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that would have been realized had the loss corporation sold its assets at fair market value and reinvested
the proceeds in high-grade tax-exempt securities.

The limitation introduced by IRC Section 382(a) is applicable to all loss corporations unless the loss
corporation is in a bankruptcy, receivership, or a similar proceeding. In these situations, the provisions
of IRC Section 382(a) may no longer apply. Instead, the NOL of the loss corporation may be subject to
the limitations imposed by IRC Section 382(l)(5) or IRC Section 382(l)(6).

In general, the provisions of IRC Section 382(l)(5) apply if the loss corporation has experienced an
ownership change; is in a bankruptcy, receivership, or similar proceeding; and if certain shareholders
and creditors retain at least 50% ownership of the stock. Rather than imposing an annual limitation, as
IRC Section 382(a) does, IRC Section 382(l)(5) requires the amount of the NOL to be reduced by cer-
tain interest deductions on debt that is being converted to stock as a result of the reorganization. fn 7 In
addition, if the corporation experiences another ownership change during the two-year period immedi-
ately following the first ownership change, the IRC Section 382(a) limitation with respect to the second
ownership change is zero. In other words, although the NOL still exists as a tax attribute and may be
used to offset cancellation of debt income, the debtor’s ability to use the NOL against income on a go-
forward basis is eliminated as a result of the second ownership change.

Rather than being subject to the provisions of IRC Section 382(l)(5), the debtor has the option to elect
out of IRC Section 382(l)(5) and adopt the provisions of IRC Section 382(l)(6). In general, IRC Section
382(l)(6) states that the pre-change NOL is limited in a manner similar to that of IRC Section 382(a)
with one primary exception — when calculating the value of the debtor’s stock, the calculation is made
after giving consideration for any surrender or cancellation of creditors’ claims in the transaction that
caused the change of ownership to occur. Section 382(l)(6) must also be adopted if certain shareholders
and creditors do not retain at least 50% ownership of the stock.

Because most acquisitions of a debtor’s operations are effectuated in the form of an asset sale, IRC Sec-
tion 382 would not affect the valuation in most situations where an outright sale of the debtor’s opera-
tions is contemplated. In limited situations, however, where the sale of the debtor’s operations is effec-
tuated as a stock sale, income taxes, and therefore the cash flow, of the debtor’s operations in the hands
of the new owner may be affected by the provisions of IRC Section 382.

The more likely scenario where IRC Section 382 applies is in a reorganization where the shareholders of
the debtor upon reorganization were creditors and shareholders of the debtor at the time the bankruptcy
petition was filed. In this scenario, careful consideration must be given to the provisions of IRC Section
382.

In summary, the professionals associated with the bankruptcy proceeding must make three significant
assessments that relate to the use of a loss corporation’s NOL. The performance of the assessments re-
quires valuation-related analyses, and the results of the assessments affect the value of the debtor’s oper-
ations in reorganization as well as in an outright sale (assuming the sale is executed as a stock sale). The
three significant assessments that must be made are as follows:

fn 7 In particular, the NOL is reduced by interest deductions on converted debt taken for the portion of the taxable year on or before
the date the ownership change occurred and for any taxable year ending during the three-year period preceding the taxable year in
which the change occurred.

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