The determination of the annual limit on the use of a loss corporation’s pre-change losses after an ownership change is a critical element in corporate tax law. This calculation restricts the amount of net operating losses, capital losses, and certain built-in losses that can be used to offset taxable income in post-ownership change years. The annual limitation is generally computed by multiplying the value of the loss corporation’s stock immediately before the ownership change by the long-term tax-exempt rate. For instance, if a corporation’s stock is valued at $1 million before an ownership change and the applicable long-term tax-exempt rate is 3%, the annual limitation would be $30,000.
Establishing this limitation is important because it prevents the trafficking of net operating losses, meaning it stops corporations with large losses from being acquired primarily for the purpose of utilizing those losses against the acquiring corporation’s future income. This helps preserve the integrity of the corporate tax system. Historically, concerns about loss trafficking led to the enactment of various provisions aimed at curbing such abuses, culminating in the current framework, which aims to strike a balance between preventing abuse and allowing legitimate business restructurings to occur.
