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New NOL Limitations Proposed

On September 9, the IRS and Treasury released proposed regulations under Section 382 of the tax code that, once finalized, may reduce the ability of loss corporations to use Net Operating Loss (NOL) carryovers and other tax attributes.  One of the most significant changes under the proposed regulations is the elimination of the often taxpayer-favorable Section 338 approach for calculating adjustments to this limitation.  Under Section 382, a corporation with NOL carryovers or certain other tax attributes is considered a “loss corporation” that is subject to annual limitation on its use of those tax attributes after a so-called “ownership change.”  This limitation may be increased if the loss corporation had a net unrealized built-in gain (NUBIG) in its assets at the time of the ownership change and then has a recognized built-in gain (RBIG) after the ownership change.  If a loss corporation instead has a net unrealized built-in loss (NUBIL) at the time of the ownership change, the use of a recognized built-in loss (RBIL) after the ownership change would also be subject to the Section 382 limitation.  Under Notice 2003-65, taxpayers were allowed to elect one of two approaches, the Section 1374 approach or the Section 338 approach, to calculate their NUBIG/NUBIL and RBIG/RBIL.  For loss corporations with NUBIGs, the Section 338 approach was generally taxpayer-favorable because it treated depreciable and amortizable assets as purchased for fair market value and treated depreciation and amortization deductions over the first five years resulting from the increased basis as a RBIG.  By doing so, the Section 338 approach could dramatically increase the Section 382 limitation for certain loss corporations holding significant built-in gain depreciable or amortizable assets at the time of an ownership change.  The proposed regulations would eliminate the Section 338 approach, effective for ownership changes occurring after the regulations are finalized.  The government’s dubious rationale for elimination is that the Section 338 approach calculations are more complex than the Section 1374 approach, the former can result in overstatements of RBIG/RBIL, and substantial adjustments would be required to ensure appropriate results under the Section 338 approach due to the Tax Cuts and Jobs Act.  Once Treasury finalizes the regulations, taxpayers will be required to actually recognize built-in gains in order to increase their Section 382 annual limitations.

The proposed regulations also include adjustments to the calculation of the Section 382 limitation that will generally reduce the availability of NOL carryovers and other tax attributes to taxpayers, and in particular bankrupt or insolvent taxpayers.  Notably, whereas under Notice 2003-65 NUBIG/NUBIL was calculated by creating a deemed transaction in which a hypothetical buyer acquires all of the loss corporation’s assets and assumes the loss corporation’s liabilities, the proposed regulations generally do not treat liabilities as assumed, which generally decreases NUBIG or increases NUBIL and thus indirectly reduces the availability and value of tax attributes.  Additionally, the proposed regulations would generally exclude certain cancellation of debt income from RBIG status with some exceptions for such income recognized in the first 12 months after an ownership change. Treasury indicated that these corrections were necessary to eliminate potentially duplicative tax benefits from liabilities and cancellation of debt income.

Key Contacts

Adam Blakemore
T. +44 (0) 20 7170 8697

Linda Z. Swartz
T. +1 212 504 6062

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

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