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NOLs in acquisitions … simplified!

Don’t let this surprise trip you up

NOLs in acquisitions … simplified!

Recently, I have had a string of opportunities to assist clients in acquisition transactions where the target has a net operating loss carryforward.

Now, most community bank acquirers naturally assume that such a target corporation is more valuable because, post-acquisition, they will be able to take advantage of the target’s NOL.

Not so fast! 

There is much confusion regarding the treatment of net operating losses in a community bank acquisition. The rules are detailed and confusing.

The purpose of this blog is to identify the issue and give you a broad brush picture of the rules as contained in Section 382 of the Internal Revenue Code. The bottom line: If there is a change in ownership, under Section 382, some portion—or even all—of the net operating losses may not be available for use by the purchaser.

What IRS Code says

Section 382 limits a “Loss Corporation’s” ability to carry forward net operating losses if an “Ownership Change,” as defined in Section 382, has occurred.

Section 382’s definition holds that such a change occurs if the major shareholders, as a result of a triggering event—in this case, an acquisition—increase their ownership in a Loss Corporation by more than 50 percentage points.

• Keep in mind, most community bank acquisitions would result in a change in ownership in a Loss Corporation by anywhere from 40% to 100%.

• Keep in mind also that the Section 382 limitations are not only applicable in an acquisition transaction where 100% of the stock of the Loss Corporation is acquired, but also in the event of a private placement where less than a 100% ownership change occurs.

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Section 382 tests for ownership changes by comparing each major shareholder’s percentage increase in ownership of common stock at any Owner Shift—which includes a private placement—to which code Section 1032 is applicable, over the major shareholder’s lowest percentage of share ownership over the testing period.

For example, a shareholder owning no shares on April 1, increasing its ownership to 8% of the outstanding common stock on June 1, would cause an 8 percentage point increase in ownership.

That increase, along with the increases for all other major shareholders, will be aggregated on the date of any ownership change. (Note that the calculation also applies to the less-than-5% shareholders category, as a group.) If that aggregate increase exceeds 50 percentage points, the company will have undergone an ownership change and will be subject to the Section 382 Limitation.

The Section 382 limitation regarding the use of net operating loss carryforwards is calculated by multiplying the value of the Loss Corporation on the date of the ownership change by the IRS long-term tax-exempt rate for the time period in which the ownership change occurred. After an ownership change, the Loss Corporation can only offset taxable income in periods after the ownership change in an amount equal to the Section 382 Limitation. Any taxable income in excess of the Section 382 limitation will be taxed.

As a quick example, assume a community bank holding company is acquiring another community bank and its holding company. The target company has $2 million in net operating loss carryforwards. These can be carried forward for 20 years. The acquisition will result in an ownership change as defined in Section 382. Assume that at the time of the acquisition the value of the target company is $10 million. In this situation, the Section 382 Limitation would be $240,000, meaning the acquirer could shield $240,000 of income from taxation on an annual basis until the entirety of the $2 million in net operating loss carryforwards was used.

How this factors into decisions

As a practical matter, in the community bank acquisition context, the key issues an acquirer needs to be concerned with are:

1. Does the target have a net operating loss carryforward?

2. Will the transaction cause a change in control?  (Generally, yes.)

3. What is the Section 382 limitation, which is the value of the Loss Corporation on the date of closing multiplied by the IRS long-term tax exempt rate (which for April is 2.47%)?

4. Will all of the target’s net operating loss carryforwards be used at some point in the future?

• If the answer to the final question is yes, there is no adjustment necessary to the target’s equity.

• If all of the target’s net operating loss carryforwards will not be used in the future, the amounts that are not used should be assumed to be written off in determining the target’s equity.

In determining an appropriate value for the net operating loss carryforwards, acquirers should generally determine the present value of the future tax savings associated with the acquisition of the net operating loss carryforward.

As those of you who have been through an acquisition involving a target with net operating loss carryforwards well know, the rules and regulations applicable to Section 382 are extensive. This has only been a simplified summary.

However, we are seeing targets with net operating loss carryforwards pop up in some deals lately, and anyone considering engaging in a community bank merger transaction should be aware of these issues.

Jeff Gerrish

Jeff Gerrish is chairman of the board of Gerrish Smith Tuck Consultants, LLC, and a member of the Memphis-based law firm of Gerrish Smith Tuck, PC, Attorneys. He frequently contributes to Banking Exchange and frequently speaks at industry events.

In mid-2016 Gerrish's blog received a national bronze excellence award from the American Society of Business Publication Editors. This followed his receipt of the regional silver excellence award for the Northeastern Region from the same group.

Gerrish formerly served as regional counsel for the FDIC’s Memphis regional office and with the FDIC in Washington, D.C., where he had nationwide responsibility for litigation against directors of failed banks. Since the firm’s formation in 1988, Gerrish Smith Tuck has assisted over 2,000 community banks in all 50 states across the nation with matters such as strategic planning, mergers and acquisitions, common stock private placements, holding company formation and reorganization, and a wide variety of regulatory matters. Jeff Gerrish can be contacted at

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