Understanding Section 382

Unlocking Value: Understanding Section 382 Analysis

Difficulties of Section 382 of the Internal Revenue Code (IRC) are considered a critical aspect of tax planning for businesses proceeding with ownership changes. Do not hesitate to join DimovTax as the nuances of this often misunderstood but indispensable tool for preserving tax attributes are unravelled.

What is Section 382?

The use of certain tax attributes like net operating losses and built-in losses after an ownership change action in a corporation is limited by Section 382 of the IRC. When there is a significant change in the ownership of a corporation’s stock by 50% or more by certain shareholders over a three year time period, an ownership change eventuates.

In order to determine if the mentioned tax attributes are usable, an Internal Revenue Code Section 382 analysis is required.

In a nutshell:

• Limiting Tax Attributes: Section 382 of the IRC has a restrictive nature on the use of certain tax attributes that occur after a significant change in ownership of a corporation’s stock by certain shareholders like net operating losses and built-in losses.
• Ownership Change Action: An ownership change event occurs when there is a 50% or more change in the ownership of a corporation’s stock by certain shareholders over a three year time period.

The Importance

Business models that face ownership changes including mergers, acquisitions or significant stock transactions should consider understanding and properly applying Section 382 rules as they are vital. Otherwise, these rules might as well result in the loss of valuable tax benefits, leading to increased tax liabilities and decreased shareholder value.

Key points include:

• Preserving Tax Benefits: To conserve certain tax benefits like the utilization of pre-change net operating losses, compliance with Section 382 rules is essential. 
• Professional Guidance: Due to the complexities of Section 382 and its implications for federal and state income taxes, seeking professional guidance is highly recommended.

If such a change occurs, the corporation’s ability to use any pre-change net operating losses each year is limited to the value of the corporation’s stock immediately before the ownership change multiplied by the applicable long term tax exempted rate under the Section 382 limitation.

Recent Issues and Considerations

Changes in the tax laws have increased the importance for corporations to analyze the implications of Section 382:

• Changes in Tax Laws: Like IRC Section 174 capitalization rules and IRC Section 163(j) limitations modifications to tax laws, impact the utilization of net operating losses and other tax attributes.
• Increased Tax Liabilities: Corporations may experience increased tax liabilities due to changes in net operating losses utilization and deductions which require careful consideration of Section 382 implications.

Key Points in Section 382 Analysis 

1. Ownership Change Validation: Paying attention to whether an ownership change has occurred should be determined is the first step in Section 382 analysis. This step includes identifying the testing date and comparing the percentage of ownership before and after the change.
2. Limitation on net operating losses: Section 382 enforces certain restraints on the amount of net operating losses that can be utilized after the change of ownership. The mentioned limitation is calculated by multiplying the value of the old loss corporation by the long term tax exempted rate in effect for the month of the ownership change.
3. Built in Gains and Losses: Built in gains and losses refer to the inherent appreciation or depreciation in the assets of the corporation at the time of the ownership change. Section 382 imposes restrictions on the use of built in losses to prevent tax avoidance strategies.
4. Exceptions and Safe Harbors: There are exceptions and safe harbors available that may allow for greater flexibility in utilizing tax attributes although Section 382 rules are generally strict. These include the small shareholder exception and the section 382(l)(5) exemption for certain transactions.

It would be difficult to confirm the availability of the net operating losses of a corporation without a formal Section 382 analysis. This analysis is exclusively important in most cases to confirm the availability of net operating losses before the Tax Cuts and Jobs Act.

If only a small portion of recently generated net operating losses is used by a company, to shortcut a Section 382 analysis may be desired. Yet, the mentioned approach would be suitable in limited situations and generally, it is not recommended since it can be a trap for the unwary due to the complexities of Section 382.

It should be remembered that an additional reason for a corporation to perform a complete Section 382 analysis is constituted by the 80% utilization limitation rule. This is to make certain that all potential Section 382 limitations on the use of net operating losses before and after the Tax Cuts and Jobs Act are accounted for and considered.

How DimovTax Can Help?

At DimovTax, we specialize in providing custom fit tax services to meet your particular needs. Our services include:

• Section 382 Analysis & Planning: Developing effective tax planning strategies to optimize the utilization of net operating losses and other tax attributes in compliance with Section 382 rules.
• Transaction Structuring: Providing strategic guidance on structuring transactions to mitigate Section 382 limitations and preserve tax benefits regardless of a merger, acquisition or other ownership change situation.
• Compliance Support: Professionals of DimovTax are also offering ongoing compliance support to ensure adherence to Section 382 rules and regulations in order to minimize risks and potential penalties.

Outcome

For businesses undergoing ownership changes, Section 382 analysis is of utmost importance in tax planning processes. Businesses might easily could maximize tax benefits and preserve shareholder value by understanding the legislation and leveraging the expertise of professionals. DimovTax is ready to help you navigate the complexities of Section 382 Analysis with vital clarity. Contact us today to learn more about how we can assist you in unlocking the full potential of your tax attributes.