Introduction to the Notice
The “Infamous IRS Notice”, or Notice 2008-83[i], was issued on 10/01/2008, days after failure of several banks. In less than a page, the Internal Revenue Service (IRS) effectively rewrote §382, and allowed banks to ‘buy’ net operating losses (NOLs) through mergers and acquisitions. This Notice would eventually be overturned through Congressional activity in PL 111-5[ii], however, even this allowed taxpayers to rely on and act according to the Notice throughout the five months in which the Notice was not overruled. While some commentators have defended the IRS’s actions as just interrupting the code[iii], especially in light of the current economic environment, this Notice was unprecedented in terms of the IRS assuming authority over the code. This paper will explore those five months in which an IRS Notice superseded a code section, examine the reaction by the tax community, look at the reaction by congress, and speculate on what the future holds, both in terms of new IRS Notices, and possible litigation that could result in such notices.
History of the Banking Crisis
In March 2008, the first major sign of the banking crisis to come appeared with the apparent failure of Bear Stearns, an investment bank. In a series of events, the Federal Reserve attempted to loan Bear Stearns enough cash to stay solvent for the next month[iv]. Ben Bernanke, the Chairman of the Federal Reserve, approved this loan due to the fact that he felt the investment bank was simply too large to fail[v]. Even with the loan and support from the Federal Reserve, Bearn Stearns continued to watch as its shares plummeted. Once again, Ben Bernanke stepped in by helping to orchestrate a buyout of Bear Stearns. The support came again because the bank was perceived as too large to fail. The potential damage that would be done to the economy was too great, and it would be more efficient and cheaper for the government to save the one struggling bank. On March 16th, J.P. Morgan Chase bought Bear Stearns for $10 a share[vi]. In 2007, Stearns had been trading above $170 a share, and even as of February of 2008, shares were above $90. For the next few months, this appeared to be the last major crisis. The financial markets were still in turmoil, but no other failure seemed to come near the epic proportions of the Bear Stearns failure. The idea that any company, bank or otherwise, had become so big that it could not be allowed to fail became a source of controversy that would continue to draw attention throughout the rest of the financial crisis.
In September, the idea of “too large to fail” was tested again. After Bloomberg reported that Merrill Lynch lost over $51.8 billion in mortgage-backed securities[vii], it became obvious that something would have to be done to save Merrill Lynch. Bank of America bought Merrill Lynch for approximately $50 billion in stock[viii]. It was later discovered that the Federal Reserve pushed Bank of America into this deal[ix].
The next day Lehman Brothers, a global financial services provider, filled for bankruptcy[x]. This announcement was made after both Bank of America, and Barclays had declined to buy the bank, and the Federal Reserve refused to offer additional funds as it had done with Bear Stearns[xi]. Lehman Brothers was quickly delisted, and liquidated, part of the assets were sold to Barclays[xii]. One day after Lehman Brothers filed for bankruptcy, Moody’s Standard and Poor’s downgraded American International Group’s (AIG) credit rating[xiii]. This led the Federal Reserve to step in and offer a rescue package totaling $85 billion[xiv] to AIG in order to keep it from failing as Lehman Brothers had just done. The rescue package would give the US government control over AIG, and would eventually lead to additional allocation of governmental funds.
Days later, Goldman Sacs found itself on the verge of collapse as well. Here, the would be savior turned out not to be the Federal Reserve, but Warren Buffett, the Chairman of Berkshire Hathaway. As Goldman Sacs saw the value of its shares spiral, Buffett paid $5 billion for preferred shares, publicly supported the bank, and encouraged the bank to raise more capital by selling additional shares to the public[xv]. This support bolstered the bank enough to pull out of its spiral. Unfortunately, not all banks saw such support. Washington Mutual, the largest savings and loans in the United States, experienced a 10-day bank run, which resulted in withdrawals of 9% of its total deposits. The FDIC who seized the banking subsidiary, and sold it to J.P. Morgan Chase for $1.9 billion ended the run on September 25th[xvi].
These series of events led the IRS to issue Notice 2008-82, which as the Washington Post calls it, was a change in the tax code[xvii]. This change would also set the stage for a buyout of Wachovia by Wells Fargo.
[i]. Notice 2008-83, 2008-42 IRB 905, 10/01/2008
[ii]. PL 111-5, American Recovery and Reinvestment Act of 2009
[iii]. Jenks, Carl, Ralph MacDonald III, and Candance Ridgeway. “Revisiting Notice 2008-83.” Jones Day Publications. http://www.jonesday.com/pubs/pubs_detail.aspx?pubID=S5711 (accessed December 9, 2009).
[iv]. Hamilton, Walter, and Tom Petruno. " Wall Street giant gets Fed bailout.” Featured Articles From The Los Angeles Times. http://articles.latimes.com/2008/mar/15/business/fi-bear15 (accessed December 9, 2009).
[v]. Macey, Jonathan. “Bear Stearns Too Big to Fail?.” The Washington Independent. http://washingtonindependent.com/1291/bear-stearns-too-big-to-fail (accessed December 9, 2009).
[vi]. Onaran, Yalman. “Fed Aided Bear Stearns as Firm Faced Chapter 11, Bernanke Says.” Bloomberg.com. http://www.bloomberg.com/apps/news?pid=20601087&refer=worldwide&sid=a7coicThgaEE (accessed December 9, 2009).
[vii]. Miller, Brett, and Chua Kong Ho. “Merrill Lynch Cut to `Sell’ at Goldman on Writedowns.” Bloomberg.com. http://www.bloomberg.com/apps/news?pid=20601087&sid=aDWTPYeHBS8g&refer=home (accessed December 10, 2009).
[viii]. KARNITSCHNIG, MATTHEW, CARRICK MOLLENKAMP, and DAN FITZPATRICK. “Bank of America to Buy Merrill.” The Wall Street Journal. http://online.wsj.com/article/SB122142278543033525.html?mod=special_coverage (accessed December 10, 2009).
[ix]. Lanman, Scott, and Craig Torres. “Republican Staff Says Fed Overstepped on Merrill Deal .” Bloomberg.com. http://www.bloomberg.com/apps/news?pid=20601110&sid=a5A4F5W_PygQ (accessed December 10, 2009).
[x]. "Lehman Brothers Holdings Inc. News.” The New York Times Topics. http://topics.nytimes.com/top/news/business/companies/lehman_brothers_holdings_inc/index.html?8qa&scp=1-spot&sq=lehman+brothers&st=nyt (accessed December 9, 2009).
[xi]. SORKIN, ANDREW ROSS. “Lehman Files for Bankruptcy; Merrill Is Sold.” The New York Times. http://www.nytimes.com/2008/09/15/business/15lehman.html?_r=1&hp&oref=slogin (accessed December 9, 2009).
[xii]. "Judge approves $1.3bn Lehman deal.” BBC NEWS. http://news.bbc.co.uk/2/hi/business/7626624.stm (accessed December 9, 2009).
[xiii]. Son, Hugh. “AIG Credit Ratings Cut, Threatening Quest for Funds.” Bloomberg.com. http://www.bloomberg.com/apps/news?pid=20601087&sid=aX_zVXoWfK54 (accessed December 9, 2009).
[xiv]. ANDREWS, EDMUND L., Michael Merced, and Mary Williams Walsh. “Fed’s $85 Billion Loan Rescues Insurer.” The New York Times. http://www.nytimes.com/2008/09/17/business/17insure.html?hp (accessed December 9, 2009).
[xv]. "Buffett boosts Goldman Sachs with $5-billion investment.” Los Angeles Times Business. http://latimesblogs.latimes.com/money_co/2008/09/warren-buffett.html (accessed December 9, 2009).
[xvi]. Ruberry, William. “OTS 08-046 - Washington Mutual Acquired by JPMorgan Chase.” Office of Thrift Supervision. http://www.ots.treas.gov/?p=PressReleases&ContentRecord_id=9c306c81-1e0b-8562-eb0c-fed5429a3a56 (accessed December 9, 2009).
[xvii]. Appelbaum, Binyamin. “After Change In Tax Law, Wells Fargo Swoops In.” washingtonpost.com. http://www.washingtonpost.com/wp-dyn/content/article/2008/10/03/AR2008100301042.html?sid=ST2008100204467 (accessed December 9, 2009).