What Is the Section 383 Limitation?
Explore the tax limitation that applies after a corporate ownership change, restricting the new owner's use of the company's prior tax credits and capital losses.
Section 383 of the Internal Revenue Code limits a corporation’s ability to use certain tax attributes, like tax credits and capital loss carryforwards, that existed before a significant change in its ownership. The rule prevents “tax attribute trafficking,” where a profitable company acquires a struggling one mainly to use its accumulated tax benefits.
This regulation is a direct counterpart to Section 382, which restricts Net Operating Losses (NOLs) after the same type of ownership change. When an ownership change triggers Section 382, Section 383 is also activated to limit these other tax attributes.
The Triggering Event An Ownership Change
Section 383 restrictions are activated by an “ownership change,” as defined by Section 382. An ownership change occurs when the stock ownership of one or more “5-percent shareholders” increases by more than 50 percentage points over a “testing period,” based on the fair market value of the stock.
A “5-percent shareholder” is any person or entity holding 5% or more of the corporation’s stock during the testing period. For publicly traded companies, all shareholders owning less than 5% are aggregated and treated as a single 5-percent shareholder to simplify tracking.
The “testing period” is the three-year period ending on a “testing date.” A testing date is any day there is a change in a 5-percent shareholder’s stock ownership, such as through a stock purchase, new stock issuance, or a redemption. On each testing date, the corporation must determine if the 50-percentage-point threshold has been crossed.
These shifts can occur through an “owner shift,” involving changes in stock ownership, or an “equity structure shift,” which is a corporate reorganization like a merger. Both events require the company to test for an ownership change.
Tax Attributes Subject to the Limitation
When a Section 383 limitation is triggered, it curtails the use of pre-existing tax attributes that a company has carried forward from previous years. The rules specify which attributes are affected.
One attribute limited is the net capital loss carryforward. Under Section 1212, if a corporation’s capital losses exceed its capital gains, the excess can be carried forward to offset future gains. Section 383 restricts the annual amount of these pre-change capital losses that can be used.
The General Business Credit (GBC) carryforward, governed by Section 39, is also limited. The GBC combines various business credits, and any unused portion can be carried forward. Section 383 limits the use of GBC carryforwards that existed before the ownership change.
The limitation also applies to Minimum Tax Credit (MTC) carryforwards. These credits originated from the corporate Alternative Minimum Tax (AMT), which was repealed by the Tax Cuts and Jobs Act of 2017. While the repeal made remaining MTCs refundable for a period, any pre-change MTC carryforwards are still subject to the Section 383 limitation.
Foreign Tax Credit (FTC) carryforwards are also subject to the Section 383 limitation. Under Section 904, corporations can claim a credit for taxes paid to foreign governments. If the foreign taxes paid exceed the U.S. credit limit, the excess can be carried forward, but Section 383 caps the use of pre-change FTCs after an ownership change.
Calculating and Applying the Section 383 Limitation
The process for determining the Section 383 limitation is directly linked to the Section 382 limitation. After an ownership change, this calculation determines how much of a company’s pre-change tax attributes it can use annually. The result is a limit on the income that can be offset by these attributes.
The starting point is the Section 382 limitation, found by multiplying the fair market value of the corporation’s stock before the ownership change by the long-term tax-exempt rate. The IRS publishes this rate monthly, and the corporation uses the highest rate from the three-month period ending in the month of the change. For example, a $10 million stock value and a 3% rate yield a $300,000 annual Section 382 limitation.
Next, the Section 382 limitation must first be used to offset any pre-change Net Operating Losses (NOLs). If a company uses $200,000 of its $300,000 limitation to offset NOLs, the remaining $100,000 becomes available for the Section 383 calculation.
This remaining amount is then converted into a “Section 383 credit limitation.” This is done by calculating the tax that would be due on the remaining limitation amount. Using a 21% corporate tax rate, a remaining limitation of $100,000 creates a Section 383 credit limitation of $21,000.
Once the credit limitation is established, the company must apply it to specific tax attributes in a prescribed order according to Treasury Regulation §1.383-1. The limitation is first used against pre-change capital losses. Any remaining credit limitation is then applied to pre-change credit carryforwards in the following sequence:
- Foreign tax credits
- General business credits
- Minimum tax credits
For example, if the credit limitation is $21,000 and the company uses $5,000 for foreign tax credits, only $16,000 is left for general business and minimum tax credits.