Matthew Cavitch on Preservation of Certain Corporate Tax Attributes in Bankruptcy Cases

by Matthew Cavitch

In bankruptcy cases involving businesses, a key consideration is often what happens to certain tax attributes, such as net operating losses, when the debtor business presumably re-emerges from the bankruptcy proceeding.

Excerpt:

In general IRC Section 382 provides that following a substantial change in ownership of a corporation that has a loss carryover, if the successor does not continue the same business for at least two years, the carryover of "pre-change losses," including net operating losses ("NOLs"), is lost completely ("the Section 382 Limitation"). Even if the successor corporation does continue the business for at least two years, IRC § 382 still limits the use of the loss carryover. Obviously, the preservation of losses can be very important to a corporation in a chapter 11 reorganization where the plan calls for a change in ownership.

The Section 382 Limitation basically works as follows. Upon a substantial change of ownership, defined as an ownership change of more than 50-percent over a three-year period, carryover losses will be available to the successor corporation, but only to a limited, specified amount in each of the successive tax years. The amount is determined by taking the value of the loss corporation immediately before the change in ownership and multiplying it by the federal long-term tax-exempt rate in effect on the date of the ownership change.

For example, if a corporation is valued at $1 million immediately before a change in ownership and the federal long term tax-exempt rate is 4-percent on the date of the change, then the corporation will only be able to use $4,000 worth of losses for each full tax year after the change in ownership occurs. This result is true even if the value of the losses is $10 million. However, any so-called built-in gain or gain recognized on account of a Section 338 election may be offset by the loss carryover.

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Matthew P. Cavitch, A.B., J.D. Member of the Tennessee Bar.