BILL ANALYSIS
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THIRD READING
Bill No: AB 11
Author: De Leon (D)
Amended: 7/14/09 in Senate
Vote: 27 - Urgency
SENATE REVENUE & TAXATION COMMITTEE : 6-0, 7/8/09
AYES: Wolk, Alquist, Ashburn, Florez, Padilla, Wiggins
NO VOTE RECORDED: Walters, Runner
ASSEMBLY FLOOR : 75-0, 4/30/09 - See last page for vote
SUBJECT : Corporate reorganization: built-in losses
SOURCE : Author
DIGEST : This bill specifies that Internal Revenue
Service Notice 2008-083, 2008-42 I.R.B. 905, issued on
October 20,2008, relating to the treatment of deductions
under Section 382(h) of the Internal Revenue Code following
an ownership change to a corporation that is a bank, shall
not be applicable for purposes of taxes imposed under the
bank and corporation with respect to any ownership change
occurring at any time.
ANALYSIS : Existing federal law provides for net
operating losses (NOLs). Taxpayers may carry forward
losses in the current taxable year for 20 years, or carry
back for two years, to reduce past or future taxable
income. California mostly conforms to the federal law for
NOLs, and recently authorized NOL carry backs beginning in
CONTINUED
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the 2010 tax year [AB 1452 (Assembly Budget Committee),
2007-08 Session.
Current federal law limits the amount of a taxpayer's
taxable income that may be offset by NOLs generated by a
corporation acquired by the taxpayer - so-called "built-in"
losses. Generally, the taxpayer may use the losses of the
acquired corporation to offset income in an amount equal to
the value of the acquired corporation, measured by the
value of its stock immediately before the acquisition,
multiplied by the long-term tax exempt rate, a base
interest rate computed by the Internal Revenue Service
(IRS). The effect of the limitation reduces the ability of
a taxpayer to shelter income gained in the regular course
of business, thereby reducing taxes due, by acquiring a
corporation with significant losses. Federal law allows
the Treasury Secretary to issue regulations to carry out
the section. California law conforms to this section as of
January 1, 2005.
On October, 20, 2008, the IRS issued notice 2008-83, which
indicated that it is studying the proper treatment under
the federal law guiding built-in losses after an ownership
change for a corporation that is a bank. The notice
further stated that the limitation for built-in losses
under federal law does not apply to banks with respect to
losses on loans or bad debts, including any deduction for a
reasonable addition to a reserve against bad debts, thereby
allowing banks to fully offset income when acquiring loss
corporations. IRS stated that taxpayers may rely on the
notice, which applies to bank acquisitions before and after
the date of the notice. IRS did not consult with Congress
prior to issuing the notice.
Comments
According to the author, "On December 1, 2008, I introduced
AB 11 to protect California's budget from the recent
guidance letter by the U.S. Treasury Department designed to
provide a new federal tax break for bank mergers. While
then-Secretary Paulson may have had substantial reason to
unilaterally rewrite federal tax law to facilitate the
takeover of failing banks, our state's General Fund should
not be adversely impacted by that decision. Unfortunately,
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state law requires the State to conform with Internal
Revenue Service (IRS) tax regulations. California should
take explicit action to ensure that the Franchise Tax Board
does not conform to this ruling. According to Franchise
Tax Board (FTB) estimates, if we were to conform with this
federal tax break, the state would lose approximately $300
Million in tax revenue during the current fiscal year, and
up to $2 Billion in future years. California was not
consulted on this breathtaking tax break. Although
recently enacted federal statute (HR 1) now asserts that
Treasury exceeded its legal authority in issuing IRS Notice
2008-83, and declares that the ruling shall have no force
or effect after January 16, 2009, AB 11 will ensure that
our state's budget is absolutely protected from the massive
corporate tax give away. It is anticipated that FTB will
adopt regulations to affirm that California will not comply
with IRS Notice 2008-83; AB 11 would add assurances that
FTB's actions cannot be challenged."
Background
Section 382 of the Internal Revenue Code (IRC), originally
added to the IRC in 1954 and completely re-written in 1986,
was enacted to limit tax-motivated acquisitions of loss
corporations. Prior to the enactment of IRC Section 382,
corporations with large losses were attractive to buyers
with large taxable income simply because the acquired
corporation's losses could be used to reduce the buyer's
taxable income and, effectively, the cost of acquisition.
The limitations currently in place preclude a buyer from
using the NOLs and built-in losses of the acquired entity
at a rate that is faster than the rate at which the
acquired corporation could have used them if it had sold
its assets and invested the proceeds in tax-exempt
governmental obligations. Built-in losses are also subject
to special limitations because they are economically
equivalent to pre-acquisition NOL carry forwards. If
"built-in losses were not subject to limitations, taxpayers
could reduce or eliminate the impact of the general rules
by causing a loss corporation (following an ownership
change) to recognize its built-in losses free of the
special limitations" and "then invest the proceeds in
assets similar to the assets sold." (General Explanation
of the Tax Reform Act of 1986, Joint Committee on Taxation,
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p. 298, May 4, 1987). The purpose of this IRC Section 382
limitation is to make losses a neutral factor in a
corporate acquisition.
Controversial History of Notice 2008-83 . Generally, IRS
administrative pronouncements are issued without much
notice from the public, but the issuance of Notice 2008-83
created quite a controversy. Questions were raised
regarding the circumstances under which the notice was
issued and the Treasury Department's legal authority to
substantively change a 22-year old tax law that limits the
use of losses by banks following acquisitions. Some current
and former congressional staff members, as well as many tax
attorneys, concluded that the Treasury Department had no
authority to issue the notice (See, e.g., "A Quiet Windfall
for U.S. Banks," by Amit R. Paley, Washington Post , Page
A01, November 10, 2008). Lawmakers were looking at
"whether the notice was introduced to benefit specific
banks, as well as whether it inappropriately accelerated
bank takeovers." (Id.) On November 18, 2008, Senator Chuck
Grassley, ranking member of the Committee on Finance, asked
Eric Thorson, the Treasury Department's Inspector General,
to review the circumstances and any possible conflicts of
interest involving the Treasury Department's administrative
move that gives a big tax break to banks that acquire
poorly performing banks. (Senate Finance Committee
Release, "Grassley Seeks Inspector General Review of
Treasury Bank Merger Move," 110th Congress, November 18,
2008) Senator Charles E. Schumer and Senator Max Baucus
also wrote to Mr. Paulson asking similar questions
regarding the Treasury Department's authority to enact the
tax break without Congressional review and expressing
concerns over the subsidy. The Treasury Department,
however, insisted that the new tax break was not intended
to benefit any particular bank and had been under
"development for many, many weeks." (See, e.g., "Bush's
tax breaks for banks could cost California $2 billion,"
Evan Harper, Los Angeles Times , November 11, 2008)
It was reported, however, that days after the tax rule was
changed, "Wells Fargo moved to acquire Wachovia Corp.,
whose losses on loans could reach more than $70 billion,"
and "PNC Financial Services Croup, which recently acquired
National City Corp, could receive as much as $5 billion in
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tax savings." (Id.) Finally, Congress put the controversy
to rest when it enacted the American Recovery and
Reinvestment Act of 2009, which President Obama signed on
February 17, 2009. The Act clearly states that Notice
2008-83 was inconsistent with the congressional intent in
enacting IRC Section 382 and that the Treasury Department's
legal authority to prescribe the notice was doubtful.
Therefore, the Act repealed Notice 2008-83, but
grandfathered in the acquisitions that occurred prior to
January 16, 2009. Notice 2008-83 is also effective for
acquisitions that occurred after January 16, 2009, if any
ownership change was pursuant to a written binding contract
entered on or before that date, or under a written
agreement entered into on or before that date, if the
agreement was described on or before January 16, 2009, in a
public announcement or in a filing with the Securities and
Exchange Commission required by reason of such ownership
change.
FISCAL EFFECT : Appropriation: No Fiscal Com.: No
Local: No
SUPPORT : (Verified 7/14/09)
American Federation of State, County and Municipal
Employees
California Church IMPACT
California School Employees Association
California Tax Reform Association
ASSEMBLY FLOOR :
AYES: Adams, Ammiano, Anderson, Arambula, Beall, Bill
Berryhill, Tom Berryhill, Blakeslee, Block, Blumenfield,
Brownley, Buchanan, Caballero, Charles Calderon, Chesbro,
Conway, Cook, Coto, Davis, De La Torre, De Leon, DeVore,
Duvall, Emmerson, Eng, Evans, Feuer, Fletcher, Fong,
Fuentes, Fuller, Furutani, Gaines, Galgiani, Gilmore,
Hagman, Hall, Harkey, Hayashi, Hernandez, Hill, Huber,
Huffman, Jeffries, Jones, Knight, Krekorian, Lieu, Logue,
Bonnie Lowenthal, Ma, Mendoza, Monning, Nava, Niello,
Nielsen, John A. Perez, V. Manuel Perez, Portantino,
Price, Ruskin, Salas, Saldana, Silva, Skinner, Solorio,
Audra Strickland, Swanson, Torlakson, Torres, Torrico,
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Tran, Villines, Yamada, Bass
NO VOTE RECORDED: Carter, Garrick, Miller, Nestande, Smyth
DLW:mw 7/14/09 Senate Floor Analyses
SUPPORT/OPPOSITION: SEE ABOVE
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