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1990

Section 382: Net Operating Loss Carryovers inCorporate AcquisitionsPeter L. Faber

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Repository CitationFaber, Peter L., "Section 382: Net Operating Loss Carryovers in Corporate Acquisitions" (1990). William & Mary Annual TaxConference. 211.https://scholarship.law.wm.edu/tax/211

SECTION 382:NET OPERATING LOSS CARRYOVERS IN CORPORATE ACQUISITIONS

Peter L. FaberKaye, Scholer, Fierman, Hays & Handler

New York, New York

December 1, 1990

TABLE OF CONTENTS

Page

I. General principles governing the use of net operatinglosses ............ .... ................ 1

A. Use of net operating losses by the corporationthat sustains them ........ ................ 1

1. General carryback and carryforward rules . . 1

2. Election to waive the carryback period 1

3. Effect of a change in L's shareholders . . . 1

B. Use of NOLs by taxpayers other than thecorporation that sustains them ..... .......... 1

1. Transfer of NOL carryover to anothertaxpayer ..... .... ................... 1

2. Use of NOL carryover of one taxpayer byanother without a transfer of ownership:consolidated returns ... ... ...... .... 3

II. Loss of NOL carryovers in acquisitions motivated bytax avoidance ...... ................... 3

A. Loss of NOL carryover if the principal purpose foran acquisition is to secure its benefit . .... 3

B. Loss of carryover even though the corporationlater using it is the acquired corporation . 4

C. Application of Section 269 to the acquisition of aprofitable corporation by a loss corporation. . . 4

D. Nature of tax avoidance purpose .... ......... 4

E. Indicators of tax avoidance purpose ... ....... 4

F. Disallowance of post-acquisition NOLs .. ...... 5

III. Effect of changes in stock ownership: pre-1987 rules . 5

A. Taxable acquisitions. Old I.R.C. S 382(a) . . . 5

1. General rule ........ ................ 5

2. Required change of ownership ... ........ 5

Page

3. Transactions to which Old S 382(a) applied

4. Continuation of business ..........

B. Tax-free reorganizations. Old I.R.C. § 382(b)

1. General rule . . . . . . . . . . . . . . . .

2. Identity of loss corporation shareholders

3. Determination of loss corporationshareholders' ownership of acquiredcorporation stock ..... ...............

4. Acquisitions using parent corporationstock . . . . . . . . . . . . . . . . . . . .

5. Exception if both corporations were owned bysubstantially the same persons in the sameproportions ...... ...................

6. Successive reorganizations .........

IV. Effect of changes in stock ownership: post-1986 rules.

A. General approach of the new rules . ...

1. Changed focus of S 382 .......

2. General operation of the statute

B. Corporations subject to the limitations

C. Tax attributes the use of which is subjectlimitations . . . . . . . . . . . . . . .

1. NOL carryovers ...........

2. Built-in losses ... .............

3. Excess credits .... .............

4. Net capital losses ... ...........

D. Acquisitions subject to S 382 ......

1. Years in which limits apply......

2. Definition of "post-change year".

ii

to the

*. . . 12

* . . . 11* . . . 12

. .. . 14

* . . . 15

* . . . 15

* . . . 15

.... 15

• O Q

Page

3. Definition of "change date" ........... .. 15

4. Definition of "ownership change." ...... 15

a. General rule .... .............. ... 15

(1) Definition of "testing period". . . 16

(2) Definition of "5-percentshareholder" ............... .... 17

b. Statutory operating rules .......... ... 17

(1) General rule .... ............ ... 17

(2) Stock ownership based on value. . . 17

(3) Changes resulting from fluctuationsin value ..... .............. ... 17

(4) Certain preferred stockdisregarded .... . .. ....... ... 17

(5) Treasury regulatory authorityrespecting options and similarinstruments ...... ............ 18

(6) Attribution of stock ownership. . . 18

(7) Exception for gifts, bequests,and divorces .... ............ ... 19

c. Regulatory operating rules ........ . 19

(1) Definition of stock ......... ... 19

(a) Preferred stock withdividend arrearages ........ ... 19

(b) Stock with disproportionatelysmall participation in growth . 19

(c) Convertible preferred stock 21

(d) Non-stock interests treatedas stock .... ............ . 21

Page

(2) Determination of stock ownership 22

(a) General concepts .......... .. 22

(b) Rules of administrativeconvenience ... .......... . 23

(c) Family attribution ......... ... 24

(d) Entity attribution ......... ... 24

(e) Option attribution ......... ... 26

(f) Aggregation of public share-holders into groups ....... .. 34

(g) Segregation of public share-holders into separate groups. 36

5. Definition of "owner shift involving a 5-percent shareholder" ... ............ . 38

6. Definition of "equity structure shift" . . 41

7. Illustrations of multiple transactionsinvolving both types of ownership changes 43

E. Calculation of the S 382 limitation . ....... . 44

1. General pattern ..... ............... ... 44

2. Determination of the "value of the old losscorporation." ...... ................ .. 45

3. Determination of the "long-term tax-exemptrate." ....... ................... .. 48

4. Increases in the basic S 382 limitation . . 49

5. Reductions in the basic S 382 limitation 51

F. Application of the S 382 limitation . ....... . 53

G. Effect of the Tax Reform Act of 1986 on otherlimitations on the use of NOL carryovers ..... .. 54

1. Section 269 and the SRLY and CRCO rules. . . 54

Page

2. Treasury Department regulatory authority toprevent the avoidance of 55 382 and 383 . . 55

H. Bankruptcy situations ..... ..... .... .... ... 55

1. General bankruptcy exception .. ........ . 55

2. Special rules if S 382(a) does not applybecause of the bankruptcy exception ..... .. 56

3. Special rules for thrift institutions .... 57

4. General rules relating to the Title 11exception ...... .................. ... 58

V. Use of preacquisition losses to shelter built-in gains.

I.R.C. S 384 ........ ..................... .. 59

A. Introduction ....... ................... ... 59

B. Transactions subject to S 384 ... .......... . 59

1. Stock acquisitions .... ............. . 59

2. Asset acquisitions ... ............... . 60

C. Exception for common control situations ........ ... 60

D. Income subject to 5 384. ... ............. .. 60

E. Acquisition date ...... ................. ... 61

1. Stock transfers ..... ............... ... 61

2. Asset transfers ..... ............... ... 61

F. Pre-acquisition losses .... .............. ... 61

G. Similar rules applicable to excess credits and netcapital losses ............ .. .......... . 61

SECTION 382:NET OPERATING LOSS CARRYOVERS IN CORPORATE ACQUISITIONS

Peter L. FaberKaye, Scholer, Fierman, Hays & Handler

New York, New York

December 1, 1990

I. General principles governing the use of net operatinglosses.

A. Use of net operating losses ("NOLs") by the corpora-tion that sustains them ("L").

1. Ordinarily, NOLs must be carried back threeyears and forward fifteen years. I.R.C.

172(b)(1).

a. Special rules are provided for certainindustries.

b. NOLs must generally be applied to the ear-liest years first.

2. The corporation can irrevocably elect to waivethe carryback period for a NOL, in which caseit will be carried forward only.

Note: This election may be advisable if thetax rate applicable to the carryback years islower than the tax rate applicable to carryfor-ward years or if credits eliminate or reduce taxfor the carryback years.

3. Unless otherwise provided by statute, NOLs arenot affected by a change in L's shareholders.

B. Use of NOLs by taxpayers other than the corporationthat sustains them.

1. Transfer of NOL carryover to another taxpayer.I.R.C. S 381.

a. Before the 1954 Code, carryovers couldgenerally only be used by L. They couldnot be transferred in a "C" reorganization.New Colonial Ice Co. v. Helvering, 292 U.S.435 (1934). It was not clear whether theycould be transferred in a statutory merger.Stanton Brewery, Inc. v. Commissioner, 176F.2d 573 (2d Cir. 1949); Newmarket

Manufacturing Company v. United States, 233F.2d 493 (1st Cir. 1956), cert. denied, 353U.S. 983 (1957).

b. NOL carryovers are transferred to theacquiring corporation in certainliquidations of subsidiaries and in "A","C", "F", ard, in some cases, "D"reorganizations. I.R.C. S 381(a) and(c)(1). If a transaction fails to qualifyas a "reorganization" for technicalreasons, the carryover does not move tothe acquiring corporation. If L isliquidated, the carryover disappears.

C. The "acquiring corporation" that gets thecarryover is the one that "pursuant to theplan of reorganization ultimately acquires,directly or indirectly, all of the assetstransferred by the transferor corporation."Regs. S 1.381(a)-l(b)(2).

d. The date of transfer of the carryover isthe date on which all transfers arecomplete, except that the date on whichsubstantially all the assets aretransferred can be used if all activitiesothr than liquidating activities have beendiscontinued and the taxpayer elects or theI.R.S. concludes that the date of transferhas been "unreasonably postponed." Regs.S 1.381(b)-l(b)(2).

e. The carryover applies to the acquiringcorporation's first taxable year endingafter the transfer. I.R.C. § 381(c)(i)(A).The acquiring corporation's taxable incomefor that year to which the carryover can beapplied is limited to the taxable incomefor the year pro-rated according to thenumber of days in the year before and afterthe transfer. I.R.C. § 381(c)(1)(B).

f. The transferor's taxable year ends on thedate of the transfer except in "F"reorganizations. I.R.C. § 381(b)(1). Evenif its last year is a short year, it countsas a full year in computing thecarryforward period under I.R.C.S 172(b)(1). Regs. S 1.381(c)(l)-l(e)(3).

g. Post-acquisition losses can be carried

back to pre-acquisition years of theacquiring corporation but not of thetransferor corporation.

2. Use of NOL carryover of one taxpayer by anotherwithout a transfer of ownership: consolidatedreturns.

a. Ordinarily, if two or more corporationsfile consolidated returns, the losses ofone can be applied against the income ofthe others.

b. Pre-consolidation losses or built-indeductions of a subsidiary can normally beused only against its own income inconsolidated return years. Regs.SS 1.1502-15, 21(c). (The separate returnlimitation year, or SRLY, rules).

c. Pre-consolidation losses of the commonparent can be used against income of allcorporations in the group in consolidatedreturn years unless it acquires a largercorporation in a "reverse acquisition" inwhich the shareholders of the acquiredcorporation end up controlling the parent.Regs. SS l.1502-i(f)(2) and (3). In thiscase, the larger corporation is treated asthe common parent for purposes of the SRLYrules.

II. NOL carryovers can be lost in acquisitions motivated bytax avoidance: I.R.C. S 269.

A. General rule: NOL carryover is lost if the principalpurpose for an acquisition is to secure its benefitand in the transaction:

1. Any person or persons acquire control (50% ofvoting power or value) of a corporation, or

2. A corporation acquires property of another

corporation-and

a. The property's basis carries over, and

b. The transferor is not controlled by theacquiring corporation or its shareholders.

B. The carryover is lost even though the corporationlater using it is the acquired corporation.Regs. S 1.269-3(a); Coastal Oil Storage Co. v.Commissioner, 242 F.2d 396 (4th Cir. 1957); MillRidge Coal Company v. Patterson, 264 F.2d 713 (5thCir. 1959), cert. denied, 361 U.S. 816 (1959); JamesRealty Company v. United States, 280 F.2d 394 (8thCir. 1960).

C. Section 269 can apply to the acquisition of aprofitable corporation by a loss corporation.Briarcliff Candy Corporation v. Commissioner, T.C.Memo. 1987-487; Vulcan Materials Co. v. UnitedStates, 446 F.2d 690 (5th Cir. 1971), cert. denied,404 U.S. 942 (1971).

D. Nature of tax avoidance purpose.

1. Tax avoidance need not be a "but for not" causeof the transaction as long as it is the mostimportant purpose. Regs. § 1.269-3(a). Theregulations suggest a plurality test but amajority standard was required in BobseeCorporation v. United States, 411 F.2d 231 (5thCir. 1969).

2. The purpose at the time of acquisition iscontrolling. The carryover is not lost if thedesire to use it arises later. Hawaiian TrustCompany, Limited v. United States, 291 F.2d 761(9th Cir. 1961); Capri, Inc. v. Commissioner, 65T.C. 162 (1975) (step transaction argument byI.R.S. rejected).

E. Indicators of tax avoidance purpose.

1. A transfer of profitable assets to losscorporation after acquisition. Regs § 1.269-3(b); J.G. Dudley Company, Incorporated v.Commissioner, 298 F.2d 750 (4th Cir. 1962);Scroll Inc. v. Commissioner, 447 F.2d 612 (5thCir. 1971). This technique is often used to tryto avoid the impact of the SRLY rules.

2. The NOL carryover is large in relation to otherassets. Meridan Corporation v. United States,253 F. Supp. 636 (S.D.N.Y. 1966).

3. There is no investigation of the business of theacquired corporation. Hart Metal ProductsCorporation v. Commissioner, 437 F.2d 946 (7thCir. 1971).

4. A decision is made to have the loss corporationsurvive the merger that is not justified bybusiness considerations. Meridan Corporation v.United States, supra.

5. The business of the loss corporation isdiscontinued after acquisition. O'Donnell, Jr.v. Commissioner, T.C. Memo. 1964-38.

F. The I.R.S. and some courts say that post-acquisitionNOLs can be disallowed. R.P. Collins & Co., Inc. v.United States, 303 F.2d 142 (1st Cir. 1962); Luke v.Commissioner, 351 F.2d 568 (7th Cir. 1965). Othercourts disagree. Zanesville Investment Company v.Commissioner, 335 F.2d 507 (6th Cir. 1964); HerculiteProtective Fabrics Corp. v. Commissioner, 387 F.2d475 (3d Cir. 1968).

III. Effect of changes in stock ownership: pre-1987 rules.

A. Taxable acquisitions. Old I.R.C. S 382(a).

1. General rule: L's NOL carryovers wereeliminated if there was a 50% change ofownership in certain transactions and L failedto continue the same business.

2. Required change of ownership.

a. The shareholders whose ownership mustchange were the 10 largest shareholders byfair market value.

b. There must have been an increase in theholdings of the 10 largest shareholders byat least 50 percentage points (not by 50%).

c. The ownership of the shareholders wascompared with their ownership at the startof the taxable year and at the start of theprior taxable year.

3. Transactions to which Old § 382(a) applied.

a. A "purchase" of L stock by one or more ofthe 10 largest shareholders.

(1) A "purchase" was generally defined inOld S 382(a)(4)(A) as an acquisition:

(a) From a person whose stock wouldnot be attributed to the buyerunder S 318 (with SS 318(a)(2)(C)and (a)(3)(C) applied withoutregard to the 50% limitation).

(b) In which the buyer's basis forthe stock was determined solelyby reference to its cost.

(2) Indirect purchases by buying aninterest in a corporation,partnership, or trust that owned Lstock were taken into account. Regs.S 1.382(a)-l(f).

b. A reduction in L's outstanding stock.

(1) This was generally accomplished by aredemption of stock from othershareholders.

(2) A redemption to pay death taxes andestate administration expenses towhich S 303 applied was not taken intoaccount.

4. L must fail to continue "substantially the same"trade or business that it conducted before thechange of stock ownership.

a. The change of business had to occur afterthe first change of stock ownership thatwas included in the 50% change.

b. The discontinuance of a significantbusiness operation was treated as a changeof business, especially if it was theoperation that generated the losses. Regs.S 1.382(a)-l(h)(7).

c. Change of location.

(1) A change in location was considered achange in business if it substantiallyaltered the business, taking intoaccount employees, customers,geographical market area, nature ofproperty used, and similar items.Regs. S 1.382(a)-l(h)(9).

(2) A relocation was not treated as achange of business when there was asubstantial continuity of products,personnel, brand name, and customers.Wallace Corp. v. Commissioner, T.C.Memo. 1964-10.

d. Cessation of business.

(1) A cessation of business activities wastreated as a termination of abusiness, even if the business waslater resumed. Regs. § 1.382(a)-l(h)(6).

(2) A temporary cessation of businessbecause of fire or similar catastrophewas not treated as a businesstermination. Regs. 5 1.382(a)-l(h)(6). The courts held that acessation while L attempted to restoreits financial health was consideredtemporary. H.F. Ramsey Co. v.Commissioner, 43 T.C. 500 (1965),nonacq. on this issue, 1965-2 C.B. 7;Clarksdale Rubber Co. v. Commissioner,45 T.C. 234 (1965).

e. The addition of a new business was nottreated as a change of business as long asthe old business was continued. Regs.S 1.382(a)-1(h)(8).

B. Tax-free reorganizations. Old I.R.C. S 382(b).

1. General rule of old S 382(b).

a. This provision applied to "A", "C", "F",and, in some cases, "D" reorganizations,but a "B" reorganization followed by aliquidation was treated as a "C". Regs.§ 1.382(b)-l(a)(6); Rev. Rul. 67-274, 1967-2 C.B. 141; Resorts International, Inc. v.Commissioner, 60 T.C. 778 (1973), aff'd inpart and rev'd in part, 511 F.2d 107 (5thCir. 1975).

b. If the L shareholders ended up with lessthan 20% of the value of the acquiringcorporation's stock (not counting certainpreferred stock), the NOL carryover wasreduced by 5% for each percentage point

less than 20. The earliest NOLs were lostfirst. Old I.R.C. S 382(b)(4).

c. Stock ownership was the only test.Continuation of business was immaterial.Nevertheless, the transaction would notqualify as a reorganization (and, hence,L's NOL carryover would not pass to theacquiring corporation) if the continuity ofbusiness enterprise test generallyapplicable to reorganizations was not met.Regs. S 1.368-1(d). This was not a problemif L was the acquiring corporation.

2. Who are the "loss corporation shareholders?"

a. The people who must meet the 20% test werethose persons owning L stock "immediatelybefore the reorganization." When does the"reorganization" begin? See Reeves v.Commissioner, 71 T.C. 727 (1979), vacatedsub nom., Chapman v. Commissioner, 618F.2d 856 (ist Cir. 1980), rev'd sub nom.,Heverly v. Commissioner, 621 F.2d 1227 (3dCir. 1980).

b. An acquisition of L stock by acquiringcorporation shareholders for the purpose ofavoiding the S 382 limits was ignored.Regs. S 1.382(b)-1(c). Reducing the valueof the acquiring corporation's common stockby a preferred stock dividend to increasethe L shareholders' share of the acquiringcorporation worked. Rev. Rul. 77-227,1977-2 C.B. 120.

3. Determination of L shareholders' ownership ofacquired corporation stock.

a. Only stock received as a result of owningstock of L before the reorganization wascounted. No credit was given for priorownership. Regs. S 1.382(b)-l(a)(2).

b. Acquiring corporation stock owned"immediately after" the reorganization wascounted.

(1) The effect of later sales was unclear.What if they were pursuant to a pre-arranged plan?

(2) The effect of contingent stock orescrowed stock subject tocontingencies was unclear.

c. The I.R.S. said that acquiring corporationstock received by L in a "C" reorganizationbut not distributed to its shareholders wasnot counted. Regs. § 1.382(b)-l(a)(2).Contra, World Service Life InsuranceCompany v. United States, 471 F.2d 247 (8thCir. 1973).

4. If stock of the acquiring corporation's parentwas the consideration for the acquisition, Lshareholders had to end up with parent stockequal to 20% of the subsidiary acquiringcorporation's value. Old I.R.C. S 382(b)(6).

a. This enabled complete avoidance of5 382(b).

b. L's NOL carryover ended up in thesubsidiary. The parent then had to getprofits into the subsidiary or the SRLYrules would limit the post-acquisition useof the carryover. A transfer of profitableassets to the subsidiary could indicate atax avoidance motive for purposes of 5 269.Regs. S 1.269-3(b).

5. There was an exception if both corporations wereowned by substantially the same persons in thesame proportions. Old I.R.C. S 382(b)(3).Constructive ownership rules did not apply.Rev. Rul. 76-36, 1976-1 C.B. 105; Kern's Bakeryof Virginia, Inc. v. Commissioner, 68 T.C. 517(1977); Commonwealth Container Corp. v.Commissioner, 48 T.C. 483 (1967), aff'd, 393F.2d 269 (3d Cir. 1968).

6. Successive reorganizations designed to avoid oldS 382(b) were tested after the last one. RegsS 1.382(b)-i(c). An integrated plan wouldprobably produce the same result even in theabsence of tax avoidance intent. See Rev. Rul.67-274, 1967-2 C.B. 141.

IV. Effect of changes in stock ownership: post-1986 rules.

A. General approach of the new rules.

1. The 1986 Tax Reform Act rules changed the focusof 5 382.

a. Under prior law, the general approach wasto eliminate or reduce the amount of L'sNOL carryovers in certain acquisitions.

b. Under the new law, the NOL carryoversremain intact but the post-acquisitionincome against which they can be applied islimited.

c. The theory of the new law is that thebuyer's ("P") use of L's NOL carryoversshould be limited to the use that L couldhave made of them if the acquisition hadnot occurred. It is assumed that L couldhave earned income each year equal to areasonable return on its value, and thepost-acquisition income against which L'sNOL carryovers can be applied is thereforelimited each year to a percentage of L'svalue on the acquisition date deemed torepresent a reasonable rate of return.The purpose of the provision is to removethe incentive for a buyer to pay more forL's stock because of L's NOL carryovers.This has been referred to as the"neutrality principle."

d. The Revenue Act of 1987 added § 384 to theCode, which prevents L from using old NOLcarryovers against built-in gains of anacquired corporation.

2. General operation of the statute.

a. If there is a more-than-50% change in theownership of L's stock, then

b. L's use of its NOL carryovers is limited ineach year to a specified return on thevalue of L at the time of the change.

3. Unlike prior law, taxable and tax-freeacquisitions are generally subject to the samerules.

B. Corporations subject to the limitations.

1. The limits apply to the use of NOL carryovers bya "new loss corporation." I.R.C. S 382(a).

2. A "loss corporation" is any corporation that is:

a. Entitled to use a NOL carryover or that hasa net operating loss for the year in whichan ownership change occurs, or

b. That has a net unrealized built-in loss(except as regulations provide otherwise).I.R.C. S 382(k)(1).

3. An "old loss corporation" is a corporation thatincurs an "ownership change" and that beforethe ownership change was a loss corporation.I.R.C. S 382(k)(2).

4. A "new loss corporation" is a corporation thatafter an ownership change is a loss corporation.The same corporation can be both an old losscorporation and a new loss corporation. I.R.C.S 382(k)(3).

Example. Corporation L has a NOL carryover.Individual A owns all of its stock. IndividualB buys all of L's stock from A. L is both anold loss corporation and a new loss corporationand the S 382 limitations apply to its use ofits NOL carryovers.

Example. Corporation L has a NOL carryover. Lmerges into corporation P in a reorganizationunder I.R.C. S 368(a)(1)(A). L's NOL carryoverpasses to P under I.R.C. S 381(a)(2). P is anew loss corporation and the § 382 limitationsapply to its use of L's NOL carryovers.

C. Tax attributes the use of which is subject to the

limitations.

1. NOL carryovers.

a. The use of "pre-change losses" by a newloss corporation is limited by S 382 in any"post-change year." I.R.C. S 382(a).

b. A "pre-change loss" is:

(1) A NOL carryforward of the old losscorporation to the taxable year endingwith the ownership change or in whichthe change date occurs, and

(2) The NOL of the old loss corporationfor the taxable year in which the -ownership change occurs to the extentallocable to the period on or beforethe change date. The NOL is allocatedto days within the year ratably exceptas provided by regulations. I.R.C.S 382(d)(1).

(3) A new loss corporation must separatelyaccount for NOLs acquired from eachold loss corporation in a S 381transaction. Regs. § 1.382-2T(f)(1)(iii).

C. A "post-change year" is any taxable yearending after the change date. I.R.C.S 382(d)(2).

Example. L, a calendar year taxpayer, hasa NOL carryover as of December 31, 1989 of$5,000,000. In 1990, it incurs a NOL of$2,000,000, $1,000,000 of which isallocable to the period from January 1 toJune 30. On June 30, 1990, all of itsstock is purchased by a new shareholder. Lhas a $6,000,000 pre-change loss. Of its$7,000,000 NOL carryforward to 1991, apost-change year, $6,000,000 will besubject to the S 382 limits.

2. Built-in losses.

a. If L has a "net unrealized built-in loss"("NUBIL"), the "recognized built-in loss"("REBIL") for any "recognition periodtaxable year" is limited as if it were apre-change loss. I.R.C. S 382(h)(l)(B).

b. Definition of NUBIL.

(1) a NUBIL is the excess of the aggregateadjusted basis of the assets of theold loss corporation immediatelybefore an ownership change over theirfair market value on that date.I.R.C. § 382(h)(3)(A).

(2) If a redemption is made in connectionwith an ownership change, the amountof the NUBIL is determined aftertaking the redemption into account.

(3) De minimis rule.

(a) A NUBIL that is not greater thanthe lesser of 15% of the value ofthe old loss corporation's assetsimmediately before the ownershipchange or $10,000,000 is ignored.I.R.C. S 382(h)(3)(B)(i). (Forownership changes andacquisitions occurring beforeOctober 3, 1989, the de minimistest was 25% of the value of thecorporation's assets.)

(b) In determining applicability ofthe de minimis rule (but not incalculating the amount of theNUBIL if the de minimis rule doesnot apply), cash, cash items, andany marketable security with avalue that does not differsubstantially from its basis aredisregarded. I.R.C.S 382(h)(3)(B)(ii).

(4) Treasury regulations may treat otheritems that accrue on or before thechange date but that are recognizedafter the change date as NUBILs.I.R.C. S 382(h)(6).

(a) The Conference Report indicatesthat these items may includeitems the deduction of which wasdeferred under I.R.C. § 267 or465 (Page 11-191).

(b) Section 621(d) of the Actrequired the Treasury Departmentto report to the Congress byJanuary 1, 1989 with respect tothe treatment of depreciation,amortization, depletion, "andother built-in deductions" asNUBILs. The Revenue Act of 1987amended S 382(h)(2) to treat

depreciation, amortization, anddepletion attributable to a NUBILas subject to the S 382 rules,without regard to the de minimisrule.

c. Definition of REBIL. I.R.C.5 382(h)(2)(B).

(1) A REBIL is any loss recognized duringthe "recognition period" on thedisposition of any asset, except tothe extent that the new losscorporation establishes that:

(a) The asset was not held by the oldloss corporation immediatelybefore the change date, or

(b) The loss exceeds the excess ofthe adjusted basis of the asseton the change date over its fairmarket value on that date. TheConference Report suggests thatthe exemption applies only to theexcess of the loss over theamount of the depreciation invalue on the change date. (Page11-191-92).

d. A "recognition period taxable year" is anytaxable year any portion of which fallswithin the "recognition period" (the fiveyears beginning on the change date).I.R.C. § 382(h)(7).

3. Excess credits. I.R.C. S 383.

a. The use of unused general business credits(I.R.C. S 39) and minimumtax credits(I.R.C. 5 53) of a corporation undergoingan ownership change shall be limited underregulations to the tax liabilityattributable to so much of the taxableincome as does not exceed the S 382limitations, after the application of § 382and those provisions of S 383 applicable tocapital losses and foreign tax credits.I.R.C. § 383(a).

b. The amount of excess foreign taxes underI.R.C. § 904(c) for any taxable year before

the first post-change year shall be limitedunder regulations for any corporationundergoing an ownership change in a mannerconsistent with § 382. I.R.C. S 383(c).

4. Net capital losses. I.R.C. § 383(b).

a. If an ownership change occurs, the amountof any net capital loss for any taxableyear before the first post-change year thatcan be used in any post-change year shallbe limited by regulations in a mannerconsistent with § 382.

b. The regulations shall provide that any suchcapital loss that is used in a post-changeyear shall reduce the S 382 limitationapplicable to pre-change NOL carryovers forsuch year.

D. Acquisitions subject to § 382.

1. The limits apply to the use of NOL carryovers ina "post-change year." I.R.C. S 382(a).

2. A "post-change year" is a taxable year endingafter the "change date." I.R.C. S 382(d)(2).

3. The "change date" is the date on which an"ownership change" occurs and:

a. If the last component of the ownershipchange is an "owner shift involving a5-percent shareholder," the date on whichsuch shift occurs, or

b. If the last component of the ownershipchange is an equity structure shift, thedate of the reorganization. I.R.C.§ 382(j).

Comment. The meaning of "date of thereorganization" is unclear in a stagedtransaction in which P acquires L's assetsor stock over a period of time.

4. Definition of "ownership change." I.R.C.S 382(g).

a. An ownership change occurs if, as a resultof an "owner shift involving a 5-percentshareholder" ("OSIFPS") or an "equity

structure shift" ("ESS"), the percentage ofstock of the new loss corporation owned byone or more 5-percent shareholders hasincreased by more than 50 percentage points(not by 50%) over the lowest percentage ofstock of the old loss corporation (or anypredecessor corporation) owned by them anytime during the "testing period." I.R.C.S 382(g)(1).

(1) Definition of "testing period."I.R.C. S 382(i).

(a) Generally, the testing period isthe 3-year period ending on theday of the OSIFPS or ESS.

(b) If an ownership change occurs,the testing period fordetermining whether a secondownership change has occurredshall not start before the firstday after the change date for thefirst ownership change.

(c) The testing period shall notbegin before the start of thefirst taxable year from whichthere is a carryforward of a lossor excess credit to the firstpost-change year. (Under thestatute, this will not apply to acorporation that has a NUBIL,except as provided byregulations. The regulationsindicate that the short periodwill apply if the corporation canshow when the NUBIL firstaccrued, in which case thetesting period cannot beginbefore the first day of thetaxable year in which thatoccurred. Regs.9 1.382-2T(d)(3)(ii)).

(d) The testing period is notextended even if someshareholders intend to acquirestock after the testing period.Regs. S 1.382-2T(d)(5)(ii).

(2) A "5-percent shareholder" is anyperson owning at least 5% of thecorporation's stock at any timeduring the testing period. I.R.C.S 382(k)(7).

b. Operating rules: statutory.

(1) In general, all stock owned byshareholders of a corporation who arenot 5-percent shareholders shall betreated as stock owned by one5-percent shareholder. I.R.C.S 382(g)(4)(A). Except as providedby regulations, the less-than-5-percent shareholders of eachcorporation that is a party to areorganization will be treated as aseparate 5-percent shareholder.

(2) Determinations of the percentageownership of stock are based on value.I.R.C. S 382(k)(6)(C). The word"value" means "fair market value."I.R.C. S 382(k)(5).

(3) Changes in percentage ownershipresulting from fluctuations inrelative values of different classesof stock will be disregarded. I.R.C.S 382(l)(3)(C).

(4) Preferred stock described in I.R.C.S 1504(a)(4) shall not be taken intoaccount. I.R.C. S 382(k)(6)(A). Thisincludes stock that:

(a) Is not entitled to vote.

(b) Is limited and preferred as todividends.

(c) Does not participate in corporategrowth to any significant extent.

(d) Has redemption and liquidationrights that do not exceed thepaid in capital or par value thatit represents (except for areasonable redemption premium).

(e) Is not convertible into anotherclass of stock.

(5) The Treasury shall adopt regulationstreating warrants, options, contractsto acquire stock, convertible debt,and similar interests as stock and,under some circumstances, treatingstock as if it were not stock. I.R.C.S 382(k)(6)(B).

(a) The Conference Report indicatesthat voting preferred or commonstock might be disregarded whereits likely percentageparticipation in future growth isdisproportionately small comparedto its percentage of value atissuance. (Page 11-173)

(b) The Conference Report indicatesthat preferred stock described inS 1504(a)(4) should not betreated as stock merely becauseits holders acquire voting rightsbecause dividends are in arrears.(Pages 11-173-74)

(6) Attribution of stock ownership.I.R.C. S 382(l)(3)(A).

(a) The constructive ownership rulesof S 318 shall apply indetermining stock ownership.

(b) Exceptions.

(i) An individual and allmembers of his familywithin the meaning ofS 318(a)(1) shall be treatedas one shareholder.

(ii) Stock owned by acorporation will beattributed proportionatelyto all its shareholders,even those owning less than50% of its stock.

(iii) Stock attributed under theentity attribution rules of

§ 318(a)(2) shall be treatedas no longer owned by theentity, except as providedby regulations.

(iv) The option attributionrules of 9 318(a)(4) shallapply if this results in anownership change, except asprovided in regulations.Similar rules shall apply toany contingent purchase,warrant, convertible debt,put, stock subject to arisk of forfeiture,contract to acquire stock,or similar interest.

(c) Exceptions may be provided byregulations in cases of foreignownership, where information onthe ownership of higher-tierentities may not be available.There is no such exception underpresent regulations. see, e.g.,PLRs 8922080 and 9005029.

(7) Stock transferred by inheritance,gift, to a spouse, or to a formerspouse incident to a divorce istreated as if it is still owned by thetransferor. I.R.C. 9 382(l)(3)(B).

c. Operating rules: regulations.

(1) Definition of stock. Regs.5 1.382-2T(f)(18).

(a) Ordinary preferred stockdescribed in § 1504(a)(4) doesnot become "stock" when itacquires voting rights because ofdividend arrearages.

(b) Disregarding of stock whoseparticipation in growth isdisproportionately small.

(M) Circumstances in which suchstock will be disregarded.

(A) The determination ofwhether the stock'sparticipation would bedisproportionatelysmall is made when thestock is issued ortransferred to or by a5% shareholder ("FPS").

(B) Treating the interestas not stock will notoccur unless it wouldresult in an ownershipchange (i.e., L cannotdisregard stock inorder to avoid anownership change).

(C) In a de minimis rule,stock will not bedisregarded unless thepre-change loss(including NUBILs) ismore than twice theproduct of the value ofL on the testing datetimes the long-term taxexempt bond rate forthat date.

(ii) No guidance is provided asto the meaning of "likelyparticipation . . . infuture corporate growth."

(iii) There is no requirement thatthe three parts of the testmust be applied at the sametime.

(iv) Despite the legislativehistory, this provision willnot prevent the result inMaxwell Hardware Co. v.Commissioner, 343 F.2d 713(9th Cir. 1965) (newshareholders contributedcash for preferred stockcomprising 40% of thecorporation's value keyed tovalue of new division). Theprovision disregards only

the stock that has adisproportionately smallinterest in corporate growthwhen it is issued ortransferred.

(v) It is unclear whether adetermination to disregardstock will be givenretroactive effectthroughout the testingperiod.

(c) Convertible preferred stock thatwould be described in I.R.C.$1504(a)(4) but for theconvertibility feature and itsright to participate in corporategrowth will be treated as an"interest that is similar to anoption" and not as stock. Notice88-67, 1988-1 C.B. 555.

(d) Treating non-stock interests asstock.

(i) Circumstances in whichnon-stock interests will betreated as stock.

(A) At the time of itsissuance or transfer toa FPS, the interestoffers a "potentialsignificant participa-tion" in corporategrowth.

(B) Treating the interestas stock would resultin an ownership change.

(C) The pre-charge loss(including NUBILs) ismore than twice theproduct of the value ofL on the testing datetimes the long-term taxexempt bond rate forthat date.

(ii) Options and otherinstruments that are subjectto the option attributionrule are excluded from thisprovision.

(iii) The rule applies only to"ownership interests."Nevertheless, the preamblestates that it could applyto participating debt.

(iv) It is unclear whether adetermination to treat aninterest as stock will begiven retroactive effectthroughout the testingperiod.

(v) No guidance is provided asto the meaning of "potentialsignificant participation"in corporate growth.

(2) Determination of stock ownership.

(a) General concepts.

(i) The statute literallyrequires a tracing ofownership all the way upthrough a chain of entitiesto the ultimate individualowners, without anyexceptions for owners of deminimis interests. Thiswould create an impossibleburden on compliance andenforcement.

(ii) The regulations generallyallow the ownership of lessthan 5% of an entity to beignored in determining stockownership.

(iii) All persons owning less than5% of L's stock are treatedas a single FPS (the"aggregation rules").

(iv) Under some circumstances,groups of publicshareholders are treated asseparate FPSs (the"1segregation rules").

(b) Rules of administrativeconvenience.

(i) L can generally disregardinterests of people andentities of less than 5% ofits stock. Regs. § 1.382-2T(g)(2).

Example. Individual A owns2% of L's stock.Corporation X owns 8% of L'sstock. A owns 50% of X'sstock. L need not considerA a FPS. It can disregardA's direct ownership becauseit is less than 5% of L'Sstock, and A's ownership ofX's stock makes himindirectly only a 4% ownerof L.

(ii) L cannot disregard ownershipinterests of less than 5%if:

(A) L has actual knowledgeof the ownership by anindividual of aless-than-5% interestin a higher-tierentity. Regs.S 1.382-2T(k)(2). (Itis not clear whoseknowledge will beimputed to L.), or

(B) Interests (direct andindirect) in L arestructured to avoidtreating a person as aFPS. Regs. 5 1.382-2T(k)(4).

(iii) If a person first becomes aFPS on a testing date, L can

treat stock he owned duringthe testing period butbefore he became a FPS asbeing owned by the public.If a FPS's ownership fallsbelow 5%, L can assume thatno further changes in his orher ownership occur. Regs.§ 1.382-2T(g)(5).

(c) Family attribution. Regs.S 1.382-2T(h)(6).

(i) The normal familyattribution rules of§ 318(a)(1) do not apply.

(ii) An individual and allmembers of his or her familyare treated as oneindividual. This does notapply to family members who,without regard to this rule,would not be FPSs. (Thisspares L the need toinvestigate family relation-ships of smallshareholders.)

(iii) If under these rules aperson would be treated as amember of more than onefamily, the family used willbe that which results in thesmallest increase in theholdings of FPSs on thetesting date.

(d) Attribution from entities. Regs.5 1.382-2T(h)(2).

(i) Stock owned by acorporation, partnership,estate, or trust isgenerally attributed to itsowners in accordance withS 318 and is not treated asowned by the entity.

Example. Individual A ownsall of L's stock. Shetransfers it to a new

holding company, HC, inexchange for all of HC'sstock. A is deemed to bethe owner of all of the Lstock owned by HC and isstill treated as L's soleshareholder.

(ii) The 50% stock ownershiplimit that normally appliesto attribution from acorporation to itsshareholders underS 318(a)(2)(C) does notapply.

(iii) The owner of an interest inan entity will not be deemedto own stock owned by theentity to the extent thathis or her interest in theentity consists of:

(A) Preferred stockdescribed in5 1504(a)(4).

(B) An ownership interestthat, althoughnominally stock, istreated as not stockunder the S 382regulations.

(C) Similar interests in anunincorporated entity.

Example. X Corporation owns30% of the stock of L.Individual A owns all of X'sordinary preferred stock(which is described inS 1504(a)(4)), comprising90% of X's value.Individual B owns all of X'scommon stock, comprising 10%of X's value. A is not aFPS of L because hispreferred stock in X isignored. Although theregulations are unclear, Bwould apparently be treated

as the owner of all of X's Lstock and would be a FPS ofL, even though his interestwould only be worth 3% ofL's value.

(iv) The following entities willbe treated as individualsand L stock owned by themwill not be attributed totheir owners:

(A) An entity that ownsless than 5% of L or ofthe next entity downthe chain.

(B) A qualified retirementplan trust under§ 401(a).

(C) A government.

(D) Any other person namedby the I.R.S. in theInternal RevenueBulletin.

(e) Option attribution. Regs.S 1.382-2T(h)(4).

(i) The statute,§ 382(1)(3)(A)(iv), providesthat the option attributionrules of § 318(a)(4) applyif such application wouldresult in an ownershipchange, except to the extentprovided by regulations.

(ii) General rule: for thepurpose of determiningwhether there is anownership change on anytesting date, L stocksubject to an option shallbe deemed to be acquired onthat date pursuant toexercise of the option ifsuch exercise would resultin an ownership change.

(iii) The option rule apparentlyapplies to options to buystock in higher-tierentities. Regs. S 1.382-2T(f)(18)(iv).

(iv) The option attribution ruleapplies separately to:

(A) Each class of options(i.e., identical terms,same issues, issued onsame date) owned byeach FPS.

(B) Each FPS.

Example. A owns 20 sharesof L's stock. B owns theremaining 80 shares. Bgives A an option to buy all80 of his shares, subjectto the requirement that, ifA exercises the option, hemust give B an option to buy40 of his newly acquiredshares back for the sameprice. An ownership changehas occurred. A's optionis deemed to be independentof B's and its presumedexercise is viewedseparately.

(v) Even though the deemed exer-cise of an option on itsissuance does not result inan ownership change, it maybe deemed to be exercised ona later testing date (e.g.,the date of a later sale) soas to result in an ownershipchange. Regs. S 1.382-2T(h)(4)(ii), Example (1).

(vi) Options are deemed to beexercised even if they arecontingent or not currentlyexercisable or if the optionprice exceeds the stock'svalue. Regs. S 1.382-2T(h)(4)(iii).

An exception is made foroptions held by an entity oranother owner of an interestin the entity to buy an in-terest in the entity on theowner's death, completedisability, or mentalincompetency. Regs.5 1.382-2T(h)(4)(x)(D).

(vii) The option rule applies tointerests that are similarto options, includingwarrants, convertible stock,convertible debt, stocksubject to a risk offorfeiture, and a contractto buy or sell stock.

Example. The owners of Lagree to merge L into P,another corporation. Clos-ing of the transaction issubject to the normalcontingencies and is to takeplace 60 days after theagreement is signed. Anownership change occurs whenthe agreement is adopted bythe parties. The date ofadoption may be unclear.See PLRs 8847067 (approvalby both boards of directors,although agreement not yetsigned) and 8903043 (signingof agreement although notyet approved by board ofdirectors).

(viii) Effect of exercise ofoption.

(A) The exercise of anoption in existenceimmediately before orafter an ownershipchange (regardless ofwhether it was treatedas exercised inconnection with thechange) is ignored if

it is exercised by thesame FPS who held it atthe time of the change.Regs. S 1.382-2T(h)(4)(vi)(A).

(B) Except as providedabove, the exercise ofan option shall betreated as a purchaseof stock. Regs.S 1.382-2T(h)(4)(xii).

(C) If an option isexercised within 120days after it is deemedexercised, L may electto treat the sale asoccurring on theexercise date. Thisrule cannot prevent anownership change fromoccurring but can onlydefer the change date.Regs. S 1.382-2T(h)(4)(vi)(B).

(I) The long-termtax-exempt bondrate may havechanged.

(II) The value of L mayhave changed.

(ix) Effect of deemed exercise ofoption on § 382. Regs.§ 1.382-2T(h)(4)(vii).

(A) The deemed exercise ofa right to sell stockto or buy stock from Lshall change the numberof shares deemed to beoutstanding indetermining whether anownership change hasoccurred.

(B) The value of L will notbe affected.

(x) Lapse or forfeiture. Regs,§ 1.382-2T(h)(4)(viii).

(A) If an option that wastreated as having beenexercised lapses or isforfeited, L can treatit as if it neverexisted.

(I) A refund claim canbe filed, subjectto the statute oflimitations.

(II) Consider filingprotective refundclaims if there isa possibility thatan option thatcaused anownership changewill lapse.

(B) The treatment of anoption that is soldback to the corporationis unclear. It shouldbe treated as a lapsedoption.

(xi) De minimis exception. Regs.S 1.382-2T(h)(4)(ix).

(A) The option rule willnot apply on a testingdate if the pre-changeNOL on that date(including NUBILs) isless than twice theproduct of the value ofL on that date timesthe long-term tax-exempt bond rate forthat date.

(B) An option that isdeemed not to beexercised on a changedate because of the deminimis rule may betreated as exercised

on a later testing dateif the conditions forthe de minimisexception are no longermet.

(xii) Options not subject toattribution. Regs. § 1.382-2T(h)(4)(x).

(A) Long-held options onactively-traded stock.

(I) The stock must bepublicly traded.

(II) The option must becontinuously ownedby the same FPSfor at least 3years, but onlyuntil the earlierof (a) thetransfer of theoption by or to aFPS, or (b) theday on which thestock's valueexceeds theoption price.

(B) A right to receive, orobligation to issue,stock pursuant to theterms of a debtinstrument that iseconomically equivalentto nonconvertible debtbecause the right iswith respect to a fixeddollar amount of stockdetermined when thestock is transferred.

(C) A right or obligationof L to redeem stock atthe time the stock isissued, but only to theextent that the stockis issued to personswho are not FPSs

immediately beforeissuance.

(I) The exceptionapparentlycontinues to applyto a person whobecomes a FPSafter redeemablestock is firstissued to him.

(II) The exception is

not limited to theoriginal holdersof the stock. Itapplies to stockheld bypurchasers,including FPSs.

(D) Options under certainshareholders buy-sellagreements.

(I) Options betweenowners of the sameentity or betweenan entity and anowner of theentity that isexercisable onlyupon the owner'sdeath, completedisability, ormental incompe-tency. (Thiswould not apply toan option that isalso exercisablewhen a

shareholderterminatesemployment orotherwise wants tosell his or herstock.)

(II) Options betweennoncorporate

owners of the sameentity or between

a noncorporateowner and theentity, but onlyif each owneractively partici-pates in theentity's trade orbusiness, theoption is issuedwhen thecorporation is nota losscorporation, andthe option isexercisable solelyon the owner's"retirement. "(This would notapply if one ormore shareholderswere passiveinvestors or toagreements signedin the early yearsif the corporationhas start-uplosses.)

(III) These rules arenarrowly drawn andwill not apply tomany common buy-sell agreements.

(E) Right to receive orissue stock in paymentof dividends orinterest.

(F) An option in existenceimmediately before orafter an ownershipchange, whether or notit was treated asexercised inconnection with thechange, as long as itcontinues to be ownedby the same FPS whoowned it immediatelybefore or after thechange.

(G) A right to acquirestock by a bank,insurance company, or aqualified employeeretirement trustsolely as a result of aloan agreement enteredinto in the ordinarycourse of such entity'strade or business.

(I) Finance companiesand investmentbanks do notappear to becovered.

(II) The option doesnot seem requiredto have beenincluded in theoriginal loanagreement.

(III) The reference tothe ordinarycourse of aqualifiedretirement plan'strade or businessis unclear. Mustthe loan havebeen made in con-nection with anunrelated businesswithin themeaning of S 513?

(f) Aggregation of publicshareholders into public groups.Regs 5 1.382-2T(j)(1).

(i) The public shareholders(i.e., all those who are notFPSs) are treated as asingle individual that is.aFPS, even if the group ownsless than 5% of L's stock.

(ii) The members of any publicgroup are presumed not to be

members of any other publicgroup, subject to rebuttal.

(iii) The analysis of publicgroups begins with thehighest tier entity (i.e.,the entity at the top levelof the ownership chain).

(A) Any owner of more thanfive percent of thehighest tier entitywho, through his or herownership of entitiesdown the chain would beconsidered a FPS of L,is treated as aseparate FPS.

(B) Any other owner of thehighest tier entity isa member of the publicgroup of that entity.

(I) If that publicgroup, tracingownership down thechain, owns morethan 5% of L'sstock, it istreated as aseparate FPS.

(II) If that publicgroup does notqualify as aseparate FPS, itis treated as amember of thepublic group ofthe next lowertier entity.

(C) This process isrepeated down the chainuntil every publicshareholder is a memberof an entity publicgroup that is a FPS oris a member of L'spublic group.

(g) Segregation of public groups.Regs. 9 1.382-2T(j)(2).

(i) The segregation rulesgenerally apply to tax-freereorganizations andissuances of L stock by L.

(ii) In general, each publicgroup that existedimmediately before thetransaction is treated as aseparate group from eachpublic group that acquires Lstock in the transaction(even though all members ofeach group could be said tocomprise one single publicgroup).

Example. L is owned by thepublic. P merges into L ina reorganization underS 368(a)(1)(A). After thetransaction, the old Pshareholders own 60% of L.The old P shareholders aretreated as a separate FPSwhose ownership of L hasincreased from 0% to 60%.

Example. L is ownedentirely by the public. Lsells stock to the publicand the stock so soldcomprises 60% of L'soutstanding stock. Thepublic shareholders whobought L stock in theoffering are treated as aseparate public group and anew FPS whose ownership of Lhas increased from 0% to60%.

(iii) It is presumed that eachsegregated public group hasno common shareholders witheach other public group.This presumption can berebutted. People in bothgroups may themselves be

treated as a separate groupif the overlappingmembership can be proved.

Example. P and L are eachowned by 50 equalshareholders. 35 of thoseshareholders own 2% of eachcorporation. P merges intoL and, after thetransaction, the old Pshareholders own 60% of L'sstock. The group of commonshareholders, who formerlyowned 70% of L's stock, nowstill own 70% of L. Theother P shareholders haveonly increased theirownership of L stock from 0%to 18%.

(iv) Other transactions to whichsimilar segregationprinciples apply.

(A) Redemptions

(B) Options (e.g., a publicissuance of convertibledebentures).

(C) Transactions involvinghigher tier entities.

(D) Other transactions thatare identified in theInternal RevenueBulletin.

(v) L may combine separatepublic groups each of whichowns less than 5% of itsstock into a single publicgroup.

(vi) The acquisition of L stockby a FPS of L from membersof different public groupsis presumed to beproportionately from eachpublic group unless adifferent proportion is

established by L or by theI.R.S.

(vii) The segregation rules do notcreate separate publicgroups of holders of optionsunless the options wereissued after September 3,1987. Rev. Rul. 90-15.I.R.B. 1990-7, 17.

(h) Presumptions regarding stockownership. Regs. S 1.382-2T(k)(1).

(i) L can rely on the existenceor absence of 13D and 13Gforms filed with the S.E.C.

(ii) L can rely on a statementsigned under penalties ofperjury by an officer orresponsible person withrespect to a higher tierentity relating to thatentity's owners unless itknows that the statement isfalse or unless the entityowns 50% or more of L'sstock.

5. Definition of "owner shift involving a 5-percentshareholder" ("OSIFPS"). I.R.C. S 382(g)(2).

a. An OSIFPS is any change in the stockownership of L that affects the percentageof stock of the corporation owned by aperson who is a FPS before or after thechange.

b. The Conference Report (Pages 11-174-76)indicates that the following transactionsare included in those that will be treatedas OSIFPSs.

(1) A taxable purchase of any amount ofL stock by a person who is a FPSbefore the purchase.

(2) A disposition of L stock by a personwho is a FPS before or after thedisposition.

(3) A taxable purchase of L stock by aperson who first becomes a FPS byreason of the purchase.

(4) A 5 351 exchange that affects thepercentage ownership in L of a FPS(even if the FPS is not a party tothe exchange, if the stock issued toother shareholders reduces hisproportionate interest).

(5) A decrease in L's outstanding stockresulting from a redemption of thestock of a FPS or of anothershareholder.

(6) A conversion of debt or excludedpreferred stock (under 9 1504(a)(4))into stock, regardless of whether theholder is a FPS.

(7) An issuance of stock by L, regardlessof whether the holder is a FPS.

Example. A owns 300 of the 1000 shares ofL. L issues one share to x for cash. Theissuance of the share to X is an OSIFPSbecause it reduces A's ownership from 30%to 29.97%.

c. Illustrations of transactions in which anOSIFPS can result in an ownership change.Conference Report pages 11-174-76.

Example. Trading of shares of a publicly-held corporation with no FPSs will not bean OSIFPS.

Example. L is publicly-held with no FPSs.A, an individual who previously owned noL stock, buys all of L's stock. A is now aFPS and, since he has increased hisownership from 0% to 100%, an ownershipchange has occurred.

Example. On January 1, 1990, Individual Iowns all 1000 shares of L's stock.

(1) On June 15, 1990, I sells 300 of hisshares to unrelated individual A.This is an OSIFPS and both I and A are

FPSS, but it is not an ownershipchange because A's interest has notincreased by 50 percentage points.

(2) On June 15, 1991, L issues 100 newshares to each of B, C, and D. Thisis an OSIFPS because all parties areFPSs and their relative interests areaffected. It is not an ownershipchange, however, because the interestsof the FPSs that have increased (A, B,C, and D) have increased to only 46%(600/1300), which is less than 50%.

(3) On December 15, 1991, L redeems 200 ofthe shares owned by I. This is anOSIFPS because it affects theinterests of everyone and they are allFPSs. It results in an ownershipchange because it increases theinterests of A, B, C, and D to 54.6%.It does not matter whether the threetransactions were accomplishedpursuant to an integrated plan.

Example. All of L's stock is owned by A.There is a public offering of L's stock asa result of which public shareholders, noneof whom is an FPS, acquire 80% of L's stockfrom the corporation. A acquires no newstock and does not sell any of her oldstock. All of the public shareholders aretreated as a single FPS. Their combinedownership has increased by more than 50percentage points (from 0% to 80%). Thetransaction is an OSIFPS and results in anownership change.

Example. L's stock is owned by A (60%) andB (40%). LS is a wholly owned subsidiaryof L. L distributes all of the LS stock toA in exchange for A's stock in L in a § 355transaction.

(1) There has been an OSIFPS of L. A§ 355 transaction can be an OSIFPS.The OSIFPS results in an ownershipchange because B's interest hasincreased by more than 50 percentagepoints (from 40% to 100%).

(2) There has been an OSIFPS of LS, butthere has not been an ownershipchange. A was deemed to own LS'sstock before (by attribution) and hisinterest has not increased by morethan 50 percentage points (it has gonefrom 60% to 100%).

6. Definition of "equity structure shift" ("ESS").I.R.C. 5 382(g)(3).

a. An ESS includes any reorganization underI.R.C. S 368 except divisivereorganizations (certain transactions underS 368(a)(1)(D)), bankruptcy reorganizations(S 368(a)(1)(G)), and reorganizationsinvolving a mere change in form(5 368(a)(1)(F)). I.R.C. § 382(g)(3)(A).An ESS need not involve any FPS.

b. Treasury regulations may expand thedefinition to include "reorganization typetransactions, public offerings, and similartransactions." I.R.C. S 382(g)(3)(B).

(1) The Conference Report (Page 11-176)indicates that a purpose of the OSIFPSdefinition was to relieve publicly-held corporations from the need totrace the holdings of minorityshareholders. The conferees felt thatthere would be cases in which changesinvolving such shareholders wouldoccur in a single integratedtransaction, in which caseidentification of changes would be"reasonably feasible." Thesetransactions will be treated as ESSsunder regulations.

(2) Transactions that may be treated asESSs under the regulations include:

(a) Public offerings.

(b) Cash mergers that do not qualifyas tax-free reorganizations.

(3) The Conference Report indicates (Page11-178) that the regulations will beeffective prospectively only.

C. In determining whether an ESS results in anownership change, the non-FPSs of eachcorporation are treated as a separate FPS.I.R.C. S 382(g)(4)(B)(i).

d. Illustrations of transactions in which anESS can result in an ownership change.Conference Report pages 11-177-78.

Example. L merges into P in a tax-freereorganization under S 368(a)(1)(A).Neither corporation has any FPSs. Lshareholders receive 30% of P's stock.

(1) The transaction is an ESS because itis a tax-free reorganization.

(2) For purposes of determining whether anownership change has occurred, thenon-FPS P shareholders are treated asa separate FPS from the non-FPS formerL shareholders.

(3) The old P shareholders now own 70% ofP. This is more than 50 percentagepoints more than their ownership of Lstock (0%) before the merger.Therefore, an ownership change hasoccurred.

Comment. The example assumes that the oldP shareholders owned no L stock before themerger. If both corporations werepublicly-held, this may be a questionableassumption. This could be critical if theold P shareholders end up owning only50.001% of P after the merger.

Example. L is publicly-held and has noFPSs. 60% of its stock is exchanged fornonvoting preferred stock. There is anESS but not an OSIFPS, because all thepublic shareholders are treated as a singleFPS who owns 100% of the L stock before andafter the transaction. Regulations willprovide, however, that the shareholders whokeep their common stock will be treated asa separate FPS and, since their ownershipincreases from 40% to 100%, an ownershipchange will be deemed to have occurred.

7. Illustrations of multiple transactions involvingboth OSIFPSs and ESSs. Conference Report pages11-178-80.

a. An ownership change can result from aseries of transactions each of which is anOSIFPS or an ESS and none of which, takenby itself, results in an ownership change.

b. The change date is based on the lastcomponent of the ownership change. I.R.C.9 382(j).

Example. L is publicly-owned with no FPS.On January 1, 1990, A buys 40% of L'sstock. On July 1, 1990, L merges into Pand the L shareholders receive 60% of P'sstock (A receiving 24%).

(1) A's purchase of L stock is an OSIFPSbut not an ownership change becausehis interest increases by only 40percentage points.

(2) The merger is an ESS and results in anownership change because the combinedinterests of A (24%) and the old Pshareholders (40%) in P after themerger exceed their interests in Lbefore the transactions (0%) by morethan 50 percentage points. [Theexplanation of this example (11) inthe Conference Report speaks in termsof A's increase and may be incorrectin analysis if not in result.]

Example. L and G corporations arepublicly-held with no FPSs. On January 1,1990, G merges into L in a tax-freereorganization and the G shareholdersreceive 49% of L's stock. On July 1, 1990,A, an individual who previously owned no Lstock, buys 5% of L's stock on a publicstock exchange.

(1) The merger is not an ownership changebecause the old G shareholders, whoare treated as a single FPS, haveincreased their ownership of L stockby less than 50 percentage points.

(2) The purchase of L stock by A is anOSIFPS because A ends up with 5% ofL's stock.

(3) A's purchase is treated as having beenmade proportionately from the old Gshareholders (2.45%) and the old Lshareholders (2.55%). I.R.C.S 382(g)(4)(B)(ii).

(4) A's purchase results in an ownershipchange because the L stock owned byhim (5%) and the old G shareholders(49% - 2.45% = 46.55%) is 51.55%,which exceeds their prior holdings(0%) by more than 50 percentagepoints.

E. Calculation of the S 382 limitation.

1. General pattern.

a. The "S 382 limitation" is the amount of thenew loss corporation's taxable income inany post-change year that can be reduced bypre-change losses. I.R.C. S 382(a).

b. The basic S 382 limitation is the "value ofthe old loss corporation" multiplied by the"long-term tax-exempt rate." I.R.C.S 382(b)(1).

c. The basic S 382 limitation is increased by:

(1) Recognized built-in gains. I.R.C.S 382(h)(1)(A). Although ordinarilythis includes only gains recognized inthe 5-year recognition periodbeginning on the change date,regulations will provide that itincludes gains recognized afterwardpursuant to installment sales madeduring the recognition period. Notice90-27, I.R.B. 1990-15, 21.

(2) Gains resulting from a § 338 election.I.R.C. § 382(h)(1)(C).

d. The basic S 382 limitation is reduced:

(1) To 0 (plus the amount of recognizedbuilt-in gains, § 338 gains, andcarryforwards of unused S 382limitation amounts) if the new losscorporation does not continue the oldloss corporation's business enterprisefor at least 2 years after the changedate.

(2) Under regulations, the 9 382 limita-tion will be reduced by net capitallosses for years preceding the firstpost-change year that are used in anypost-change year. I.R.C. S 383(b).

2. Determination of the "value of the old loss cor-poration."

a. Generally, the value of the old losscorporation is the value of its stock im-mediately before the ownership change.I.R.C. § 382(e)(1).

Note. The Conference Report indicates thatarm's-length sale prices are evidence ofvalue but are not necessarily controlling.An example is given of sales over a periodof time at varying prices affected by thedegree of control. (Page 11-187)

b. All stock is included, includingnonparticipating preferred stock describedin § 1504(a)(4) that is not taken intoaccount in determining whether there hasbeen an ownership change.

c. "Value" means "fair market value." I.R.C.5 382(k)(5).

d. The value is reduced under the followingcircumstances:

(1) If a stock redemption occurs "inconnection with an ownership change,"the reduction in value resulting fromthe redemption is taken into account.I.R.C. § 382(e)(2).

Comment. The words "in connectionwith" suggest that the redemption must

be functionally related to the owner-ship change and not merely a transac-tion that occurs at around the sametime.

(2) A capital contribution received by theold loss corporation as part of a plan"a" principal purpose of which is toavoid or increase any limit underS 382 will be disregarded. I.R.C.S 382(1)(I)(A).

(a) A capital contribution madewithin 2 years before the changedate will be conclusively pre-sumed to be part of such a plan,except as provided inregulations. I.R.C.5 382(I)(1)(B).

(i) The Conference Report (Page11-189) indicates that theregulations should except:

(A) Capital contributionsreceived on theformation of thecorporation.

(B) Capital contributionsmade before the NOL orother carryforward itemarose.

(C) Capital contributionsto continue currentoperations (e.g., tomeet payroll costs).

(ii) Under the statute, the 2-year presumption isconclusive unless theregulations provide other-wise. The I.R.S. may pro-vide a general exception inthe regulations if the tax-payer can show the absenceof a tax avoidance motive,but it is not required to doSO.

(b) The Conference Report indicates(Page 11-189) that theregulations may considerdistributions to shareholders asoffsets to capitalcontributions.

(c) The treatment of capitalcontributions of property thatchanges in value between thechange date and the contributiondate is unclear.

(3) The value is reduced if immediatelyafter an ownership change the new losscorporation has "substantialnonbusiness assets." I.R.C.S 382(l)(4).

(a) The amount of the reduction isthe excess of the fair marketvalue of the nonbusiness assetsof the old loss corporation overthose assets' share ofindebtedness for which thecorporation is liable. I.R.C.S 382(l)(4)(A).

(i) The share of indebtednessallocated to nonbusinessassets is based on theirrelative fair market values.I.R.C. § 382(l)(4)(D).

(ii) Since only indebtedness forwhich the "corporation isliable" is considered, thestatus of nonrecourse debtis unclear.

(b) Nonbusiness assets means assetsheld for investment. I.R.C.S 382(l)(4)(C).

(i) Assets held to meetstatutory or regulatoryreserve requirements are notdeemed to be held forinvestment. ConferenceReport, page 11-190.

(ii) It is likely that reasonablecontingency reserves andminority interests insuppliers held for businesspurposes will be treated asbusiness assets.

(iii) Stock and securities of asubsidiary corporation ofwhich the corporation ownsat least 50% of the votingpower and value will be'disregarded and the parentwill be treated as owningits ratable share of thesubsidiary's assets.I.R.C. § 382(I)(4)(E). Nosimilar rule is provided forpartnership interests.

(c) Nonbusiness assets are "substan-tial" if at least 1/3 of thevalue of the corporation's assetsare nonbusiness assets. I.R.C.S 382(l)(4)(B)(i).

Comment. The statutory languagesuggests that this test isapplied by reference to grossassets without regard toliabilities.

(d) Regulated investment companies,real estate investment trusts,and real estate mortgage poolsare exempt by statute from thenonbusiness asset rule. I.R.C.5 382(l)(4)(B)(ii).

3. Determination of the "long-term tax-exemptrate."

a. The rate is the highest of the federallong-term rates under I.R.C. S 1274(d) forany month in the 3-calendar-month periodending with the calendar month in which thechange date occurs, adjusted to reflect therate differential between taxable and tax-exempt obligations. I.R.C. S 382(f).

b. The Treasury Department publishes the long-term tax-exempt rate monthly.

4. Increases in the basic § 382 limitation.

a. Recognized built-in gains ("REBIGs").

(1) General rule: if the old loss corpo-ration has a "net unrealized built-ingain" ("NUBIG"), the basic § 382limitation will be increased by theamount of recognized built-in gains("REBIGs") during any "recognitionyear." I.R.C. § 382(h)(1)(A)(i). Theincrease cannot exceed the amount ofthe NUBIG reduced by REBIGs in priorrecognition years. I.R.C.§ 382(h)(1)(A)(ii).

(2) Definition of NUBIG.

(a) A NUBIG is the excess of theaggregate value of the loss cor-poration's assets immediatelybefore the ownership change overtheir aggregate adjusted bases.I.R.C. § 382(h)(3)(A)(i).

(b) If a redemption occurs "inconnection with an ownershipchange," the determination of theexistence of a NUBIG will be madeafter taking the redemption intoaccount. I.R.C.S 382(h)(3)(A)(ii).

(c) De minimis rule.

(i) There will be no NUBIGunless the appreciation isat least the lesser of 15%of the fair market value ofthe corporation's assets or$10,000,000. I.R.C.§ 382(h)(3)(B)(i). (Forownership changes andacquisitions occurringbefore October 3, 1989, thede minimis test was 25% ofthe value of thecorporation's assets.)

(ii) In applying the de minimisrule, cash, cash items, and

any marketable security thathas a value that does notsubstantially differ fromits adjusted basis will bedisregarded. I.R.C.§ 382(h)(3)(B)(ii).

(3) Definition of REBIG.

(a) A REBIG is any gain recognizedduring a "recognition periodtaxable year" if the new losscorporation shows that:

(i) The asset was held by theold loss corporationimmediately before thechange date, and

(ii) The gain does not exceed theexcess of the asset's valueon the change date over itsadjusted basis on that date.I.R.C. 5 382(h)(2)(A).

Comment. The statute literally.indicates that there is no REBIGif the gain recognized on thesale exceeds the appreciation invalue of the asset on the changedate. It should be interpretedto exclude from REBIG treatmentonly the excess of recognizedgain-over the amount of suchappreciation.

(iii) The Treasury Department willadopt regulations governingthe treatment of assetstransferred in wholly orpartly tax-freetransactions. I.R.C.9 382(h)(9). Theseregulations will presumablytreat assets acquired insuch transactions inexchange for assets held onthe change date as if theyhad been held on the changedate.

(iv) A "recognition periodtaxable year" is a taxableyear any portion of whichfalls within the five yearsstarting on the change date.I.R.C. S 382(h)(7).

b. Section 338 gains.

(1) The basic § 382 limitation in anytaxable year is increased by theamount of the excess of any "gain"recognized by reason of an electionunder I.R.C. S 338 over the amount ofsuch gain taken into account incomputing REBIGs for that year.I.R.C. § 382(h)(l)(C).

(2) Not all of the income recognizedbecause of a § 338 election is "gain."Recoveries of bad debt reserves andpreviously deducted expenses areincluded in income under thesecircumstances. Neither the statutenor the Conference Report indicateshow such income should be treated.

5. Reductions in the basic § 382 limitation.

a. Continuity of business enterprise.

(1) The basic § 382 limitation is reducedto 0 (but not less than REBIGs, S 338gains, and unused § 382 limitationamounts carried forward under§ 382(b)(2)) if the new losscorporation does not continue thebusiness enterprise of the old losscorporation at all times during the2-year period beginning on the changedate.

(2) The Conference Report indicates (Page11-189) that this rule is the same asthe continuity of business enterpriserule applicable to corporatereorganizations under I.R.C. S 368.

(a) The regulations require that theacquiring corporation in areorganization continue thetarget's historic business or use

a significant portion of thetarget's historic business assetsin a business. Regs.§ 1.368-1(d). See, generally,Faber, "Continuity of Interestand Business Enterprise: Is itTime to Bury Some Sacred Cows?"34 Tax Lawyer 239 (1981).

(b) The continuation of one of threeequal businesses satisfies theS 368 requirement and willapparently satisfy the 5 382requirement as well. ConferenceReport, Page 11-189.

(c) The Conference Report makes clear(Page 11-189) that changes in thelocation of a loss corporationbusiness or of its key employeeswill not result in a failure tosatisfy the business continuitytest even though they might havecaused a failure to satisfy thebusiness continuity requirementof old S 382(a).

(d) The application of the steptransaction doctrine is unclear.A sale of a business more than2 years after a reorganizationcould disqualify thereorganization under § 368 if ithad been planned at the outset.Will it be protected under § 382by the 2-year rule?

Comment. The business continuitytest introduces an unfortunateelement of uncertainty into thelaw.

b. Net capital losses. I.R.C. S 383(b).

(1) If an ownership change occurs, theamount of any net capital loss for anytaxable year before the firstpost-change year that can be used inany post-change year will be limitedby regulations based on the principlesof S 382.

(2) Any such net capital loss that is usedin a post-change year shall reduce the§ 382 limitation that is applied toany pre-change losses for such year.

F. Application of the S 382 limitation.

1. The taxable income of the new loss corporationfor any post-change year that can be offset bypre-change losses cannot exceed the § 382limitation for such year. I.R.C. S 382(a).

2. For the post-change year that includes thechange date:

a. The 9 382 limitation does not apply to thetaxable income for the year allocable tothat part of the year on or before thechange date. I.R.C. § 382(b)(3)(A).

(1) Taxable income is allocated to days inthe year on a ratable basis, except asshall be provided in regulations.

(2) Taxable income shall be computed forthis purpose by disregarding REBIGSand S 338 gains. I.R.C. S 382(h)(5).

b. In applying the § 382 limitation to thatpart of the taxable year after the changedate, the limitation shall be a fraction ofthe limitation computed in the normal way,the numerator of which is the number ofdays in the year after the change date andthe denominator of which is the number ofdays in the year. I.R.C. § 382(b)(3)(B).

c. The regulations will allow L to elect toallocate income based on a closing of thebooks on the change date. Income realizedafter the change date may be allowed to beallocated to the period before the changedate in "appropriate circumstances" (e.g.,discharge of indebtedness income that is"integrally related" to a transactionresulting in an ownership change). Notice87-79, 1987-2 C.B. 387.

(1) Until regulations are adoptedreflecting Notice 87-79, taxpayersmust get a private letter ruling touse the closing-of-the-books method.

See, e.g., PLRS 9005049, 9006065, and9034052.

(2) The Service has ruled that, if L hastaxable income for the taxable yearincluding the change date, the amountallocated to the pre-change periodwill be the lesser of the taxableincome for the pre-change period andthe taxable income for the taxableyear. Thus, pre-change taxableincome must be reduced by post-changelosses. PLRs 9017020 and 9030023.

3. If the S 382 limitation for a taxable yearexceeds the new loss corporation's taxableincome for the year that is offset by pre-changelosses, the excess is carried forward andincreases the S 382 limitation for the nextyear. I.R.C. S 382(b)(2).

4. ordering rules.

a. NOL carryovers in excess of the 5 382limitation for any taxable year are carriedforward to the next year in full, eventhough the taxable income of the yearexceeds the § 382 limitation. I.R.C.S 382(l)(2)(A).

b. If in any year a corporation has incomethat can be offset by both a pre-changeloss (i.e., one the use of which is subjectto § 382) and an NOL that is not subject toS 382, the income will be deemed to beoffset first by the NOL subject to the5 382 limitation. This rule reduces theeffect of the limitation. I.R.C.S 382(1)(2)(B).

G. Effect of the Tax Reform Act of 1986 on otherlimitations on the use of NOL carryovers.

1. The statute does not refer to S 269 and the SRLYand CRCO rules. The Conference Report (Page II-194) confirms that these rules remain in effect.The Libson Shops doctrine will not apply.

Comment. The S 382 limits should effectivelyremove the incentives for buyers to attempt tobuy NOL carryovers and it should have beenpossible to repeal these other limitations.

2. The statute gives the Treasury Departmentregulatory authority to prevent the avoidance ofSS 382 and 383 by multiple transactions,taxable year changes, and the use of relatedpersons, pass-through entities, and otherintermediaries. I.R.C. § 382(m).

a. The Conference Report indicates (Pages II-194-95) that the regulations should addressthe use of so-called tax-loss partnershipsto make special allocations of losses of apartnership to partners with taxableincome.

b. The Conference Report states (Page 11-195)that the application of these regulationsto partnerships should be effective as ofthe date of enactment of the Act(October 22, 1986).

H. Bankruptcy situations.

1. The S 382 limits do not apply to a corporationif:

a. Immediately before the ownership change theold loss corporation is under courtjurisdiction in a Title 11 or similar case(i.e., a receivership, foreclosure, orsimilar proceeding in a federal or statecourt), and

b. The shareholders and creditors of the oldloss corporation determined immediatelybefore the ownership change own immediatelyafter the change stock of the new losscorporation (or of a controllingcorporation if that corporation is inbankruptcy) equal to at least 50% of thevoting power and 50% of the value. I.R.C.S 382(I)(5)(A).

(1) The stock ownership requirement iseffected by a cross reference toI.R.C. S 1504(a)(2). It is not clearwhether stock described in5 1504(a)(4) is excluded. A literalreading of § 382(k)(6)(A) wouldindicate that it is because thatprovision excludes § 1504(a)(4) stock

from the term "stock" "[flor purposesof this section."

(2) Stock transferred to a creditor insatisfaction of indebtedness istreated as owned by the creditor forthis purpose only if the indebtedness:

(a) Was owned by the creditor atleast 18 months before the filingof the Title 11 or similar case,or

(b) Is held by the person who at alltimes held the beneficialinterest in the indebtedness andarose in the ordinary course ofthe old loss corporation's tradeor business. I.R.C.S 382(l)(5)(E).

(3) In applying these rules, options willbe deemed to have been exercised ifthis would cause a failure to meet theS 382(l)(5) requirements. Prop.Regs. S 1.382-3(c) (applicable toownership changes occurring afterSeptember 4, 1990).

2. Special rules if 5 382(a) does not apply becauseof the exception in S 382(l)(5)(A).

a. The NOL deduction under 5 172(a) for anypost-change year is determined as if nodeduction was allowable for interest ondebt converted into stock pursuant to thecourt proceeding during any taxable yearending within 3 years preceding the taxableyear in-which the ownership change occursand that part of the year of the change onor before the change date. I.R.C.5 382(l)(5)(B).

b. The pre-change losses and excess creditsthat may be carried to a post-change yearare reduced by 50% of the amount that wouldhave been included in gross income but forthe application of the Title 11 andinsolvency exception of I.R.C.S 108(e)(10)(B) to the normal rule thatcancellation of indebtedness income resultsfrom the satisfaction of debt with stock

with a value less than the debt's faceamount. I.R.C. S 382(1)(5)(C).

c. If a second ownership change occurs within2 years after the first ownership change,the Title 11 exception will not apply tothe second change and, in applying 9 382 tothat change, the § 382 limitation shall be0. Thus, pre-change losses will no longerbe available. I.R.C. 9 382(I)(5)(D).

d. Proposed regulations indicate that § 269may present major problems in bankruptcyreorganizations.

(1) The continuity of business requirementof § 382(c) does not apply toS 382(l)(5) transactions. Prop.Regs. S 1.382-3(b).

(2) An acquisition of control or propertyin a S 382(l)(5) transaction willnormally be considered to be made forthe principal purpose of tax avoidanceunless the corporation "carries onmore than an insignificant amount ofan active trade or business" duringand after the Title 11 or similarcase. Prop. Regs. §'1.269-3(d).

(3) An acquisition of control of thecorporation will be deemed to occurfor purposes of § 269 no earlier thanthe date on which the bankruptcy courtconfirms the reorganization. Prop.Regs. § 1.269-5(b).

(4) A finding by a bankruptcy court thatthe principal purpose of the plan wasnot the avoidance of taxes forpurposes of § 1129(d) of theBankruptcy Code is not controlling forpurposes of § 269 (the burden of proofis on the government under S 1129(d)and on the taxpayer under S 269).Prop. Regs. § 1.269-3(e).

3. Special rules for thrift institutions. I.R.C.S 382(l)(5)(F).

a. In determining the application of thegeneral Title 11 exception, the

shareholders and creditors of the old losscorporation need only end up owning 20% ofthe corporation's voting power and value.

b. Treatment of deposits.

(1) A depositor in the old losscorporation is treated as astockholder.

(2) Deposits that after the ownershipchange became deposits in the new losscorporation are treated as stock ofthe new loss corporation.

(3) Such deposits are included in thevalue of the new loss corporation.

c. Transactions subject to the special rulesfor thrift institutions.

(1) An equity structure shift that is areorganization described in I.R.C.5 368(a)(3)(D)(ii). This includes:

(a) A reorganization under§ 368(a)(1)(G) involving a mutualsavings bank or otherorganization described in I.R.C.S 593, if

(b) The federal or state agencyhaving jurisdiction over theproceeding certifies as to thecorporation's financialdifficulties.

(2) Any other ESS or S 351 exchange thatis an integral part of aS 368(a)(3)(D)(ii) transaction.

d. The special rules for thrift institutionswill not apply to ESSs or transactionsoccurring after December 31, 1988.

4. General rules relating to the Title 11exception.

a. A new loss corporation may elect to besubject to the general § 382(a) rulesrather than the Title 11 rules. I.R.C.9 382(l)(5)(H). Corporations often make

this election because of the reductions ofNOLs resulting from the special rulesdescribed above.

b. If the Title 11 rules do not apply to areorganization under S 368(a)(1)(G) or to adebt-stock exchange in a Title 11 orsimilar case, the value of the old losscorporation in applying the regular § 382rules will be the value of the new losscorporation immediately after the ownershipchange (i.e., taking conversions of debtinto stock into account ). I.R.C.9 382(l)(6).

c. The special rules do not apply to debt-stock exchanges in informal workouts, butthe Treasury Department was instructed tosubmit a report to Congress on informalworkouts before January 1, 1988. TaxReform Act S 621(d)(2).

V. Use of preacquisition losses to shelter built-in gains.

I.R.C. S 384.

A. Introduction.

1. Section 382 limits the use of L's NOLs if thereis a change in L's shareholders, but it does notaffect L's use of its NOLS under othercircumstances.

2. Section 384 prevents the use of L's NOLs against

built-in gains of a corporation that L acquires.

B. Transactions subject to § 384.

1. Stock acquisitions.

a. General rule.

(1) If a corporation acquires "control" ofanother corporation and eithercorporation ("G") has built-in gains(defined as NUBIGs, including the deminimis rule)

(2) Then, the income of G during anyrecognition period taxable year(defined as under § 382 but byreference to the acquisition date) tothe extent attributable to a REBIG

shall not be offset by any pre-acqui-sition loss of any corporation otherthan G.

Note: The rule applies regardless ofwhich corporation is the acquiror.

Note: L's NOL cannot be used at allagainst G's NUBIG. Its use is notmerely limited by the S 382 rules.

b. "Control" generally means at least 80% ofthe voting power and value of thecorporation.

2. Asset acquisitions.

a. General rule.

(1) If the assets of a corporation areacquired by another corporation in atax-free reorganization under§S 368(a)(1)(A), (C), or (D), andeither corporation has built-in gains(defined in the same manner as forstock acquisitions) ("G")

(2) Then, the income of G during anyrecognition period taxable year to theextent attributable to a REBIG shallnot be offset by the pre-acquisitionloss of any corporation other than G.

C. Exception for common control situations. I.R.C.S 384(b).

1. General rule. Section 384 does not apply if Land G were members of the same controlled groupof corporations (defined in terms of § 1563(a)but using a 50% test) throughout the 5-yearperiod ending on the acquisition date.

D. Income subject to § 384. I.R.C. § 384(c)(1).

1. Gain on any asset disposed of that is recognizedduring the recognition period except to theextent that G can show that it was not owned byG on the acquisition date or that the gainexceeds the excess of the property's value overits basis on that date. Regulations willprovide that S 384 will apply to gainsrecognized after the recognition period pursuant

to installment sales made during the recognitionperiod. Notice 90-27, I.R.B. 1990-15, 21.

Comment. An inventory and appraisal of propertyshould be made on the acquisition date.

2. Other items of income that are taken intoaccount for a recognition year but that areattributable to periods before the acquisitiondate are considered in determining the amount ofthe NUBIG.

E. Acquisition date. I.R.C. S 384(c)(2).

1. Stock transfer: the date on which control wasacquired.

2. Asset transfer: the date of the transfer.

F. Pre-acquisition losses. I.R.C. 9 384(c)(3).

1. Pre-acquisition losses include:

a. Any NOL carried forward to the taxable yearin which the acquisition date occurs.

b. Any NOL for the taxable year in which theacquisition date occurs. The loss isallocated ratably to each day in the yearexcept to the extent provided inregulations.

2. REBILs are treated as pre-acquisition losses.

G. Similar rules will apply to excess credits (asdefined in S 383(a)(2)) and net capital losses.I.R:C. S 384(d).