After amassing losses during the financial crisis, many companies that couldn’t make it through the downturn on their own found themselves bought by companies with stronger balance sheets.
Further, under Section 382 of the Internal Revenue Code, those acquiring companies face major restrictions on carrying forward the net operating losses of the purchased companies. The curbs are so severe that most of the NOLs expire before the acquiring companies can use them, making the target companies less valuable.
How, then, was American International Group, which was essentially taken over by the federal government in 2008, able to carry forward its NOLs in the last quarter for a $17.7 billion accounting gain — the bulk of its $19.8 billion profit?
Thanks to a tax break hatched during the financial crisis, AIG, along with a few other companies taken over by the government, can hold on to NOLs despite the substantial ownership change. The deals have drawn criticism from members of Congress and others who think it’s unfair to give bailed-out companies a free pass on taxes for decades to come. Elizabeth Warren, former chairwoman of the Congressional Oversight Panel and a current Massachusetts candidate for Congress, has called the deal a “stealth bailout.”
Indeed, the deal is especially valuable given the record level of the losses sustained by AIG when it couldn’t cover guarantees it made to other companies prior to the financial crisis.
“It’s an arcane and hard-to-follow way of disguising billion of dollars paid to firms that, for whatever reason, are politically favored,” says J. Mark Ramseyer, a Harvard law professor who wrote a paper on a similar tax treatment given to General Motors when it was taken over. “It’s one thing to announce through TARP that you’re going to give a firm a billion dollars. But if you issue a letter saying that the company can use a net operating loss that they would otherwise lose, that’s harder for people to follow,” he says, referring to the Troubled Asset Relief Program enacted in 2008 by the U.S. government to buy assets and equity from financial institutions to strengthen them. Besides AIG and GM, Citigroup, Fannie Mae, and Freddie Mac got tax breaks as part of their bailouts.
If all companies could hold on to their operating losses following being acquired like AIG can, that would make them much more valuable targets. That’s exactly why the government instituted the limits on NOL carry-forwards after a change of ownership back in 1986. Congress wanted to prevent companies from buying each other merely to traffic in losses for tax gains. Treasury has argued that since the federal government can’t traffic in losses, the rule doesn’t apply to companies it acquires.
“Allowing those companies to keep their NOLs made them stronger businesses, helped attract private capital and further stabilized the overall financial system,” Emily McMahon, the acting assistant secretary for tax policy, wrote in a Treasury blog post March 1. “It would have been counterproductive — and perhaps irresponsible to undermine the stability of those same institutions, at the height of the financial crisis, by imposing a tax code provision that was never intended to apply in this context,” she wrote.
Still, four years later, AIG executives with compensation packages tied to the company’s stock price could profit from the arrangement. The government will also benefit from the increased value of AIG shares as they sell the stock.
In a February 24 research note, analysts at J.P. Morgan estimated that AIG’s deferred tax assets, which are comprised mostly of NOLs but also include some capital losses and some foreign tax credits, were worth about $5 per share.
“It’s unprecedented,” says New York–based corporate tax consultant and regular CFO columnist Robert Willens. “It’s a deal where the party that benefits from the waiver of the rule is the one that’s waiving it. In the private sector, that could never happen.”
On March 8, the U.S. government announced plans to sell a portion of its AIG stock for $29 per share.
Ed Kleinbard, who served as chief of staff of the Congressional Joint Committee on Taxation when the deal was struck, defends the waiver. He argues that since the federal government represents the public, the public collectively owns AIG.
“The government is just new members of Mr. Public buying AIG,” says Kleinbard, who now teaches law at the University of Southern California. “It’s consistent with the purpose of Section 382.”
Beth Braverman is a business journalist based in Scarsdale, N.Y.