Tag Archives: policy

Revenue Code Section 382: in the face of a financial crisis

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I gave a presentation in my tax policy seminar today, scratchy throat and all, based on the topic of a paper I am writing for the class. The U.S. Treasury Department intrigued and scared me with some of the moves it made in September and October so I ended up writing my paper on the actions it is taking. In particular, I focus on one notice of guidance issued by the I.R.S. that essentially waives application of a section of the code – 26 U.S.C. 382(h) – for banks only. This waiver is credited with Wells Fargo snatching up Wachovia, which had already agreed to a sale to Citibank. The drama of it all. I estimate Wells Fargo will save about $26 billion in taxes and enlarge itself to boot.

The slides below are followed by my notes, including for the missing slide. Keep in mind that this presentation greatly simplifies one of the most complex sections of the code. Comments are welcome. Enjoy!

  • I am interested in how the tax code is being used to help combat the current financial crises.
  • one place Treasury started was 382, which limits the use of losses and gains by a new loss corporation

We will quickly cover …

The treasury department has been active in identifying trouble spots and issing guidance to corporations to help deflect some of the market turmoil.

  • it started with the rescue of Fannie Mae and Freddi Mac, which remain publicly traded corporations
  • then it was confronted with AIG
  • then it decided to help recapitalize corporations so it gave a safe harbor from the law
  • The last one is the topic of my paper
    • treasury excuses banks from 382(h) which restricts trafficking in built-in losses
    • we’ll come back to this, but first …382

NOL:

  • Occurs when tax-deductible expenses exceed taxable revenues
  • carry back: to offset income during the previous two tax years;
    • OR
  • carry over for a 20 years before they expire.
  • considered a tax asset under GAAP accounting standard and shows as an asset on balance sheets
    • Good example: GM took a $39 billion write-down in September 2007 to realize losses on tax assets that were expiring or it did not expect to redeem.  GM lists â??Other current assets and deferred income taxesâ? in its 10Q. In the August 2008 10Q, it is  $3.58 Billion.Key terminology:

Loss Corporation is entitled to use the loss

  • Old loss corporation is the one that generated the loss before the change date
  • New loss corporation is the one that can use the NOL after the change date

382(b) â?? places annual limits on NOLs after ownership change

Change in ownership is complex

  • Just know it can be triggered by a number of things:
  • sale of the corporation, reorganizations, recapitalization, capital injection, stock transfer, IPO.The old and new loss corp can be the same
  • Assumption here: corporation acquired all at once

Annual limit

  • equal to, or less than, the value of the old loss corporation times the long-term federal tax-exempt bond rate – set by the IRS monthly 4.65%
  • Carryforward allowed, carry back prohibited.
  • Wachovia example: 24.5 Billion * 4.65% = 1.14 Bill.
  • GM example: 3.64 Billion * 4.65% = 169 million

NOLs expire after 20 years.

  • If the annual limit is $5 million dollars due to 382, the maximum deductible amount is $100 million dollars.
  • Wachovia ex: 1.14 Billion * 20 years = $22.79 Bill.
  • GM example: 169 million * 20 years = $3.4 billion – based on market cap on Y! Finance
  • These are the  NOLs that can be utilized by the new loss corporation over the 20 year carry forward term.
  • 382(h): Limits new loss corporations from using net unrealized built-in gains or losse (I’ll cover losses only)
  • Without 382(h), a loss corporation could speed up or slow down recognition of gains or losses.

NUBIL: net unrealized built-in losses

  • includes depreciation, amortization, and depletion.
  • When built-in loss is recognized, that loss is then added to the pre-change NOL carryovers and limited as such.
  • limits are only placed on losses recognized during the five years after the change date.
  • Elements
    • must be accrued at the time of the ownership changes
    • the amount must be substantial (>=15% fmv of the assets or $10mill) â?? de minimis rule
    • recognized within a limited period (five years).
    • After year 5, the built-in losses are carried over without limitation.

Burden on the new loss corp. to establish that a loss recognized during the recognition period is not a RBIL.

IRS Notice 2008-83

  • Waives application 382(h) for banks
  • Applies only to banks
  • Has no termination date

Immediately after the merger is complete

  • Wells can recognize NUBILs it owns through its acquisition of Wachovia
  • apply those losses through carry back mechanism to offset income during the past two tax years.
  • gets a refund check from the I.R.S.

Wells expects to eventually write down $74 Billion in value from Wachovia’s loan portfolio – NUBIL.

  • once recognized, those $74 billion in losses would be attributed to Wells Fargo, rather than Wachovia.
  • immediately be used to offset income
  • Any remaining amount can then be carried over as NOL to subsequent tax years, to offset future gains, either as NOLs that are carried forward or that offset income during a given tax year.

Possible scenario for carryback:

  • Taxable income â?? 2007: $11.6 Billion
    • annual report: 3.57Bill. tax paid / 30.7% effective tax rate
  • Taxable income â?? 2006: $12.7 Billion
    • annual report: $4.23 Billion tax paid / 33.4% effective tax rate
  • Unequal treatment creates macroeconomic distortions.
  • Generally, similarly situated taxpayers should be treated similarly.
  • Others w/ large NUBIL: insurance companies, investment banks, manufacutures, real estate developers or holding companies, and

Similarly situated taxpayers can include both small and large corporations and span across different industries because the corporations follow the same tax laws and regulations. It can also be used more narrowly to only apply to companies large or small or only companies within a particular industry. I think it should apply broadly and inclusively.

argument for providing the banks (under 581) a bypass around 382(h).

  • perhaps saving the financial system could trump economic efficiency arguments.
  • Counter: Citibank bid for Wachovia without this provision.
    • Citi had the gov’t assume certain risks. Here Wells assumed the risk and paid a premium for Wachovia, versus Citi.
  • Counter what about all the other companies part of the finanical system not covered? And other important industries?

distortions are pushing non-bank financial servicers to become banks or bank holding companies

  • take advantage of tax breaks and other government assistance that is being provided to banks.
  • take advantage of 2008-83.
  • GMAC announced on Nov. 5
  • Amex on Monday
  • Investment banks Goldman Sachs and Morgan Stanley have already received permission to become bank holding companies.
  • Will insurance companies be next?

Moral Hazard â?? taxpayer behavior distorted by removing some risk of failure

Missing slide:

Start by asking what is this regulation intended to correct? Does it actually accomplish that goal or are there other intended or unintended consequences

  • Seems this guidance is intended to help recapitalize banks.
  • If so, compare to other methods to recapitalize banks. Are there better ways? Direct capitalization? Bankruptcy?

Direct capitalization

  • Wells: $74 billion write off – Assume 35% tax rate â?? expect $25.9 billion in taxes lost
  • Is $25.9 billion in lost tax revenue better used recapitalizing Wachovia?

Bankruptcy or receivership?

  • 382 includes a bankruptcy exception that provides what amounts to a waiver of 382.

Creates super bank

  • Is Wells taking risks it would not otherwise take (moral hazard)?
  • What if Wells Fargo is mistaken about the risks inherent in the bank it acquires or their own portfolios?
  • Is it worth the risks to have two banks fail rather than one if there are bigger losses than anticipated in the new loss corporation as a result of the acquisition?

[no notes]

  • Notice 2008-83 has received public attention of Senators from both parties
    Charles Schumer (democrat)
    Charles Grassley (republican)
    Both are upset because Congress was not consulted, yet this will cost hundreds of billions of dollars.

Poor tax policy to give only one industry a waiver to 382(h) requirements.

Better choice?

  • Apply waiver temporarily to all corps that can show the purpose was not to traffic in NOLs
    • require sale of an operating business & business continuity
  • Limits macroeconomic distortions by encouraging investment and recapitalization of all business types
  • Ensures the original intent of Congress, to prevent or limit trafficking in NOLs
  • More administrable than ad hoc regulation directed to correct market failures in one industry or group of corporations
  • Might not be politically acceptable because it will limit Federal revenues and it will

I think it would have also been better for Treasury to insert this into the discussions of the big bailout package since Notice 2008-83 came out while Congress was debating the bailout.

… now for me to finish writing the paper.

Update (12/18/08): I finished the paper. Sources for the information given above is identified in the paper. 🙂

Schwarzenegger: $4.4B in tax hikes to end deficit – Yahoo! News

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Schwarzenegger: $4.4B in tax hikes to end deficit – Yahoo! News.

SACRAMENTO, Calif. â?? Gov. Arnold Schwarzenegger on Thursday proposed $4.4 billion in new taxes and a similar amount in spending cuts to deal with California’s worsening fiscal crisis, saying, “We must stop the bleeding.”

Much of the new revenue would come from a 1.5-percentage-point increase in the sales tax; the Republican governor described the hike as temporary but did not say how long it would last.

“We have a dramatic situation here and it takes dramatic solutions … and immediate action,” Schwarzenegger said as he called the Legislature back into session to deal with the budget shortfall.

The governor said $4.5 billion in cuts will be necessary across all state programs, including education, social services, health care and prisons.

If this goes through, sales taxes in San Jose will be 9.75% (8.25% currently + 1.5%). That might be a bit too much to handle for a lot of people, especially when one of the issues is lower consumption. This also just gives people more incentive to avoid taxes by purchasing through mail order. I think the state government will eventually need to ask for broad pay cuts – yikes – in addition to cuts to services and lay offs.

California: We’re almost out of water

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Calif. to cut water deliveries to cities, farms – Yahoo News.

The Department of Water Resources projects that it will deliver just 15 percent of the amount that local water agencies throughout California request every year.

This is horrible news. Rationing should have started with the drought, followed the snow level, and definitely followed the drier pumps. We had better all pray for a wetter than usual winter.

BTW: Agriculture accounts for about 80% of water used in California.

Dire warnings issued again about the Sacramento and San Joaquin Rivers Delta

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SF Chronicle: Panel issues dire warning on Delta

A task force appointed by the governor warns that California must build new dams, canals and desalination plants and amend its laws or face economic and ecological disaster.

The state must elevate environmental needs for water to a standing equal to that of human needs to restore the state’s ailing water network, a report by the Delta Vision Blue Ribbon Task Force said.

…

In addition to new dams and reservoirs, the plan calls for other measures, including: designating the estuary a National Heritage Area by 2010, increasing the amount of recycled water in the state to 1.5 million acre feet annually and cutting California’s water use 20 percent by 2020.


The goals of this report are laudable. One major problem with the plan is that there is only one truly suitable dam site left in the state – Temperance Flat. We will end up relying on desalination and toilet-to-tap plants, like the one Singapore operates. Although I wonder if such projects will provide enough water for agriculture, which uses 80% of the water in the state.

10 Trillion Reasons

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10 Trillion Reasons, originally uploaded by dfb.

In all this talk about bailing out Wall Street (let’s all call a pig a pig; this is a bailout) nobody is really talking about how we will pay for it. Are those assets really worth $700 billion dollars? I don’t think that anyone can say they certainly are worth that, let alone half that much.

The value of those assets is at the heart of the credit crisis. Banks and other financial firms world-wide do not trust lending to each other because nobody knows how much they really are worth. And because nobody knows what they are worth, they are no longer acceptable collateral to use in securing additional debt obligations, even if for the short term. Which brings me back to my initial point. Nobody is really talking about how we will ultimately pay for this bail out. Who, really, will pay? That’s right, regular tax payers.

Fiscal responsibility seems to escape politicians and Wall Street alike.

I do not understand why the Federal Government needs to pay
for toxic securities, or at least pay up front for them. Why can’t the program accept full portfolios of these fancy securities with no known value, and take on all the risk. If that wipes out the capital of an institution, so be it. The Feds will sort everything out, unbundling the securities and re-packaging them into fully transparent securities that can be adequately valued. Those transparent securities will be sold off. Fifty percent (50%) of the value, after factoring in cost of the program, will go to the Federal Government for taking on the risk. The other 50% to the previous holder of the securities or their creditors.

Every bailout must come with some serious revenge, otherwise what is to stop this same issue from happening again. CEO pay caps and small equity stakes in the firms are a good start. But if we really want them to pay for this and to give strong incentive against future, similar behavior, we need to make them pay more. And in the meantime, maybe, just maybe we can pay down the debt a little and not leave it to our children and grandchildren. Oh, that’s right, wishful thinking. The big spenders in both major parties are more interested in waging war, porking it up, and spreading the wealth around, than in responsibly running our government.

Nouveau Capitalism

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The Merriam-Webster dictionary should add the following entry.

Word: Nouveau capitalism (nou·veau cap·i·tal·ism)
Pronunciation: \nÃŒ-vō-ka-pÉ?-tÉ?-liz-É?m\
Function: noun
Date: 2008
: a capitalist economic system characterized by all the risks taken by the state and all of the rewards taken by private parties.
related:

There are several examples of nouveau capitalism in the news during the past few weeks.

First, the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac were placed into conservatorship by the U.S. government. Both GSEs were and are publicly trade private companies whose debts were guaranteed by the U.S. government. That fact was a moral hazard since the companies’ actions were distorted knowing they could take high risks with little personal repercussions. Well, one good thing did happen in that the existing shareholders’ stock values were diluted when the government took a 79% share of each company as they entered conservatorship.

Then, the Federal Reserve Bank and U.S. Treasury provided an $85 billion loan to the giant insurance company A.I.G. in return for 80% stock, a move that, in effect, it nationalized A.I.G. and likewise diluted existing shareholder value.

Now, the Treasury wants to buy all the toxic, bad debt from the credit and money markets.

$700 Billion Is Sought for Wall Street in Massive Bailout – NYTimes.com.

The ambitious effort to transfer the bad debts of Wall Street, at least temporarily, into the obligations of American taxpayers, was first put forward by the administration late last week, after a series of bold interventions on behalf of ailing private firms seemed unlikely to prevent a crash of world financial markets.

A $700 billion expenditure on distressed mortgage-related assets would be roughly what the country has spent so far in direct costs on the Iraq war and more than the Pentagonâ??s total yearly budget appropriation. Divided across the population, it would amount to more than $2,000 for every man, woman and child in the United States.

Whatever is spent will add to a budget deficit already projected at more than $500 billion next year. And it comes on top of the $85 billion government rescue of the insurance giant, American International Group, and a plan to spend up to $200 billion to shore up the mortgage finance giants, Fannie Mae and Freddie Mac.

Well, seriously folks, the bailout proposed by the Bush administration is more than a bailout. It proposes to take only the most toxic debt off the hands of those holding it. That means, we’ll be left holding the bag entirely while the rewards of better debt will be left in private hands. There has to be a better way. I’m certain of it. I’d like to see the investment bankers and those who profited off the toxic debt cough up some most of their gains as a result of this plan.  Otherwise, what will make people think twice about the consequences of their actions in the future? Why can’t the government just accept all debt from a given portfolio, good and bad? I can barely wait to see how economists and financial industry watchers react to the bailout. I’d also like to hear how Bush, McCain, and Obama, Congress, etc. expect to pay for this. More tax cuts?

btw: if you’re wondering why I’m spending time reading/writing about this when I have other, higher priorities, Fannie/Freddie are subjects of a tax policy paper I’m writing. That, and I can’t help but chime in; that’s my son’s future they’re pissing away. 😉

My First Pottytunity

Digital Converter Box is here

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I used the analog to digital converter box coupon card this past weekend. So now we can still get TV after the super bowl when the transition to digital television is complete. It is an RCA brand converter box.

I don’t generally shop in Wal*Mart (ruthless and toothless); however the converter box cost $10 after the coupon ($50 retail price). That beat the $65 charged by Radio Shack for a no brand item.

The nice thing I found out about this box is that it includes a V-Chip intended to let parents filter out inappropriate content from their youngsters. It is likely that most people who rely on the government coupons to purchase a converter box will not have televisions built since 2000 when the V-Chip was mandated. The program is still a boondoggle, just not as big as I had previously made it out to be.

In case you still are not aware of the television transition, these are the dates you need to be aware of:

  • January 2, 2008 – Digital to analog converter coupon program becomes available. * Coupons are now available.
  • February 17, 2009 – Last day for analog broadcasts.
  • February 18, 2009 – Analog broadcasts will be turned off. Televisions will need a digital tuner, digital-to-analog converter box, or cable/satellite subscription.

You CAN have a sense of humor in the gov’t

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There is a widespread belief that government bureaucrats lack senses of humor and that individuality is discouraged when in the ranks of government. The folks at the Social Security Administration (SSA) disproved that last week in a press release.

“For reasons likely to puzzle baby name experts around the world, American parents have become infatuated by names, particularly for their sons, that rhyme with the word â??maiden.â?Â  …  Social Security spokesman Mark Lassiter indicated that the agency would resist any legislative efforts to standardize the spelling of these names.”

SSA Press Release: Pop Culture Makes Mark on Social Security’s Most Popular Baby Names List

SSA tracks the most popular names born in the U.S. through registrations for Social Security numbers. It publishes its list annually. You can see the most popular names for the past 130 years on its web site.

Race is not always the issue

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I think it is unfortunate for African Americans and others who are non-white that some people choose to blame race whenever something goes wrong in life. For example, consider the reaction to a verdict today in New York regarding three police officers shooting 50 rounds from their guns and killing an unarmed man.

NYPD officers cleared in killing; rights leaders want probe – Yahoo! News
NEW YORK – Civil rights leaders demanded a federal investigation and vowed to march through the streets in protest after three police officers were cleared of all charges Friday in the killing of an unarmed man cut down in a hail of 50 bullets on his wedding day.

The verdict by Justice Arthur Cooperman elicited gasps as well as tears of joy and sorrow. Detective Michael Oliver, who fired 31 of the shots, wept at the defense table, while the mother of victim Sean Bell cried in the packed courtroom. Shouts of “Murderers! Murderers!” and “KKK!” rang out on the courthouse steps.

Two of the three police detectives involved were African-American. I don’t understand the connection to the Ku Klux Klan (KKK) to this case. I can see a strong argument for excessive force but I don’t see much, if any, argument for racism.

It is unfortunate for America when the race card is pulled in a situation like this. In fact, it occurs far too often. Another example comes out of the Motor City. Current Detroit Mayor Kwame Kilpatrick has accused numerous folks of racism in his recent text messaging scandal, even though race doesn’t play a role. He is accused of perjury in his testimony during a lawsuit by former cops (neither white) he had fired because they were looking into corruption. Speaking of Detroit, former Detroit Mayor Coleman Young used it too frequently through the 1970’s and 80’s to retain his hold on political power, meanwhile driving his city further into the ground. Remnants of the antagonistic relationships with other local cities is still evident in local life and politics.

Race comes out too often when it has no relevance to a situation and is used only to raise hackles. But the louder and more frequent these cries are, the more they are ignored. Sadly, it has become a situation much akin to the parable regarding the boy who cried wolf. This was demonstrated by the Jena 6 imbroglio. It took weeks before the mainstream press bothered to cover the story and it is still taking a beating these many months later. That story deserved the discussion about racism that our country should have. But it didn’t and has been largely forgotten by most of America less than a year later.

As Barack Obama recently argued, a discussion about race in America does need to occur. However, I don’t think it can be very constructive in a world in which the little boy who cries wolf about racism is ignored. It is time for people to step back and collect all details about a situation before inferring that racism is a cause and, even then, to be more careful before pulling it out. There are many other reasons beyond racism that may cause a person to say or do something. In the case of the New York City cops killing Sean Bell, I would think that there are many, many other reasons such as fear, the early morning hour, a crowd of mostly intoxicated young men dispersing after an altercation, and society’s love for and access to guns. In the end, I think that America has been desensitized to cries of racism, as unfortunate as that is for us all.

BTW: I think Obama’s speech is well worth watching. I wish someone spoke up and made this many years ago.

McCain: Cutting taxes more important than balanced budget

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I don’t think John McCain subscribes to the belief that: “A deficit today means a tax tomorrow.”

McCain: Cutting taxes more important than balanced budget – Yahoo! News

WASHINGTON – Republican John McCain said Sunday that cutting taxes and stimulating the economy are more important than balancing the budget, and accused both Hillary Rodham Clinton and Barack Obama of supporting tax hikes that would worsen the impact of a recession.

“The goal right now is to get the economy going again,” the GOP presidential nominee-in-waiting said on ABC’s “This Week,” adding that he would put the country “on a path to a balanced budget” by attacking wasteful spending.

What John McCain asks for is not a tax cut, it is a deferred tax. As far as he’s concerned, he won’t need to pay the tax man today (but his kids/grandkids surely will).

The thing I don’t think John McCain or our Congress quite understands is that they are pushing 96% taxes someday in the future to pay for the war they refuse to pay for today. In the end, someone needs to pay for war spending, in addition to all the regular stuff the government spends on domestically. I’d rather we all pay our fair share today through taxes (yes, even increased taxes) than it be forced on my generation later on. If that’s the case, I’d rather the U.S. Government default on its debt obligations today rather than force the younger generations to do so later.

Note: I’m not against trimming or cutting programs, I just think a balanced budget is required before tax cuts can be implemented. The first place I’d cut is Congressional pay. The second is the war in Iraq. What a boondoggle!