Mary Bernard

Too Little, Too Late

What does the bailout program mean to you?

October 23, 2008
by Mary Bernard, CPA/MST

When the dust settles, the Emergency Economic Stabilization Act of 2008 may solve some problems while creating others. While there is no foolproof solution to correcting the current economic climate, every attempt at improvement should be embraced.

Executive Compensation Limitations

The so-called "bailout legislation" seeks to correct some of the excesses blamed for the failure of financial institutions. One of the key components of the bill targets excessive executive compensation of key employees of the recipient institutions benefiting from the bailout. The key executives covered, however, are limited to the chief executive officer (CEO), the chief financial officer (CFO) or the three highest officers in addition to the CEO or CFO. Their compensation — including commissions and performance-based compensation — is limited to $500,000 in any year in which the bailout provisions are implemented by the financial institution. Previously, these covered employees could be paid compensation up to $1 million, while commissions and performance-based compensation was unlimited. If compensation in excess of the imposed limits is paid to these covered employees, the financial institution would be subject to an excise tax. In the past, this type of penalty has not served as a deterrent to excessive compensation. Many institutions may be willing to pay the excise taxes imposed on noncompliance and create methods of payment that circumvent the limitations. The limitation on deductibility of compensation, however, does not apply to any deferred compensation that is ordinarily not currently deductible.

Golden Parachute Limitations Extended to
Bailout Recipients

Under golden-parachute rules, publicly-held corporations cannot deduct excessive severance payments to "disqualified individuals" who are usually among the highest paid one percent of employees. The new act extends this restriction to executives of employers participating in the troubled asset-relief program. A nondeductible parachute payment would be subject to excise tax and includes compensation to a covered executive due to severance from employment in the case of an involuntary termination, or employer's bankruptcy, liquidation or receivership. It should be noted that the imposition of an excise tax may not be a sufficient deterrent for some financial institutions involved in the bailout program.

One possible effective control of the prior excesses could be evident in the actions of concerned boards of directors who now may be unwilling to condone the prior extravagant behavior under current economic conditions. Increased accountability may have a positive impact on enforcing these restrictions. The weak economy may also put pressure on budgets and subsequently result in constraints in this area. Vocal, disgruntled shareholders may also influence boards to
control compensation.

Extension of Home Mortgage Debt Forgiveness

The new act extends the provision granting relief to homeowners who discharge mortgage debt on their principal residence for three additional years. Ordinarily, the forgiveness of debt results in the recognition of taxable income unless the debtor is deemed to be insolvent. The relief provision applies to acquisition indebtedness related to the taxpayer's principal residence, as defined under the home sale exclusion rules of IRS code section 121. Acquisition indebtedness of a principal residence includes debt incurred to acquire or construct the principal residence, as well as refinancing the debt. The excluded amount of forgiven debt will subsequently reduce the basis of the taxpayer's principal residence.

Fannie Mae and Freddie Mac Stock Losses

The act provides for the conversion of capital losses to ordinary losses for certain financial institutions incurring losses on the sale of stock in troubled Fannie Mae and Freddie Mac. Capital losses are generally only available to offset capital gains. This provision allows financial institutions to use capital losses from these investment sales to offset current ordinary income without limitation.

The results to the economy of this $700 billion bailout legislation remain to be seen. It has been said that the cost of this solution equates to $2,333.33 for each resident in this country. Is this too high of a price to pay?

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Mary F. Bernard, CPA/MST is a Tax Principal and Director of State and Local Tax Services at Kahn, Litwin, Renza & Co., Ltd. in Providence, RI.