NY Times: Treasury Bent NOL Rules to Provide $26 Billion to AIG

New York Times Deal Book, Bending the Tax Code, and Lifting AIG’s Profit, by Andrew Ross Sorkin:

Last week, AIG reported a whopping $19.8 billion profit for its fourth quarter. It was a quite a feat for a company that was on its death bed just a little over three years ago, so sick that it needed a huge taxpayer bailout.

But if you dug into the numbers, it quickly became clear that $17.7 billion of that profit was pure fantasy — a tax benefit, er, gift, from the United States government. The company made only $1.6 billion during the quarter from actual operations. Yet AIG not only received a tax benefit, it is unlikely to pay a cent of taxes this year, nor by some estimates, for at least a decade.

The tax benefit is notable for more than simply its size. It is the result of a rule that the Treasury unilaterally bent for AIG and several other hobbled companies in 2008 that has largely been overlooked.

This rule-twisting could deprive the government of tens of billions of dollars, assuming the firm remains profitable. The tax dodge, and let’s be honest, that’s what it is, also will most likely help goose the bonuses of AIG's employees, some who helped create many of the problems that led to its role in the financial crisis.

“We suggest that Congress give its members standing to challenge such manipulation in court,” J. Mark Ramseyer, a Harvard professor, and Eric B. Rasmusen, a professor at Indiana, wrote in a paper last year. The paper provocatively asked: Can the Treasury Exempt Its Own Companies From Tax?.

Here’s the back story: AIG’s tax benefit comes in large part from its immense “net operating losses” during its depths of despair in 2008 before its rescue. The government had to dump $182 billion into the company after it was crippled by bad bets it had made insuring mortgage-backed securities.

The tax benefit comes in the form of something called net operating losses — NOLs in Wall Street parlance — that could be worth more than $25 billion, possibly more. Those losses can be very valuable, in part because companies can spread them over many years to lower or wipe out their income tax bills.

However, according to longstanding tax laws, if a company files for bankruptcy or is taken over, it loses the ability to use its net operating losses. AIG would fit that profile perfectly: on the verge of bankruptcy, the federal government took control of AIG, exchanging its bailout billions for shares in the company. The government — taxpayers — still own 77% of the company, down from 92% three years ago.

Still, the Treasury issued “Notices” exempting AIG from losing its right to make use of its NOLs. In total, the insurer estimated those losses were worth $26.2 billion as of 2009, and it claimed almost $9 billion in other “unrealized loss on investments.” ...

All of this brings us to the inevitable questions: How did this happen? Why would Treasury exempt AIG from the law?    [S]enior Treasury officials said privately that they had exempted AIG because they did not consider the rescue to be a traditional takeover. The original law preventing companies from using the losses after a takeover were intended to prevent corporations from buying failing companies with lots of losses simply for the tax benefits. ...

Prior TaxProf Blog coverage:

• GM's Tax Shelter Not Available to Other Car Makers (or Other Taxpayers) (Aug. 1, 2009)
• GM's Special $45 Billion NOL Provides Lucrative Tax Shelter (Nov. 3, 2010)
• GM's Sweetheart Tax Deal (Feb. 25, 2011)
• AIG Adopts Poison Pill to Preserve $65 Billion NOL (Mar. 23, 2011)
• Ramseyer & Rasmusen: IRS Had No Authority to Waive NOL Rules for GM (June 17, 2011)

(Hat Tip: Rebecca Kysar.)