Paul L. Caron

Tuesday, February 28, 2012

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

AIGNew 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:

(Hat Tip: Rebecca Kysar.)

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First off, big fan of the blog and have read for years. 2 comments.

1) As noted, the IRS/us/Feds already own most of AIG.

2) These funds are totally fungible - it can no more go just to 'goose bonuses' than it can to 'increase employment' or 'pay SG+A' or 'buy subprime RMBS/CMBS.'

Given the size, most of it will go to buying bonds and similar credit instruments, as it should for a solvent insurer.

Posted by: horn | Feb 29, 2012 5:28:59 PM

ISTM that there is no great ripoff here. AIG did take the losses in question. The de facto acquisition of AIG by the US, as noted, could not transfer the losses to another entity with taxable income, so the rule arguably does not apply.

Furthermore, the US is the 77% owner of AIG, so these tax benefits flow directly back to the US anyway. If AIG could not offset these current profits with the previous losses, AIG would pay taxes to the US. Instead, AIG avoids the taxation, and pays the money to its shareholders - the US! Six of one, half a dozen of the other.

AIG may be retaining these earnings rather than paying them out in dividends - but the improved financial state of the company would be reflected in the increase price of its shares - 77% owned by the US.

So the US collects, no matter what. Not a big problem, IMHO.

Posted by: Rich Rostrom | Feb 29, 2012 10:28:51 AM

Our paper's in print now:

J. Mark Ramseyer and Eric B. Rasmusen,
"Can the Treasury Exempt Companies It Owns from Taxes? The $45 Billion General Motors Loss Carryforward Rule" (with J. Mark Ramseyer), The Cato Papers on Public Policy, Vol. I, article 1 (2011) edited by Jeffrey Miron,

Posted by: Eric Rasmusen | Feb 29, 2012 10:10:21 AM

Isn't this what the equal protection clause is supposed to protect? The laws are supposed to be applied equally, not at the whim of an administrator.

Posted by: Ira | Feb 29, 2012 5:53:38 AM

Why haven't Kristin Hickman and all the other advocates of applying APA review to IRS pronouncements attacked Notice 2008-83? One cannot imagine a more arbitrary and capricious exercise of federal administrative rulemaking authority.

Posted by: Jake | Feb 28, 2012 5:31:56 PM

...if it walks like a duck....

Posted by: ColoComment | Feb 28, 2012 2:23:04 PM