Paul L. Caron
Dean


Monday, March 16, 2009

Use the Tax Code to Reclaim the AIG Bonuses

AIG Aaron Zelinsky (Yale 2L & son of Tax Prof Ed Zelinsky (Cardozo)) writes:  Larry Summers: Stop the AIG Bonuses. Yes You Can:

Larry Summers claims that nothing can be done about the AIG bonuses. As a former Secretary of the Treasury, he should know better.

Treasury Secretary Tim Geithner should direct the Commissioner of Internal Revenue to challenge the AIG bonuses as unreasonable compensation under the Internal Revenue Code. Finding the AIG bonuses to be unreasonable compensation would render them nondeductible for federal tax purposes, and would strengthen potential shareholder derivative suits to recapture The Great AIG Giveaway. ...

If the AIG bonuses are determined to be unreasonable compensation, AIG would be unable to deduct such compensation for federal income tax purposes. The American taxpayers would thereby recoup some of the money they advanced to keep AIG solvent, money which wound up instead in the pockets of AIG's managers. Even if AIG does not owe any federal income tax this year, challenging the bonuses as unreasonable compensation prevents AIG from carrying the deduction forward for use as Net Operating Losses (NOLs) to offset future corporate earnings and thereby reduce AIG's future income taxes.

Determining these bonuses to be unreasonable compensation will also benefit AIG's shareholders. Corporate law allows a shareholder to bring a derivative action against the board of a corporation for recovery of excessive executive compensation. These shareholder claims will be buttressed by an IRS determination that the AIG bonuses are unreasonable.

https://taxprof.typepad.com/taxprof_blog/2009/03/use-the-tax-code-to-reclaim-the-aig-bonuses.html

News, Tax | Permalink

TrackBack URL for this entry:

https://www.typepad.com/services/trackback/6a00d8341c4eab53ef0112796dee4128a4

Listed below are links to weblogs that reference Use the Tax Code to Reclaim the AIG Bonuses:

Comments

It's been awhile since I took FIT in law school, but I distinctly remember learning that compensation above $1 million was already non-deductible as a business expense. Did that change?

Posted by: KipEsquire | Mar 16, 2009 6:14:16 AM

One problem....

Why would AIG, with massive losses, care about deductibility? ($165M versus maybe $100B losses)

And if the shareholders sue, they are in effect suing for taxpayer funds.

Better strategy:

1) order the CEO to breach the contracts
2) invite the executives to sue

There would be a mad scramble to sit for jury duty on that trial.

Posted by: save_the_rustbelt | Mar 16, 2009 6:54:15 AM

I am always skeptical of the argument that "nothing can be done" about something. There are tax angles, the possibility of securities law actions, even the possibility if not likelihood that some of these folks were misleading in their testimony preceding the grant of federal assistance. "We can't do anything" most typically means, we don't want to.

Posted by: mike livingston | Mar 16, 2009 7:00:00 AM

Tax bonuses from 70% t0 99%. This is the only way to teach the THIEVES a lesson

Posted by: Basil T Doumas | Mar 16, 2009 8:20:13 AM

Mr. Caron,

Doesn't code section 7217 specifically prohibit the Treasury Secretary from doing what is suggested?

Posted by: Brad | Mar 16, 2009 8:30:23 AM

Maybe I'm not following. Not allowing AIG to deduct the payments helps taxpayers how exactly? The taxpayers are effectively the equity holders of AIG and therefore the negative tax treatment would seem to doubly harm the equityholders (bonuses paid out but cannot be treated as compensation) with no consequences to the recipients of the bonus money. Plus AIG will not be paying income taxes anytime soon. And how could a board be found in violation of a fiduciary duty if the corporation had contractual obligations to pay the bonuses? This seems like a silly argument.

Posted by: William Dexcente | Mar 16, 2009 8:51:10 AM

Whether alone, or in addition to company-level non-deductibility, why not impose a special surtax on the employees of AIG (and similar bailed-out) organizations on 'excessive compensation'?

For example, let the first X amount of W-2 wages be subject to normal tax rules, and any amount exceeding X subject to a special tax of say 80%. X could be set at a very generous amount, say $400,000 (=POTUS salary). Preferably this would all be carried out at payroll, but if the bonuses are already paid out, then require the surtax to be paid by the employee as estimated tax immediately.

This could also be applied to 1099-MISC's for contractors of these organizations.

Posted by: L Edelman | Mar 16, 2009 9:43:01 AM

This would be a good move. Right now, there's a lot of obscurity about who is getting the bonuses -- AIG is in the news for blowing billions on credit derivatives, so the assumption I've heard is that it must be the money-losing people who are getting these bonuses.

But AIG's management has a huge incentive to do what they can to retain their non-trading employees ( http://www.taxrascal.com/why-barney-franks-phony-aig-outrage-is-worse-than-the-bonuses/360/ ), so it's much more likely that that's the explanation. Investigating this would be the best way to find out.

Posted by: TaxRascal | Mar 16, 2009 10:01:57 AM

This sounds really good, except

1. AIG surely will not pay income tax for decades to come, so not allowing this deduction will not harm them.
2. It sounds like the recovery action is against the Board? Is it realistic to get this money from the Board, and if so, the undeserving employees still retain the money.
3. To the extent that this action reduces the future value of AIG, it will be more difficult for the Government to "refloat" the company and get back its capital investment.

My recommendation is to tell employees receiving these bonus that they have a choice, they can keep the bonus or they can keep their jobs. Their choice.

Posted by: Sid Finkel | Mar 16, 2009 2:02:52 PM

Posting here because I'll be damned if I register at HuffPo...

"Even if AIG does not owe any federal income tax this year, challenging the bonuses as unreasonable compensation prevents AIG from carrying the deduction forward for use as Net Operating Losses (NOLs) to offset future corporate earnings and thereby reduce AIG's future income taxes."

That's a bit of an understatement. You don't exactly have to be combing EDGAR to notice that AIG recently posted the biggest corporate loss ever. In fact, you can learn that tidbit without having to leave the HuffPo world:

http://www.huffingtonpost.com/2009/03/02/aig-quarterly-loss-is-617_n_171001.html

In and of itself, this is a dumb idea. AIG isn't gonna be paying any taxes for a long time. Even if AIG were paying taxes, corporate tax rates wouldn't recover enough to compensate for how offensive and grotesque these bonuses are.

No, what is really needed is a special 100% tax at the individual level on these bonuses. AIG itself can't effectively be punished. They already Can't Fail(TM).

As a reminder, while ex post facto regulations are always distasteful, they are only unenforceable in criminal contexts.

Also, why does the post focus on AIG shareholders? I mean, the shareholders of the 20% of AIG not owned by the Fed are indeed hurting, but shareholders are always subject to the whims of a Board of Directors. The outrage is that U.S. taxpayers are subject to the same whims.

This is a truly awful post. I expect more from a Yalie.

Posted by: FAIL | Mar 16, 2009 5:09:42 PM

With all those giant profits AIG is anticipating, I'm sure a denial of deduction will really sting.

Posted by: jpe | Mar 16, 2009 5:24:56 PM

I don't much like the AIG bonuses either but I like using the IRS as a political hammer even less. I don't believe in the slippery slope argument but once the administration uses the IRS to do its bidding, what will stop it from doing even more? Whatever happens with the bonuses, let's leave the IRS out of it. If they find this to be unreasonable compensation, fine. But the IRS should do so on its own, and not prodded by the latest political wind.

Posted by: Pete Terranova | Mar 17, 2009 5:04:45 AM

While this seems like a plausible strategy, even a distant look at the Regs and case law leads one to the conclusion that Section 162(a)(1) is mostly concerned with disguised dividend payments. This problem is not likely to be an issue when there is no extraneous relationship (shareholder-corporation, parent-child, vendor-vendee). See, e.g., Exacto (1999) and Menard's (2009).

One wonders whether such payments might pass the ordinary and necessary acid test under 162.

Posted by: Nutty Tax Prof | Mar 17, 2009 6:15:31 AM

Surely that challenge would fail. There are loads of situations where the board of directors would love to violate their contracts with execs because a failure exec is getting paid big bucks. Golden parachutes are a good example. Those contracts are valid, and their tax deductibility is not challenged because they indeed *are* reasonable business expenses. First, what matters is whether they are reasonable at the time the contract is made and the obligation incurred, not with 20-20 hindsight. Second, you'd have to show that these particular execs were failures, which is quite a different thing from the company as a whole having made mistakes. Third, I would argue that AIG has done very well in the past year. From total insolvency, it has gotten billions in government handouts. The shareholders should be cheering the execs who did that, and paying them a small share of what they obtained is only fair.

Posted by: Eric Rasmusen | Mar 17, 2009 7:01:33 AM

Don't 2Ls still take a tax class. Paul send the article to Prof Zelinsky asking him to grade it for errors. Also as much as I respect your blog Paul, why do you reprint the garbage in the Huffungton Post? Is it purely for humor?

Posted by: Mory | Mar 17, 2009 1:28:56 PM

Today's news stories say that Congress wants to tax the recipients 91% to 100% on these bonuses. I find such an ex post facto confiscation much more troubling than the bonuses themselves.

Congress seems to be violating the very principle they are invoking: Just because our legal system lets you get away with something, that doesn't make it right.

Or, more simply, two wrongs don't make a right.

I would prefer a government that is a cut above "the end justifies the means". With the present attitudes toward legal stability and the rule of law, it's no wonder the stock market is in a funk. Nobody knows what the government will do next, and stock markets hate uncertainty.

Posted by: AMTbuff | Mar 17, 2009 2:23:52 PM

I'm glad to have Charlie Rangel on my side on this issue. He says "It's difficult for me to think of the code as a political weapon."

Lawrence Tribe takes the opposite side. From http://www.salon.com/politics/war_room/feature/2009/03/18/aig/index.html

Rangel, who chairs the House Ways and Means Committee, which is responsible for writing tax code, came out against the idea on Tuesday, saying, "It's difficult for me to think of the code as a political weapon." (Some House Republicans haven't been wild about the idea either, but as the vote over the stimulus showed, their support isn't necessary even for the biggest pieces of legislation.)

Then, there's the issue of whether a tax like this would pass constitutional muster. The Constitution prohibits bills of attainder, which former Supreme Court Chief Justice William Rehnquist defined as, "a legislative act that singled out one or more persons and imposed punishment on them, without benefit of trial."


Harvard Professor Laurence Tribe, who participated in one of the more significant bill of attainder cases in recent memory, has dismissed this concern. Congress, Tribe says, can draft the law in such a way that -- even if it's obvious it's specifically aimed at AIG and its employees -- it's general enough to be constitutional. "The fact that the individuals subject to the tax in its retroactive application would in principle be readily identifiable would not suffice to doom the tax either from a bill of attainder perspective or from a due process perspective," Tribe wrote to the Atlantic's Conor Clarke. "Moreover, the fact that the aim of such a tax would be manifestly regulatory and fiscal rather than punitive and condemnatory, and that the tax would be part of a measure that would be prospective as well as retroactive in its operation, would serve to blunt the force of any bill of attainder challenge."

Posted by: AMTbuff | Mar 19, 2009 7:24:39 AM

This is a touchy situation... I think these guys do owe the American people some payback, but I'm not sure if this is the right way to do it...

http://politic.ology.com/2009/03/19/in-which-i-try-to-wrap-my-head-around-this-aig-business/

-Jared J. H. Catapano (ology.com)

Posted by: Jared J. H. Catapano | Mar 20, 2009 10:33:35 AM

only a liberal would think to use the IRS as a tool of punishment meted out to "unfavorable" (but legal) activities

Posted by: refjohn | Mar 22, 2009 11:26:43 AM