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By Ronald Fink
Time Warner will be able to load AOL with a considerable amount of debt and dump the so-called "hot stock" in the company that it recently acquired from Google without worrying about tax consequences, thanks to recent rule changes.
As expected, Time Warner announced that it would spin off AOL by the end of this year in a deal that it said would be tax-free to shareholders. But that would not have been possible without a helping hand from the government.
Until last December 11, a company that spun off assets to shareholders that included what the IRS calls "hot stock" would have subjected shareholders to tax on the proceeds. The rule applied to any stock a company bought within five years of a spin-off. Under that rule, 5% of all the stock in AOL that Time Warner distributes to shareholders that represents the stake in AOL that Time recently repurchased from Google would have been subject to tax.
The idea behind the rule was to prevent companies from converting income that might otherwise be paid out to shareholders as taxable dividends into tax-free capital gains, said Robert Willens, a tax and accounting expert in New York City. But the IRS dropped that rule on Dec. 11 without any explanation, Willens observed.
The spinoff might also have generated tax had Congress not recently allowed companies to defer tax on forgiven debt for up to five years. Partly as a result, Willens said he expected Time Warner to shift a considerable amount of debt onto AOL, much as it did earlier this year with Time Warner Cable and Verizon Communications recently did when it spun off Frontier Communications assets to shareholders in exchange for $3.3 billion in dividends and another $5.5 billion in other considerations, including the assumption of debt.
"Time Warner may follow a lot of what Verizon is doing," Willens said.
Since tax on forgiven debt is much less of a concern following Congressional action earlier this year, Willens said that he expects more companies to shift debt through such spin-offs. "These deals will be loaded up with bells and whistles," he said.
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