November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis Presented by: Jonathan B. Dubitzky, Esq. Christopher M. Flanagan, Esq. Jay Jenkins, Esq. Douglas S. Stransky, Esq.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 2 Jay Jenkins Partner, Corporate and Financings Groups Moderator for today’s discussion Christopher M. Flanagan Partner, Tax Group Douglas S. Stransky Partner, Tax Group Jonathan B. Dubitzky Counsel, Employee Benefits Group Panel

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 3 Agenda Overview Domestic Provisions › S Corporation Participation in the CPP › Net Operating Loss Limitation Provisions › Ordinary Losses for Fannie Mae and Freddie Mac Investments › Potential Collateral Effects of Participation in the CPP International Provisions › Attempts to Free Intragroup Sources of Financing › Extension of Tax Provisions Executive Compensation Provisions › Restrictions Imposed Upon TARP Participants › New Tax Provisions

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 4 Overview Second installment in a series of Sullivan & Worcester Webinars on legislation responding to the current credit crisis. First Webinar introduced the Capital Purchase Program (“CPP”) instituted under the Emergency Economic Stabilization Act of 2008 (“EESA”), and reviewed how a financial institution decides whether to participate in this program. The IRS and the Treasury Department have provided detailed advice related to both the effect of participation in the CPP and certain other government investment programs and the credit crisis generally. › Common themes: Free-up sources of credit and investment; facilitate implementation of mergers and acquisitions.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 5 S Corporation Participation in CPP In our first Webinar, we briefly addressed some uncertainties related to the participation of S corporations in the CPP. What are the issues here, and what is the status of the developments in this area? › S corps. are tax favored, generally afforded pass-through treatment. › Certain restrictions in order to qualify for this treatment. Single class of stock requirement. Qualified shareholder requirement. › Issuance of CPP preferred stock would likely violate both of these requirements. Could cause loss of S corp. status. › No formal advice yet. Indications are for some form of relief to S corps. wishing to participate in the CPP.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 6 Section 382 Notices We mentioned in the Overview a Treasury Department goal of freeing up sources of credit and investment, and facilitating the implementation of mergers and acquisitions. How does this relate to the CPP or other government investment programs? › IRS and Treasury notices address the application of IRC Section 382 both to participation in government investment programs such as the CPP and in light of the current credit crisis generally. Liberalize the Section 382 limitations that might otherwise present obstacles or uncertainties in a workout or acquisition transaction. › Background on Section 382. Limits a corporation’s ability to utilize its tax losses following a more than 50 percent change in ownership. Important consideration in transactions involving the acquisition of or an investment in a corporation with tax losses.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 7 Section 382 Example Assumptions: Company Value=$ 50,000,000 Existing NOLs= 20,000,000 Sale of stock constituting an ownership change Long term tax exempt rate= 4.94% Company Value $ 50,000,000 L.T. Tax Exempt Rate 4.94% Annual Section 382 Limitation $ 2,470,000 No. of Years to Use NOLs = 8+ Next Year With Section 382 Net Income$ 5,000,000 NOL Deduction (2,470,000) Taxable Income $ 2,530,000 Tax Rate 35% Tax$ 885,500 Next Year Without Section 382 Net Income$ 5,000,000 NOL Deduction (5,000,000) Taxable Income$ 0 Tax Rate 35% Tax$ 0

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 8 Notice › 2008 Housing Act authorized Treasury to purchase Fannie Mae and Freddie Mac securities. › To avoid triggering a Section 382 limitation, suspends the application of provisions that would otherwise create such a limitation, for periods after Treasury acquires an equity interest. Would otherwise likely result in increased tax liabilities during Treasury’s ownership period, and make the entities less desirable to future potential investors. › Applies for all periods following the bailout, including potentially after Treasury ceases to hold any investment in the entity.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 9 Notice › Expands the principles of Notice beyond Fannie Mae and Freddie Mac. › Effectively turns off the provisions of Section 382 that would otherwise create a Section 382 limitation while the U.S. government owns a more than 50 percent interest in the company. Applies to a broader group of companies than Notice Applies only as long as the government maintains the required interest. More than 50 percent interest is measured by vote or value.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 10 Notice › Provides relief for companies participating in the CPP, particularly where the government’s interest does not meet the more than 50 percent requirement of Notice CPP applies generally to qualifying troubled financial institutions. › Prescribes special rules intended to decrease the likelihood that the government investment might trigger the application of Section 382 limitations. Ignores government ownership of stock in certain situations. Does not turn Section 382 off.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 11 Notice › Eliminates Section 382 provision adversely impacting capital contributions made within two years of an ownership change. Section 382 limitation is based upon a percentage of the subject corporation’s value. Such contributions were generally ignored in calculating this value, resulting in an artificially low Section 382 limitation. › Replaced with a general facts-and-circumstances test. Contributions are eliminated only if they are part of a plan to increase the Section 382 limitation. Provides safe harbors. Intended to make it easier for ailing companies to obtain capital. › Unlike the prior Notices, is not limited to corporations in which the government has made a specified investment.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 12 Notice › Relief to troubled banks on the write-down of their loan portfolios. › Bank which has undergone an ownership change not required to treat subsequent deductions for losses on loans or bad debts as “built-in” losses from before the change date. Permits these deductions without subjecting them to Section 382 limitations that might otherwise apply. › Facilitate investments in or acquisitions of troubled institutions. Widely reported that the issuance of this Notice assisted in persuading Wells Fargo to acquire Wachovia. › No stated effective date, implying that it might be able to be applied retroactively. › More detailed discussion of all of these Notices in a Client Advisory posted on our website, “Internal Revenue Service and Treasury Offer Breaks under Loss Limitation Rules Amid Financial Crisis.”

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 13 International Provisions Many U.S. companies own foreign subsidiaries that may have excess cash. Are there any new opportunities in light of the credit crisis that would permit the U.S. parent to access this cash? › Repatriation of cash via a dividend may result in U.S. federal (and possibly state) income tax consequences. › Repatriation via a loan possible, but may have consequences under IRC Section 956.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 14 Notice Section 956 treats certain controlled foreign corporation (“CFC”) investments in U.S. property, including loans from a CFC to a U.S. affiliate, as a deemed repatriation of earnings and profits (“E&P”). Notice allows a CFC to loan to a U.S. affiliate for 60 days or less without an income inclusion. A CFC can only make three such loans in a taxable year. The Notice is elective and will not apply to the taxable year of a CFC beginning after December 31, US Company CFC Loan excess cash

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 15 Other Repatriation Opportunities Is Notice the only repatriation opportunity? The Tax Executives Institute stated in a recent letter to Eric Solomon, Assistant Secretary of the Treasury for Tax Policy, and Donald L. Korb, IRS Chief Counsel, that while the recent notice is “welcome and appropriate” in the context of the financial liquidity crisis, they believe that additional action is warranted to further expand the time periods for CFC loans. The IRS is also considering other possibilities with respect to Section 956, e.g., reinstituting an annual test (v. the quarterly test) or an entire suspension of its application for some limited period of time. There is significant pressure being put on the government to reinstate Section 965 to again permit the repatriation of foreign earnings at a reduced U.S. income tax rate (e.g., 5.25%).

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 16 Extension of Look-Through Rules Did the EESA provide any other favorable provisions for U.S. multinationals? EESA extended the look-through rule for payments between related CFCs under foreign personal holding company income rules (extended through 2009). Applies to interest, dividends, rents, and royalties received by one CFC from a related CFC.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 17 Planning with Section 956 and Look- Through Dividends from a CFC reduce E&P before calculation of the CFC’s Section 956 amount. Previously, this rule was of limited use because cross-border dividends generated taxable Subpart F income. From a planning perspective, U.S. multinationals can apply CFC look-thru to reduce adverse Subpart F consequences of pre- Section 956 transaction dividend distributions. CFC1 (E&P Deficit) USCo CFC2 Step 1: Dividend Step 2: Loan Excess Cash to USCo

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 18 Active Financing Income EESA extended the Subpart F exception for active financing income (extended through 2009). Excludes from Subpart F income derived in the active conduct of a banking, financing or similar business, active business gains from sales of commodities, and for “exempt” or “qualified” insurance income.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 19 Ordinary Loss on Fannie Mae and Freddie Mac Investments We have spoken about investments being made in companies in need of capital, and accommodations being made to facilitate these investments. Are there additional provisions related to the treatment of companies’ investments that have been adversely affected by the credit crisis? › Section 301 of the EESA allows banks and certain other financial institutions to treat losses on qualified Fannie Mae and Freddie Mac preferred stock as ordinary losses. Lobbied for by banking associations following bailout. Avoids potential limitation on utilization of capital losses. Preferred stock held on September 6, 2008 or sold during › Revenue Procedure Extends coverage to qualified preferred stock held by a partnership or subsidiary, or received in a “carryover basis” transaction.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 20 Rev. Proc Rev. Proc sets forth circumstances in which the IRS will not challenge whether a security is a “readily marketable security” for purposes of Section 956(c)(2)(J). The term “United States Property” includes an obligation of a U.S. person, excluding an obligation of a U.S. person to the extent the principal amount of the obligation does not exceed the fair market value of readily marketable securities sold or purchased pursuant to a sale and repurchase agreement or otherwise posted or received as collateral for the obligation in the ordinary course of its business by a U.S. or foreign person that is a dealer in securities.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 21 Rev. Proc The revenue procedure states that current market conditions and liquidity constraints are creating some uncertainty regarding whether a security is “readily marketable” for this purpose. In response to taxpayer’s concerns, the IRS will not challenge whether a security is readily marketable if the security is of a type that was readily marketable under ordinary market conditions at any time within three years prior to the effective date of the revenue procedure.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 22 Executive Compensation Issues We have all heard that participants in the CPP are potentially subject to more stringent limitations on executive compensation. How does this work? › Concern about levels of executive compensation at companies receiving taxpayer money through TARP and the CPP. › Sections 111 and 302 of the EESA established special rules for executive compensation of employers participating in TARP. Treasury authorized to set certain executive compensation restrictions for participating employers. New provisions added to IRC Sections 162(m) and 280G. › Notice and Interim Rule provide additional guidance in Q&A format.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 23 Executive Compensation Provisions Affected Institutions: The most important category is financial institutions in which the U.S. Treasury takes a meaningful equity or debt position whether as a result of purchasing troubled assets or by acquiring preferred stock (“TARP CPP Participants”). Also includes other financial institutions (“Affected Sellers”) that sell over $300 million of troubled assets to the Treasury, of which at least some portion is sold other than by direct purchase (that is, even if Treasury does not acquire a meaningful equity or debt position in the seller). Relevant Executive: Generally the top five executive officers. Payments to others are not implicated. Relevant Period: For TARP CPP Participants, so long as the Treasury maintains its equity or debt position. For other Affected Sellers, generally only through 2009 (or 2010 if program is extended).

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 24 Expansion of Golden Parachute Provisions Existing Law: If a public corporation undergoes a change of control, and in connection therewith makes payments to an executive that exceed 300% of his “base amount” (average annual compensation in the preceding five years), then the excess over 100% of the base amount is (a) nondeductible by the payor corporation and (b) subject to a 20% excise tax imposed on the executive.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 25 Expansion of Golden Parachute Provisions Expansion of Golden Parachute Rules: Golden parachute rules expanded to include payments made by any Affected Institution to a Relevant Executive after involuntary severance or in the case of bankruptcy/insolvency even if no change of control has occurred. › Such payments may not be made by a TARP CPP Participant during the period the Treasury has its meaningful equity or debt stake. › New agreements providing for such payments may not be entered into by financial institutions that have sold over $300 million of troubled assets to the Treasury (unless all such sales are direct purchases). › Affected Sellers subject to nondeductibility rule (and recipients to 20% excise tax) if such golden parachute payments are made during 2008, 2009 (or 2010 if extended).

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 26 Extension of IRC Section 162(m) Existing Law: IRC Section 162(m) limits the deductibility of annual compensation paid to one of the top five public company executives to $1 million. For these purposes, commissions and qualifying incentive compensation are not counted. Expansion: Expanded Section 162(m) applies to all TARP CPP Participant employers and to Affected Sellers. The $1 million limit is reduced to $500,000. › Commissions and incentive compensation are counted. › Special rules apply in logical manner to deferred compensation (thus, deferred compensation entitlements for services during a relevant CPP period continue to carry the Section 162(m) taint even if the deferred compensation is paid after the CPP rules have generally expired; deferred compensation vested before CPP period may be paid without restriction).

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 27 Other Executive Compensation Provisions Participating institutions must take steps to ensure that incentives are not created for senior executive officers to take unnecessary and excessive risks that threaten the value of the enterprise. Under a Treasury notice, guidelines are given for the compensation committee to audit this matter and certify compliance. Contractual provisions must be created so that the financial institution can recover bonus or incentive compensation paid to a senior executive officer if it later turns out payments were made based on statements of earnings that proved to be materially inaccurate.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 28 Implications of All This Reduced compensation tax deductions: › How much does this matter to anyone? Severance deals limited to 3X historic annual pay: › How much does this depart from current deals? No limits on current executive pay, but some of it may become nondeductible.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 29 Other Collateral Effects Looking forward, beyond the immediate effects of the capital infusion accomplished by the CPP, are there any other potential collateral consequences of Treasury’s investment in a company under the CPP? › IRC Section 382 discussed above. › Notice provides that amounts furnished to a financial institution under TARP, including the CPP, not treated as “federal financial assistance” under IRC Section 597. Might otherwise have been required to be treated as income. › Qualification of certain tax-free reorganization structures may be impacted by presence of Treasury’s preferred stock investment. Attributable to definition of control for certain reorganization structures (primarily related to reverse subsidiary mergers). May require restructuring to keep qualified reorganization status. Bank of America/Merrill Lynch merger wrestled with this issue.

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 30 Questions?

November 20, 2008 Tax Provisions Related to the New Law: IRS and Treasury Department Responses to the Current Credit Crisis © 2008 Sullivan & Worcester LLP 31 Contact Information Sullivan & Worcester LLP Please visit our Credit Crisis Task Force profile at Today’s Presenters: Jonathan B. Dubitzky Jon M. Jenkins (617) (212) Christopher M. FlanaganDouglas S. Stransky (617) (617)