You may have heard by now that GM, a company that received $49.5 billion in bailout funds, will receive a tax break on up to $45 billion of past operating losses. With the standard federal corporate tax rate at 35 percent, that tax break could save GM as much as $15.75 billion in taxes. GM will benefit from the operating tax-loss provision in IRS regulations. The provision enables a company that has been experiencing operating losses to use those losses to offset past or prior income amounts. The result is to lower taxable income during the carryback (2 year) and/or carryforward (20 year) periods. Companies can forego the carryback provision, a benefit for GM since it has not been profitable since 2004 so there’s no income available to offset the carrybacks. The carryforward provision will enable GM to reduce taxable income for up to twenty years by offsetting future income amounts by the operating loss carryforwards from 2005 through 2009. The losses are considered to be valuable assets on a company’s balance sheet but they usually don’t survive bankruptcy as occurred in the case of GM.
A reasonable question to ask is why the operating loss carryforward provision is available to GM given that tax dollars were used under the Troubled Asset Relief Program (TARP) to bailout the company? Moreover, the government currently owns 61 percent of GM, although that amount will decline after an IPO later this month. Typically, companies that undergo a significant change in ownership have major restrictions put on their tax benefits. Well, it seems as though the IRS decided last year that recipients of TARP funds are exempt from any such limitations. The reason given was that the value of the tax credits of the company to potential investors is greater than the tax payments to the Treasury. That may be true but from an ethical perspective it seems to be unfair to companies like Ford that played by the rules and did not take any TARP funds. Sure, Ford can still use any carryforwards under the normal IRS rules. The issue is one of “moral hazard.” Moral hazard occurs when a party protected from risk behaves differently than it would if it were fully exposed to the risk. It arises because an individual or organization does not take full responsibility for its actions so that the consequences of bad behavior do not befall on that party. Instead, responsibility passes to another party that covers the cost of the risky behavior. In this case it’s you and me and our tax dollars.
GM recently stated that it expects to report $1.9 billion to $2.1 billion in third-quarter profit in 2010 as compared to a $1.2 billion loss in 2009. GM made $865 million in the first quarter of 2010 and $1.2 billion in the second. So, GM has about $4 billion of profits so far this year that will be wiped out by the carryforward provision. If we assume GM’s profit averages $6 billion a year into the future, the company won’t pay any taxes until 2017.