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IRS Issues Significant Guidance on Losses Available After an Ownership Change

October 2, 2008

This week the IRS modified and potentially expanded the amount of losses available to offset taxable income after an ownership change.

Internal Revenue Code Section 382 generally provides that a corporation that undergoes a more than 50% change in ownership is limited in its use of pre-change net operating losses to offset post-change taxable income.  The annual limitation for such losses generally is the product of the value of the loss corporation before the ownership change and the long term tax-exempt rate.  In determining the value of the loss corporation, the Code provides that capital contributions received by the loss corporation pursuant to a plan a principal purpose of which is to avoid or increase the limitation under Code Section 382 shall not be taken into account, and contributions made during the two year period before the ownership change shall, except as provided in regulations, be treated as part of such a plan.  Code Section 382 also generally provides that the amount of pre-change losses subject to limitation includes the corporation's net unrealized built-in loss with respect to its assets as of the time of an ownership change recognized within five years after the ownership change.

In the past week, the IRS has issued two notices potentially expanding the amount of losses available to offset taxable income after an ownership change.  First, in Notice 2008-78, the IRS eliminates the presumption that capital contributions to a loss corporation within two years prior to an ownership change are part of a plan to avoid or increase the Section 382 limitation.  Instead, whether such contributions are part of such a plan will be determined based upon all facts and circumstances, unless the contribution is described in one of four safe harbors and thus not considered to be part of such a plan. 

In addition, in Notice 2008-83, applicable only to banks, the IRS states that any deduction properly allowed with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) after an ownership change shall not be treated as a built in loss or deduction that is attributable to a period before the change date, and thus will not be subject to the limitation on use imposed by Code Section 382.