This article was originally published in Forbes

I’ve discussed the changes to IRC Section 174 at length in previous articles, warning about the TCJA’s change to research and experimental costs under 174, as well as the IRS finally providing some guidance on how to calculate the capitalization. In 2025, we’re beginning to fully grasp the repercussions for tech companies at all stages of their life cycle.

In my experience over the past 10 years working with growth-stage technology companies, I have encountered many that have net operating losses (NOLs) resulting from expenses related to hiring developers, investing in technology and marketing products. Pre-revenue tech companies raising eight-figure Series B and C fundraising rounds have become accustomed to recording large taxable losses and paying no federal income tax.

Despite a history of losses and growing research and development (R&D) credit carryforwards, many growth-stage companies have been shocked to discover potential corporate income tax liabilities due to limitations resulting from the application of IRC Section 382 (382).

When does Section 382 come into play?

For those unfamiliar with 382, this section of the tax code limits a corporation’s ability to utilize its “prechange” NOLs and other carryforward attributes following an ownership change. Applying 382 and its accompanying regulations can be complex. A 382 ownership change generally occurs when a loss corporation (i.e., a corporation with NOLs, tax credits or other attributes) experiences an aggregate shift in ownership of more than 50% during a three-year testing period.

While a 100% business sale makes it relatively easy to identify a change, the testing period often spans multiple transactions over three years, leading to the potential for “creeping” ownership changes. Moreover, a company may experience multiple ownership changes, each imposing its own limitations on the company’s ability to utilize attributes.

For growing tech companies undergoing successive fundraising rounds, determining whether a change has occurred requires careful analysis. Despite the significant downturn in tech company fundraising that hit the industry, 2024 has seen a resurgence thanks to record fundraising in the artificial intelligence (AI) space. Rapid fundraising rounds, combined with valuation changes due to the terms of successive preferred rounds, can result in a significant shift in ownership — potentially crossing the 50% threshold. Founders and chief financial officers (CFOs) who delay addressing this issue until a liquidity event may face unexpected tax bills due to limitations on NOL availability.

How is the limitation determined?

The calculation of the annual limitation under 382 is determined by a formula involving the implied valuation of the company and the IRS-published long-term tax-exempt rate at the time of the ownership change. While this formula might sound straightforward, factors such as multiple ownership changes and valuation shifts can complicate the calculation.

Why does properly documenting these limitations matter?

Over the past two years, we’ve worked with numerous clients on 382 studies. Here are three key benefits of properly documenting these limitations:

1. Net Unrealized Built-In Gain (NUBIG)

In addition to the annual limitation, companies may be eligible to utilize losses based on NUBIG at the time of the ownership change. Significant built-in gains can materially increase the total post-change limitation. IRS Notice 2003-65 provides safe harbor procedures for identifying NUBIG or net unrealized built-in loss (NUBIL), which are critical for accurate calculations.

2. Due Diligence at Liquidity Events

Growth-stage companies aim to monetize their investments. Maintaining thorough 382 documentation helps ensure that NOLs existing at the time of acquisition can provide value to buyers. Failure to meet 382 documentation requirements may create uncertain tax positions, reducing the company’s valuation during a liquidity event.

3. NOL And R&D Credit Limitations

The Tax Cuts and Jobs Act of 2017 (TCJA) limited NOLs created after Dec. 31, 2017, to offset only 80% of taxable income in future periods. The longer a company has been in existence with rounds of equity funding, the more likely its NOLs are impacted by 382. Companies with pre-TCJA NOLs are of particular concern because these NOLs expire after 20 years.

Additionally, R&D credit limitations restrict corporate taxpayers with liabilities exceeding $25,000 from offsetting more than 75% of their tax liability. By identifying potential limitations early, companies can plan to optimize their use of NOLs and R&D credits within the constraints imposed by 382 and TCJA. This can help avoid surprises and ensure maximum utilization of these valuable tax attributes. Thorough documentation also reassures investors and buyers that the company is managing its tax attributes effectively and proactively.

Key Takeaway

382 is a complex provision of the tax code that affects almost every growth-stage tech company. Preparing for unexpected tax liabilities resulting from 382, as well as the interplay of R&D expense changes created by the TCJA and the One Big Beautiful Bill Act, is a critical step. Collaborating with a tax advisor can help companies be well-prepared and compliant.