Income taxes are very confusing, but they do benefit taxpayers at times, and yet at other times the taxpayer faces losses that could have been prevented if Washington’s powerhouses had been stopped from meddling.
Such meddling happened with the Internal Revenue Code Sec. 382. In its simplest form, Sec. 382 limits net losses from operations when it comes to the taxable income calculation once a company has changed ownership.
Under Sec. 382, net operating losses can be carried back two years and forward 20 years to offset any taxable income, but only if the majority of a firm had been sold in the market.
“To discourage firms from trying to buy and sell tax deductions, Sec. 382 of the tax code limits the ability of a firm that acquires another company to use the target’s ‘net operating losses’ (NOL’s),” according to the abstract of a Harvard Law School discussion paper, published in April 2011.
Sec. 382 should apply to all firms, be they public, private, or government owned. However, in a number of notices concerning Sec. 382, such as Notices 2008-83, 2008-76, and others, the U.S. Internal Revenue Service (IRS) exempts the U.S. Department of the Treasury from having to comply with Sec. 382 when acquiring and selling corporate stocks under the Emergency Economic Stabilization Act of 2008.
Treasury’s Ability to Solve Tax Problems
Treasury, having acquired ownership in certain banks and corporations, came to the conclusion that if it purchased stock in companies that received Troubled Asset Relief Program (TARP) funds, it may run into problems when selling that ownership because of Sec. 382.
Once put on the block, the new owner of the respective firm wouldn’t be able to use the past net operating losses (NOLs), given the IRS Sec. 382, which might make it more difficult to sell the securities in the stock market.
“Treasury ’solved‘ this problem by issuing a series of ’Notices’ in which it announced that the law [Sec. 382] did not apply,” according to the Harvard Law School discussion paper.
Entities acquired and covered by the Treasury Notices, as they received TARP funds, include General Motors Co. (GM), Chrysler Group LLC, American International Group Inc. (AIG), General Motors Acceptance Corp. (GMAC), more than 600 banks, as well as the two government-sponsored enterprises, Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corp.).
Due to Treasury’s meddling with Sec. 382, tax experts estimated that taxpayer losses would be between $105 billion and $110 billion, while the Jones Day law firm estimated the cost to be close to $140 billion, according to the Harvard discussion paper.
Legality Questioned
The Notices resulted in inquiries and opinions by many tax experts, law professors, and lawyers regarding the specific law or authorization for the exemption under Sec. 382.
“Treasury officials hemmed and hawed and basically claimed that it [their authority] resided in the TARP legislation,” according to a 2009 article on the ataxingmatter blog.
A 2008 entry on the OMB Watch website went even further, questioning the legality of the Sec. 382 action.
“A few weeks ago, we mentioned the Treasury Department’s decision to change a bit of the tax code that would give banks some $140 billion in tax breaks without authorization from Congress. By many accounts, the action was simply illegal,” according to the OMB Watch website entry. OMB Watch is a nonprofit research and advocacy firm.
The Harvard discussion paper presented a perplexed note, a tone professors use when confronted with acts by students that defy intelligence: “We do not address the wisdom of the bailouts. ...We focus on the propriety of the Treasury’s manufacturing a tax break. More generally, we focus on the wisdom of giving a President the ability to invent a tax deduction for his political supporters without answering to the courts or Congress,” the Harvard discussion paper stated.
The Law Is Incontestable
“In fact, the law—arcane in the extreme—does not grant New GM, Citigroup, or AIG any right to the tax benefits they claim,” according to the Harvard discussion paper.
Yes, Treasury assumed the NOLs of the new GM, as well as AIG and Citigroup. Under Treasury ownership, it was legal to reduce taxes on future earnings, but only as long as the U.S. Treasury owned the majority of the stock. But, once Treasury unloaded the stock in the market, the new owner of GM could no longer use the NOLs.
Different situations call for different tax laws, with one of them being that during a debt-for-stock swap, only the assets and not the NOLs of the firm are being sold to the new owner. The losses belong to the selling firm, and it would be illegal for the new owner to buy the losses.
“Conceptually, these tax attributes describe the financial characteristics of a firm; they are not ’things’ that firms can buy and sell,” the Harvard discussion paper explained.
Gifts Not Prohibited Under Tax Code Sec. 382
However, under TARP, Treasury is authorized to hand out gifts, either in the form of funds or NOLs. There is no prohibition under TARP against the type of gift Treasury wants to hand out. By allowing the firm to use the NOLs for reducing future taxes, Treasury bypasses any limits set by Congress.
“The statute establishing TARP authorized Treasury to issue ’regulations and other guidance' to implement it, and Sec. 382(m) authorized Treasury to issue the regulations necessary to implement Sec. 382. The Treasury declared those provisions authority enough,” the Harvard discussion paper argues.
Taxpayer Losses Due to Meddling
AIG’s 2011 fourth quarter and 2011 year-end “net income reflected a U.S. consolidated income tax group deferred tax asset valuation allowance release of $17.7 billion for the quarter and $16.6 billion for full year 2011,” according to AIG’s Feb. 23 press release.
AIG benefited greatly from Treasury’s gift of $17.7 billion, boosting its net earnings to $19.9 billion during the fourth quarter of 2011. For the full year 2011, the tax benefit was $19.1 billion, achieving net earnings of $18.5 billion instead of net losses of $595 million.
GM’s 2011 year-end financial statements didn’t break out the deferred tax due to Treasury’s gift of exempting GM from Sec. 382.
But “at December 31, 2011 deferred tax asset valuation allowances for the U.S. and Canada were $36.4 billion and $3.2 billion,” according to the new GM 10-K Securities and Exchange Commission filing dated Feb. 27, 2012.
Barking Up the Wrong Tree
Tax code experts, lawyers, and academia agree that Treasury skirted the tax code, and it most likely was illegal in some form or another. However, that the deferred tax would be an added benefit for receiving bonuses is certainly not an issue.
Bonuses aren’t a simplistic calculation based just on net income. Net income is made up of revenues and a large number of different expenses. Bonuses are mostly based on some performance-based appraisal system for the lower ranks, and for upper management, on an agreed upon employment contract.
Therefore, the following remark in a Feb. 27 dealbook article on the New York Times website is a little farfetched: “The tax dodge—and let’s be honest, that’s what it is—also will most likely help goose the bonuses of A.I.G.’s employees, some of whom helped create many of the problems that led to its role in the financial crisis.”
