IRS TO EASE LOSS CARRYOVER RESTRICTIONS

Code Section 382 limits trafficking in net operating losses by imposing restrictions on use of net operating losses of a corporation after a substantial change in ownership. One of the restrictions that arises after such a change in ownership is that the available net operating losses are effectively written down to the fair market value of the corporation at the time of change in ownership.

Given such restrictions, taxpayers are encouraged to make capital contributions to a loss corporation before a change in ownership to beef up its value and thus reduce the write-down of its NOLs. To restrict this gamesmanship, Code Section 382(l)(1)(A) will disregard any capital contribution received by a loss corporation as part of a plan a principal purpose of which is to avoid or increase any limitation under Code Section 382. Code Section 382(l)(1)(B) then goes on to provide that any capital contributions made during the two years leading up to the change in ownership will be presumed to be part of such a plan and disregarded, except as provided in regulations.

Surprisingly, the IRS has indicated that regulations will be issued that will not provide for a per se presumption of a plan to avoid Code Section 382limitations for contributions in the two years leading up to the change in ownership. Instead, it will apply a facts and circumstances analysis to determine if there was a plan to avoid the Code Section 382 limitations. Further, the regulations will have certain safe harbor capital contribution situations that will not give rise to a finding of a plan to avoid the limitations.

These safe harbor capital contributions are:

(1) The contribution is made by a person who is neither a controlling shareholder (determined immediately before the contribution) nor a related party, no more than 20% of the total value of the loss corporation's outstanding stock is issued in connection with the contribution, there was no agreement, understanding, arrangement, or substantial negotiations at the time of the contribution regarding a transaction that would result in an ownership change, and the ownership change occurs more than six months after the contribution.

(2) The contribution is made by a related party but no more than 10% of the total value of the loss corporation's stock is issued in connection with the contribution, or the contribution is made by a person other than a related party, and in either case there was no agreement, understanding, arrangement, or substantial negotiations at the time of the contribution regarding a transaction that would result in an ownership change, and the ownership change occurs more than one year after the contribution.

(3) The contribution is made in exchange for stock issued in connection with the performance of services, or stock acquired by a retirement plan, under the terms and conditions of certain regulations under Code Section 355.

(4) The contribution is received on the formation of a loss corporation (not accompanied by the incorporation of assets with a net unrealized built in loss) or it is received before the first year from which there is a carryforward of a net operating loss, capital loss, excess credit, or excess foreign taxes (or in which a net unrealized built-in loss arose).

The inclusion of practical safe harbors is always welcome!

Notice 2008-78