Sec. 382 Final Regs. for Small Shareholders

By Greg A. Fairbanks, J.D., LL.M., Washington, D.C.

Corporations & Shareholders

On Oct. 22, Treasury issued final regulations under Sec. 382 (T.D. 9638) that should help streamline and facilitate analysis of Sec. 382 issues. The final regulations are largely unchanged from the rules proposed in November 2011 (REG-149625-10) with two notable exceptions discussed below. This author previously discussed the proposed regulations in the February 2012 Tax Clinic (see “Proposed Sec. 382 Regs. Simplify Small Shareholder Treatment,” 43 The Tax Adviser 80 (February 2012)). This item provides a brief background on the regulations and then discusses the two substantive changes and some planning opportunities.

Sec. 382 states that if there is an “ownership change,” net operating losses (NOLs), and certain other tax attributes, are subject to an annual limitation. The statute and regulations are designed to curb “loss trafficking,” in which a buyer and target might otherwise engage in a merger, acquisition, or other transaction with the purpose of using an NOL, but without a business-related motive. The rules are designed to preserve the “neutrality principle,” which is the idea that NOLs should not be any more or less valuable in the hands of a corporation’s new owners than they were in the hands of the old owners and that tax considerations such as pursuing NOLs should not otherwise interfere with business decisions. The statute and Treasury regulations provide a complex set of rules to effectuate long-standing congressional intent to preserve the neutrality principle and stymie loss trafficking.

The final regulations modify several of these rules to provide easier administration and to avoid unfair results, reflecting a shift away from a more rules-based approach to a “purposive” approach (see Notice 2010-49). The three main provisions in the final regulations are (1) a secondary-transfer exception that helps mitigate unintentional ownership changes that may arise in the ordinary course of stock trading; (2) a small-redemption exception that provides relief from small redemptions of stock during a tax year; and (3) modified rules on first-tier (and higher-tier) entities that ease the rules’ administrability by disregarding certain events that may take place at the first-tier (or above) level. The two main changes in the final rules are to the modified rules on first-tier entities and the effective date provision.

The final regulations provide that segregation events are generally ignored for first-tier entities that own 10% or less of the loss corporation’s stock. Thus, under the old rules (pre-proposed regulations), if Fund X owned 8% of LossCo, there was an affirmative duty to “look through” Fund X and potentially track indirect issuances, redemptions, and other transactions involving Fund X interests. The proposed regulations proposed a rule to “turn off” the segregation rules for entities owning 10% or less of the loss corporation’s stock, but requiring the taxpayer corporation to know that the entity’s investment in the corporation was less than 25% of the total gross assets of the entity.

Thus, under the proposed regulations, LossCo can ignore certain indirect shifts of Fund X only if LossCo knows that Fund X ’s 8% stake in LossCo is less than 25% of Fund X ’s aggregate gross assets. Commentators quickly observed that this likely would be difficult for most taxpayers to establish. The final regulations remove the gross-asset test and replace it with a more general anti-abuse rule that allows taxpayers to ignore segregation events for 10%-or-less owners, provided the taxpayer has not participated in a transaction with the entity to avoid application of the segregation rules. Thus, under the final regulations, LossCo ignores the indirect shifts unless LossCo and Fund X were trying to make an end run around the Sec. 382 rules. The effect of ignoring these shifts not only eases administration of the rules, but also helps alleviate the all-too-common situation where the Fund Xs of the world do not provide lookthrough information to corporations.

The other major development in the final regulations is the effective date. The final regulations apply prospectively to testing dates on or after Oct. 22, 2013. However, the regulations allow for elective retroactive application up to the beginning of the testing period including the effective date (i.e., as far back as Oct. 23, 2010) so long as application of the final regulations neither creates nor undoes an ownership change. For example, assume that on Oct. 23, 2010, the cumulative ownership shift was 20% and there have been no ownership changes since then. On Oct. 20, 2013, the cumulative shift was 47%. On Nov. 2, 2013, an event occurred that resulted in a 5% shift. If no retroactivity applies, it appears an ownership change occurs (with a cumulative shift over 50%). However, if the final regulations were to be applied retroactively to all testing dates from Oct. 23, 2010, onward, the taxpayer determines its cumulative shift is only 35%. Thus, the taxpayer can avoid the Nov. 2, 2013, change date through elective, permissible retroactive application.

By contrast, if the 5% shift event occurred on Oct. 21 and not Nov. 2, the taxpayer would be out of luck. There would be a change date on Oct. 21 (prior to the effective date of the final regulations), and the taxpayer could not retroactively apply the regulations to undo that change date.

The final regulations create several planning opportunities for taxpayers with NOL carryovers (or other loss attributes). With the effective date provisions, there is a benefit to running a “with” and “without” calculation essentially for the six-year period from Oct. 23, 2010, to Oct. 22, 2016. This can be done to determine not only if an ownership change has occurred for the three-year period before the final regulations’ effective date, but also potentially to determine when a change occurs in the three-year period after that date.

For example, if there are ownership-shift events in 2014, a taxpayer may be able to decide whether applying the regulation retroactively helps or hurts the timing of an inevitable ownership change. Finally, taxpayers should consider these regulations in the context of Notice 2010-50, which provides guidance under Sec. 382 for measuring ownership shifts of loss corporations that have more than one class of stock and, in particular, the effect of fluctuations in the value of one class of stock relative to another class of stock.

For taxpayers with multiple classes of stock, Notice 2010-50 provides several safe harbors for addressing relative value fluctuations between the classes of stock. The choice of methodology is another factor that can play into how one applies the effective date provisions of the final regulations.


Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, D.C.

For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.

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