USA: Record settlement with Bank of America, creating tax fund and potential tax deductions
22 August 2014
Posted by: Author: Kelly Phillips Erb
Author: Kelly Phillips Erb (Forbes)
Bank of America BAC +4.12% Corporation (BoAC) will pay$16.65 billion to settle claims against Bank of America and its related parties (including including Countrywide Financial Corporation and Merrill Lynch). That was the word today from Attorney General Eric Holder and Associate Attorney General Tony West. It is the largest civil settlement with a single entity in American history.
The size of the settlement was clearly intended to be a public "shame on you.” Attorney General Holder emphasized this point, saying, "This historic resolution – the largest such settlement on record – goes far beyond ‘the cost of doing business.’ Under the terms of this settlement, the bank has agreed to pay $7 billion in relief to struggling homeowners, borrowers and communities affected by the bank’s conduct. This is appropriate given the size and scope of the wrongdoing at issue.”
Except maybe it wasn’t quite so bad. Just hours after the settlement was announced, Bank of America Corporation’s stock was headed north, increasing nearly 5%.
Why are shareholders so optimistic? Under the terms of the settlement, BoAC isn’t required to write a big check – not all at once anyway. Instead, the company will pay out just $9.65 billion in cash, including a $5 billion penalty under the Financial Institutions FISI +1.34% Reform, Recovery and Enforcement Act (FIRREA). Funds will also be paid to settle federal and state civil claims for fraud and related charges. Still additional monies will be paid to settle claims in California, Delaware, Illinois, Kentucky, Maryland and New York.
The remaining $7 billion will be paid out as "relief” to consumers harmed by BoAC’s conduct in the first place. That relief will come, according to the Department of Justice, in the form of principal reduction loan modifications, new loans to credit worthy borrowers, donations to assist communities in recovering from the financial crisis, and financing for affordable rental housing. That’s right. Nearly half of the settlement involves BoAC assisting the same kinds of consumers they beat up the first go round: only this time, they’re doing it with the government’s blessing. They’re being "punished” by being forced to make loans or put simply: it’s business as usual.
On the tax side, BoAC has agreed to put nearly half a billion dollars (or, more precisely, $490 million) in a "tax relief fund.” That money is expected to "help defray some of the tax liability” of those same consumers harmed by BoAC if Congress doesn’t extend the relief under Mortgage Forgiveness Debt Relief Act of 2007. I don’t know about you but I can almost hear the lobbyists rubbing their hands together…
Under the Mortgage Forgiveness Debt Relief Act in 2007, qualifying homeowners were offered an exception to the debt as taxable income rule. For federal income tax purposes, once a lender writes off any part of your debt – even a mortgage – that amount which is forgiven is reported to the Internal Revenue Service on a form 1099-C: that amount may be includable as income. This, of course, exacerbated a problem for struggling homeowners who found themselves under water as a result of the conduct of certain lenders. You know, maybe those lenders with names starting with "Bank” and ending with "America.”
The original version of the Act applied to mortgages discharged through December 31, 2009. When the economy didn’t recover quickly enough, the Act was extended in 2008 for another three years, through December 31, 2012. And when recovery still didn’t come quickly enough, the Act was extended through December 31, 2013. But it ended there. Congress did not extend the Act for 2014, despite a number of proposals to do so. I’m not a fan of extending relief on tax policy grounds – but I suspect we’ll now see a big push to get it through. Wait… did I mention those lobbyists?
But the tax consequences don’t stop there.
The settlement is essentially structured in two pieces: the settlement on claims and the FIRREA penalty. The FIRREA penalty is not tax deductible to BoAC because it’s a punishment. You may recall from my Ray Rice story that fines, fees or penalties paid to the government as a consequence of breaking the law are not tax deductible under section 162(f) of the Internal Revenue Code.
But the remaining settlement? It’s highly likely that it’s deductible. Assuming that it’s structured like the JP Morgan Chase settlement (and it’s highly like that’s the case), the language in the settlement will almost certainly yield a deduction. With a 35% corporate tax rate, that translates into over $4 billion in deductions for BoAC – quite a bite. And don’t forget: some of those settlement terms actually improve the bank’s balance sheet. It’s a win-win for BoAC plus the feds get to pat themselves on the back for the awesomely huge settlement. Who doesn’t win here?
I mean, except for those homeowners who spent a few years digging out of nightmares as a result of the crisis. And those who lost out when Countrywide failed to disclose what they knew about exception loans. And those that were mislead when BoAC "failed to make accurate and complete disclosure to investors.” And, of course, taxpayers who potentially make up the difference in lost revenue in those tax coffers as a result of the deductions.
But everyone else? Big thumbs up, right? They’re all laughing all the way to, well, the bank.
This article first appeared on forbes.com.