Section 382 limits the amount of deduction allowed for net operating losses and built in losses subject to section 382(h). Suppose a corporation subject to section 382 recognizes a built in loss of $100 in Year 1 and can deduct only $20 of the loss due to the section 382 limitation. Is the corporation’s earnings and profits reduced for Year 1 by $20 or by $100? The basic rule for earnings and profits reductions is that they follow taxable income, but there are important exceptions.
The answer lies in Reg. section 1.312-7(b)(1), which states: “A loss (other than a wash sale loss with respect to which a deduction is disallowed under the provisions of prior revenue laws) may be recognized though not allowed as a deduction (by reason, for example, of the operation of sections 267 and 1211 and corresponding provisions of prior revenue laws) but the mere fact that it is not allowed does not prevent decrease in earnings and profits by the amount of such disallowed loss.”
A loss limited by section 382 is recognized and it is not disallowed; its deduction is simply delayed. Therefore, given that the law is clear that a disallowed loss reduces earnings and profits currently, surely a deferred loss should do so. By analogy, losses not deductible due to sections 267 and 1211 currently reduce earnings and profits. The Tax Court has noted that excess charitable contributions that are not deductible due to a percentage limit currently reduce earnings and profits in full. Leon R. Meyer, 46 TC 65 (1966). That percentage limit is somewhat similar to the section 382 limit.
Conclusion. Whether this answer to this question is beneficial to taxpayers is another matter. Sometimes corporations want to have more earnings and profits and sometimes they want less earnings and profits. If they want more earnings and profits, perhaps an alternate argument could be made on this question.
