Protecting Net Operating Losses in Distressed Investments

The authors of this article provide an overview of the rules pertaining to net operating losses in bankruptcy.

Many businesses recognized significant net operating losses or “NOLs” as a result of the COVID-19 pandemic. The Internal Revenue Code of 1986, as amended (the “Code”), generally allows many types of taxpayers (including individuals, estates and trusts, exempt organizations, and most C corporations) to utilize NOLs to offset taxable income in other tax years, subject to certain limitations. In fact, the CARES Act, as part of COVID-19 relief legislation, relaxed the limitation on carrying back NOLs for the 2018 through 2020 tax years, generally allowing NOLs to be carried back to each of the five taxable years preceding the loss year, in addition to the general rule allowing NOLs to be carried forward indefinitely following the loss year. As a result, NOLs can be valuable tax tool for a loss-recognizing corporation (the “Loss Corporation”).

However, NOLs are not freely transferable. The Code places limits on the extent to which a Loss Corporation may utilize an NOL following a change in ownership. While these limitations can be significant, importantly, there are exceptions for restructuring transactions completed through a bankruptcy proceeding. Accordingly, as with many other aspects of distressed investing, a bankruptcy proceeding may provide a valuable avenue for maximizing and preserving the value of NOLs.

Click here to read the full article written by Matt Ehinger and Michael Ott published in Pratt's Journal of Bankruptcy Law.