Tax Provisions Related to the New Law: IRS
and Treasury Department Responses to the
Current Credit Crisis
November 20, 2008
Presented by:
Jonathan B. Dubitzky, Esq.
Christopher M. Flanagan, Esq.
Jay Jenkins, Esq.
Douglas S. Stransky, Esq.
Panel
Jay Jenkins
Partner, Corporate and Financings Groups
Moderator for today’s discussion
Christopher M. Flanagan
Partner, Tax Group
Douglas S. Stransky
Partner, Tax Group
Jonathan B. Dubitzky
Counsel, Employee Benefits Group
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
2
Agenda
•
Overview
•
Domestic Provisions
›
›
›
›
•
S Corporation Participation in the CPP
Net Operating Loss Limitation Provisions
Ordinary Losses for Fannie Mae and Freddie Mac Investments
Potential Collateral Effects of Participation in the CPP
International Provisions
›
Attempts to Free Intragroup Sources of Financing
› Extension of Tax Provisions
•
Executive Compensation Provisions
›
Restrictions Imposed Upon TARP Participants
› New Tax Provisions
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
3
Overview
•
Second installment in a series of Sullivan & Worcester Webinars on
legislation responding to the current credit crisis.
•
First Webinar introduced the Capital Purchase Program (“CPP”)
instituted under the Emergency Economic Stabilization Act of 2008
(“EESA”), and reviewed how a financial institution decides whether to
participate in this program.
•
The IRS and the Treasury Department have provided detailed advice
related to both the effect of participation in the CPP and certain other
government investment programs and the credit crisis generally.
›
Common themes: Free-up sources of credit and investment; facilitate
implementation of mergers and acquisitions.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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S Corporation Participation in CPP
•
In our first Webinar, we briefly addressed some uncertainties related
to the participation of S corporations in the CPP. What are the issues
here, and what is the status of the developments in this area?
›
S corps. are tax favored, generally afforded pass-through treatment.
› Certain restrictions in order to qualify for this treatment.
• Single class of stock requirement.
• Qualified shareholder requirement.
›
Issuance of CPP preferred stock would likely violate both of these
requirements. Could cause loss of S corp. status.
› No formal advice yet. Indications are for some form of relief to S corps.
wishing to participate in the CPP.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
5
Section 382 Notices
•
We mentioned in the Overview a Treasury Department goal of
freeing up sources of credit and investment, and facilitating the
implementation of mergers and acquisitions. How does this
relate to the CPP or other government investment programs?
›
IRS and Treasury notices address the application of IRC Section
382 both to participation in government investment programs such
as the CPP and in light of the current credit crisis generally.
• Liberalize the Section 382 limitations that might otherwise present
obstacles or uncertainties in a workout or acquisition transaction.
›
Background on Section 382.
• Limits a corporation’s ability to utilize its tax losses following a more
than 50 percent change in ownership.
• Important consideration in transactions involving the acquisition of or
an investment in a corporation with tax losses.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Section 382 Example
Assumptions:
Company Value
=
$ 50,000,000
Existing NOLs
=
20,000,000
Sale of stock constituting an ownership change
Long term tax exempt rate
=
4.94%
Company Value
$ 50,000,000
L.T. Tax Exempt Rate
4.94%
Annual Section 382 Limitation $ 2,470,000
No. of Years to Use NOLs = 8+
Next Year Without Section 382
Next Year With Section 382
Net Income
$ 5,000,000
NOL Deduction
Taxable Income
(2,470,000)
$ 2,530,000
Tax Rate
Tax
November 20, 2008
35%
$
885,500
Net Income
$ 5,000,000
NOL Deduction
Taxable Income
(5,000,000)
$
0
Tax Rate
Tax
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
35%
$
0
7
Notice 2008-76
›
2008 Housing Act authorized Treasury to purchase Fannie Mae and
Freddie Mac securities.
›
To avoid triggering a Section 382 limitation, suspends the application of
provisions that would otherwise create such a limitation, for periods after
Treasury acquires an equity interest.
• Would otherwise likely result in increased tax liabilities during Treasury’s
ownership period, and make the entities less desirable to future potential
investors.
›
Applies for all periods following the bailout, including potentially after
Treasury ceases to hold any investment in the entity.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Notice 2008-84
›
Expands the principles of Notice 2008-76 beyond Fannie Mae and Freddie
Mac.
›
Effectively turns off the provisions of Section 382 that would otherwise
create a Section 382 limitation while the U.S. government owns a more
than 50 percent interest in the company.
• Applies to a broader group of companies than Notice 2008-76.
• Applies only as long as the government maintains the required interest.
• More than 50 percent interest is measured by vote or value.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Notice 2008-100
›
Provides relief for companies participating in the CPP, particularly where
the government’s interest does not meet the more than 50 percent
requirement of Notice 2008-84.
• CPP applies generally to qualifying troubled financial institutions.
›
Prescribes special rules intended to decrease the likelihood that the
government investment might trigger the application of Section 382
limitations.
• Ignores government ownership of stock in certain situations.
• Does not turn Section 382 off.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
10
Notice 2008-78
›
Eliminates Section 382 provision adversely impacting capital contributions
made within two years of an ownership change.
• Section 382 limitation is based upon a percentage of the subject corporation’s
value.
• Such contributions were generally ignored in calculating this value, resulting in
an artificially low Section 382 limitation.
›
Replaced with a general facts-and-circumstances test. Contributions are
eliminated only if they are part of a plan to increase the Section 382
limitation.
• Provides safe harbors.
• Intended to make it easier for ailing companies to obtain capital.
›
Unlike the prior Notices, is not limited to corporations in which the
government has made a specified investment.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Notice 2008-83
›
Relief to troubled banks on the write-down of their loan portfolios.
›
Bank which has undergone an ownership change not required to treat
subsequent deductions for losses on loans or bad debts as “built-in” losses
from before the change date.
• Permits these deductions without subjecting them to Section 382 limitations that
might otherwise apply.
›
Facilitate investments in or acquisitions of troubled institutions.
• Widely reported that the issuance of this Notice assisted in persuading Wells
Fargo to acquire Wachovia.
›
No stated effective date, implying that it might be able to be applied
retroactively.
›
More detailed discussion of all of these Notices in a Client Advisory posted
on our website, “Internal Revenue Service and Treasury Offer Breaks
under Loss Limitation Rules Amid Financial Crisis.”
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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International Provisions
•
Many U.S. companies own foreign subsidiaries that may have
excess cash. Are there any new opportunities in light of the
credit crisis that would permit the U.S. parent to access this
cash?
›
Repatriation of cash via a dividend may result in U.S. federal (and
possibly state) income tax consequences.
›
Repatriation via a loan possible, but may have consequences
under IRC Section 956.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Notice 2008-91
•
Section 956 treats certain
controlled foreign corporation
(“CFC”) investments in U.S.
property, including loans from a
CFC to a U.S. affiliate, as a
deemed repatriation of earnings
and profits (“E&P”).
•
Notice 2008-91 allows a CFC to
loan to a U.S. affiliate for 60 days
or less without an income
inclusion.
•
A CFC can only make three such
loans in a taxable year.
•
The Notice is elective and will not
apply to the taxable year of a CFC
beginning after December 31,
2009.
US Company
Loan excess cash
CFC
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Other Repatriation Opportunities
•
Is Notice 2008-91 the only repatriation opportunity?
•
The Tax Executives Institute stated in a recent letter to Eric Solomon,
Assistant Secretary of the Treasury for Tax Policy, and Donald L. Korb,
IRS Chief Counsel, that while the recent notice is “welcome and
appropriate” in the context of the financial liquidity crisis, they believe
that additional action is warranted to further expand the time periods
for CFC loans.
•
The IRS is also considering other possibilities with respect to Section
956, e.g., reinstituting an annual test (v. the quarterly test) or an entire
suspension of its application for some limited period of time.
•
There is significant pressure being put on the government to reinstate
Section 965 to again permit the repatriation of foreign earnings at a
reduced U.S. income tax rate (e.g., 5.25%).
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
15
Extension of Look-Through Rules
•
Did the EESA provide any other favorable provisions for U.S.
multinationals?
•
EESA extended the look-through rule for payments between
related CFCs under foreign personal holding company income
rules (extended through 2009).
•
Applies to interest, dividends, rents, and royalties received by
one CFC from a related CFC.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
16
Planning with Section 956 and LookThrough
•
USCo
Step 2:
Loan Excess
Cash to USCo
•
CFC1
(E&P
Deficit)
•
Step 1:
Dividend
CFC2
November 20, 2008
Dividends from a CFC reduce
E&P before calculation of the
CFC’s Section 956 amount.
Previously, this rule was of
limited use because cross-border
dividends generated taxable
Subpart F income.
From a planning perspective,
U.S. multinationals can apply
CFC look-thru to reduce adverse
Subpart F consequences of preSection 956 transaction dividend
distributions.
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
17
Active Financing Income
•
EESA extended the Subpart F exception for active financing
income (extended through 2009).
•
Excludes from Subpart F income derived in the active conduct
of a banking, financing or similar business, active business
gains from sales of commodities, and for “exempt” or “qualified”
insurance income.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
18
Ordinary Loss on Fannie Mae and
Freddie Mac Investments
•
We have spoken about investments being made in companies
in need of capital, and accommodations being made to
facilitate these investments. Are there additional provisions
related to the treatment of companies’ investments that have
been adversely affected by the credit crisis?
›
Section 301 of the EESA allows banks and certain other financial
institutions to treat losses on qualified Fannie Mae and Freddie
Mac preferred stock as ordinary losses.
• Lobbied for by banking associations following bailout.
• Avoids potential limitation on utilization of capital losses.
• Preferred stock held on September 6, 2008 or sold during 2008.
›
Revenue Procedure 2008-64
• Extends coverage to qualified preferred stock held by a partnership or
subsidiary, or received in a “carryover basis” transaction.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Rev. Proc. 2008-26
•
Rev. Proc. 2008-26 sets forth circumstances in which the IRS
will not challenge whether a security is a “readily marketable
security” for purposes of Section 956(c)(2)(J).
•
The term “United States Property” includes an obligation of a
U.S. person, excluding an obligation of a U.S. person to the
extent the principal amount of the obligation does not exceed
the fair market value of readily marketable securities sold or
purchased pursuant to a sale and repurchase agreement or
otherwise posted or received as collateral for the obligation in
the ordinary course of its business by a U.S. or foreign person
that is a dealer in securities.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Rev. Proc. 2008-26
•
The revenue procedure states that current market conditions
and liquidity constraints are creating some uncertainty
regarding whether a security is “readily marketable” for this
purpose.
•
In response to taxpayer’s concerns, the IRS will not challenge
whether a security is readily marketable if the security is of a
type that was readily marketable under ordinary market
conditions at any time within three years prior to the effective
date of the revenue procedure.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
21
Executive Compensation Issues
•
We have all heard that participants in the CPP are potentially
subject to more stringent limitations on executive
compensation. How does this work?
›
›
Concern about levels of executive compensation at companies
receiving taxpayer money through TARP and the CPP.
Sections 111 and 302 of the EESA established special rules for
executive compensation of employers participating in TARP.
•
•
›
November 20, 2008
Treasury authorized to set certain executive compensation
restrictions for participating employers.
New provisions added to IRC Sections 162(m) and 280G.
Notice 2008-94 and Interim Rule 2008-24781 provide additional
guidance in Q&A format.
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
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Executive Compensation Provisions
•
Affected Institutions: The most important category is financial
institutions in which the U.S. Treasury takes a meaningful equity or
debt position whether as a result of purchasing troubled assets or by
acquiring preferred stock (“TARP CPP Participants”). Also includes
other financial institutions (“Affected Sellers”) that sell over $300
million of troubled assets to the Treasury, of which at least some
portion is sold other than by direct purchase (that is, even if Treasury
does not acquire a meaningful equity or debt position in the seller).
•
Relevant Executive: Generally the top five executive officers.
Payments to others are not implicated.
•
Relevant Period: For TARP CPP Participants, so long as the Treasury
maintains its equity or debt position. For other Affected Sellers,
generally only through 2009 (or 2010 if program is extended).
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
23
Expansion of Golden Parachute
Provisions
•
Existing Law: If a public corporation undergoes a change of
control, and in connection therewith makes payments to an
executive that exceed 300% of his “base amount” (average
annual compensation in the preceding five years), then the
excess over 100% of the base amount is (a) nondeductible by
the payor corporation and (b) subject to a 20% excise tax
imposed on the executive.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
24
Expansion of Golden Parachute
Provisions
•
Expansion of Golden Parachute Rules: Golden parachute rules
expanded to include payments made by any Affected Institution to a
Relevant Executive after involuntary severance or in the case of
bankruptcy/insolvency even if no change of control has occurred.
›
Such payments may not be made by a TARP CPP Participant during the
period the Treasury has its meaningful equity or debt stake.
› New agreements providing for such payments may not be entered into by
financial institutions that have sold over $300 million of troubled assets to
the Treasury (unless all such sales are direct purchases).
› Affected Sellers subject to nondeductibility rule (and recipients to 20%
excise tax) if such golden parachute payments are made during 2008, 2009
(or 2010 if extended).
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
25
Extension of IRC Section 162(m)
•
Existing Law: IRC Section 162(m) limits the deductibility of annual
compensation paid to one of the top five public company executives to
$1 million. For these purposes, commissions and qualifying incentive
compensation are not counted.
•
Expansion: Expanded Section 162(m) applies to all TARP CPP
Participant employers and to Affected Sellers. The $1 million limit is
reduced to $500,000.
›
Commissions and incentive compensation are counted.
› Special rules apply in logical manner to deferred compensation (thus,
deferred compensation entitlements for services during a relevant CPP
period continue to carry the Section 162(m) taint even if the deferred
compensation is paid after the CPP rules have generally expired; deferred
compensation vested before CPP period may be paid without restriction).
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
26
Other Executive Compensation
Provisions
•
Participating institutions must take steps to ensure that
incentives are not created for senior executive officers to take
unnecessary and excessive risks that threaten the value of the
enterprise. Under a Treasury notice, guidelines are given for
the compensation committee to audit this matter and certify
compliance.
•
Contractual provisions must be created so that the financial
institution can recover bonus or incentive compensation paid to
a senior executive officer if it later turns out payments were
made based on statements of earnings that proved to be
materially inaccurate.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
27
Implications of All This
•
Reduced compensation tax deductions:
›
•
Severance deals limited to 3X historic annual pay:
›
•
How much does this matter to anyone?
How much does this depart from current deals?
No limits on current executive pay, but some of it may become
nondeductible.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
28
Other Collateral Effects
•
Looking forward, beyond the immediate effects of the capital
infusion accomplished by the CPP, are there any other
potential collateral consequences of Treasury’s investment in a
company under the CPP?
›
IRC Section 382 discussed above.
›
Notice 2008-101 provides that amounts furnished to a financial
institution under TARP, including the CPP, not treated as “federal
financial assistance” under IRC Section 597.
• Might otherwise have been required to be treated as income.
›
Qualification of certain tax-free reorganization structures may be
impacted by presence of Treasury’s preferred stock investment.
• Attributable to definition of control for certain reorganization structures
(primarily related to reverse subsidiary mergers).
• May require restructuring to keep qualified reorganization status.
• Bank of America/Merrill Lynch merger wrestled with this issue.
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
29
Questions?
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
30
Contact Information
Sullivan & Worcester LLP
Please visit our Credit Crisis Task Force profile at www.sandw.com.
Today’s Presenters:
Jonathan B. Dubitzky
jdubitzky@sandw.com
(617) 338-2936
Jon M. Jenkins
jjenkins@sandw.com
(212) 660-3016
Christopher M. Flanagan
cflanagan@sandw.com
(617) 338-2439
Douglas S. Stransky
dstransky@sandw.com
(617) 338-2437
November 20, 2008
Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the
Current Credit Crisis
© 2008 Sullivan & Worcester LLP
31