A View of EESA Through Income Tax Glasses
By: THOMAS W. GARTON
December 2008
The Emergency Economic Stabilization Act of 2008 (EESA) and the program set up to administer relief functions under EESA, the Troubled Asset Relief Program (TARP), have been evolving since EESA’s passage on October 3, 2008. Although EESA’s objective was certainty and clarity in tax laws, there still remain some significant income tax questions. For example, as of the date of this writing, it is unclear how an S Corporation bank or an S Corporation bank holding company will be able to participate in the Capital Purchase Program initiated under EESA. Hopefully by publication date, the Treasury will have clarified this question.
In addition to the financial stability and troubled asset aspects that dominate public attention on EESA, the Legislature tacked on more than 250 specific tax provisions. Some changes, such as the executive compensation changes described below, are specific to the efforts to restore financial stability. A number of other changes, such as the Alternative Minimum Tax (AMT) and other amendments described below, fall into a class of miscellaneous modifications of the Internal Revenue Code or extension of otherwise soon-to-expire provisions of the Code.
Executive Compensation Rules for Banks Participating in TARP Programs
In response to taxpayer discontent over perceived excessive executive compensation in large troubled financial institutions, TARP is enforcing specific disincentives relating to excessive executive compensation. The executive compensation rules described below apply to “senior executive officers”—the Chief Executive Officer, the Chief Financial Officer, and the top three most highly compensated employees of the financial institution other than the CEO and CFO.
The existing golden parachute rules of Code Section 280G generally limit deductions for payment of certain extraordinary compensation and impose a surtax on the recipient. Historically these rules have been limited to payments associated with a change in control of the paying corporation. For institutions participating in the Capital Purchase Program (CPP) of TARP, golden parachute rules have been extended by new Section 280G(e) to severance payments made to top executives where the payment is triggered by an involuntary termination or in connection with the employer’s bankruptcy, liquidation or receivership. If an employer financial institution participates in the CPP, these expanded golden parachute rules will apply as long as the Treasury holds equity or debt interests in the institution, even in the absence of a change in control of the employer. The objective is to discourage, or at least make more costly through denial of tax benefits, extraordinary exit compensation paid to top executives of CPP participants.
A second compensation-related tax provision modifies Code Section 162(m). Section 162(m) generally denies a deduction to companies for certain executive compensation in excess of $1,000,000. Under the modification contained in new Section 162(m)(5), this limitation is reduced to $500,000 and can be extended to privately held institutions. Under the CPP rules, an institution that chooses to participate in the CPP will be subject to this new limitation on deduction of compensation paid to a top executive. Like the golden parachute modifications described above, this limitation is applicable while the Treasury holds equity or debt interests in the institution.
The CPP also provides for some nontax-related executive compensation limitations. First, it prevents institutions from providing incentives for their senior executive officers to take unnecessary and excessive risks that threaten the value of the financial institution. Second, the CPP requires that institutions recover any bonus or incentive compensation paid to a senior executive officer that was based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate.
AMT Relief for Individual Taxpayers
The AMT applies to a much broader range of taxpayers today than the limited number of high income taxpayers for whom it was originally intended. The provisions are not indexed for inflation and are long overdue for fundamental adjustment. Although many believe the AMT provisions of the Code continue to cry out for significant update and adjustment, EESA provided a short term patch that eases the burden of AMT for 2008.
Among other technical adjustments, EESA increased the AMT exemption for 2008 to levels above those that would have otherwise applied. This exemption is a measure of income that is not subject to the alternative minimum tax regime. The changes help reduce the burden on AMT taxpayers who arguably were not intended to be covered when AMT was originally enacted.
Miscellaneous Tax Rule Extensions and Amendments
Among the other income tax changes attached to EESA are extensions of otherwise expiring tax provisions and benefits:
There are energy tax breaks in the bill extending special deductions for energy efficient commercial buildings. These extensions will continue through 2013. The renewable energy production credits that have fueled the wind energy generation industry and were slated for expiration at the end of 2008 have been extended. The $500 maximum residential energy-efficient property credit that applies to such improvements as insulation and exterior windows and doors was extended through 2016.
The ability to deduct state and local sales taxes in lieu of claiming a state sales tax deduction in computing federal taxable income expired in 2007, but was extended by EESA through 2009. Similarly, the qualified tuition deduction, which allows eligible taxpayers to deduct higher education tuition and fees, was extended.
A tax benefit directly targeted to defaulting mortgage borrowers was extended to 2012. Generally, a taxpayer whose debt obligations are discharged for less than full consideration are required to recognize income in the amount of the debt forgiveness. The provision that is extended by EESA generally allows homeowners to avoid paying tax on debt forgiveness arising in connection with a foreclosure or mortgage workout on a principal residence.
Takeaway
Understanding fully how TARP will administer EESA, particularly as it relates to community banks and S Corporation banks, will take time. Stay tuned.