NOL’s, Section 382 and Bankruptcy Rules

Corporate RestructuringTimothy Thompson

Net Operating Losses A corporation with a NOL this tax year

may carry back or carry forward to offset the loss against taxable income 2 years back (used to be 3) 20 years forward (used to be 15)

Company can elect not to carry back AMT rules reduce some of benefit

Simple exampleYear Income After NOL

IncomeAfter 2nd NOL Inc

1998 -1.2M 0

1999 1.6M 0.4M

2000 2.5M 0

2001 4.0M 0

2002 -8.2M 0

1.7 more

Capital losses Capital losses can only be offset by

capital gains Carry back three years Carry forward five years

IRC Section 382 IRS wants the NOL’s to stay only with

the company that lost the money In most ownership changes, NOL’s of a loss

company are limited Section 382 limitation

Following a “more than 50%” ownership change, corporations ability to deduct pre-ownership change NOL’s is limited, annually, to fair market value of equity (one month prior to ownership change) times the Section 382 rate.

Special rules may mitigate the limitation in bankruptcy

Example Company has NOL’s of 115

Goes through an ownership change C’s equity one month prior was $90 Annual deduction = 90*5% = 4.5M Even if you can take all over 20 years

20(4.5) = 90M PV (@ 10%) = 4.5(8.51) = 38.3M Vs. taking all of 115 next year 115/1.1 =

104.5M

What is an ownership change? Ownership change

Occurs if, during a three-year period, the ownership of stock of the corporation by “5% holders” increases by more than 50%

In taxable or tax free transaction

Section 382 in bankruptcy reorganizations If the ownership change occurs in a

bankruptcy case The calculation of the annual limitation is

based on the value of the corporation immediately after the ownership change

Since this calculation is usually after significant debt relief, the equity value is higher, more NOL’s

Special bankruptcy exception, however!

Example Chapter 11 reorganization plan

Old stock cancelled, many old liabilities replace with stock, equity value will be used to calculate loss limitation

Had reorganization been outstide Chapter 11, lose all NOL’s

Special bankruptcy exception If the ownership change occurs in

Chapter 11 and At least 50%of the stock of the

corporation, after the ownership change, is owned by its existing shareholders, creditors that held debt of the corporation for at least 18 months prior to announcement of the bankruptcy case, or ordinary business creditors

Then no Section 382 limitations on NOL’s apply.

Tough to get special exception If there has been trading of troubled

debt, then may not qualify Acquisition of more than 50% of the

stock by an acquirer Even if you get it, it is reduced by last

three years of interest paid or accrued on debt converted into stock.

No ownership changes for next two years, or NOL’s gone.