Treasury issued proposed regulations under IRC Section 382(h) which may significantly reduce the amount of net operating losses and other tax attributes, tax credits and deduction carryovers, that a company can use following an ownership change, as defined in the Section 382 (“382 ownership change”).
Generally, a 382 ownership change occurs when there is a more than 50% ownership shift during the rolling 3 year period. When a corporation experiences a 382 ownership change, its ability to use net operating losses and other tax attributes of the pre-ownership change is generally subject to annual limitation equal to the fair market value of the company multiplied by the long-term tax-exempt rate, adjusted by recognized pre-ownership change built-in gains or built-in losses (“RBIG” or “RBIL”) during the recognition period (five years from the ownership change date). RBIG increases the annual limitation and RBIL decreases the annual limitation because such income or loss is attributable to the pre-ownership change date.
For nearly two decades, taxpayers have relied on Notice 2003-65 in applying afore-mentioned RBIG or RBIL adjustments to the annual limitation. The Notice 2003-65 provides two methods: The Section 1374 approach and the Section 338 approach. The Section 1374 approach generally relies on accrual method of accounting concepts to identify built-in income and deduction items. The Section 338 approach generally identifies built-in income and deduction recognizable during the recognition period had the transaction been structured as an asset purchase – widely used by taxpayers to maximize the annual limitation.
The proposed regulations reject this Section 338 approach and make a number of other significant changes to the Section 1374 approach. If finalized, the proposed regulations would generally reduce the ability of acquiring companies to utilize pre-ownership change tax losses of acquired corporations. The proposed regulations will be effective for ownership changes occurring on or after the date the regulations become final.