1. Ownership Changes.
    1. Ownership Changes Triggers § 382 Limitation.
      1. The § 382 limitations apply only:
        1. If a corporation is a loss corporation on a testing date; and
        1. Immediately after the testing date, and ownership change has occurred (Reg. § 1.382-2T(a)).
        1. A loss corporation is a corporation entitled to a net operating loss carryover (§ 382(k)(1) and Reg. § 1.3822T(f)(1)).
          1. This includes any net unrealized built-in loss.
          1. It could be the corporation which originally incurred the loss or the corporation entitled to carry it forward in a § 381 transaction (e.g., a reorganization under § 368(a) or a subsidiary liquidation under § 332).
      1. An ownership change occurs with respect to a corporation if:
        1. It is a loss corporation on a testing date,
        1. Immediately after the close of the testing date, the percentage of stock owned by any one or more 5% shareholders has increased by more than 50 percentage points,
        1. Relative to the lowest percentage of stock of such corporation owned by such shareholders,
        1. At any time during the testing period (generally a three-year period ending on the day of any owner shift or equity structure shift) (new § 382(g)(1), Reg. § 1.382-2T(a)(1)).
      1. The increases in percentage ownership for each 5% shareholder whose percentage ownership has increased during the testing period are aggregated for purposes of the 50% test.
        1. Generally, all stock owned by persons who own less than 5% of a corporation's stock is treated as stock owned by a single 5% shareholder (new § 382(g)(4)(A)).
        1. The determination of whether an ownership change has occurred is made after any owner shift involving a 5% shareholder or any equity structure shift.
    1. Computing the Amount of Increases in Percentage Ownership. (Reg. § 1.382-2T(c))
      1. In order to determine whether an ownership change has occurred on a testing date, the loss corporation must identify:
        1. Each 5% shareholder whose percentage of stock ownership in the loss corporation immediately after the close of the testing date has increased,
        1. Compared to such shareholder's lowest percentage of stock ownership in such corporation at any time during the testing period.
      1. The amount of the increase in the percentage of stock ownership in the loss corporation of each 5% shareholder must be:
        1. Computed separately by comparing the percentage ownership of each such 5% shareholder immediately after the close of the testing date,
        1. To such shareholder's lowest percentage ownership at any time during the testing period.
      1. Each such increase in the percentage ownership of a 5% shareholder is then added together with any other such increases of other 5% shareholders to determine whether an ownership change has occurred.
      1. Because only those 5% shareholders whose percentages of stock ownership have increased are take into account,
        1. A 5% shareholder is disregarded if his percentage of stock ownership, immediately after the close of the testing date,
        1. Has decreased (or has remained the same), compared to his lowest percentage ownership interest on any pervious date during the testing period.
      1. A loss corporation is required to determine whether an ownership change has occurred immediately after any owner shift, any equity structure shift, or any transaction in which an option with respect to stock of a loss corporation is transferred or assumed (Reg. § 382(g)(1), Reg. § 1.382-1T(a)(2)).
        1. Owner Shift. (Reg. § 1.382-2T(e)(1))
          1. Defined - An owner shift is any change in the ownership of the stock of a loss corporation that affects the percentage of such stock owned by any 5% shareholder (i.e., any person holding 5% or more of the stock of the corporation at any time during the testing period (see § 382(k)(7)). An owner shift includes, but is not limited to, the following transactions.
            1. A purchase or disposition of loss corporation stock by a 5% shareholder,
            1. A § 351 exchange that affects the percentage of stock owned by a 5% shareholder,
            1. A redemption or a recapitalization that affects the percentage of stock owned by a 5% shareholder,
            1. An issuance of loss corporation stock that affects the percentage of stock owned by a 5% shareholder, and
            1. An equity structure shift that affects the percentage of stock owned by a 5% shareholder.
        1. Equity Structure Shift.
          1. Tax-Free Reorganizations - Any equity structure shift is any reorganization within the meaning of § 368 with respect to which the loss corporation is a party of the reorganization, except that such term does not include a reorganization described in:
            1. Section 368(a)(1)(D) or (G) unless the requirements of § 354(b)(1) are met, or
            1. Section 368(a)(1)(F).
          1. Overlap of Owners Shift and Equity Structure Shift - Any equity structure shift that affects the percentage of loss corporation stock owned by a 5% shareholder also constitutes an owner shift.
        1. Worthlessness Treated as Owner Shift - New § 382(g)(4)(D) added by Revenue Act of 1987 provides that if:
          1. Stock held by any 50% shareholder is treated by such shareholder as becoming worthless during the year, and
          1. Such shareholder holds the stock after the close of the year,
          1. Such shareholder is treated as acquiring such stock as of the first day of the next succeeding taxable year, as if it may have owned such stock during a prior period.
          2. The term 50% shareholder means any person owning 50% or more at any time during the three-year period ending on the last day of the taxable year with respect to which stock was so treated. Effective for worthlessness in taxable years beginning after December 31, 1987.
        1. Certain Transactions Which Do Not Constitute Ownership Changes.
          1. Death, Gifts or Divorce - If the basis of any stock in the hands of any person is determined under § 1014 (relating to property acquired from a decedent), § 1015 (relating to property acquired by a gift or transfer in trust), or § 1041(b) (relating to transfers of property between spouses or incident to divorce), stock is received by any person in satisfaction of a right to receive a pecuniary bequest, or stock is acquired by a person pursuant to a divorce or separation instrument (within the meaning of § 71(b)(2)), then
            1. Such persons shall be treated as owning such stock during the period such stock was owned by the person from whom it was acquired (new § 382(l)(3)(B)), and
            1. Such transfers would not constitute owner shifts.
          1. Special Rule for Employee Stock Ownership Plans.
            1. If certain ownership and allocation requirements are satisfied, the acquisition of employer securities (within the meaning of § 409(1)) by either a tax credit employee stock ownership plan or an employee stock ownership plan (within the meaning of § 4975(e)(7)) shall not be taken into account in determining whether an ownership change has occurred (new § 382(l)(3)(C)).
            1. The acquisition of employer securities from any such plan by a participation of any such plan pursuant to the requirements of § 409(h) also will not be taken into account in determining whether an ownership change has occurred.
    1. Three Year Testing Period. (§ 382(i) and Reg. § 1.382-2T(d))
      1. In General - The relevant testing period for determining whether an ownership change has occurred is the three-year period preceding any owner shift involving a 5% shareholder or any equity structure shift (§ 382(i)(1)).
        1. A series of unrelated transactions occurring during a three-year period may constitute an ownership change.
        1. A shorter period, however, may be applicable following any ownership change. In such a case, the testing period for determining whether a second ownership change has occurred does not begin before the day following the first ownership change (§ 382(i)(2)).
      1. The testing period does not begin before the first day of the first taxable year from which there is a loss carryforward (including a current NOL that is defined as a pre-changed loss) or excess credit (§ 382(i)(3)).
        1. Transactions that occur prior to the creation of any attribute subject to limitation under § 382 or § 383 are disregarded.
        1. Except as provided in regulations, the special rule described above does not apply to any corporation with a net unrealized built-in loss.
          1. If the corporation has a net realized built-in loss (i.e., aggregate loss in excess of 25% of the fair market value of the corporation's assets, excluding cash and marketable securities without substantial appreciation) on the testing date, unless the loss corporation establishes the taxable year in which the net unrealized built-in loss first accrued.
          1. In that event, the testing period shall not begin before the earlier of:
            1. The first day of the taxable year in which the net unrealized built-in loss first accrued, or
            1. The day described in Reg. § 1.382-2T(d)(3)(i). See § 382(h) for the definition of net unrealized built-in loss.
      1. Disregarding Testing Dates - Any testing date that occurs before the beginning of the testing period shall be disregarded for purposes of this section.
      1. Example 2: A owns all of 100 outstanding shares of L stock. A sells 40 shares to B on January 1, 1996. C purchases 20 shares of L stock from A on July 1, 1999. In determining if an ownership change occurs on the July 1, 1999 testing date, B's acquisition of L stock is disregarded because it occurred before the testing period that ends on such testing date. Thus, B's ownership interest in L does not increase during the testing period, and no ownership change results from C's acquisition.
      1. Earliest Commencement of the Testing Period - For purposes of determining if an ownership change has occurred at any time after May 5, 1986, the testing period shall begin no earlier than May 6, 1986.
        1. Pre-May 6, 1986 Owner Shifts - Shifts in ownership of stock of the loss corporation prior to May 6, 1986, are disregarded.
        1. Application of Old § 382 - Old § 382 shall not apply to a loss corporation on or after the date on which an ownership change occurs, but only if such ownership change results in the application of the § 382 limitations (as defined in § 382(b)) with respect to the loss corporation.
        1. Effect on Testing Period - The application of old § 382 to a transaction is disregarded unless the transaction that results in such application is the last component of an ownership change after May 5, 1986 that is not subject to § 382 under the effective date rules (e.g., an ownership change occurring as the result of an individual's purchase of more than 50% of L stock on any date after May 5, 1986 or before December 31, 1986).
    1. Examples of Ownership Shifts Involving 5% Shareholders.
      1. Example 3: the stock of L corporation is publicly traded; no shareholder holds 5% or more of L stock. During the three-year period between January 1, 1995 and January 1, 1998, there are numerous trades involving L stock. No ownership change will occur as a result of such purchases, provided that no person (or persons) becomes a 5% shareholder, either directly or indirectly, and increases his (or their) ownership of L stock by more than 50 percentage points.
      1. Example 4: On January 1, 1998, the stock of L corporation is publicly traded; no shareholder holds five percent or more of L stock. On September 1, 1998, individuals A, B, and C, who were not previously L shareholders and are unrelated to each other or any L shareholders, each acquire one-third of L stock. A, B, and C each have become 5% shareholders of L and, in the aggregate, hold 100% of the L stock. Accordingly, an ownership change has occurred, because the percentage of L stock owned by the three 5% shareholders after the owners shift (100%) has increased by more than 50 percentage points over the lowest percentage of L stock owned by A, B, and C at any time during the testing period (0% prior to September 1, 1995).
      1. Example 5: On January 1, 1998, individual I owns all 1,000 shares of corporation L . On June 15, 1998, I sells 300 of his L shares to unrelated individual A. On June 15, 1999, L issues 100 shares to each of B, C, and D. After these owner shifts involving I, A, B, C, and D, each of whom is a 5% shareholder, there is no ownership change, because the percentage of stock owned by A, B, C, and D after the owner shifts (approximately 46% -- A-23%; B, C, and D-7.7% each) has not increased by more than 50 percentage points over the lowest percentage of stock owned by those shareholders during the testing period (0% prior to June 15, 1998). On December 15, 1999, L redeems 200 of the shares owned by I. Following this owner shift affecting I, a 5% shareholder, there is an ownership change, because the percentage of L stock owned by A, B, C, and D (Approximately 55% -- A-27.3%; B, C, and D-9.1% each) has increased by more than 50 percentage points over the lowest percentage owned by those shareholders during the testing period (0% prior to June 15, 1998).
      1. Example 6: L corporation is closely held by four unrelated individuals, A, B, C, and D. On January 1, 1998, there is a public offering of L stock. No person who acquires stock in a public offering acquires 5% or more, and neither A, B, C, nor D acquires any additional stock. As a result of the offering, less than 5% shareholders own stock representing 80% of the outstanding L stock. The stock ownership of the less than 5% shareholders are aggregated and treated as owned by a single 5% shareholder for purposes of determining whether an ownership change has occurred. The percentage of stock owned by less than 5% shareholders after the owner shift (80%) has increased by more than 50 percentage points over the lowest percentage of stock owned by those shareholders at any time during the testing period (0% prior to January 1, 1998). Thus, an ownership change has occurred.
      1. Example 7: On January 1, 1998, L corporation is wholly owned by individual X. On January 1, 1999, X sells 50% of his stock to 1,000 shareholders, all of whom are unrelated to him. On January 1, 2000, X sells his remaining 50% interest to an additional 1,000 shareholders, all of whom are unrelated to him. Based on these facts, there is not an ownership change immediately following the initial sales by X, because the percentage of L stock owned by the group of less than 5% shareholders (who are treated as a single 5% shareholder) after the owner shift (50%) has not increased by more than 50 percentage points over the lowest percentage of stock owned by this group at any time during the testing period (0% prior to January 1, 1999). On January 1, 2000, however, there is an ownership change, because the percentage of L stock owned by the group of less than 5% shareholders after the owner shift (100%) has increased by more than 50 percentage points over their lowest percentage ownership at any time during the testing period (0% prior to January 1, 1999).
      1. Example 8: The stock of L corporation is publicly traded; no shareholder owns 5% or more. On January 1, 1998, there is a stock offering as a result of which stock representing 60% of L's value is acquired by an investor group consisting of 12 unrelated individuals, each of whom acquires 5% of L stock. Based on these facts, there has been an ownership change, because the percentage of L stock owned after the owner shift by the twelve 5% shareholders in the investor group (60%) has increased by more than 50 percentage points over the lowest percentage of stock owned by those shareholders at any time during the testing period (0% prior to January 1, 1998).
      1. Example 9: On January 1, 1998, L corporation is owned by 2 unrelated shareholders, A (60%) and C (40%). LS corporation is a wholly owned subsidiary of L corporation and is therefore deemed to be owned by A and C in the same proportions as their ownership of L (after application of the attribution rules, as discussed below). On January 1, 1999, L distributes all the stock of LS to A in exchange for all of A's L stock in a § 355 transaction. There has been an ownership change of L, because the percentage of L stock owned by C (100%) has increased by more than 50 percentage points over the lowest percentage of L stock owned by C at any time during the testing period (40% prior to the distribution of LS stock). There has not been an ownership change of LS, because the percentage of LS stock owned by A (100%) has not increased by more than 50 percentage points over the lowest percentage of stock owned by A at any time during the testing period (60%, after application of the attribution rules, as discussed below), prior to January 1, 1999.
      1. Example 10: On January 1, 1998, L corporation (a loss corporation) is merged (in a transaction described in § 368(a)(1)(A)) into P corporation (not a loss corporation) with P surviving. Both L and P are publicly traded corporations with no shareholder owning 5% or more of either corporation or the surviving corporation. In the merger, L shareholders receive 30% of the stock of P. There has been an ownership change of L, because the percentage of P stock owned by the former P shareholders (all of whom are less than 5% shareholders who are treated as a separate, single 5% shareholder) after the equity structure shift (70%) has increased by more than 50 percentage points over the lowest percentage of L stock owned by such shareholders at any time during the testing period (0% prior to the merger). If, however, the former shareholders of L had received at least 50% of the stock of P in the merger, there would not have been an ownership change of L. An ownership change would similarly occur after a taxable merger in which L acquires P (in which L's losses are not affected other than by the special limitations), if L's former shareholders receive only 30% of the combined company, pursuant to new § 382(g)(4)(C). Congress expected that § 382(g)(4)(C) would, by its terms, generally cause the segregation of the less than 5% shareholders of separate entities where an entity other than a single corporation is involved in a transaction. Section 382(g)(3)(B) and § 382(m)(5) provide additional authority for Treasury to segregate groups of less than 5% shareholders where there is only one corporation involved.
      1. Example 11: On January 1, 1997, L corporation is owned by 2 unrelated shareholders, A (60%) and C (40%). On January 1, 1998, L redeems all of A's L stock in exchange for nonvoting preferred stock described in § 1504(a)(4). Following this recapitalization (which is both an equity structure shift and an owner shift involving a 5% shareholder), there has been an ownership change of L, because the percentage of L stock (which does not include preferred stock within the meaning of § 1504(a)(4)) owned by C following the equity structure shift (100%) has increased by more than 50 percentage points over the lowest percentage of L stock owned by C at any time during the testing period (40% prior to the recapitalization). Assume, alternatively, that on January 1, 1997, the stock of L corporation was widely held, with no shareholder owning as much as 5%, and that 60% of the stock was redeemed in exchange for nonvoting preferred stock in a transaction that is otherwise identical to the transaction described above (which would be an equity structure shift, but not an owner shift involving a 5% shareholder because of the existence of only a single 5% shareholder, the aggregated less than 5% shareholders, who owns 100% of L both before and after the exchange). In such a case, the Secretary will prescribe regulations segregating the less than 5% shareholders of the single corporation, so that the group of shareholders who retain common stock in the recapitalization will be treated as a separate, single 5% shareholder. Accordingly, such a transaction would constitute an ownership change, because the percentage of L stock owned by the continuing common shareholders (100%) has increased by more than 50 percentage points over the lowest testing period (40% prior to the recapitalization).
      1. Example 12: L corporation stock is widely held; no shareholder owns as much as 5% of L stock. On January 1, 1998, L corporation, which has a value of $1 million, directly issues stock with a value of $2 million to the public; no one person acquired as much as 5% in the public offering. No ownership change has occurred, because a public offering in which no person acquires as much as 5% of the corporation's stock, however large, by a corporation that has no 5% shareholder before the offering would not affect the percentage of stock owned by a 5% shareholder. In other words, the percentage of stock owned by less than 5% shareholders of L immediately after the public offering (100%) has not increased by more than 50 percentage points over the lowest percentage of stock owned by the less than 5% shareholders of L at any time during the testing period (100%). To the extent provided in regulations that will apply prospectively from the date the regulations are issued, a public offering can be treated, in effect, as an equity structure shift with the result that the offering is a measuring event, even if there is otherwise no change in ownership of a person who owns 5% of the stock before or after the transaction. Rules also would be provided to segregate the group of less than 5% shareholders prior to the offering and the new group of less than 5% shareholders that acquire stock pursuant to the offering. Under such regulations, therefore, the less than 5% shareholders who receive stock in the public offering could be segregated and treated as a separate 5% shareholder. Thus, an ownership change may result from the public offering described above, because the percentage of stock owned by the group of less than 5% shareholders who acquire stock in the public offering, who are treated as a separate 5% shareholder (66.67%), has increased by more than 50 percentage points over the lowest percentage of L stock owned by such shareholders at any time during the testing period (0% prior to the public offering). The Act contemplates that the regulations may provide rules to allow the corporation to establish the extent, if any, to which existing shareholders acquire stock in the public offering.
      2. Example 13: On January 1, 1998, I (an individual) purchased 40% of the stock of L. The remaining stock of L is owned by 25 shareholders, none of whom own as much as 5%. On July, 1998, L is merged into P – which is wholly owned by I – in a tax-free reorganization. In exchange for their stock in L, the L shareholders (immediately before the merger) received stock with a value representing 60% of the P stock that is outstanding immediately after the merger (24% to I; 36% to the less than 5% shareholders of L). No other transactions occurred with respect to L stock during the testing period preceding the merger. There is an ownership change because the percentage of stock owned by I in the combined entity (64% – 40% by virtue of I's ownership of P prior to the merger plus 24% received in the merger) has increased by more than 50 percentage points over the lowest percentage of stock in L owned by I during the testing period (0% prior to January 12, 1998).
      1. Example 14: On July 12, 1998, L corporation is owned 45% by P, a publicly traded corporation (with no 5% shareholders), 40% by individual A, and 15% by individual B. All of the L shareholders have owned their stock since L's organization in 1993. Neither A nor B owns any P stock. On July 30, 1998, B sells his entire 15% interest to C for cash. On August 12, 1998, P acquires A's entire 40% interest in exchange for P stock representing an insignificant percentage of the outstanding P voting stock in a "B" reorganization. There is an ownership change immediately following the B reorganization, because the percentage of L stock held (through the attribution, as described below) by P shareholders (all of whom are less than 5% shareholders who are treated as one 5% shareholder) and C (100% -- P shareholders-85%; C-15%) has increased by more than 50 percentage points over the lowest percentage of stock owned by P shareholders and C at any time during the testing period (45% held constructively by P shareholders prior to August 13, 1998).
      1. Example 15: The stock of L corporation is widely held by the public; no single shareholder owns 5% or more of L stock. G corporation also is widely held with no shareholder owning 5% or more. On January 1, 1998, L corporation and G corporation merge (in a tax-free transaction), with L surviving, and G shareholders receive 49% of L stock. On July 1, 1998, B, an individual who has never owned stock in L or G, purchases 5% of L stock in a transaction on a public stock exchange. The merger of L and G is not an ownership change of L, because the percentage of stock owned by the less than 5% shareholders of G (who are aggregated and treated as a single 5% shareholder) (49%) has not increased by more than 50 percentage points over the lowest percentage of L stock owned by such shareholders during the testing period (0% prior to the merger). The purchase of L stock by B is an owner shift involving a 5% shareholder, which is presumed (unless otherwise established) to have been made proportionately from the groups of former G and L shareholders (49% from the G shareholders and 51% from the L shareholders). There is an ownership change of L because, immediately after the owner shift involving B, the percentage of stock owned by the G shareholders (presumed to be 46.55% -- 49% actually acquired in the merger less 2.45% presumed sold to B) and B (5%) has increased by more than 50 percentage points over the lowest percentage of L stock owned by those shareholders at any time during the testing period (0% prior to the merger).
      1. Example 16: The stock of L corporation and G corporation is widely held by the public; neither corporation has any shareholders owning as much as 5% of its stock. On January 1, 1998, B purchases 10% of L stock. On July 1, 1998, L and G merge (in a tax-free transaction), with L surviving, and G shareholders receiving 48% of L stock. The merger of L and G is an ownership change because, immediately after the merger, the percentage of stock owned by G shareholders (49%) and B (5.1%) has increased by more than 50 percentage points over the lowest percentage of L stock owned by such shareholders at any time during the testing period (0% prior to the stock purchase by B).
    1. Stock - Determination of the percentage of stock in a loss corporation owned by any person is made on the basis of value (Reg. § 1.382-2T(f)(18)).
      1. Changes in proportionate ownership attributable solely to fluctuations in the relative fair market values of different classes of stock are not taken into account (new § 382(l)(3)(D)).
      1. In determining whether an ownership change has occurred, changes in the holding of certain preferred stock are disregarded.
        1. All "stock" (not including stock described in § 1504(a)(4) is taken into account (new § 382(k)(6)(A)).
        1. The term stock does not include stock that:
          1. Is not entitled to vote,
          1. Is limited and preferred as to dividends and does not participate in corporate growth to any significant extent,
          1. Has redemption and liquidation rights that do not exceed the stock's issue price upon issuance (except for a reasonable redemption premium), and
          1. Is not convertible to any other class of stock. If preferred stock carries a dividend rate materially in excess of a market rate, this may indicate that it would not be disregarded.
      1. In addition, the Treasury Department will promulgate regulations regarding the extent to which stock that is not described in § 1504(a)(4) should nevertheless not be considered stock. For example, the Treasury Department may issue regulations providing that preferred stock otherwise described in § 1504(a)(4) will not be considered stock simply because the dividends are in arrears and the preferred shareholders thus become entitled to vote.