Potential Income Tax Attribute Limitation with Ownership Change

Whether we’re in a buying market or a selling market, it seems the M&A world continues to spin.

With any potential acquisition, the buyer can be attracted to any number of aspects of the target company, which typically include the assets within the company, either tangible or intangible. And while the saying goes, “don’t let the tax tail wag the dog,” tax implications can certainly impact the value of the assets to be acquired. The target’s tax attributes, such as net operating losses (NOLs) that have been previously generated and carried forward, may hold value to the potential buyer. But, buyer beware, the IRS has restrictions in place that may limit the utilization of NOLs under Section 382 and income tax credits under Section 383 of the Internal Revenue Code

Section 382 was enacted by the IRS to prevent loss-trafficking by imposing a limitation on the use of NOLs that were generated prior to an ownership change of a C corporation. This limitation impacts companies classified as “loss corporations,” whereby the target has either NOL carryforwards, tax credit carryforwards, a net unrealized built-in loss or a carryover of disallowed business interest expense under Section 163(j)

Should the target be a “loss corporation” under the above-mentioned rules, the impact of the Section 382 limitation upon sale needs to be considered if there’s to be an ownership change. This is where things can get complicated, as the determination of an ownership change – like most areas in tax – is not easily defined. While selling the entire stock of a corporation to an unrelated party can clearly be considered an ownership change, often there are partial sales, stock issuances or stock redemptions that can constitute a change in ownership and thus trigger the Section 382 limitation. Generally, an ownership change occurs when the cumulative ownership of 5% or more shareholders of a loss corporation has increased by more than 50% within a three-year period. 

Once we go through these complex rules and determine that a proposed transaction would cause a triggering event under Section 382, we need to look at the impact on tax attributes like the NOLs. This requires a determination of the value of the company at time of ownership change. The value of the C corporation, multiplied by the long-term exempt rate as prescribed by the IRS for the month of the transaction, will become the basis for the annual NOL-limitation calculation. Should the company also have income tax credits as of the date an ownership change is determined under Section 382, a similar calculation will need to be done to determine any limitation under Section 383.

This article is intended to serve as a reminder of these rules to ensure consideration is appropriately given before completing a transaction. Contact your Schneider Downs representative if you’d like to discuss your current situation and any tax implications that may result from a proposed transaction.

About Schneider Downs Tax Services

Schneider Downs’ tax advisors have experience and expertise in a wide range of industries, including Automotive, Construction, Real Estate, Manufacturing, Energy & Resources, Higher Education, Not-for-profits, Transportation and others. Our industry knowledge and focus ensure the delivery of technical tax strategies that can be implemented as practical business initiatives.  

To learn more, visit our dedicated Tax Services page. 

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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