February 17, 2009
Authored by: Frank Crisafi
The American Recovery and Reinvestment Act of 2009 (the “Act”) contained a number of tax provisions that are likely to be of particular interest to and will directly impact most, if not all, of our bank and other financial institution clients. One of the tax provisions, the provision increasing the period that a net operating loss (“NOL”) can be carried back from two (2) to up to five (5) years, saw the addition of a provision that will substantially limit the number of taxpayers eligible to take advantage of the expanded carryback period. The new limitation makes it likely that only smaller financial institutions will be able to take advantage of the expanded carryback period allowed by the Act. The Act also repealed (with limited transitional protection) the relief provided in Notice 2008-83 issued by the Internal Revenue Service (“IRS”) in the fall of 2008 that exempted certain losses on loans and foreclosure property incurred by banks from the NOL limitation rules applicable to built-in losses.
Increase in the Net Operating Loss Carryback Period
Original provisions coming out of the tax writing committees of the House and Senate included a provision extending the period in which 2008 and 2009 NOLs could be carried back from two (2) to up to five (5) years. The provision also eliminated the 90% limitation on the use of AMT NOLs that were carried back from 2008 or 2009. The limitations in the original provisions were that the expanded carryback period did not apply (i) if the bank or other financial institution received any money under the Troubled Assets Relief Program (TARP) (ii) to Fannie Mae, Freddie Mac, or (iii) any corporation that is a member of the same affiliated group for income tax purposes as a bank or other financial institution that received TARP funds.
The Act retains the expanded carryback period for NOLs, but only for those generated in 2008 (or, at the election of the taxpayer, taxable years beginning in 2008). Further, only taxapayers that are “eligible small businesses” may take advantage of the expanded carryback period. An “eligible small business” that elects may carryback a 2008 NOL for up to five (5) years. An eligible small business is a taxpayer having less than $15,000,000 in average annual gross receipts for the three (3) years prior to the year in which the NOL occurs. Thus, the usefulness to most financial institutions of the expanded NOL carryback provisions appears to have been severely limited by the change in eligibility requirements.
Repeal of IRS Notice 2008-83
The Act retains the provisions repealing IRS Notice 2008-83 originally included in the House bill and subsequently added to the Senate bill. An explanation of these provisions is set forth below.
The tax law currently limits the use of NOL carryovers if the corporation possessing the NOLs experiences an ownership change with respect to its stock (i.e., a more than 50% shift in the ownership of its stock) measured over a three (3) year period. The limitations also can apply to built-in losses (i.e., losses that economically accrue with respect to a corporation’s assets prior to an ownership change) that exceed a threshold amount and that are recognized for tax purposes after the ownership change occurs. The IRS issued Notice 2008-83 on October 1, 2008, in which it provided that losses recognized by a bank on loans or bad debts that accrued economically prior to an ownership change with respect to a bank’s stock were excepted from the NOL limitations applicable to built-in losses. A number of questions were raised subsequent to the issuance of Notice 2008-83 as to whether (i) Treasury had the authority to issue regulations applicable to particular industries or classes of taxpayers, (ii) such notice was consistent with the provisions of the tax law, and (iii) Treasury complied with appropriate internal procedures in connection with the issuance of the notice. The Act effectively repeals Notice 2008-83 for all ownership changes occurring after January 16, 2009, but the notice will be deemed to have the force and effect of law for (1) all ownership changes occurring on or before such date, and (2) all ownership changes occurring after such date if such change occurs with respect to a transaction that (i) is pursuant to a written binding contract entered into on or before such date, or (ii) was described in a public announcement or in a filing with the Securities and Exchange Commission on or before such date.
TARP Bailout Will Not Trigger NOL limitation Rules
As explained above under IRS Notice 2008-83, an ownership change with respect to a financial institution’s stock will result in the imposition of limitations on the subsequent use of NOLs and built-in losses that arise prior to the ownership change. The Act provides that any ownership change that occurs as a result of a restructuring plan required under a loan agreement or a commitment for a line of credit entered into with the Treasury Department under the Emergency Economic Stabilization Act of 2008 is not subject to the limitations on the subsequent use of NOLs and built-in losses that arise prior to the ownership change.
Other provisions of the Act likely to be of interest to banks and other financial institutions include:
Extension of 1st Year Bonus Depreciation – For most new depreciable assets (other than buildings) placed in service during 2008, The Economic Stimulus Act passed in early 2008 permitted 50% of the cost to be expensed immediately, with the balance recovered under the regular depreciation rules. This special first-year deduction applied both for regular tax and alternative minimum tax purposes. These bonus depreciation rules were to apply only for 2008. The Act extends these rules through 2009.
Extension of Section 179 Expense Amount – The Economic Stimulus Act passed in 2008 increased the amount of eligible purchases that businesses could elect to immediately expense to $250,000 for purchases made during 2008, and also increased the level of purchases at which this benefit would begin to be phased out to $800,000. The new legislation extends these amounts for another year.
Work Opportunity Tax Credit (WOTC) – The list of individuals that are eligible employees for the WOTC is expanded to include “unemployed veterans” (generally defined to include those who have been discharged from active duty within the past 5 years who have been receiving unemployment compensation for at least 4 weeks) and “disconnected youth” (generally defined as those between the ages of 16 and 25 who have not been in school or employed for the previous 6 months and who lack the basic skills to be employable). Employers hiring these individuals during 2009 or 2010 may be eligible for a tax credit of $2,400 per such person hired.
Cancellation of Business Indebtedness – A corporation that satisfies its indebtedness or any other taxpayer satisfying trade or business indebtedness at a discount in 2009 or 2010, which otherwise would result in the recognition of cancellation of debt (COD) income under current law, can elect to defer taxation of the COD income and recognize the deferred COD income ratably over five (5) taxable years beginning with the year 2014. The provisions allowing for the deferral of COD income are quite complex and they include rules (i) limiting the deduction for any original issue discount arising in connection with the issuance of a new or revised debt instrument issued (or deemed issued) in satisfaction of the indebtedness giving rise to the deferred COD income and (ii) accelerating the recognition of deferred COD income in certain cases in which subsequent events have occurred.
S Corporation Banks and Other Financial Institutions
Banks and other financial institutions that have elected to be taxed under the provisions of subchapter S also should be aware that the 10-year period in which built-in gains tax applies to a sale of assets by an S corporation that was formerly a C corporation has been shortened to seven (7) years for asset sales which occur during 2009 or 2010.