More Importance Being Placed on the Tax Aspects of Corporate M&A

Ernst & Young reviewed the tax aspects of corporate M&A in its second annual Global M&A tax survey and trends. 57% of the tax directors surveyed by Ernst & Young said their companies place more importance on the tax aspects of corporate M&A than they did three years ago. 56% of the tax directors said that the range of tax matters evaluated in a transaction has increased compared to three years ago. Also, 2/3 of these companies now consider the effects of tax planning in their valuations. The results of Ernst & Young’s survey show a positive trend for those working on the tax aspects of corporate M&A deals.

For a summary of the survey results see this link

For the complete report of the survey results see this link

Senators Propose Closing the Stock Option Tax Loophole

In one of my first posts I discussed the tax benefit Facebook will receive from its IPO. Earlier this week Senators Carl Levin and Kent Conrad proposed legislation to do away with what they called “the stock option tax loophole.” Under the senators’ bill, corporations would not be allowed to claim tax deductions for stock options that are larger than the expense they report on their financial statements. The bill would also subject stock options to the same $1 million cap on deductions for executive compensation that currently applies to other forms of compensation. The bill also proposes to close many tax loopholes besides the stock option tax loophole discussed here.

For my previous post on the tax consequences of Facebook’s IPO see this link

For Senator Levin’s statement on the stock option tax loophole see this link

For more information on the complete bill see this summary

Treasury Department Responds to Criticism for Changing NOL Rules in Bailout Context

On Thursday I wrote about the tax benefit given to AIG and GM by the Treasury Department, and on that same day Treasury responded to the criticism it was receiving from many commentators. In a blog post on Treasury’s blog, Treasury Notes, it responded by saying the purpose of Section 382 was not violated in the bailouts. The purpose of Section 382 is to prohibit profitable companies from acquiring companies with large NOL carryforwards and using those NOL carryforwards immediately. The blog post goes on to argue that the government is not a taxpayer so it could not use the NOL carryforwards, and therefore the purpose of Section 382 was not violated. I agree with Treasury’s justification for changing the Section 382 rule in the bailout context, but Treasury had to realize it would be criticized for giving even more benefit to these companies that were just bailed out by the government.

Treasury Gives Tax Benefit to AIG and GM

In two related stories to yesterday’s post on deferred tax assets, a Wall Street Journal article and a New York Times article this week discuss a huge tax benefit the Treasury Department gave to GM and AIG as part of their bailouts. Both GM and AIG had accumulated large NOLs before their bailouts, but a section of the Internal Revenue Code should have limited them from using those NOLs. Section 382 states that a limitation applies to the use of NOLs when a company’s ownership changes by a specified amount. In both circumstances ownership changed enough to trigger this rule when the government bailed out each company, and thus GM and AIG should have been subject to the NOL limitation in Section 382. To avoid this situation Treasury issued a series of Notices in which it stated that the law did not apply. The result of this exception to the rule for GM and AIG was that they had the full access to the use of their NOLs, and could create a deferred tax asset for the future benefit of the NOLs. The articles stated that Senior Treasury officials said they did not believe the bailouts were traditional takeovers, and the justification for the limitation in Section 382 was not present in these non-traditional takeovers. Nonetheless, GM and AIG would not have received this benefit without the help of Treasury in creating an exception to the rules in Section 382 through its series of Notices.

Deferred Tax Assets: The Reason Some Corporations Do Not Want a Reduction in the Corporate Tax Rate

A deferred tax asset is a financial accounting concept on the balance sheet that is recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A deferred tax asset is often created by a net operating loss (NOL) carryforward, which allows the company to reduce taxable income in future years. If a company believes it is more likely than not that some portion or all of the deferred tax asset will not be realized, a valuation allowance must be recognized. The idea behind a deferred tax asset created by a NOL carryforward is that the company will earn enough income in the future to use the NOL carryforward. Therefore, at the time the NOL carryforward was created the company could create a deferred tax asset because it would get the tax benefit in the future.

Two US banks are currently carrying large net deferred tax assets on their balance sheets. On their most recent 10-Ks Citigroup and Bank of America have net deferred tax assets on their balance sheets of $51.53 billion and $31.99 billion, respectively. A deferred tax asset is calculated using the current corporate tax rate. For example, if a company had a NOL carryforward of $100 in a given year, a deferred tax asset of $35 would be created, which is the future benefit the company would receive from the NOL carryforward. This future benefit is calculated by multiplying the $100 NOL carryforward by the maximum corporate tax rate of 35%. President Obama proposed a corporate tax rate reduction from 35% to 28%, which is good news for most corporations, but not for corporations with large deferred tax assets, like Citigroup and Bank of America. Instead of the future tax benefit being a deduction valued at 35%, the future tax benefit will now be 28%, and thus the deferred tax asset will now have a lower value. When these companies are forced to write down the value of their deferred tax assets they must also have a corresponding reduction to their equity on their balance sheet. The negative results of the reduction in equity would be that it would have to be disclosed because the reduction would be material, and could possibly lower the banks’ regulatory capital. Companies with large deferred tax assets on their balance sheets are not lobbying against the corporate tax rate reduction in the public, but they cannot be pleased with the potential negative consequences that will result from a corporate tax rate reduction.

Wall Street Journal Editorial: Obama’s Dividend Assault

A Wall Street Journal editorial explains that the total tax on corporate earnings distributed to shareholders as dividends would be 64.12% under President Obama’s 2013 budget. The current total tax on corporate earnings distributed to shareholders as dividends is 44.75%, which means Obama’s 2013 budget would result in an almost 20% increase. Under Obama’s 2013 budget, the 64.12% number would only apply to single taxpayers with adjusted gross income greater than $200,000 and married couples with adjusted gross income greater than $250,000, but the WSJ editorial argues that this increase will affect all shareholders. The editorial supports this argument with historical evidence that shows corporate dividend payouts are sensitive to the dividend tax rate. The amount of dividends reported on tax returns grew substantially starting when the dividend tax rate dropped to 15% in 2003, and companies that had never paid a dividend before, such as Microsoft, began paying dividends when the dividend tax rate dropped to 15%. The historical evidence from the editorial certainly raises some interesting questions that need to be analyzed before such a large increase in the dividend tax rate takes effect.