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On October 3, 2008, Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (EESA), along with a number of other Acts intended to provide economic relief. These new Acts are often referred to collectively as “the bailout,” and are intended to provide individual and business tax relief through the extension of many credits and deductions and the creation of the Troubled Assets Relief Program (TARP). Some of the major tax provisions of the Acts are outlined below.

Ordinary Loss or Gain on Sale of Fannie Mae and Freddie Mac Preferred Stock

EESA allows certain banks and financial institutions that sold or exchanged preferred stock of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) to treat gains or losses as ordinary income or loss. In order to qualify for this treatment, a bank must have held the preferred stock on September 6, 2008 or have sold the stock between January 1, 2008 and September 7, 2008. Partnerships that made a distribution of Fannie Mae or Freddie Mac preferred stock and partnerships that have an applicable financial institution as a partner or a subsidiary of an applicable financial institution that sold such stock may also be eligible for ordinary income or loss treatment.

Limits on Executive Compensation for Financial Institutions that Participate in TARP

TARP authorizes the Treasury Department to purchase, through auction or directly, assets of financial institutions. An institution that sells an aggregate of $300 million of assets to the Treasury may become subject to new limits on executive compensation. 

• Deduction of Executive Compensation: Institutions that participate in TARP, including non-public companies and non-corporate entities, may deduct only $500,000/year of individual compensation for their CEOs, CFOs, and the three other highest compensated employees. This new rule alters a prior rule limiting such a deduction for public companies to $1,000,000. TARP further alters the allowable deduction by including within the $500,000 limitation commissions and performance based compensation.
• Excess Parachute Payments and Involuntary Termination from Employment: Restrictions under Section 280G on the deductibility of “excess parachute payments” and excise taxes on those payments, are now applicable to payments made in connection with an involuntary termination from employment, bankruptcy or liquidation. Previously, the prohibition on deducting excess parachute payments was applicable to payments made in connection with a change in ownership or effective control of a corporation. An excess parachute payment occurs when the aggregate amount of payments made, or intended to be made, to an employee equals or exceeds three times the employee’s base amount (the average of the employee’s gross income over the five preceding years). Upon such a payment the employer is prevented from deducting the difference of the excess payment and the base amount. Under the Acts, payments made upon involuntary termination, bankruptcy or liquidation include certain payments that are normally excluded in computing the total parachute payment. Furthermore, TARP prohibits employers from entering into new employment contracts that include excess parachute payments.
• Prohibition on Excess Parachutes Following Direct Asset Sales: Where the Treasury directly purchases assets of a financial institution, rather than through auction, TARP prohibits the payment of any excess parachute payments to the CEO, CFO or any one of the three other highest paid employees during the time in which the Treasury holds those assets.
• Recognition of Non-Qualified Deferred Compensation: Non-qualified deferred compensation from a non-qualified entity will now be recognized as income to the service provider once there is no “substantial risk” of forfeiture. Non-qualified entities include certain foreign corporations and partnerships that are exempt from U.S. income tax or that allocate more than an insubstantial amount of their income to foreign persons not subject to comprehensive foreign income tax.

For more information about other aspects of TARP, please refer to the following issues of the Nutter Bank Report:

Click here for the October Bank Report
Click here for Special Edition: Capital Purchase Program Explained
Click here for Special Edition: Treasury Will Provide Equity Capital Directly to Financial Institutions
Click here for Special Edition: Economic Rescue Legislation Signed into Law

Extension of Credits and Deductions for Businesses

Many tax credits and deductions have been extended or created to encourage investment, research and the development of energy efficient properties.

• Manufacture of Energy Efficient Appliances: Varying credits for energy efficient dishwashers, clothes washers and refrigerators will apply for appliances manufactured through 2010.
• Mental Health Benefits: To the extent that private health insurance plans covering 51 or more employees provide mental health benefits, those benefits must be on par with the medical-surgical benefits.  This provision would have expired on December 31, 2008 and has now been made permanent.
• Building Costs of Energy Efficient Commercial Buildings:There is a deduction for the cost of energy efficient commercial building property placed in service during the year. This deduction is extended to property placed in service before December 31, 2013.
• Reuse and Recycling Property Deduction:Beginning in 2009, a taxpayer may claim a depreciation deduction equal to 50 percent of the adjusted basis of qualified reuse and recycling property put into use in that year. The basis of such property must be reduced by the depreciation deduction. Qualified reuse and recycling property must have a useful life of at least five years.

The following provisions were extended to apply in tax years 2008 and 2009:

• Look-through Rules for Related Controlled Foreign Corporations: Dividends, rents, interest and royalties received by one controlled foreign corporation from a related controlled foreign corporation will continue not to be treated as foreign personal holding company income.
• Interest Related Dividend Treatment: Regulated investment companies may designate all or a portion of a dividend as an “interest related dividend,” allowing a shareholder to avoid taxation.
• Research Expense Credit: 20 percent of the excess of qualified research expenses over a base may be claimed as a credit. In addition, the Acts eliminate the election for an alternative incremental research credit and increase the alternative simplified research credit rate to 14 percent.
• Investment in Community Development Entities Credit: A new market credit may be claimed for qualified equity investments in stock of community development entities. For the first three years that the stock is held, a five percent credit may be claimed; for the following four years, a six percent credit is available.
• Deduction for Environmental Remediation: A qualified environmental remediation expense may be treated as deductible rather than as chargeable to a capital account.

Individual Tax Relief Provisions

The Acts provide individual tax benefits and extend provisions that were scheduled to expire.

• Child Tax Credit: For 2008, a taxpayer whose tax liability is exceeded by the $1,000/child tax credit is entitled to a refundable tax credit of up to 15 percent of earned income in excess of $8,500.
• Energy Efficient Improvement Credit: During 2009, a taxpayer may claim a lifetime nonrefundable credit of up to $500 for energy efficient improvements made to residential property.
• Energy Efficient Property Purchase Credit: Through 2017, a taxpayer may claim a credit for 30 percent of the purchase price of specific residential energy efficient property placed in service in a taxpayer’s residence. There is no longer a $2,000 limit on credit for qualified solar energy expenditures.
• Discharge of Mortgage Indebtedness: Complete or partial discharge of a homeowner’s indebtedness on a qualified principal residence is not included in the gross income of a taxpayer. This provision is now applicable through January 1, 2013. This exclusion is not applicable in the case of Chapter 11 bankruptcy.

For tax years 2008 and 2009 the following deduction allowances were extended.

• Local and State Property Tax Deduction: A taxpayer who otherwise does not itemize his or her deductions may claim both the basic standard deduction and up to $500 (or $1,000 for married couples) for state and local property taxes.
• Education Expense Deduction: Higher education tuition and expenses up to $4,000 and eligible educator expenses up to $250 may be deducted from gross income.
• Election of Local and State Sales or Income Tax Deduction: A taxpayer who otherwise does not itemize his or her deductions may choose between claiming an itemized deduction for either local and state sales taxes or local and state income taxes.

Alternative Minimum Tax Provisions

The following Alternative Minimum Tax (AMT) provisions apply through December 31, 2012.

• AMT Exemption Amount: For tax years beginning in 2008, AMT exemption amounts have been increased to $69,250 for married couples filing jointly, $44,350 for individuals, and $34,975 for married individuals filing separately. This exemption is deducted from a taxpayer’s alternative minimum taxable income in order to determine the amount to which the alternative minimum tax will be applied.
• Personal Tax Credits Applicable: Nonrefundable personal tax credits (e.g. child and dependant care credit, lifetime learning credits, credit for elective deferrals and IRA contributions) may be used to offset both the AMT and regular tax through the 2008 tax year.
• Refundable Credit Amount: The AMT refundable credit amount is now the greater of 50 percent of the individual’s long-term unused minimum tax credit or the amount of the AMT refundable credit for the preceding taxable year. In addition, the new rule accelerates the claiming of long-term minimum tax credits from five years to two years. All individuals who qualify for an AMT refundable tax credit are now entitled to the full amount of the credit. The prior phase-out of the credit according to adjusted gross income has been removed.
• Underpayment Abated: Underpayment of an outstanding tax that is attributable to the application of a minimum tax adjustment for incentive stock options is abated.

Extension of Charitable Giving Provisions

Businesses and individuals may benefit from provisions that encourage contributions to charities through the extension of numerous provisions. Please click here to refer to the Nutter Charitable Advisors advisory for more information.

This advisory was prepared by Nutter’s Tax Department. For more information, please contact your Nutter attorney at 617-439-2000.

Circular 230 Disclosure: To ensure compliance with IRS Circular 230, we inform you that any federal tax advice included in this communication is not intended or written to be used, and it cannot be used, for the purpose of (i) avoiding the imposition of federal tax penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.