Ownership Changes and IRC. Sec. 382
Under the Internal Revenue Code (IRC), various federal income tax attributes of an acquired corporation can be used, assuming certain statutory conditions are met, by the acquiring or successor corporations following a tax-free reorganization. (IRC Sec. 381 and Sec. 382)
In general, Sec. 381 establishes the circumstances under which a corporation can succeed to the tax attributes of another corporation when it acquires the assets of that corporation, and Sec. 382 limits a corporation's ability to claim a net operating loss carryover following a change of ownership. (i.e., a stock acquisition)
From a state income or franchise tax perspective, the tax attribute of most significance is generally the net operating loss (NOL) carryover. Capital loss carryovers, tax credits and excess charitable contribution carryovers are also potentially impacted by state limitations on the use of acquired tax attributes.
The states have adopted various approaches to the succession of net operating loss carryovers following a reorganization. Some states, either through express provision or by their general adoption of federal taxable income as the starting point for their tax base, follow the federal rules. Other states employ their own rules or otherwise limit the carryover.
Most states do not provide detailed statutory or administrative guidance on their treatment of IRC Sec. 382. Massachusetts and Minnesota specifically adjust the federal IRC Sec. 382 annual limitations to be consistent with state computed post-apportionment NOLs. The vast majority of other states are silent with respect to how IRC Sec. 382 applies for state purposes even though this code section is explicitly or implicitly adopted in defining their income tax base.
It is possible that on audit, a state without specific guidance could challenge a corporation’s use of the entire federal IRC Sec. 382 limitation. A logical assertion would be that the federal limit ought to be apportioned to reflect its application to state NOL carryforwards that are often determined on a post-apportionment basis. Some states, like Wisconsin, have acknowledged in administrative releases that their annual cap on acquired NOL carryover deductions is equal to the federally computed IRC Sec. 382 limitation. However, this situation is uncommon.
Another area of uncertainty is exactly how states with combined or consolidated returns apply IRC Sec. 382. For U.S. income tax purposes, the annual limitation is computed at the affiliated group level as part of the consolidated return filing. In some states, a taxpayer’s unitary group included in a combined return might not be the same as its federal affiliated group. Additionally, some states only permit combination or consolidation of affiliates that have state nexus.
If your company has an ownership change that "triggers" the Federal IRC. Section 382 rules, remember to review the rules in the applicable states to accurately determine the State IRC Sec. 382 limits.