The Art of Vulture Investing: Adventures in Distressed Securities Management

APPENDIX 1

Net Operating Loss Carry Forwards

Section 172 of the U.S. Internal Revenue Code of 1986, as amended (the IRC) permits corporations to carry forward net operating losses (NOLs) to offset future income, thereby reducing their federal income tax liability on this future income and significantly improving their cash position. This is often very important for distressed companies—since usually their income is hugely negative up until they restructure. The opportunity this allows for for the new owners to pay reduced income taxes, or no income taxes, can become an important factor.1

A Debtor company’s NOLs can be a valuable asset of the estate, and their availability may help facilitate the future success of the reorganized company since NOLs have the effect of improving after-tax cash flow. However, a Debtor’s ability to use its NOLs may be limited under section 382 of the IRC.

Section 382 of the IRC limits the amount of taxable income that can be offset by a corporation’s NOL carry forwards in any taxable year following an “ownership change.”2 Generally, an “ownership change” occurs if the percentage (by value) of the stock of the corporation owned by one or more 5 percent shareholders has increased by more than 50 percentage points over the lowest percentage of stock owned by such shareholders at any time during the three-year testing period ending on the date of the ownership ...