october 17, 2008

ECONOMIC STIMULUS AND BAILOUT: WINS AND LOSSES

In response to the economic downturn and credit crisis, the US Treasury Department (“Treasury”) and Internal Revenue Service (“IRS”) have begun to undertake projects and issue guidance to ease the tax burdens that banks and other companies would otherwise be facing as a result of such events. Recent legislation and Treasury and IRS guidance include provisions and policies aimed at:

  • lessening the adverse tax consequences that would otherwise apply to certain bail out programs


  • providing tax incentives to stimulate the economy and lessen the difficulties of the liquidity crunch


  • providing certain penalties related to “excessive” compensation

Following are some of the highlights.

Money Market Share Price Guarantee Program

The Treasury’s Temporary Guarantee Program for Money Market Funds (the “Program”) makes funds available, upon prescribed terms and conditions, to certain money market funds in need of liquidity to repay shareholders upon liquidation of their shares. In October 2008, Treasury announced a technical correction allowing additional money market funds to be eligible to participate in the Program.

In response to practitioners' concern that participation in the Program may raise tax issues for certain money market funds, the following guidance has been issued:

  • Treasury and the IRS, per IRS Notice 2008-92, will not assert that participation by an insurance-dedicated money market fund in the Program causes a violation of the diversification requirements of Internal Revenue Code section (“Section”) 817(h) for any segregated asset account that invests in such participating fund. The notice also provides that Treasury and the IRS will not assert that a fund's participation in the Program causes the holder of a variable contract, supported by a segregated asset account that invests in the fund, to be treated as an owner of the fund.


  • Participation in the program will not, per Notice 2008-81, be treated as a federal guarantee that jeopardizes, under Section 149(b), the tax-exempt treatment of payments by “tax-exempt money market funds” (i.e., money market funds holding enough of their total assets in tax-exempt bonds to be eligible to pay Section 852(b)(5) exempt interest dividends), so that tax-exempt money market funds will maintain their ability to designate exempt interest dividends and the shareholders of such funds can continue to claim the benefits of tax exemption with respect to such exempt interest dividends.

Tax-Exempt Bond Market Relief

Due to ongoing issues with liquidity and credit in the short-term sector of exempt bond markets, the IRS issued Notice 2008-88, which extends through the end of 2009 the relief provided earlier this year permitting government issuers to purchase their own exempt bonds (including purchasing and holding all qualified tender bonds and tax-exempt commercial paper). Absent this relief, repurchases by government issuers would be treated as re-issuance or retirement of the bonds, potentially eliminating the bonds’ tax exempt status.

Other time limits in earlier relief were also extended by the IRS, including, but not limited to, the December 31, 2009, extension of the final date for the purchase of bonds pursuant to a qualified tender right and the final date on which covered waivers of interest rate caps are disregarded.

Controlled Foreign Corporations Lending Flexibility

The IRS, in Notice 2008-91, temporarily liberalized Section 956, making it easier for US companies to meet US liquidity needs by accessing funds accumulated by foreign subsidiaries on a short-term basis without triggering Subpart F deemed dividend income.

The guidance expands, on an elective basis, the short-term financing exception period of Notice 88-108. Obligations that are collected within 60 days, provided the controlled foreign corporation does not hold obligations that would otherwise constitute investments in US property for 180 or more calendar days during the taxable year, will be excluded from the definition of US property.

This relief will apply to only the first two tax years of a foreign corporation ending after October 3, 2008; provided that this relief will not apply to taxable years of a foreign corporation beginning after December 31, 2009.

Net Operating Loss Limitation Rules Liberalized

The Treasury Department’s purchase of financial institution stock, under the Capital Purchase Program, will not be considered an increase in ownership by a five-percent shareholder for purposes of Section 382. Notice 2008-100 further provides that if such shares are redeemed, the shares will be treated as never having been outstanding, for purposes of measuring shifts in ownership. Options and warrants held by Treasury will not be treated as stock and will not be deemed exercised, and preferred stock held by Treasury will be treated as preferred stock under Section 1504(a)(4).

Similarly, in Notice 2008-76, the IRS announced that it will issue regulations providing that the acquisition by the Treasury Department of certain obligations and other securities issued by Fannie Mae and Freddie Mac will not result in a “testing date” that might trigger the application of the Section 382 loss carryover use limitation rules.

Notice 2008-84 provides that a “testing date” may not occur on a date that the United States government holds more than 50 percent of the interests in a loss corporation.

Notice 2008-78 provides relief to corporations by allowing certain contributions to a corporation prior to a change in control to not be presumed to be part of a plan to avoid the loss limitation rules of Section 382. In addition, this notice provides four safe harbors for capital contributions that will not be treated as part of plan to avoid the loss limitation rules of Section 382.

In Notice 2008-83, the IRS announced that any deduction properly allowed after an ownership change to a bank with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) will not be treated as a built-in loss or a deduction that is attributable to periods before the ownership change date, for purposes of Section 382(h). Banks may rely on this notice unless and until the IRS issues additional guidance. The effect of this notice is that such tax deductions will not be subject to a limitation that might otherwise apply to prevent the use of the deductions to offset post-ownership change taxable income. A bank would not need to treat a bad debt loss claimed within the first 12 months of the recognition period as a recognized built-in loss even if the debt was owed to the bank on the ownership change date. Click here for our Alert on this issue.

Relief for Securities Lenders

Revenue Procedure 2008-63 provides relief for securities lenders who use collateral retained for defaulted securities loans to acquire securities that are substantially identical to the securities that were subject to the defaulted securities loan. Under Section 1058, securities lenders are generally allowed tax-free exchange treatment upon the delivery of securities by the borrower upon the maturity of a securities loan. This tax-free treatment was not available prior to the issuance of this Revenue Procedure if the securities lender used collateral to acquire identical securities.

Ordinary Losses for Fannie Mae and Freddie Mac Preferred Stock

Community banks and other qualifying financial institutions that hold Fannie Mae or Freddie Mac preferred stock may treat losses on such stock held on September 6, 2008, or sold or exchanged on or after January 1, 2008, and before September 7, 2008, as ordinary losses. Under prior law, Section 582(c)(1) limited ordinary loss treatment to bonds, debentures, notes and certificates or other evidence of indebtedness by a financial institution described in Section 582(c)(2).

Compensation Reforms

The Emergency Economic Stabilization Act of 2008 (the “Act”) places limits on compensation for certain executives at companies that benefit from the Capital Purchase Program or the Troubled Assets Relief Program (“TARP”) authorized by the Act. Deduction limitations apply to compensation paid to “senior executive officers,” who are generally the top five “named executive officers” whose compensation must be disclosed for SEC reporting purposes. The restrictions also apply to the senior officer counterparts in privately held companies. Depending on the extent and type of bailout, there are two levels of compensation restrictions. See Notice 2008-94 for additional guidance regarding calculation of compensation limitations.

For institutions in which the government obtains a “meaningful” debt or equity position through direct purchases pursuant to the Capital Purchase Program, Treasury and the IRS have provided guidance on executive compensation limitations, which standards continue to apply for as long as the government holds debt or equity in the entity. Any financial institution participating in the Capital Purchase Program must meet certain compensation standards, including:

  • ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution


  • a required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate


  • a prohibition on the financial institution from making golden parachute payments to senior executives


  • an agreement not to deduct executive compensation in excess of $500,000 for each senior executive

Stricter rules apply when the bailout reaches $300 million (determined by including auction purchases of troubled assets) pursuant to TARP. These restrictions amend Section 162(m) by generally reducing the cap on deductible compensation from $1,000,000 to $500,000 per year per senior executive and expanding the definition of golden parachute payments pursuant to Section 280G. In addition, any financial institutions that sell more than $300 million of troubled assets to the Treasury via an auction will be prohibited from entering into new executive employment agreements that include golden parachutes. These second-level restrictions apply for as long as Treasury is authorized to act under the legislation (December 31, 2009) and as extended by Congress.

The legislation also prevents hedge fund managers and others from deferring taxes on compensation payable by an offshore corporation organized in a tax haven. Click here for our Alert on this issue.

Business Tax Incentives

For information about new energy tax incentives, please click here to read our Alert.

Research tax credits are also part of the economic stimulus package. The Section 41 research credit has been extended for two years, through December 31, 2009. For tax years beginning after December 31, 2008, the election to use the alternative incremental method to calculate the research credit can no longer be made. The percentage used in computing the credit under the alternative simplified method is increased to 14 percent.

The package also contains incentives for restaurant improvements and retail space improvements. The 15-year MACRS recovery period for qualified restaurant property that is an improvement to a restaurant is extended to apply to property placed in service before January 1, 2010. The new law also expands the definition of qualified restaurant property to include a building placed in service after December 31, 2008, and before January 1, 2010, if more than 50 percent of the building's square footage is devoted to preparation of, and seating for on-premises consumption of, prepared meals. The 50 percent bonus depreciation deduction allowed under Section 168(k) may not, however, be claimed on any qualified restaurant property.

A new category of MACRS 15-year property, “qualified retail improvement property,” has been created under Sections 168(e)(3)(E)(ix) and 168(e)(9). The property must be an improvement to an interior portion of a building that is nonresidential real property, the interior portion of the building must be open to the general public and used in the retail trade or business of selling tangible personal property to the general public, the improvement must be placed in service more than three years after the building was first placed in service and the improvement must be placed in service during the 2009 calendar year.

Charitable contributions are also affected by the new legislation, which enhances deductions for contributions of food to charitable organizations, as well as for contributions of books and computer equipment to qualifying schools. The period in which these deductions may occur has been extended to December 31, 2009.

The New Markets Tax Credit, aimed at encouraging taxpayers to invest in or make loans to small businesses in economically distressed areas, has been extended through December 31, 2009.