Discussion:NOL Consideratons for a Business Combination Scenario

My client (A) has a small NOL of approximately 400K. In this scenario can A merge with B where B is the survivor in a way that B can preserve and use the 400K NOL? (I'm not that interested in the State tax issues, mainly federal tax impact.)

Is the answer is Yes, what are the prerequisite conditions or requirements that must be followed to preserve the NOL use?

By the way, both companies have actual operations, and are publicly traded as "penny stock" firms and both companies have less than 30 employees each.

In this case the offer by B is not especially generous, and the tie breaker might be the tax impact. Any insights have would be greatly appreciated!

In general, the survivor in a statutory merger succeeds to the tax attributes, including NOLs, of the disappearing corporation (IRC Sec. 381). However, if the reorganization results in a change of ownership, utilization of the NOL is limited by IRC Sec. 382. The maximum NOL deduction that B can utilize in any year is calculated by multiplying the value of the old loss corporation (A) immediately before the reorganization by the long-term federal tax-exempt rate. The idea is to limit annual utilization of the loss to the income A would have earned if it had sold all its assets and invested the proceeds in long-term tax-exempt securities.

The rate is published monthly by the IRS, and the applicable rate is the one that is in effect for the month in which the change of ownership occurs. For November 2008 the rate is 4.94%. So if the value of A immediately before the merger is $100,000, the maximum amount of its NOL that B could deduct annually would be 4.94% of $100,000, or $4,940. At that rate something less than a quarter of the $400,000 NOL could be utilized before the NOL expired. Of course, the higher the FMV of A before the merger, the greater the amount of NOL that could be utilized each year.

A change of ownership occurs if there is any change in the stock ownership, and if that change increases or decreases the percentage owned by any person who owns more than 5% of the stock either before or after the change.