Considering the SRLY rules and Sec. 382 in the post-TCJA world

By Heath Wang, E.A., Boston

Editor: Kevin D. Anderson, CPA, J.D.

Corporations with net operating losses (NOLs) and other attributes need to be cognizant of limitations that restrict their use, including Sec. 382 and the separate-return-limitation-year (SRLY) rules that apply to consolidated returns. Generally, the purpose of these limitations is to preclude taxpayers from trafficking losses. The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, significantly broadened the application of these limitation rules as a result of the amendments to Sec. 163(j).

For tax years beginning after Dec. 31, 2017, Sec. 163(j) restricts the deduction of business interest to the sum of (1) the taxpayer's business interest income, (2) 30% of the taxpayer's adjusted taxable income, and (3) the taxpayer's floor plan financing interest (the Sec. 163(j) limitation). The business interest deduction disallowed due to the Sec. 163(j) limitation is carried forward indefinitely but is subject to the SRLY rules and Sec. 382, which imposes a limit on deducting built-in losses after an ownership change. As a result, more corporations will need to consider the SRLY rules and Sec. 382, including corporations that have historically had taxable income.

The SRLY rules

Under the SRLY rules, when a loss corporation joins a consolidated group and Sec. 382 does not apply, the consolidated group may use the losses of the new member only to the extent it contributes to consolidated taxable income. In the case of a disallowed business interest carryforward, the consolidated group can deduct the new member's carryforward to the extent it contributes to the Sec. 163(j) limitation of the consolidated group, but only if the consolidated group has excess Sec. 163(j) limitation after deducting any current-year business interest. Unlike the SRLY rules applicable to NOLs, which are tracked on a cumulative basis, the SRLY application for Sec. 163(j) purposes is recomputed annually.

Example 1: Consolidated P Group has current-year business interest expense of $100 and a consolidated Sec. 163(j) limitation of $125. In addition, the P Group has a $50 disallowed business interest carryforward attributable to subsidiary S from a separate return limitation year and therefore is subject to the SRLY rules. Since the P Group has an excess Sec. 163(j) limitation ($125 limitation minus $100 current-year business interest), the $50 SRLY carryforward may be used to the extent of the $25 excess. However, S first needs to calculate its current-year SRLY limitation by computing its own Sec. 163(j) limitation, determined by reference to only S's tax items. The P Group may then deduct the S carryforward by the lesser of the SRLY limitation or the excess Sec. 163(j) limitation. Any unused SRLY limitation will not carry forward to the following years. The P Group will have to recompute S's SRLY limitation without regard to any prior-year excess. (See Prop. Regs. Sec. 1.163(j)-5.)

Sec. 382

Sec. 382 also imposes a limitation on NOLs and other attributes when a loss corporation undergoes an ownership change. Under Sec. 382, an ownership change occurs when the ownership of shareholders owning 5% or more of the loss corporation increases by more than 50 percentage points within a three-year period. Once an ownership change occurs, the loss corporation's ability to use any pre-change losses each year is limited to the applicable Sec. 382 limitation, calculated as the value of the loss corporation's stock immediately before the ownership change multiplied by the applicable long-term tax-exempt rate.

For Sec. 382 purposes, a disallowed business interest carryforward under Sec. 163(j) is considered a pre-change loss and therefore is subject to the Sec. 382 limitation. The loss corporation may use that carryforward in a post-change period to the extent of the Sec. 382 limitation (but not to exceed the excess Sec. 163(j) limitation). Under the proposed regulations, the disallowed business interest carryforward is used before the NOL carryforward (see REG-106089-18).

Example 2: Loss corporation X, with a $100 NOL carryforward and a $50 disallowed business interest carryforward, experienced an ownership change on the first day of the current year. The Sec. 382 limitation calculated for the ownership change is $80 per year. X has a current-year Sec. 163(j) limitation of $150 and incurred current-year business interest expense of $120. Under these circumstances, X has an excess Sec. 163(j) limitation of $30 ($150 limitation minus $120 current-year business interest expense). Therefore, X can deduct the $30 disallowed business interest carryforward and a maximum of $50 NOL carryforward. (See Prop. Regs. Sec. 1.382-2(a)(7).)

Sec. 382 and SRLY overlaps

Often, a loss corporation will become a member of a consolidated group (a SRLY event) and experience an ownership change (a Sec. 382 event) on the same date. Under Regs. Sec. 1.1502-21(g), where a SRLY event and a Sec. 382 event overlap, only the Sec. 382 limitation applies. For situations in which the SRLY event and the Sec. 382 event are not simultaneous, the overlap rule could also apply if both events take place within six months of each other. This six-month-lag relief presents an opportunity for taxpayers that seek to undertake post-transaction restructuring to avoid a SRLY limitation where an ownership change has occurred.

Example 3: Foreign corporation A looks to enter the U.S. market by acquiring two unrelated domestic loss corporations, B and C. As a result of the acquisition, the losses of B and C will be subject to Sec. 382. To streamline its investments in the United States, A plans to contribute the stock of B to C, such that B and C will meet the affiliation requirements needed to file a consolidated return. Under the overlap rule, only the Sec. 382 limitation will apply if A is able to contribute the stock of B to C within six months of the original acquisitions.

The operation of the overlap rule presents some complexity, especially if a SRLY event and a Sec. 382 event are not simultaneous, or if there are SRLY subgroups and Sec. 382 loss subgroups. Specifically, if a SRLY event occurs within six months before a Sec. 382 event, the SRLY rules will still apply in the year(s) that the SRLY event and the Sec. 382 event occur but will be eliminated starting with the first tax year that begins after the Sec. 382 event. By contrast, if a Sec. 382 event occurs within six months before a SRLY event, the SRLY rules will not apply at all. With respect to SRLY subgroups and Sec. 382 loss subgroups, the SRLY rules will be eliminated only if the SRLY subgroup is coextensive with the Sec. 382 loss subgroup (see Regs. Sec. 1.1502-21(g)(4)).

While a SRLY event can be easy to identify because it is based on members joining a consolidated group, a Sec. 382 ownership change can be more difficult to detect because the ownership shifts are based on a lookthrough approach to the ultimate shareholders of the loss corporation. For example, if loss corporations are combined into a consolidated group in a tax-free manner, and prior to the transaction the ultimate ownership of those corporations is not identical, a Sec. 382 analysis will need to be undertaken to determine whether there is overlap.

In limited contexts, identifying a SRLY event may involve some complexity. In a reverse acquisition described under Regs. Sec. 1.1502-75(d)(3), the acquirer in form may not be the acquirer for purposes of applying the SRLY rules.

Example 4: When loss corporation A acquires 100% of the stock of profitable corporation B, and in exchange, B shareholders receive more than 50% of the fair market value of A's stock, a reverse acquisition has occurred. Under these circumstances, B is considered as the acquirer for consolidated return purposes, and therefore A's losses will be subject to the SRLY rules, as they pertain to the new consolidated group.


Sec. 163(j) as amended by the TCJA has created a new category of tax attribute that is subject to the SRLY rules and Sec. 382. This is significant to corporations and consolidated groups that expect to generate disallowed business interest carryforwards, especially to those that have historically had taxable income. Corporations with disallowed business interest carryforwards will need to start tracking the ownership shifts of their shareholders in case of a Sec. 382 ownership change. Challenges presented to consolidated groups are even greater because consolidated groups will need to track not only their shareholder ownership shifts but also disallowed business interest carryforward of each member to which the SRLY rules may apply. The interplay of these rules will need to be a U.S. tax consideration in structuring acquisitions going forward.


Kevin D. Anderson, CPA, J.D., is a partner, National Tax Office, with BDO USA LLP in Washington, D.C.

For additional information about these items, contact Mr. Anderson at 202-644-5413 or

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.

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