Can Tax Losses Be Transferred to Another Company? – Avoid This Mistake + FAQs

Can tax losses be transferred to another company? Yes, but only under strict conditions.

In other words, one company can use another company’s tax losses, but only through specific legal mechanisms like mergers or group filings, and even then there are limits.

According to IRS data, U.S. corporations used roughly $537 billion in net operating loss deductions in a recent year – a huge tax benefit.

Businesses need to navigate complex rules to make it happen. This article breaks down exactly when and how tax losses (net operating losses, or NOLs) can move between companies.

What you’ll learn:

• 🚦 Quick answer & key conditions: The exact scenarios when one company can use another’s tax losses (and the many times it cannot).

• 🏛️ Federal vs. State rules: How federal law allows NOL transfers only via mergers or common ownership, and how state laws differ (with a handy state-by-state table).

• 🏢 C-Corp vs S-Corp: Why C corporations can carry losses forward (with limits) while S corporations pass losses to owners (no transfer to other companies).

• 🔎 IRS codes & cases decoded: A breakdown of key tax codes (Sections 382, 381, 269, etc.) and court rulings that govern loss transfers in mergers, acquisitions, and reorganizations.

• ⚠️ Pitfalls and planning tips: Common mistakes to avoid (like buying a company just for its losses) and how to structure deals to keep valuable losses from disappearing.

When Can You Transfer Tax Losses to Another Company?

Transferring tax losses is only possible in special situations. The tax law doesn’t let you simply “give” or “sell” a loss to an unrelated company.

The losses stay with the company that incurred them – unless there’s a legal combination of the companies or a group filing. In practice, there are two main paths for one company to benefit from another company’s net operating losses (NOLs):

• 1. Merge or Reorganize the Companies: If a company with NOLs merges into or is acquired by another company, the losses may carry over to the surviving entity.

  • The IRS allows NOL carryovers in certain mergers, acquisitions, and reorganizations (under IRC Section 381). Essentially, the loss company becomes part of the profit company (or vice versa), so it’s now one combined taxpayer.

  • However, strict limits apply – notably IRC Section 382, which caps how much of those losses the new combined company can use each year. We’ll explain those limits shortly. In short, yes, tax losses can transfer in a merger, but you must follow the rules (same ownership continuity, etc., described below).

• 2. Join a Consolidated Tax Group: If two companies are in the same corporate group (common ownership), they can file a consolidated tax return. In a consolidated return, the IRS treats affiliated companies as one entity for tax purposes. Losses from one group member can offset profits of another.

  • So if a parent company owns subsidiaries, a subsidiary’s losses can effectively “transfer” to offset the parent’s or another sub’s income within the group return. This isn’t a direct transfer but a result of unified tax filing. The catch: the companies must be affiliated (generally 80% common ownership) to qualify. You can’t consolidate with an unrelated company.

  • Also, if a company with prior losses joins a new group, special Separate Return Limitation Year (SRLY) rules ensure it can’t suddenly use old losses to shield the entire group’s income – it can only use them against its own portion of income.

  • Only companies under the same ownership umbrella can share losses through consolidation.

Outside of these scenarios, one company cannot use another company’s losses. For example, you cannot simply buy a company’s losses without buying the company itself. Tax losses aren’t a commodity you can detach and sell; they are a “tax attribute” tied to the corporate entity.

Even in allowed transfers (mergers or group filings), the IRS imposes conditions to prevent abuse. The policy aim is to stop corporations from “trafficking” in losses just for tax avoidance. If you try to skirt the rules, the losses will be disallowed.

Key Conditions to Use Acquired Losses

When a tax loss is transferred via a merger or acquisition, strict conditions must be met for the acquiring company to actually use those losses:

• Ownership Continuity: Generally, the acquiring company must own a controlling stake in the loss company (or fully merge it). A mere asset purchase won’t transfer NOLs – it must be a stock acquisition or statutory merger so that the loss company’s identity continues in some form. If the loss company is completely absorbed, the new owner must effectively step into its shoes as the same taxpayer for tax purposes.

• Same Business (for some states): Under federal law today, there’s no absolute requirement that the exact same business continue (beyond certain reorganization types). However, some states and older federal cases required a “continuity of business enterprise.” Practically, if after the merger the company completely changes its business, the losses might be at risk (especially in certain states). Generally, the intent should be to continue operating the loss company’s line of business, not just grab the losses.

• Section 382 Limitation (Federal): Whenever a company with NOLs undergoes a significant ownership change (more than 50% change in stock ownership), IRC § 382 kicks in. This rule limits the annual NOL usage post-acquisition. The maximum NOL deduction each year equals roughly the value of the company at the time of change multiplied by a federal interest rate (published monthly). In plain language, if you buy a loss company, you can only use a small portion of its losses each year going forward.

• This prevents a profitable giant from fully soaking up a smaller firm’s big losses in one go. For example, if a loss company is valued at $10 million when acquired and the applicable rate is 4%, the acquiring firm can use at most $400,000 of the NOL per year (plus any unused allowance rolls over).

• Section 382 is a major roadblock to unlimited loss transfers – it ensures the loss is only used against income that the acquired company could have theoretically generated on its own value.

• No “Loss Buying” Motive (Section 269): The tax code (IRC § 269) gives the IRS power to deny the losses entirely if the principal purpose of acquiring a company was to evade or avoid tax (i.e. grabbing its NOLs).

• If a profitable company were to buy a shell corporation only to use its NOL, the IRS can disallow that benefit. Essentially, an acquisition should have a valid business purpose beyond just tax avoidance. Buying a struggling competitor that happens to have losses is okay; buying a defunct company solely for a “tax refund” is not.

In summary, tax losses can transfer via mergers or group filings, but the circumstances are narrow. The government wants to prevent trafficking in losses while still allowing legitimate business combinations to utilize tax attributes. Next, we’ll explore common mistakes to avoid, because trying to get around these rules can easily backfire.

Common Mistakes to Avoid With NOL Transfers

Even when a loss transfer is allowed, there are many pitfalls. Avoid these common mistakes that companies (and their advisors) sometimes make with net operating losses:

• ❌ Buying a company just for its losses: Acquiring a shell corporation that has no business value aside from a big NOL is a recipe for trouble. The IRS will likely view this as a tax-motivated transaction and invoke Section 269 to deny the loss usage.

• At best, Section 382 will severely limit the deduction, often to the point where the purchase wasn’t worthwhile. Don’t treat NOLs like a commodity – they only have value if a real business continues.

• ❌ Triggering an unwanted ownership change: Companies with large NOLs need to be careful with issuing new stock or changing ownership. A greater than 50% cumulative change in ownership (under the complex Section 382 rules) will limit future use of the losses.

• A common mistake is bringing in new investors or owners without monitoring the 382 thresholds. Some firms even adopt “NOL poison pills” (limiting stock transfers) to prevent inadvertent ownership changes. Plan equity moves carefully if you want to preserve NOLs.

• ❌ Not continuing the loss business (in states that require it): Federally, after a merger you can pivot business models without automatically losing NOLs. But some states demand continuity of the loss corporation’s business for the NOL to carry over.

• If you acquire a company for its losses in a state like Arizona or Connecticut and then completely discontinue that line of business, the state may disallow the loss deduction against your other income. Always check state-specific continuity tests. In short, don’t shut down the loss company’s operations right after acquiring it if you expect to use its losses.

• ❌ Merging in the wrong direction: When combining a profitable company and a loss company, the merger’s direction can matter for state taxes. For instance, merging a loss corporation into a profitable one might cause the loss to disappear in certain states (because the loss company ceases to exist).

• Often, the better approach is to merge the profitable company into the loss company – so the loss company survives and keeps its NOL. Companies sometimes botch this and lose the NOL in the process. Structure mergers to preserve the loss entity when possible, especially in states with strict carryover rules.

• ❌ Assuming S corporation losses transfer: A very frequent mistake is thinking an S-corporation’s losses can be sold or used by a buyer. In reality, S-corp losses are personal to the shareholders (they flow through to personal tax returns each year). If you buy an S-corp or its assets, the corporate entity’s prior losses do not carry over to you. We’ll delve more into this below, but never pay for an S-corp’s “tax losses” – you won’t get that benefit as the new owner.

By steering clear of these pitfalls, you can maximize the chance that a legitimate NOL transfer will actually yield tax savings. Now let’s look at some concrete examples of how tax loss transfers play out in real scenarios.

Examples of Tax Loss Transfers in Action

To make these concepts more concrete, here are a few real-world scenarios showing when tax losses can transfer – and when they can’t. Each scenario includes a description and the outcome under tax rules:

As these examples show, context matters enormously. In a genuine acquisition (first scenario), the losses survive but are metered out slowly by the tax code. In a pure tax play (second scenario), the losses turn out to be practically worthless to the buyer. And in entity type mismatches (third scenario), certain losses just can’t transfer at all.

Real companies take these rules very seriously. For instance, during mergers, tax teams model out how much of the target’s NOL can actually be used under Section 382. If the limit makes the NOL usage negligible, that NOL won’t add much value to the deal price. On the other hand, a target with large NOLs and modest value can be attractive – but only if the acquiring company expects consistent future profits to absorb those losses under the annual limits.

Next, we compare how different types of companies and different jurisdictions handle loss transfers.

C-Corporations vs. S-Corporations: Who Can Transfer Losses?

Entity type makes a big difference in how tax losses are treated. Here’s a comparison:

🌐 C-Corporations (Regular Corporations): A C-corp is taxed as a separate entity. If it incurs a net operating loss, that loss stays with the corporation as a carryforward (to offset its own future taxable income). C-corps can generally carry NOLs forward indefinitely at the federal level (with the 80% of income per year limitation). The only way another company can use a C-corp’s loss is by acquiring or merging with that C-corp.

After an acquisition, as discussed, the loss becomes an attribute of the combined entity (subject to Section 382 limits). Within a corporate group, if the C-corp is part of a consolidated return, its losses can offset siblings’ income. Outside of those situations, a C-corp’s NOL cannot benefit any other taxpayer. Notably, shareholders of a C-corp do not directly use the company’s losses on their personal returns. The loss is locked at the corporate level.

👥 S-Corporations (Pass-Through Entities): An S-corp is a flow-through entity for tax purposes – it generally doesn’t pay federal income tax itself. Instead, any profit or loss passes through to its shareholders each year. This means if an S-corp has a $1M loss, that loss is allocated to the owners (in proportion to their shares) to claim on their personal tax returns (subject to basis and at-risk limitations). The S-corp does not accumulate an NOL carryforward at the corporate level. So, can an S-corp’s losses be transferred?

No – at least not in the way C-corp losses can. If someone buys an S-corp or if an S-corp merges into a C-corp, there’s no NOL asset to carry over within the company. The past losses have already been absorbed (or suspended) on the prior owners’ individual returns. In fact, when a corporation converts from S to C status, any unused S-corp losses that shareholders couldn’t deduct (due to basis limits) vanish at the corporate level. They don’t become a NOL for the now-C-corp.

Likewise, if an S-corp with past losses liquidates or is acquired, its prior shareholders might lose any remaining unused losses – and the new corporate owner gets no deduction benefit from those old pass-through losses.

Bottom line: C-corps can carry losses forward and potentially transfer them via acquisitions or mergers, whereas S-corps cannot transfer losses to a new owner because the losses were never the corporation’s to begin with (they belonged to the shareholders each year).

If you’re acquiring a company and hoping to use its losses, you’d generally need it to be a C-corp (or be willing to convert it to one before the transaction, though that has its own complexities). With an S-corp, the focus shifts to the shareholders’ tax situation rather than the company’s.

One extra nuance: If a C-corp with NOLs elects S-corp status, it cannot use those NOLs during its S years. Those NOLs are essentially put on hold. If it later switches back to C status (within a certain time frame), it might regain the ability to use the old NOLs (this is governed by specific rules in the tax code).

This is a rare scenario, but it underscores that C and S status don’t mix losses freely – the tax law keeps them largely in separate buckets.

State-by-State Variations in Loss Transfer Rules

State tax laws add another layer of complexity. While many states follow the federal framework for net operating losses, some states have special rules that affect whether and how NOLs transfer after mergers or ownership changes.

Here is a look at several notable state rules regarding NOL transfers:

These examples show that state treatments vary widely. Some states (like Delaware, not listed above) fully conform to federal rules – if the IRS allows the NOL in a merger, so do they. Other states either decouple from federal NOL rules or have antiquated provisions reminiscent of pre-1954 federal law.

For instance, Arizona and Connecticut still effectively require the old “same business” continuity for NOLs – a rule the federal system abandoned long ago (but Section 382 now plays a similar role in limiting abuse). New Jersey outright prevented NOL transfers for decades, only softening a bit with modern combined reporting. Tennessee has unique merger-specific rules.

What does this mean practically? If you’re planning a merger or acquisition and the target has big NOLs, you must evaluate the state tax impact, not just federal. A deal that makes sense federally could yield no benefit in certain states. Companies often do a state-by-state review to see where the NOLs will survive or where an ownership change resets the clock.

Planning tip: Structure the transaction in a way that optimizes state outcomes. For example, if State X only allows NOL transfer if the loss company is the surviving entity, consider having that entity be the one that continues legally after the merger.

Also, be mindful of which states require separate vs combined reporting, as that affects if one entity’s losses can offset another’s income in that state.

Key Laws and Rulings Governing NOL Transfers

Transferring tax losses touches several key sections of U.S. tax law and has been shaped by important court cases. Here is a breakdown of the most relevant laws and rulings:

• IRC Section 381 – Carryovers in Reorganizations: Section 381 is the foundation that allows tax attributes (including NOLs) to carry over when corporations undergo certain types of tax-free reorganizations (mergers, consolidations, etc.). If a merger meets the criteria of a reorganization (like a statutory merger or consolidation, Type A reorg, etc.), the surviving or acquiring company succeeds to the target’s NOLs (along with other tax items like credits).

  • This provision, added in 1954, ensures that a merger for legitimate business reasons doesn’t wipe out the tax benefit of prior losses. However, Section 381 doesn’t automatically guarantee you can use all those NOLs – it just lets them carry over. The usage is then subject to other limits like Section 382.

• IRC Section 382 – Limitation After Ownership Change: This is the big one. Section 382 limits the annual use of NOLs after a company undergoes an “ownership change.” An ownership change typically means over 50% of the company’s stock (by value) is acquired by new owners (within a 3-year period). After that point, an annual cap applies to pre-change losses.

  • The formula: Value of the loss corporation × IRS long-term tax-exempt rate (~published monthly, often around 3–5%). If the loss company had unrealized built-in gains, there are adjustments, but the key is: you can’t use more than the capped amount of NOL per year. Any unused portion of the cap carries forward (so you eventually might use the losses over many years if you have enough time and income).

  • Section 382 is meant to prevent the trafficking of losses – ensuring that the use of old losses is tied to the corporation’s value at the time of purchase. It also has special sub-rules: for instance, if a loss company has not continued its historic business or if it has big unrealized gains, there are additional complications. In short, Section 382 is why you often see companies with NOLs still paying taxes – the NOL use each year is throttled.

• IRC Section 269 – Acquisitions Made to Evade Tax: Section 269 gives the IRS a broad hammer: if a company acquires control of another corporation (or assets of another) primarily for the purpose of using its losses (or credits), the IRS can disallow those deductions.

• The threshold is “principal purpose,” which can be subjective. The IRS looks at whether the business had substantial activity or assets apart from the tax attributes. Section 269 is not invoked as routinely as 382 (which is automatic), but it’s there to catch egregious cases where essentially a tax shell was bought.

• For example, if a profitable company with no real synergy buys a dormant corporation that only holds a giant NOL, Section 269 could be applied to deny the NOL deduction entirely. This is a deterrent against buying tax benefits with no business motivation.

• IRC Section 172 – Net Operating Loss Basics: This section defines what an NOL is and how carrybacks/carryforwards work. After tax reform changes, corporations (post-2017) generally cannot carry back NOLs and can carry them forward indefinitely, but each year’s usage is capped at 80% of taxable income. While Section 172 doesn’t directly address transfers, it’s the baseline rule that, combined with 381 and 382, dictates how losses are used. Notably, Section 172 states that an NOL deduction is taken by the “taxpayer” that incurred the loss (except as otherwise provided).

• When one corporation succeeds to another’s NOL under Section 381, it effectively becomes the same taxpayer for that purpose. Think of 381 as the exception that hands the baton of the NOL from one taxpayer to another, and 172 then lets the new combined taxpayer use it (subject to limits).

• Libson Shops v. Koehler (U.S. Supreme Court, 1957): This was a seminal court case before the modern laws were in place. In Libson Shops, a profitable corporation sought to use losses from other corporations after a merger. The Supreme Court denied it because the income post-merger was from a business different from the ones that generated the losses.

• The Court introduced the “continuity of business enterprise” requirement: losses can only offset income if the income is from substantially the same business that incurred the loss. While Libson Shops was effectively overridden at the federal level by the enactment of Section 381 (which allowed carryovers in mergers) and later Section 382 (which imposed different limitations), the case’s principle lived on in some state laws (as we saw).

• It’s a reminder that historically the law was concerned that a merger shouldn’t magically make unrelated losses deductible. Today, Section 382 has largely taken over that policing role with a formula rather than a subjective business continuity test (except in states that still use Libson-like rules).

• Other Relevant Rulings: Numerous court cases and IRS rulings have refined the application of these code sections. For instance, New Colonial Ice Co. v. Helvering (1934) was an earlier Supreme Court case establishing that a taxpayer (corporation) can’t deduct another’s losses (the “entity theory” – only the entity that sustained the loss can use it). This case set the stage for requiring statutory provisions to move losses between entities – which we got later on with Section 381.

• There are also special rules like IRC Section 384, which prevents a profitable company from using its own built-in gains to absorb an acquired company’s losses (an anti-abuse rule applicable when a profitable company acquires a loss company and has built-in gains at the time – beyond our scope here, but worth noting the tax code covers many angles).

• The IRS has issued regulations and rulings clarifying how 382 applies in consolidated groups, how to measure ownership changes, etc., which tax professionals painstakingly follow when planning transactions.

In summary, the law tries to balance two things: fairness to businesses (allowing them to carry over losses through legitimate reorganizations) and preventing abuse (making sure losses can’t be traded like a commodity to wipe out someone else’s income).

Understanding these provisions is crucial for any company with significant NOLs that is considering bringing in new owners or merging with another company.

Key Terms Explained

Some jargon and key concepts used in this discussion include:

• Net Operating Loss (NOL): A tax term for when a company’s deductions exceed its income in a given year, resulting in a negative taxable income. An NOL can be carried forward to offset taxable income in future years (and historically could be carried back to prior years). It’s basically a business loss for tax purposes that can reduce taxes in other years.

• NOL Carryforward (Carryover) vs. Carryback: An NOL carryforward means you apply the loss to future years’ profits (reducing future taxable income). A carryback means you apply the loss to past years (and get a refund for taxes previously paid). Current federal law disallows most carrybacks for corporations, so carryforward is the norm. Carryforwards now are generally indefinite (no expiration), but each year’s usage is capped to 80% of that year’s taxable income. Some states still have expiration periods (e.g., 20 years) for NOLs.

• Ownership Change: In the context of Section 382, an “ownership change” occurs when there is more than a 50 percentage point increase in ownership by 5% shareholders within a rolling 3-year period. In simpler terms, if a corporation’s stock ownership shifts significantly (majority change of who owns the company) – for example, a merger, or one big shareholder buying out others – the IRS deems an ownership change to have happened. This triggers the Section 382 limitation on losses incurred before the change. The calculation of ownership change is complex, involving tracking shareholders or groups of shareholders over time.

• Consolidated Return: A single income tax return filed by an affiliated group of corporations (usually a parent corporation and its 80%-owned subsidiaries). Filing consolidated allows the group to combine income, losses, and credits. So, losses from one member can offset income of another in the same tax year. However, pre-consolidation losses of a member are subject to their own limits (so you can’t join a group and instantly use old losses against another affiliate’s income unless certain conditions are met – see SRLY rules). Consolidated returns are a way to effectively share losses within a corporate family, but only available if ownership requirements are met.

• Section 382 Limit: The annual cap calculated under IRC §382 after an ownership change. Often referred to as the “382 limitation,” it’s equal to the value of the loss corporation at the time of ownership change multiplied by the federal long-term tax-exempt interest rate (a rate published monthly by the IRS, typically around a few percent). This figure is the maximum NOL that can be used to offset income each year. Any unused portion of the NOL stays alive and can be used in future years (subject to the same annual cap). If a corporation’s NOL exceeds what can be used during the remaining carryforward period (for instance, if a state has a time limit), some NOL might ultimately expire unused because of 382.

• Tax Attribute: A term for various tax-related items of a taxpayer that have economic value, such as NOLs, credits, capital loss carryovers, etc. In a reorganization, tax attributes like NOLs often carry over to the successor. Attributes are tracked because they can reduce taxable income in other years. The IRS places restrictions (like 382) on certain attributes to prevent manipulation.

• Continuity of Business Enterprise: A concept from tax law (and mergers) meaning the acquiring company continues the target’s business after a reorganization. In the context of NOLs, the old doctrine (Libson Shops) required that the loss-producing business continue in order for the losses to be usable. Modern federal law doesn’t explicitly require continuity of business for NOLs (382 focuses on ownership, not operations). However, continuity of business is still a requirement for a merger to be tax-free and it appears in some state NOL rules. Essentially, it means you keep running the same fundamental business if you want the tax benefits to carry over.

Understanding these terms helps clarify why and how tax losses can (or can’t) be transferred. Next, we summarize some pros and cons of trying to leverage another company’s losses.

Pros and Cons of Transferring Tax Losses

Is pursuing a tax loss transfer strategy worthwhile? Here are some pros and cons to consider:

As shown, transferring losses is not a free lunch. The advantages can be substantial in the right situation – it can turn past setbacks into future tax savings. However, the downsides are the myriad rules ensuring those savings aren’t too easy to grab. Companies must weigh the administrative burden and delayed gratification (small annual deductions) against the cumulative tax benefit of using the losses.

Often, the best approach is to treat any transferable NOL as a bonus rather than a deal driver. If a merger makes sense operationally and there happen to be usable losses, that’s a win. But chasing a loss for tax reasons alone can be a trap if the cons outweigh the pros.

FAQs

Q: Can I use one company’s losses to offset another company’s profits?
A: No. Not unless the companies are legally merged or part of a consolidated tax group. Separate companies file separate taxes, so one’s losses can’t directly reduce another’s taxable income.

Q: If I close my business and start a new company, can the new company use the old NOL?
A: No. When a corporation ceases to exist, its unused losses typically die with it. A brand-new company cannot inherit the predecessor’s tax losses (unless it was a formal reorganization of the same entity).

Q: Can I sell my company’s net operating losses to another firm?
A: No. You can’t outright sell an NOL as an asset. The only way another company can get your loss is by acquiring your company (or merging with it). Even then, tax law limits the use of those losses.

Q: Do losses carry over if my company is acquired by a larger corporation?
A: Yes, the losses carry into the larger corporation if the transaction is structured as a tax-qualified merger or stock acquisition (so your company’s identity continues). However, the Section 382 limit will cap how much of those losses the new parent can use each year.

Q: My S-corp has losses. If a C-corp buys us, can it use those past losses?
A: No. S-corp losses belong to the S-corp’s shareholders (who used them on personal returns). A C-corp buyer gets no benefit from the S-corp’s prior losses. After the acquisition, it’s as if starting without any NOL on the books.

Q: Will an NOL definitely save me taxes in the future?
A: Maybe. An NOL only has value if you generate taxable profits that it can offset. It also must survive any ownership changes and comply with limitations. If the company never returns to profitability, or limits drastically slow usage, the NOL might expire unused (in states with expiration) or simply continue to carry forward without providing immediate benefit. Always project future taxable income to gauge the real value of an NOL.