Frequently Asked Questions about Rasmusen v. Citigroup

Citigroup's Taxes

1. What did Citigroup do wrong?
   Corporations pay state income tax, just as individuals do. In New York State the corporate income tax on banks is called the "franchise tax". For several years after 2009 Citigroup took deductions for "Net Operating Losses" (NOL's) to which it was not entitled.

2. What are Net Operating Losses (NOL's) and Section 382?
   If a corporation makes losses instead of profits in 2007, 2008, and 2009, it doesn't pay income tax in those years. If it finally makes profits in 2010, it is allowed to deduct the sum of its old losses from its current income. Thus, if it had $4 billion in 2010 income and $3 billion in old losses, it would only have to pay tax on $1 billion in 2010. If it didn't use up all its old losses in 2010, it could have carried forward whatever part it didn't use up. The current level of the old losses it hasn't used up yet is called Net Operating Losses. Section 382 of the Tax Code limits the amount of NOL's a company can deduct if it changes ownership.

3. What's wrong with Citigroup reducing its taxes using Net Operating Losses?
   For most corporations, it is perfectly okay to deduct NOL's. If a corporation changes ownership, though, it loses almost all of its NOL's--- it can't deduct more than a very small amount of its old losses(from Section 382 of the Tax Code). In 2009 Citigroup changed ownership. 34% of it was acquired by the U.S. Treasury and it issued large amounts of new shares that were acquired by the general public.

4. Can you explain exactly how Section 382 works?
   No, not on a FAQs page. You can try my 2001 article with J. Mark Ramseyer. What is important for the Citigroup case is that it sold enough new shares to the U.S. Treasury and the general public that it triggered an ownership change for the purposes of Section 382, and that this ownership change greatly reduces the NOL deduction it can take, though it doesn't eliminate them entirely. Explaining exactly what "enough new shares" and "greatly reduces" mean is tricky. Section 382 is possibly the most complicated single section of the U.S. Tax Code and I would rate it as the most complex statute I have ever read (except maybe for Section 383, on tax credits after ownership change). A 1993 Tax Law Review paper on it, "Strange Loops and Tangled Hierarchies," is the only law journal article I've ever seen that uses matrix algebra. I happened on an assignment for Professor Asofsky's bankruptcy law course at the University of Houston, "Section 382--- Overview, Identification of Ownership Change", that starts out in capital letters like this:

   THIS ASSIGNMENT IS LENGTHY. IT IS THE MOST DIFFICULT MATERIAL WE
   WILL COVER ALL SEMESTER. IT IS SUGGESTED THAT YOU SET ASIDE FIVE
   OR SIX HOURS IN A QUIET PLACE. IT REQUIRES INTENSE
   CONCENTRATION. IT IS ALSO SUGGESTED THAT YOU READ THE
   MATERIALS IN THE ORDER ASSIGNED

   Section 382's complexity made it an ideal vehicle for slipping extra billions to Citigroup.

5. What if a company can prove it has a good business reason to buy another company that's losing money. Does Section 382 still apply, even though the purchase isn't a tax dodge?
   Yes. When it wrote the law, Congress knew that otherwise companies trying to buy other companies as a tax break would always claim they had a good business reason and hire clever lawyers to argue their case. Rather than make the IRS hire more lawyers to fight the bogus claims, Congress simply said, "No excuses allowed." The Section 382 limitation was written in 1954 using objective criteria to replace an earlier tax rule that proved impractical because it relied on proving that the acquiring company's purpose was to reduce taxes. Tax attorney Mark Hoenig writes, "Congress thought that the subjective intent test of then-section 129 (the predecessor of section 269) increased the chance of litigation and hampered a taxpayer�s ability to conduct legitimate business transactions. Accordingly, the 1954 version of section 382 enumerated objective criteria in an attempt to add certainty to the determination of when loss carryovers would be limited."

6. Nonprofit corporations don't have to pay income tax. If nonprofit corporation A bought 51% of the shares of for-profit corporation B, would for-profit corporation B lose its NOL's anyway?
   Yes.

7. Are there examples of companies losing their NOL's because of Section 382 even though their new owners weren't just to reduce their taxes?
   Yes. We know that because when one firm acquires another, the Section 382 limitation means that they don't reduce their taxes--- so the purpose must be something else. Some examples are the HC2 Holdings acquisition of Global Marine Systems Limited (a loss of about $134 million in deductions), the merger of Biofuel Energy with JBGL Capital (a loss of $63 million in tax assets), and the acquisition of Lake Region Medical by Greatbatch ($360 million in NOL's subject to section 382).

8. Does Section 382 apply when a government agency such as the U.S. Treasury buys a company?
   Yes. If a state government, a federal agency, or a foreign government were to buy a U.S. corporation, the tax laws still apply. The corporation must still pay federal and state income tax, and Section 382 still applies.

9. Why did Citigroup think it could get away with making billions of dollars of illegal tax deductions?
   Secretary Geithner of the U.S. Treasury made a special exception to Section 382 for companies whose shares it purchased under TARP (the Troubled Asset Relief Program). This was announced in the "EESA Notices" released in 2009 and 2010.

10. Didn't anyone object to Secretary Geithner waiving Section 382 for companies Treasury bought stock in?
    Yes, lots of people did, including Representative Dennis Kucinich and Senator Chuck Grassley, who requested investigations into Treasury's motives. On the main Citigroup page I have a section of media and political commentary on the waiver. Nobody had the power and the will to make Treasury obey the law, however.

11. What is the relationship between the Internal Revenue Service (the IRS), the U.S. Treasury, and the U.S. President?
    The President is elected every four years. He nominates a Secretary of the Treasury, and the U.S. Senate must vote to confirm the nominee. He also nominates a Commissioner for the IRS (the IRS boss) and a Chief Counsel for the IRS (the IRS top lawyer). He can fire any of these three people for any reason whenever he wants to. The IRS is an agency within the U.S. Treasury, so the Secretary of the Treasury is the boss of the Commissioner.

12. What reason did Treasury provide for giving billions of dollars of tax deductions to Citigroup?
    You can read this defense of the waiver. It boils down to Treasury wanting to help strengthen Citigroup and saying that the law was never intended for this kind of situation. This is beside the point, though. The law was intended to stop one company from buying another company for tax reasons, but it was purposely made to be an objective test, with no excuses by the company that tax avoidance played no part. And, in fact, tax avoidance did play a part in Treasury's decision to buy Citigroup stock: by waiving Section 382, Treasury raised the price of Citigroup's stock so it would look better when it came time for Treasury to sell the stock.

13. Can the Secretary of the Treasury give out tax breaks to whoever he wants?
    No. The tax laws are made by Congress. It is unclear legally whether the Secretary of the Treasury is legally bound to enforce the tax laws as written. He does not, for example, have to audit every single taxpayer--- that would be too expensive. He can settle tax lawsuits out of court even if he thinks the taxpayer really does owe the money. Whether he (or the U.S. President) can decide for reasons of policy to just give someone a break on his taxes is unclear.

14. Wasn't Secretary Geithner the one who cheated on his own taxes?
    Yes. Geithner failed to pay $34,000 in self-employment taxes fon his earnings from the International Monetary Fund from 2001 to 2004, even though he'd signed a document for the IMF acknowledging that he knew he had to pay them. He said he used TurboTax (but didn't really use it as an excuse, apparently). He also tried to illegally deduct his children's summer camp expenses as childcare expenses and failed to pay the 10% tax on early withdrawals from his retirement account.

1. Who is the relator, Eric Rasmusen?
   Dr. Rasmusen is the Dan R. and Catherine M. Dalton Professor of Business Econ and Public Policy, Kelley Sch. of Bus., Indiana University, Bloomington, Indiana. He received his B.A. and M.A. in economics from Yale in 1980 and his PhD from MIT in 1984, and has held visiting positions in law at Yale and Harvard and in economics at Harvard, Chicago, Tokyo, and Oxford

2. What kind of law firm is Hodgson-Russ LLC, Dr. Rasmusen's representatives?
   Hodgson Russ LLP, a New York law firm active in civic affairs which was founded in 1817. It can claim two U.S. Presidents as past partners--- Millard Fillmore and Grover Cleveland.

3. What is the background of the Attorney-General of New York, Eric Schneiderman?
   Eric Schneiderman started as a public-interest lawyer. He was then elected to the State Senate, where he sponsored New York's False Claims Act. In 2010 he was elected Attorney-General of New York.

4. How is it that a private person can be a "relator' and sue on behalf of the State of New York?
   The New York False Claims Act authorizes a private person to sue "qui tam"--- that is, to collect money on behalf of the state. The federal government and the states have qui tam laws allowing private person to sue when the government is defrauded in a contract. New York State's law is unusual because it allows to sue qui tam when the government is defrauded via a tax return.

5. Can the Attorney-General prevent someone from suing on behalf of the State of New York?
   No.

6. Can the Attorney-General join a case when someone sues on behalf of the State of New York?
   Yes. In that case, he assumes direction of the case, and the relator's reward is correspondingly reduced.

7. Does the relator get a reward for successfully collecting taxes for the State of New York?
   Yes. Under the False Claims Act the court awards attorney's fees adn from zero to thirty percent of the amount collected to the relator, the amount depending on how important his efforts were to the succes of the case.

8. Why would a relator want the Attorney-General to join his case against a delinquent taxpayer?
   The Attorney-General has investigative subpoena powers that the relator does not. In addition, even if the delinquent taxpayer underpaid his taxes unintentionally, the Attorney-General (but not the relator) can collect the taxes from him, though not the treble damages.

9. Can a private person sue for unpaid taxes on behalf of the United States government, for federal taxes?
   No. The Internal Revenue Service does have a whistleblower law that requires it to give a reward to private persons who provide information that leads to collection of unpaid taxes, but the private person cannot force the IRS to collect any taxes, and cannot sue delinquent taxpayers on his own.

10. On October 2, 2015, Citigroup asked to "remove" the case to the U.S. District Court. What does that mean?
    Citigroup has asked a federal court to take the case away from the state court, arguing that federal tax law is a big part of the case and so it is appropriate that a federal court hear it. The case is still decided under the New York False Claims Act, and is only about New York state taxes. If a federal court rules that under federal tax law the NOL exemption was unlawful, however, that could have big implications for the $21 billion in deferred tax assets from federal taxes that Citigroup carried forward in 2009.

11. What are the next steps in the lawsuit?
    The next step is for Citigroup to "answer" the complaint, saying which factual and legal claims it agrees with and which it disagrees with. Citigroup can also "make a motion to dismiss", arguing that their legal position on Section 382 is correct.