Proposed Sec. 382 regs. simplify small shareholder treatment.

• Author: Fairbanks, Greg Alan

Sec. 382 and the regulations there under rank among some of the most complex, nonintuitive rules in federal tax law, all aimed at curbing the practice of trafficking in net operating losses (NOLs), or other loss attributes, in a corporation. If a corporation undergoes a change in ownership, then the NOLs (or other loss attributes such as research and development credits or capital losses) that arc attributable to periods before the change in ownership are subject to a Sec. 382 limitation for use in periods after the ownership change. Sec. 382(g) defines what constitutes a change in ownership with three major factors: (1) There must be a greater than 50% change in ownership (2) by the 5% shareholders in the corporation (3) within a given "testing period" (generally a three-year window). At first blush, the statute appears fairly simple.

There are many examples of ownership changes within the meaning of Sec. 382 that not only result from following the statute but also appear fully intuitive in light of the above rules. For example, LossCo is 100% owned by Founder. Founder then sells all the stock to Buyer. This clearly is an ownership change. Another slightly more nuanced example is if LossCo is equally owned by A, B, and C. In year 1, A sells his one-third interest to D, and in year 2, B sells his one-third interest to E. A practitioner at first blush may wonder if this is an ownership change, but simple application of the statute makes the result quite clear. Within two years, there has been a two-thirds change in ownership by significant shareholders.

One of the many areas of complexity within the regulations under Sec. 382 is how to apply the statute (and legislative intent) with regard to "small shareholders," i.e., shareholders (whether individuals, corporations, partnerships, etc.) who own less than 5% of the corporation. Temp. Regs. Sec. 1.382-2T provides an array of rules by which such shareholders are aggregated or segregated, and it governs simple transactions such as stock issuances, stock redemptions, and the sale or exchange of stock where one party to the sale is a small shareholder. The result is situations where an ownership change can occur in very nonintuitive circumstances. One of the classic situations is the "yo-yo ownership change."

The yo-yo ownership change occurs when a 5% shareholder sells its stock to small shareholder(s), and those shareholders are segregated into a new agglomeration of such shareholders (a direct public group) that will be treated as a new and distinct 5% shareholder; however, when a new...