Tax
Section 382 and Your Startup's NOLs: The Ownership Change Hiding in Your Series B
A funding round can quietly cap your startup's NOLs under IRC Section 382. The annual limit is your equity value times 3.88%, fixed on the closing date.
By 409.AI Team - 2026-09-03
# Section 382 and Your Startup's NOLs: The Ownership Change Hiding in Your Series B
A company burns through $22 million over five years, carries roughly $22 million of federal net operating losses, and the finance team treats them the way most finance teams do: as money already spent that the IRS will hand back once the business turns profitable.
Then the Series B closes. Nothing about the losses changes. Nothing about the business changes. But somewhere in the closing, the company crossed a line in the tax code, and the NOLs stopped being a $22 million asset available on demand. They became an annuity, released at a fixed dollar amount per year, and that amount was set by a number nobody in the round was thinking about: what the company's equity was worth on the morning of the closing.
That's Internal Revenue Code [Section 382](https://www.law.cornell.edu/uscode/text/26/382), and venture-backed companies walk into it routinely, because the thing that triggers it is the thing startups do on purpose every eighteen months.
The test is cumulative, and three years long
Section 382 doesn't care about the size of any single round. Under §382(g)(1), an ownership change happens when the percentage of stock owned by one or more "5-percent shareholders" has increased by more than 50 percentage points over the lowest percentage those shareholders owned at any point during the testing period. Section 382(i)(1) sets that testing period at a rolling three years ending on the day of any owner shift.
Read that again with a cap table in mind. A Series A that sells a quarter of the company, a Series B eighteen months later that sells another fifth, and a founder secondary in between all land inside the same three-year window, and the test looks at what they did together. No single event looks dangerous. The running total does.
Which stock gets counted matters. Section 382(k)(6)(A) defines stock as stock "other than stock described in section 1504(a)(4)," and [§1504(a)(4)](https://www.law.cornell.edu/uscode/text/26/1504) describes a narrow kind of plain vanilla preferred: nonvoting, limited and preferred as to dividends, non-participating, with redemption and liquidation rights that don't exceed issue price, and not convertible into another class. Venture preferred fails that description on the convertibility prong alone, and usually on voting too. So every Series Seed, A, and B share counts toward the shift.
Options, warrants, and convertible instruments have their own regime. [Treas. Reg. §1.382-4(d)](https://www.law.cornell.edu/cfr/text/26/1.382-4) starts from the position that an option isn't treated as exercised, then treats it as exercised if it meets an ownership test, a control test, or an income test, each of which turns on whether a principal purpose of the arrangement was avoiding or softening an ownership change. The regulation's definition of "option" is deliberately wide: warrants, convertible debt, contingent purchase rights, and stock subject to a risk of forfeiture all sit inside it. Ordinary compensatory grants with customary terms get a safe harbor.
Two practical points fall out of that. First, an instrument issued to fund the business, rather than to manage a tax result, generally isn't a deemed exercise, but the analysis is fact-driven and it belongs with a tax adviser rather than a spreadsheet. Second, and less arguable: when the instrument actually converts, the shares that come out are a real owner shift on that date. If you've been tracking [how convertible notes move your cap table](https://409.ai/articles/convertible-notes-effect-on-409a-valuation) or [what a SAFE does when it converts](https://409.ai/articles/how-safes-affect-your-409a-valuation), you already have most of the data the Section 382 test needs.
The cap is a valuation multiplied by a rate
Here's where this becomes a valuation problem rather than a tax-compliance chore.
Section 382(b)(1) sets the annual limitation at the value of the old loss corporation multiplied by the long-term tax-exempt rate. Section 382(e)(1) defines that value as the value of the corporation's stock *immediately before* the ownership change. Section 382(f) defines the rate as the highest adjusted federal long-term rate in effect for any month in the three-month period ending with the month of the change date, and the IRS publishes it monthly. For ownership changes during September 2026, [Rev. Rul. 2026-17](https://www.irs.gov/pub/irs-drop/rr-26-17.pdf), Table 3, puts the long-term tax-exempt rate at 3.88%.
So take the company above. Say its equity was worth $60 million immediately before the Series B closed. The annual limitation is $60,000,000 × 3.88%, or $2,328,000. Against $22 million of NOLs, that's roughly nine and a half years of full absorption, and only in years profitable enough to use the whole allowance.
Two features of the rules soften that, and two sharpen it. Unused limitation carries forward under §382(b)(2), so a year with no taxable income isn't wasted. Post-2017 NOLs never expire under [§172(b)(1)(A)](https://www.law.cornell.edu/uscode/text/26/172), so the losses aren't destroyed. But §172(a) separately caps the use of post-2017 NOLs at 80% of taxable income, and that limit stacks on top of the Section 382 cap rather than replacing it. In the change year itself, §382(b)(3) prorates the annual limitation by the days remaining after the change date, so a September 15 closing for a calendar-year company yields a little over a quarter of the annual amount for that year.
The valuation is not your 409A, and not your post-money
The number that drives all of this is the fair market value of the company's entire equity on a single date. It isn't the post-money valuation from the term sheet, which is a headline figure derived by multiplying the new preferred price across every share as though common and preferred were worth the same thing. And it isn't the per-share common stock value from your 409A, which is a junior-class number that arrives after allocation and marketability discounts. We've written about [why a 409A comes in below post-money](https://409.ai/articles/why-is-your-409a-valuation-lower-than-post-money-valuation) and [why "409A value" and "fair market value" aren't interchangeable terms](https://409.ai/articles/409a-valuation-vs-fair-market-value); Section 382 needs a third number, a defensible total equity value at a specific moment, which is a valuation engagement in its own right and a common request in acquisition diligence.
The timing consequence is blunt. A company that crosses the 50-point threshold in the middle of a [down round](https://409.ai/articles/down-round-409a-underwater-options-repricing) locks its annual cap to the depressed value, permanently. Recovering later doesn't reset it. The measurement happens once, immediately before the change, and the answer is the answer.
What shrinks the number, and what lifts it
Three provisions push the value down.
Section 382(l)(1)(A) disregards capital contributions made as part of a plan with a principal purpose of avoiding or increasing the limitation. The statute at §382(l)(1)(B) then sweeps in anything contributed within two years of the change date. The IRS softened that in [Notice 2008-78](https://www.irs.gov/pub/irs-drop/n-08-78.pdf), which says a contribution won't be presumed to be part of such a plan solely because it landed in the two-year window, and gives four safe harbors; the test is facts and circumstances instead. Taxpayers may rely on it.
Section 382(e)(2) reduces the value for redemptions and other corporate contractions that occur in connection with the ownership change. A company-funded buyback bolted onto a financing is exactly that, which is one more reason to think carefully before a [tender offer or company-run secondary](https://409.ai/articles/tender-offers-secondary-sales-409a-valuation) rides along with a round.
And §382(c)(1) is the cliff: if the business isn't continued for the two years following the change date, the limitation drops to zero. A hard pivot away from the historic business after a change-triggering financing puts the entire carryforward at risk.
Pushing the other way, §382(h)(1)(A) increases the limitation by recognized built-in gains during the recognition period, which §382(h)(7)(A) sets at five years from the change date. Net unrealized built-in gain counts only if it exceeds the lesser of 15% of the fair market value of the company's assets or $10 million, per §382(h)(3)(B)(i). Startups are unusually strong candidates here, because most of their enterprise value sits in internally developed IP with almost no tax basis. A company that sells or licenses that IP inside the five-year window can lift its annual cap well above the base calculation.
The mechanics for measuring built-in gain still come from [Notice 2003-65](https://www.irs.gov/pub/irs-drop/n-03-65.pdf) and its two safe harbors, the 1374 approach and the 338 approach. That was in doubt for six years: proposed regulations issued in 2019 and revised in 2020 would have obsoleted the notice and made a modified 1374 approach mandatory. On July 2, 2025, Treasury and the IRS [formally withdrew those proposals](https://www.federalregister.gov/documents/2025/07/02/2025-12193/regulations-under-section-382h-related-to-built-in-gain-and-loss-withdrawal) and said they expect to issue a revised proposal after further study. Until that happens, both safe harbors remain available.
NOLs aren't the only thing caught
[Section 383](https://www.law.cornell.edu/uscode/text/26/383) applies the same limitation to unused general business credits under §39, minimum tax credits under §53, and net capital losses under §1212. For an R&D-heavy company sitting on research credit carryforwards, the credits can be the bigger of the two exposures.
One more reason this is getting bigger rather than smaller: the One Big Beautiful Bill Act restored immediate expensing of domestic research costs under new §174A for tax years beginning after December 31, 2024, reversing the capitalization regime that had been suppressing NOL balances at R&D-heavy companies since 2022. The IRS set out the method-change mechanics in [Rev. Proc. 2025-28](https://www.irs.gov/pub/irs-drop/rp-25-28.pdf). Losses are growing again. So is the amount at stake when the threshold gets crossed.
Where this usually surfaces, and when it should
Most founders meet Section 382 in one of two rooms. The first is the audit, where the deferred tax asset and its valuation allowance have to reflect a limitation that may already have happened. The second is acquisition diligence, where the buyer's tax team asks for a Section 382 study before pricing the carryforwards into the deal, and where the answer flows into the [purchase price allocation](https://409.ai/articles/asc-805-purchase-price-allocation-startup-acquisition). Both rooms are years too late to do anything about it.
The useful version of this work is boring and cheap. Keep a running tally of cumulative 5% shareholder movement across the trailing three years, refreshed at every financing, every secondary, and every meaningful conversion. When the total approaches 50 points, commission a Section 382 study before the next closing rather than after it. And make sure someone can produce a supportable total equity value as of the likely change date, because that single number sets the ceiling on every dollar of loss the company has generated. If you need that valuation work done properly, that's what our [409A and business valuation reports](https://409.ai/products/409a) are built for.
Section 382 is one of the few tax outcomes at a startup that's decided entirely by a date and a valuation. You can't renegotiate the rate, you can't undo the shift once the wire lands, and you can't argue the cap upward later. What you can do is know where the three-year total stands before the next term sheet arrives, which takes an afternoon and a current cap table.