This past year has been described as historic and unprecedented. As governments continue to react to calm the markets and the global economy, investors, corporations and workers remain on edge, hoping that the effects of recent events are contained. Governments have put on the table every fiscal, monetary and political tool available to help stem the crisis. One such tool is the formulation and implementation of tax policy and a targeted implementation of that policy through legislation and administration of the tax laws. In the United States, Congress, the Treasury and the IRS have reacted, in some cases quite aggressively, to the deepening crisis. The following is a summary that broadly traces legislative and administrative responses by the United States government from the first days of the crisis.

  1. December 6, 2007 – Revenue Procedure 2007-72 In tandem with the Paulson-Jackson plan aimed at stemming foreclosures by freezing adjustable rate mortgages subject to reset, the IRS issued Rev. Proc. 2007-72, which provided that, under certain conditions, the IRS will not challenge a REMIC's status for U.S. federal income tax purposes in connection with "fast track modifications" of certain subprime mortgage loans under a framework recommended by the American Securitization Forum. A fast-track modification program is a program that permits servicers to modify eligible troubled mortgage loans subject to certain broad parameters. Specifically, the IRS stated that: (i) it will not challenge a securitization vehicle's qualification as a REMIC on the grounds that the loan modifications are not permitted under the REMIC rules; (ii) it will not contend that the loan modifications are prohibited transactions under the REMIC rules; and (iii) it will not challenge a securitization vehicle's qualification as a REMIC on the grounds that the loan modifications resulted in a deemed reissuance of the REMIC regular interests. The Rev. Proc. was issued in an effort by the Treasury and the IRS to stem foreclosures by removing barriers imposed by tax laws, arguably too restrictive in light of prevailing economic and market circumstances, to broad-based mortgage modification plans.
  2. December 20, 2007 – Debt Relief Act of 2007 The Act excludes cancellation of indebtedness from gross income if the indebtedness is "qualified principal residence indebtedness" (meaning, generally, indebtedness with respect to the taxpayer's principal residence) that is discharged, initially, before January 1, 2010 (this provision was later extended in the Emergency Economic Stabilization Act, described below, through the end of 2012). The legislation was enacted to provide relief to troubled borrowers at risk of losing their homes as a result of the credit crisis. These borrowers would otherwise be subject to tax if lenders forgave a portion of their mortgages as part of a refinancing or to avoid foreclosure. The Debt Relief Act imposes a $2 million limit (or $1 million in the case of married taxpayers filing separately) on the amount of cancelled debt that may be excluded from income.
  3. February 19, 2008 – Notice 2008-27 & March 25, 2008 – Notice 2008-41 In general, interest on auctionrate tax-exempt bonds may be exempt from U.S. federal income taxation provided certain requirements are met at issuance. Tax-exempt bond issuers may obtain credit enhancement on the bonds they issue from municipal bond insurers (e.g., MBIA and Ambac). Accordingly, if a rating agency downgrades municipal bond insurers, such downgrades may affect the tax-exempt bonds, including the interest rates payable on the bonds. In addition, if the auctions at which the interest rates on the bonds are reset fail, interest rates reset to a specified maximum (or penalty) rate. Auction failures may also cause severe liquidity issues and investors may be unable to sell their notes at par under these circumstances. In these situations, a bond issuer may seek to convert auction-rate bonds into standard fixed or floating-rate bonds. Alternatively, the issuer may seek to provide additional liquidity through other measures by, for example, temporarily repurchasing the bonds. However, under current U.S. federal income tax law, debt may be considered to be "reissued" if a debt instrument is significantly modified; a reissuance, in turn, could cause significant adverse tax consequences, including a redetermination of whether the instruments qualify as tax-exempt bonds. A repurchase treated as a retirement would cause similar issues. Notice 2008-27 and Notice 2008-41 were issued primarily in response to rating agency downgrades of municipal bond insurers and auction failures in the tax-exempt bond market. In general, for purposes of determining whether bonds qualify for tax-exempt status, Notice 2008-41 provides that bonds issued as auction rate securities but converted by the issuer into fixed or floating-rate bonds for their remaining term will not be treated as having been significantly modified (and thus reissued). In addition, in order to provide liquidity in the taxexempt bond market, the Notice permits issuers to repurchase bonds on a temporary basis without causing a retirement of the bonds for U.S. federal income tax purposes. The exemption applies to bonds purchased before October 1, 2008 and held for not more than 180 days after purchase.
  4. May 12, 2008 – Revenue Procedure 2008-26 A U.S. shareholder that owns 10% or more of the voting stock of a controlled foreign corporation ("CFC") is generally required to include "subpart F income" on a current basis if the CFC invests in "U.S. property," which includes certain obligations of United States persons (e.g., mortgage-backed securities) unless the obligations are "readily marketable." The Rev. Proc. provides that the IRS will not question whether a security is "readily marketable" in determining whether the security constitutes U.S. property if the security is of a type that was readily marketable at any time within three years before May 5, 2008. The Rev. Proc. is aimed at addressing the effect of market dislocations in respect of securities that likely would be marketable under "normal" market conditions.
  5. May 16, 2008 – Revenue Procedure 2008-28 Similar to Rev. Proc. 2007-72, Rev. Proc. 2008-28 provides that if mortgage loans are modified in accordance with certain specified conditions (including limits on the size of the underlying residences, a condition that the underlying properties be owner-occupied, and that there be a reasonable belief that there is a significant risk of foreclosure under the original loans) the IRS will not seek to challenge the status of a REMIC securitization. This Rev. Proc. expanded Rev. Proc. 2007- 72 to permit additional fast-track loan modifications.
  6. June 13, 2008 – Notice 2008-55 Notice 2008-55 provides that the IRS will not challenge the equity characterization of auction-rate securities ("ARS") for federal income tax purposes if certain liquidity facility agreements are put in place that permit holders of the ARS to sell their ARS to a liquidity provider upon a failed auction. Thus, payments on the ARS would continue to be characterized as exempt-interest dividends (to the extent of the issuer's exempt interest). If the ARS were instead characterized as debt, payments would be treated as taxable interest for the ARS holders. In general, the Notice only applies if, among other requirements, the ARS are issued by closed-end funds that are RICs and that invest exclusively in taxable or tax-exempt bonds, the ARS were outstanding on February 12, 2008 (or issued after that date to refinance ARS that were outstanding on that date) and the liquidity provider is unrelated to the issuer. The Notice was issued to provide some relief for closed end funds that sought to restructure their ARS amid a seizure of the ARS markets.
  7. July 8, 2008 – Revenue Procedure 2008-47 Rev. Proc. 2008-47 provides that the IRS will not challenge the tax status of a REMIC or assert that a REMIC engaged in a "prohibited transaction" when certain mortgage loans – primarily adjustable rate mortgages with teaser rates – held by a REMIC are modified by freezing rates prior to their reset in accordance with the American Securitization Forum's "Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans" (which was issued on July 8, 2008). The Rev. Proc. amplifies and supersedes Rev. Proc. 2007-72.
  8. July 30, 2008 – Housing and Economic Recovery Act of 2008 In response to a deepening housing crisis and speculation regarding the failure of Fannie Mae and Freddie Mac, the Act (i) granted the United States Treasury the ability to place Fannie and Freddie into conservatorship, (ii) increased regulatory oversight over the GSEs, (iii) increased the conforming loan limits of the GSEs to $625,000 from $417,000 (to provide liquidity in the mortgage market by allowing the GSEs to purchase additional mortgages and to decrease interest rates on such mortgages over time), (iv) created a temporary program within the Federal Housing Administration ("FHA") that would insure up to $300 billion in mortgages available to distressed borrowers looking to refinance their mortgages and (v) provided certain tax credits, including a refundable first time homebuyer credit that works like an interest-free loan for first-time home buyers of up to $7,500 to be repaid over 15 years in equal installments as a surcharge on the homeowner's tax returns.
  9. August 8, 2008 – Revenue Procedure 2008-51 The crisis in the credit markets resulted, in some cases, in significant dislocations between the time at which a corporation arranged for the issuance of debt pursuant to a binding financing commitment and the time at which the corporation called upon the lender to perform on the commitment by advancing cash to the issuer and selling the issuer's debt instruments in the market. This can result in situations in which the issue price of a debt instrument (generally, the price paid by the public) is significantly less than the amount of money actually received by the corporation from the lender. The resulting original issue discount ("OID") may cause the debt to be treated as an applicable high yield discount obligation ("AHYDO"), resulting in an increased after-tax funding cost to the issuer due to deferred or foregone interest deductions, and may potentially affect the willingness of borrowers and lenders to enter into financing commitments. Acknowledging these problems, the Rev. Proc. suspends the application of the AHYDO rules in this and certain other situations in order to ameliorate the affects of the credit crisis on corporate issuers.
  10. September 8, 2008 – Notice 2008-76 The Housing and Economic Recovery Act of 2008 authorized the Treasury to purchase obligations of, or securities issued by, Fannie Mae and Freddie Mac where necessary to stabilize the financial markets. After the Treasury placed Fannie and Freddie into conservatorship, the IRS issued Notice 2008-76, which provided that the IRS and the Treasury will issue new regulations providing that the application of Section 382 will be suspended in situations where Treasury acquires stock or options to acquire stock pursuant to the Housing Act. Section 382 is a section in the Internal Revenue Code that is aimed at policing the trafficking of corporate tax attributes, including operating losses and built-in losses, via the sale of significant ownership interests in loss corporations. The Notice is aimed at preserving Fannie Mae's and Freddie Mac's tax attributes in the event of what would otherwise be an impermissible "ownership change" resulting from the Treasury's acquisition of ownership interests.
  11. September 12, 2008 – Notice 2008-77 In general, under regulations finalized in 2006, widely held fixed investment trusts ("WHFITs") must satisfy certain reporting requirements. The requirements first applied for the 2007 calendar year, but the preamble to the final regulations stated that the IRS would not impose any penalties for 2007 where the trustee or middleman was unable to change its information reporting systems to comply with the regulations. Notice 2008-77 extends this deadline for an additional year. The Notice also states in the case of widely held mortgage trusts ("WHMTs") that, pending future published guidance, under certain circumstances, modifications of mortgages held by a WHMT that has entered into a guarantee arrangement that compensates the trust or all the trust interest holders for any shortfalls from such modifications are not required to be reported under the WHFIT reporting rules.
  12. September 24, 2008 – Notice 2008-81 In response to the credit crisis that threatened the ability of money market funds to maintain a $1 per share net asset value ("breaking the buck"), the United States Treasury established a temporary guarantee program for the U.S. money market mutual fund industry. Under this program, the Treasury will insure, in return for a fee, the holdings of any publicly offered eligible money market mutual funds. The Treasury will make available as necessary the assets of the Exchange Stabilization Fund (an emergency fund originally established in 1934 to manage exchange rates), up to a limit of $50 billion. (For more information on this program, consult our prior Client Alert "First Look at Treasury Plan; Money Market Fund Bailout" at http://www.mofo.com/news/updates/files/080921FirstLook.pdf .) In general, the tax law frowns on federal guarantees of tax-exempt bonds and interest on such bonds would lose their tax-exempt status. Also, under current law a mutual fund that owns tax-exempt bonds that have an aggregate value of at least 50 percent of the fund's total assets is permitted to pay tax-exempt dividends to its shareholders. Notice 2008-81 clarifies that the Treasury money market guarantee program will not violate the restrictions against federal guarantees of tax-exempt bonds held by tax-exempt money market funds. In addition, the IRS will not assert that the program impairs the ability of a money market fund to designate and distribute tax-exempt dividends.
  13. September 24, 2008 – Revenue Procedure 2008-58 Rev. Proc. 2008-58 addresses holders of ARS who, amid failing auctions, accept settlement offers from brokers for claims that the brokers acted improperly in the sale and distribution of the ARS. The Rev. Proc. addresses agreements pursuant to which holders who acquired ARS prior to February 12, 2008 are given the right during a specified period of time (not to extend beyond December 31, 2012) to sell the ARS to the brokers at par. The Rev. Proc. provides that the IRS will not challenge (i) that the taxpayer continues to own the ARS upon accepting (or "opting into") the settlement offer; (ii) that the taxpayer does not realize any income as a result of accepting the settlement offer and does not reduce the basis of ARS from its original purchase price; and (iii) that the taxpayer's amount realized from the sale of ARS to the party offering the settlement is the full amount of the cash proceeds received from that party.
  14. September 26, 2008 – Revenue Procedure 2008-63 Rev. Proc. 2008-63, effective for taxable years ending on or after January 1, 2008, provides that if a borrower defaults under a Section 1058 compliant securities loan agreement (generally a securities loan agreement that requires the borrower to return identical securities borrowed to the lender, requires the borrower to pay interest and dividend equivalent amounts to the lender, and does not reduce the lender's risk of loss or opportunity for gain) as a direct or indirect result of its bankruptcy (or the bankruptcy of an affiliate) and the lender applies the collateral to purchase identical securities as soon as is commercially practicable after the default (but not more than 30 days following the default), the lender will not recognize any gain or loss for U.S. federal income tax purposes as a result of the transaction.
  15. September 26, 2008 – Notice 2008-78 As the credit crisis deepened, companies that had already raised significant amounts of capital needed to raise even more. Additionally, investors that had recently invested in such companies experienced a significant decline in the value of those investments in a very short period of time. Prior to Notice 2008-78, the rules under Section 382 generally presumed that capital contributions made within a two-year period prior to the date on which a Section 382 ownership change occurs are part of a tax-avoidance plan. A capital contribution, if counted, has the effect of increasing the Section 382 limitation by increasing the value of the stock immediately before an ownership change. The tax avoidance presumption excludes such capital contributions in determining the Section 382 limitation. The Notice announced that the IRS intends to issue regulations waiving this tax avoidance presumption. Notice 2008-78 instead provides a facts and circumstances test to determine whether the contribution is made for tax avoidance. It also provides four safe harbors under which a contribution will not be treated as having a tax avoidance motive, signaling a marked shift in the way the IRS intends to view capital contributions in the context of Section 382.
  16. September 26, 2008 – Notice 2008-84 Under Section 382, each date on which a corporation is required to determine whether an ownership change has occurred that may limit the future use of the corporation's operating or built-in losses is called a "testing date." After the U.S. government effectively nationalized AIG, the largest insurance company in the world, the IRS issued Notice 2008-84. The Notice announced that the IRS and the Treasury will issue regulations under Section 382 providing that the term "testing date" does not include any date as of the close of which the United States directly or indirectly owns a more than 50 percent interest in the loss corporation. In effect this means that the acquisition of a loss corporation by the United States government does not result in an ownership change that would limit the use of the loss corporation's net operating losses in subsequent years (but only so long as the United States continues to own a more than 50 percent interest in the corporation).
  17. September 30, 2008 – Notice 2008-83 The failures of some of the largest financial institutions in the United States caused systemic risk to the entire global banking system. Notice 2008-83 demonstrated the IRS's willingness to go to great lengths to relieve some of that stress. Notice 2008-83 generally provides that if a bank undergoes an ownership change, losses and deductions attributable to loans that are otherwise allowable will not be treated as built-in losses or deductions attributable to a pre-change period for purposes of Section 382. In practice, this means that if an acquirer acquires a target troubled bank in which a Section 382 ownership change occurs, the target's use of its net unrealized built-in losses attributable to underwater loans (including underwater mortgages) will not be limited by Section 382. The full amount of the loss attributable to the underwater loans, when recognized after a Section 382 ownership change, could be used to offset the acquiror's and target's future taxable income. The apparent policy behind Notice 2008-83 appears to be to ease the credit crisis by unlocking significant value in troubled banks and by encouraging acquisitions of troubled banks by stronger financial institutions. Consider the events around the time of the Notice. On Monday, September 29, 2008, Citigroup announced it would acquire Wachovia for approximately $2 billion (with help from the FDIC). The next day, the IRS issued Notice 2008-83 and, three days later, Wells Fargo announced that it would acquire Wachovia for approximately $15 billion (without FDIC help). It is widely speculated that Notice 2008-83 contributed to the change in the value of Wachovia as a target.
  18. October 1, 2008 – Notice 2008-88 As the credit crisis continued to take its toll on the municipal bond market, through Notice 2008-88 the IRS extended relief initially provided in Notice 2008-41 by expanding covered securities to include qualified tender bonds (e.g., seven-day variable rate bonds with seven-day put options) and tax-exempt commercial paper. In addition, the Notice extends the period during which relief is available to December 31, 2009 (extended from October 1, 2008).
  19. October 3, 2008 – Emergency Economic Stabilization Act of 2008 On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 ("EESA"). EESA allocated in the aggregate $700 billion to the Treasury under the Troubled Asset Relief Program ("TARP") and authorized the Treasury to purchase "troubled assets" from eligible "financial institutions." The EESA contained significant tax provisions, including allowing qualified financial institutions to treat losses on Fannie Mae and Freddie Mac preferred stock as ordinary losses, rather than capital losses, and providing new limitations on the deductibility of executive compensation for those that participate in the program. (For an executive summary of the tax provisions of the EESA, consult our prior Client Alert "Bailout Bill Tax Provisions – An Executive Summary" at http://www.mofo.com/news/updates/files/14546.html)
  20. October 6, 2008 – Notice 2008-91 As a result of the recent liquidity crisis, the IRS issued Notice 2008-91, which relaxed the standards set forth in Notice 88-108, issued on September 16, 1988. In general, a U.S. shareholder that owns 10% or more of the voting stock of a CFC must include in Subpart F income certain amounts invested in U.S. property, which includes loans by the CFC to its U.S. shareholders. Under Notice 88-108, loans that are collected within 30 days from the time they are incurred (the "30-day rule") are excluded from the definition of United States property, thereby providing short-term lending to a parent company. The exclusion did not apply if the CFC held obligations that would be U.S. property without regard to the 30-day rule for more than 60 days in a calendar year. Notice 2008-91 temporarily extends the two limits of Notice 88-108 to 60 days and 180 days, respectively. The Notice only applies for the CFC's first two taxable years ending after October 3, 2008. However, the Notice does not apply to taxable years of a foreign corporation beginning after December 31, 2009. The Notice is designed to provide shortterm liquidity to U.S. corporations from their foreign subsidiaries without triggering adverse tax consequences.
  21. October 7, 2008 – Notice 2008-92 On October 7, 2008, the Treasury and the IRS issued Notice 2008-92, which clarified that the Treasury and the IRS will not assert that participation in the Treasury's temporary guarantee program by an "insurance-dedicated money market fund" (generally a money market fund available only to insurance company segregated accounts) causes a violation of required diversification requirements (described below) or that participation in the program causes the holder of a variable insurance policy that invests in the fund through a segregated account to be treated as an owner of the fund for tax purposes. Under current law, if a life insurance policy is properly structured and respected for federal income tax purposes, income from the investments underlying the policy are permitted to accumulate tax-free and, if held until death of the insured, the entire death benefit paid is not subject to tax. However, these benefits are lost if the segregated account is not adequately diversified or if the policy holder is deemed to own the underlying investments directly because the holder violates the "investor control" doctrine. To be adequately diversified, the segregated account is subject to specified concentration limits, restricting it from holding too many securities or obligations of any one issuer. For this purpose and in the case of government securities (generally securities issued or guaranteed by the United States or any instrumentality thereof), each government agency or instrumentality is treated as a separate issuer. In addition, the holder of a policy generally may be treated as an owner of the underlying investments if the holder exercises sufficient control over the assets to be deemed the owner for tax purposes or if the investments are not available exclusively through the purchase of a life insurance contract. Prior to the Notice, practitioners had expressed concern that participation in the Treasury's temporary guarantee program by insurance-dedicated money market funds may raise both diversification issues (presumably because the underlying guarantee may be viewed as concentrating an account's investments in one government issuer) and investor control issues (presumably because the guarantee was made available to money market funds available to investors outside of insurance company segregated accounts). The Notice states that it was issued to provide "administrative relief in furtherance of public policy to promote stability in the market for money market funds."
  22. October 14, 2008 – Notice 2008-100 Notice 2008-100 generally provides, among other things, that (i) preferred stock acquired by the Treasury pursuant to the TARP Capital Purchase Program is not treated as "stock" for purposes of Section 382 and, consequently, will not trigger a Section 382 ownership change; (ii) for purposes of testing for Section 382 ownership changes on or after the date that stock held by the Treasury is redeemed, the redeemed shares will be treated as if they were never outstanding; and (iii) any capital contribution made by the Treasury pursuant to the TARP Capital Purchase Program will not be considered to have been made as part of a tax-avoidance plan. In effect, Notice 2008-100 removes any potential disincentive resulting from participation by a bank in the TARP Capital Purchase Program by clarifying generally that a Treasury purchase of capital would not by itself trigger application of the limitations of Section 382 on the use of the bank's losses going forward.
  23. October 14, 2008 – Notice 2008-101 When the Treasury injects capital into financial institutions, a question arises as to whether such amounts would constitute "federal financial assistance" within the meaning of Section 597, which would cause those amounts to be includable as income to the recipient institution and, if received in connection with certain acquisitions, could wipe out all of the favorable tax attributes of the target. Notice 2008-101 provides that, until future guidance is issued, no amount furnished by the Treasury to a financial institution under TARP will be treated as federal financial assistance for purposes of Section 597.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved