{"id":23812,"date":"2021-07-23T19:23:12","date_gmt":"2021-07-24T00:23:12","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/?post_type=biws_kb&#038;p=23812"},"modified":"2025-04-01T07:52:00","modified_gmt":"2025-04-01T12:52:00","slug":"section-382","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/section-382\/","title":{"rendered":"Section 382 Limitations and Net Operating Losses (NOLs) in the U.S. Tax Code"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Section 382 Limitations and Net Operating Losses (NOLs) in the U.S. Tax Code<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/section-382\/#Why_Do_Net_Operating_Losses_Matter_in_M_A_Deals\">Why Do Net Operating Losses Matter in M&amp;A Deals?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/section-382\/#What_Do_the_Section_382_Limitations_Say_About_NOLs_in_M_A_Deals\">What Do the Section 382 Limitations Say About NOLs in M&amp;A Deals?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/section-382\/#Section_382_Limitations_in_a_Real-Life_Quarterly_Merger_Model\">Section 382 Limitations in a Real-Life Quarterly Merger Model<\/a><\/li><\/ul><\/nav><\/div>\n\n<blockquote><p><strong>Section 382 Definition:<\/strong> Section 382 of the U.S. tax code states that an Acquirer in an M&amp;A deal structured as a Stock Purchase may use only a limited amount of the Target\u2019s Net Operating Losses (NOLs) to reduce its Taxable Income each year and must write down the remaining NOL balance that will go unused.<\/p><\/blockquote>\n<p>The U.S. tax code is complicated and confusing, and Section 382 is a small part of it that sometimes affects <a href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/merger-model-walkthrough\/\" target=\"_blank\" rel=\"noopener\">merger models<\/a>.<\/p>\n<p>If you want the detailed \u201cacademic\u201d treatment of this term, <a href=\"https:\/\/www.law.cornell.edu\/uscode\/text\/26\/382\" target=\"_blank\" rel=\"noopener\">take a look at Cornell\u2019s summary here<\/a>.<\/p>\n<p>We\u2019re going to focus on the <strong>practical implications in financial models <\/strong>in this tutorial:<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Why_Do_Net_Operating_Losses_Matter_in_M_A_Deals\"><\/span><strong>Why Do Net Operating Losses Matter in M&amp;A Deals?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Traditionally, we discuss <a href=\"https:\/\/breakingintowallstreet.com\/kb\/accounting\/net-operating-losses\/\" target=\"_blank\" rel=\"noopener\">Net Operating Losses (NOLs)<\/a> in the context of a company\u2019s standalone operating performance.<\/p>\n<p>If the company loses money (i.e., negative Pre-Tax Income) in one period, it accrues \u201closses\u201d that it can use to reduce its Taxable Income in future periods.<\/p>\n<p><strong>However, many companies lose money over long periods and build up <em>substantial NOL balances<\/em> that could make them more attractive to potential acquirers<\/strong>.<\/p>\n<div class='code-block code-block-12' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2025\/03\/11231532\/adv-ma-modeling-square.png\" alt=\"Advanced M&A Modeling\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Advanced M&A Modeling for Investment Banking<\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Build a quarterly merger model with variable close dates<\/h4>\n              <p>You\u2019ll learn to build \u201cindustrial-strength\u201d M&A models for real-life deals<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Analyze tax-free spinoff transactions<\/h4>\n            <p>Learn more advanced structures and analyze deals using Sum-of-the-Parts valuation<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Model majority-stake acquisitions<\/h4>\n            <p>Understand the model setup and how the EPS accretion\/dilution is counterintuitive<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/advanced-ma-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Advanced-MA-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div>\n<\/div>\n\n<p>But it\u2019s not as simple as an Acquirer finding a Target with a huge NOL balance and then acquiring the Target and \u201ctaking\u201d all its NOLs.<\/p>\n<p>First of all, the transaction must be structured as a <strong>Stock Purchase<\/strong> rather than an Asset Purchase or 338(h)(10) Election (a deal type specific to the U.S. tax code).<\/p>\n<p>A \u201cStock Purchase\u201d means that the Acquirer gets all the Target\u2019s Assets and Liabilities <em>and<\/em> all its off-Balance Sheet line items.<\/p>\n<p>But in an \u201cAsset Purchase,\u201d the Acquirer selects the specific Assets it wants to acquire and the specific Liabilities it will assume, and it pays for <em>only<\/em> the Assets Acquired \u2013 Liabilities Assumed:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-23813 size-full\" title=\"Stock Purchases vs. Asset Purchases\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075110\/01-Stock-Purchases-vs-Asset-Purchases.jpg\" alt=\"Stock Purchases vs. Asset Purchases\" width=\"756\" height=\"467\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075110\/01-Stock-Purchases-vs-Asset-Purchases.jpg 756w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075110\/01-Stock-Purchases-vs-Asset-Purchases-300x185.jpg 300w\" sizes=\"(max-width: 756px) 100vw, 756px\" \/><\/p>\n<p>These transaction structures also create tax implications in models.<\/p>\n<p>The main one is that the depreciation &amp; amortization on asset write-ups is <strong>not<\/strong> cash-tax-deductible in Stock Purchases but <strong>is<\/strong> deductible in Asset Purchases.<\/p>\n<p><strong>Also, in an Asset Purchase or 338(h)(10) deal, the Target\u2019s Net Operating Losses are written down 100%, so the Acquirer CANNOT use them after the deal closes.<\/strong><\/p>\n<p>Therefore, if an Acquirer finds a Target with a huge NOL balance, it <em>must<\/em> purchase the Target with a deal structured as a Stock Purchase \u2013 or the Target\u2019s NOLs will be useless.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"What_Do_the_Section_382_Limitations_Say_About_NOLs_in_M_A_Deals\"><\/span><strong>What Do the Section 382 Limitations Say About NOLs in M&amp;A Deals?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Section 382 says that the maximum allowable annual usage of a Target\u2019s NOLs equals the Equity Purchase Price * the Maximum of the Past 3 Months\u2019 \u201cAdjusted Long-Term Rates.\u201d<\/p>\n<p>For example, let\u2019s say the Target\u2019s <a href=\"https:\/\/www.mergersandinquisitions.com\/enterprise-value-vs-equity-value\/\" target=\"_blank\" rel=\"noopener\">Equity Value<\/a> or Market Cap is $500 million. This Target also has $100 million in NOLs.<\/p>\n<p>The Acquirer offers a 20% premium for the Target, so the Equity Purchase Price is $600 million.<\/p>\n<p>The \u201cAdjusted Long-Term Rates\u201d are determined by the IRS (the tax agency in the U.S.), and <a href=\"https:\/\/apps.irs.gov\/app\/picklist\/list\/federalRates.html\" target=\"_blank\" rel=\"noopener\">you can find a monthly list here<\/a>.<\/p>\n<p>These rates are close to the current Federal Funds Rate, or the interest rate that banks charge each other to borrow money. The Federal Reserve normally sets this rate.<\/p>\n<p>So, if the Adjusted Long-Term Rates over the past 3 months were 1.0%, 1.5%, and 2.0%, the Acquirer in this deal could use:<\/p>\n<ul>\n<li>$600 million * MAX(1.0%, 1.5%, 2.0%) = $600 million * 2.0% = $12 million per year of the Target\u2019s NOLs<\/li>\n<\/ul>\n<p>Would the Acquirer have to write down any portion of the Target\u2019s NOL balance in this case?<\/p>\n<p><strong>We don\u2019t know because we don\u2019t know when the Target\u2019s NOLs expire \u2013 and there\u2019s always an expiration date, which depends on the country and region (state\/province).<\/strong><\/p>\n<p>For example, let\u2019s say that the Target\u2019s NOLs expire 20 years after the deal closes.<\/p>\n<p>Since 20 * $12 million = $240 million, which is greater than the Target\u2019s balance of $100 million, the Acquirer will be able to use all the Target\u2019s NOL before they expire.<\/p>\n<p>Therefore, it will not write down any portion of the NOLs in this case.<\/p>\n<p>On the other hand, let\u2019s say that the NOLs expire 5 years after the deal closes.<\/p>\n<p>In this case, 5 * $12 million = $60 million, which is <em>less than<\/em> the Target\u2019s balance of $100 million.<\/p>\n<p>Therefore, the Acquirer cannot use all the Target\u2019s NOLs, so it will have to write down $100 million \u2013 $60 million = <strong>$40 million<\/strong> when the deal closes.<\/p>\n<p><strong>The bottom line is that if an Acquirer wants to do a deal because of the Target\u2019s NOLs, it will have to scrutinize the expiration date(s) of those NOLs before making an offer to acquire the Target.<\/strong><\/p>\n<p>Otherwise, the Acquirer could end up with an expensive asset that\u2019s not very useful.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Section_382_Limitations_in_a_Real-Life_Quarterly_Merger_Model\"><\/span><strong>Section 382 Limitations in a Real-Life Quarterly Merger Model<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>In a real merger model, you would apply Section 382 by finding the Target\u2019s Net Operating Losses and calculating how much the Acquirer could use each year:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-23814 size-large\" title=\"Merger Model - Allowable NOL Usage\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/02-Merger-Model-Allowable-NOL-Usage-1024x323.jpg\" alt=\"Merger Model - Allowable NOL Usage\" width=\"1024\" height=\"323\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/02-Merger-Model-Allowable-NOL-Usage-1024x323.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/02-Merger-Model-Allowable-NOL-Usage-300x95.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/02-Merger-Model-Allowable-NOL-Usage-768x242.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/02-Merger-Model-Allowable-NOL-Usage.jpg 1114w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/p>\n<p>In this deal, no write-down is necessary because the Acquirer can easily apply the Target\u2019s entire NOL balance before the NOLs expire.<\/p>\n<p>But if the expiration period were much shorter, such as 3 years, a write-down would be necessary:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter size-large wp-image-23815\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/03-Merger-Model-Allowable-NOL-Usage-Shorter-Expiration-1024x311.jpg\" alt=\"Merger Model - Allowable NOL Usage with Shorter Expiration Period\" width=\"1024\" height=\"311\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/03-Merger-Model-Allowable-NOL-Usage-Shorter-Expiration-1024x311.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/03-Merger-Model-Allowable-NOL-Usage-Shorter-Expiration-300x91.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/03-Merger-Model-Allowable-NOL-Usage-Shorter-Expiration-768x233.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075109\/03-Merger-Model-Allowable-NOL-Usage-Shorter-Expiration.jpg 1113w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/p>\n<p>Continuing with the first scenario here \u2013 the NOLs that expire in 10 years \u2013 we continue with the rest of the model by calculating the Taxable Income for the combined company.<\/p>\n<p>We do this by adding together the Income Statements of the Acquirer and Target and adjusting for acquisition effects, such as the interest paid on new debt, the foregone interest on cash, and the depreciation &amp; amortization on asset write-ups created in the deal.<\/p>\n<p>Since this new D&amp;A is <strong>not<\/strong> cash-tax deductible in a Stock Purchase, the Taxable Income looks like this:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-23816 size-large\" title=\"Taxable Income in a Stock Purchase M&amp;A Deal\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075108\/04-Taxable-Income-Stock-Purchase-1024x279.jpg\" alt=\"Taxable Income in a Stock Purchase M&amp;A Deal\" width=\"1024\" height=\"279\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075108\/04-Taxable-Income-Stock-Purchase-1024x279.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075108\/04-Taxable-Income-Stock-Purchase-300x82.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075108\/04-Taxable-Income-Stock-Purchase-768x209.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075108\/04-Taxable-Income-Stock-Purchase.jpg 1213w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/p>\n<p>Once we\u2019ve calculated the \u201cPre-NOL Cash Taxable Income,\u201d we can apply the amount of NOLs the Acquirer can use in each period.<\/p>\n<p>The annual amount of $21.5 million is divided by 4 since this is a quarterly model:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-23818 size-large\" title=\"Section 382 Limitations on NOL Usage\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075107\/05-Section-382-NOL-Usage-Limitations-2-1024x647.jpg\" alt=\"Section 382 Limitations on NOL Usage\" width=\"1024\" height=\"647\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075107\/05-Section-382-NOL-Usage-Limitations-2-1024x647.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075107\/05-Section-382-NOL-Usage-Limitations-2-300x190.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075107\/05-Section-382-NOL-Usage-Limitations-2-768x486.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2021\/07\/19075107\/05-Section-382-NOL-Usage-Limitations-2.jpg 1202w\" sizes=\"(max-width: 1024px) 100vw, 1024px\" \/><\/p>\n<p>Because the Target\u2019s NOL balance is so small here \u2013 less than $100 million vs. an Equity Purchase Price of $2.5 billion \u2013 it barely makes a difference.<\/p>\n<p>The NOLs are a nice bonus for the Acquirer, but hardly a primary reason to do the deal.<\/p>\n<p>The Section 382 limitations tend to make a bigger difference when:<\/p>\n<p>1) The Target\u2019s NOL balance is large relative to its Equity Purchase Price (e.g., 20%+); and<\/p>\n<p>2) Interest rates are low, so the annual NOL usage is quite limited; and<\/p>\n<p>3) The combined company has positive Taxable Income above the allowable NOL usage in each period.<\/p>\n<p><em>Some<\/em> deals are motivated by the Target\u2019s Net Operating Losses, but they\u2019re not common in most industries.<\/p>\n<p>Even in fields like technology and biotech, where early-stage startups lose huge sums of money, most acquisitions are motivated by companies\u2019 <strong>technology<\/strong> and <strong>intellectual property<\/strong> rather than their tax attributes.<\/p>\n<p>But an Acquirer will never say \u201cno\u201d to the bonus of an NOL balance acquired in a deal \u2013 at least, not if it understands Section 382 of the U.S. tax code.<\/p>\n<p><em><strong>This tutorial is a small taste of the knowledge you&#8217;ll gain in our paid courses. <\/strong><\/em><strong>Breaking Into Wall Street<\/strong><em><strong> uses real-life modeling tests and interview case studies to prepare you for investment banking and private equity interviews \u2013 and a leg up once you win your offer and start working. Find out more about our advanced training by via the button below:<\/strong><\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this lesson, you&#8217;ll learn how the Section 382 limitations on Net Operating Loss (NOL) usage affect M&#038;A deals and determine the transaction structures that Acquirers are likely to use.<\/p>\n","protected":false},"featured_media":29321,"template":"","class_list":["post-23812","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-ma-and-merger-models"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/23812","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/29321"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=23812"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}