NOLS generated after that date, because they can’t expire.

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