Use this link for a 25% discount on a subscription to The Dig until June 30. We’re celebrating my new role as a full-time Lecturer at Wharton starting July 1.

Things are settling in here in Philadelphia. My job at Wharton officially starts July 1. I’m juggling writing for The Dig, continuing my academic research on the KPMG-PCAOB scandal with a team from Ohio State and Univ. of Baltimore, and working on developing the MF Global story for film!

I get out of bed around 7 am — although my dog Hailey has lately been nuzzling me to get up at 5:30, likely because the glorious light from the high windows in my new vintage apartment wakes her up. I work all day, talk on the phone, and tweet. It’s the tweeting that puts me off track because there is always something in the news that interests me and, then, people ask me to comment or write about it.

Hailey likes the splash fountain at Philadelphia’s Dilworth Plaza near City Hall.

I stop, typically at about 6:30pm, open a few more boxes of books, take Hailey out, and then fix something to eat. I unwind between 8-11 pm with the latest serial show on one of the streaming services – knocked out Better Call Saul, Hacks, and Bosch Legacy and watched The Life and Times of Judge Roy Bean (it’s odd) on Criterion channel just since arriving in Philly.

Last one I watched was Pieces of Her. I like actress Toni Collette in everything — United States of Tara is fabulous—but this show had one episode too many. Once we came full circle in Episode 7, the final episode seemed a duplicative denouement and plugged in an unnecessary hook for a second season that may never come.

That’s how I feel about the ongoing Elon Musk/Twitter drama. It’s trying our patience with too many McGuffins when we’d figured out twenty minutes in how this was likely to turn out.

But, I’m going to indulge myself and hope you will indulge me with one more take. Please, goddess, bring the actual climax soon because, as fun as this has been, I am bored and very tired.

On April 14th I tweeted that I thought the whole effort was tax-motivated.

The Dig

Elon Musk's Latest Genius Move

I hadn’t weighed in here on Elon Musk’s purported bid for Twitter. But, boy oh boy, have I had some things to say about it on Twitter, where I have been a user since 2008…

3 months ago · 7 likes · Francine McKenna

On April 19th Time Magazine published my OpEd that said Elon Musk should have never made it to this deal: he should have been stopped from operating at this level by the SEC back in 2018.

The Dig

Writing about Warren Buffett and Elon Musk during interesting times

In conjunction with, and in part because of, my two recent newsletters on Elon Musk and Warren Buffett, I was asked to write columns for Time Inc. about Elon Musk’s bid for Twitter and for the Financial Times on Warren Buffett and Berkshire Hathaway in time for the annual meeting last Saturday…

3 months ago · 8 likes · 2 comments · Francine McKenna

I wrote once more about the transaction on May 12, mostly to explain better all the obstacles to completing the deal that had surfaced, obstacles I warned about back on April 19 in Time.

I said then, and I said again and again, and I say again now: I still think the deal won’t go through.

But, boy oh boy, it’s been a roller coaster ride.

As a result of Musk’s many manic-inflected shenanigans, he’s been able to get even those who were against him buying Twitter to push for him to be forced to complete the deal at the original price of $54.20. He’s a mad genius! Kidding. He’s been such a jerk and it would mean he was significantly overpaying given the current market.

I continued to think that the Musk-Twitter deal had to have a tax angle, and the fact that PwC suddenly stepped up its tax services to Tesla in 2021 — while continuing to bill Twitter an enormous amount for tax services every year, too — didn’t dissuade me from continuing that line of inquiry.

In September of 2013, I wrote for Chicago Booth Review: “Using tax laws to achieve corporate goals as well as overall economic policy objectives is nothing new.”

Consider General Motors and Chrysler, the carmakers, which ended up majority-owned by the federal government when they took bailout funds from the Treasury Department's 2008 Automotive Industry Funding Program.
Companies can use net operating losses for up to 20 years into the future to reduce taxes, but Section 382 of the Internal Revenue Code eliminates much of that benefit if the company is acquired.
The Internal Revenue Service issued guidance to make sure the GM and Chrysler bailouts did not trigger [fm note: based on the ownership change to the Federal government] the Section 382 restrictions, which would have wiped out the prior net operating losses that are now being used to offset record automaker profits.

I was tuned into tax guru Robert Willens, and The Willens Report, by my regular contributor, CPA Dan Hoicowitz. Willens wrote about the Musk-Twitter tax angle on April 27.

One noteworthy thing about TWTR was its ability to rack up losses on a rather consistent basis. Thus, as of December 31, 2021, TWTR had accumulated some $2.39 billion of federal net operating losses, ("NOLs") and approximately $1.36 billion of state and local NOLs. The company had also earned approximately $500 of R&D tax credits that it has yet to utilize.
Clearly, TWTR will be experiencing an "ownership change" within the meaning of section 382(g) of the Code. EM is a five percent shareholder of TWTR, since he will have an indirect ownership interest therein of five percent or more. Moreover, such five percent shareholder will experience a more than 50 percentage point increase in his percentage ownership of TWTR's stock over the "testing period." Thus, there is little doubt that TWTR will undergo an ownership change.
When a loss corporation experiences an ownership change, the so-called "section 382 limitation" comes into play. Under the section 382 limitation, the loss corporation's pre-change losses can only be used against income for any post-change year to the extent of the section 382 limitation.
The section 382 limitation, therefore, limits the amount of income, for any taxable year ending after the date of the ownership change, that the pre-change NOLs can offset. In general, the section 382 limitation is an amount equal to the product of (i) the value of the loss corporation's stock "immediately before the ownership change;" and (ii) the long-term taxexempt rate.
Thus, without more, the limits imposed on TWTR's NOLs would not be too onerous since, with an equity value of $44 billion and a long-term tax-exempt rate of approximately two percent, the section 382 limitation would be about $880 million. Thus, as much as $880 million of post-change taxable income earned in any year following the ownership change would be eligible to be offset by TWTR's pre-change NOLs.

That is, Twitter, as the corporation, not Elon Musk, can use some of its losses to offset future taxable income, up to certain section 382 limitations.

So I asked Willens about Musk and Twitter and what it is about the structure of the deal — where Musk is the intended majority owner of a new private company — that prevents Musk from using the Twitter losses to offset his own significant taxable income, such as from Tesla share sales.

Like Jeff Bezos could when he bought the Washington Post.

Bezos’ recent individual purchase of the assets, not the shares, of the Washington Post allows him to use its prolonged losses to offset his own income — if he plays an active role in its management.

Willens told me that it may have been the case for Bezos, but it's not here.

That’s because Musk is buying Twitter through a corporation of which he will be the principal owner. According to tax law, none of the corporation's nor Twitter’s "tax attributes" pass through to Musk. Musk may realize a tax benefit to the extent he personally borrows to fund the deal — he can deduct the interest expense, but only on a limited basis. But the interest expense would be investment interest expense, deductible only to the extent of his net investment income, which I suspect is rather small.
Musk may also get some tax benefits if he sold his Tesla or other stock at a loss. If he has a high basis in his Tesla stock because he recently acquired it related to the exercise of options, he may have losses because Tesla shares have declined since he made the bid for Twitter.

So, I asked Willens: If Musk wanted to use Twitter’s losses to offset his own tax liabilities, the huge tax bills he is always complaining about, how should his advisors have structured the deal?

The current structure for the acquisition, one that is still valid based on the latest filings, was described by Willens in his newsletter on April 27 this way:

Twitter, Inc., ("TWTR"), as everyone now knows, is being acquired by Mr. Elon Musk, ("EM"). EM will be acquiring TWTR through what Ginsburg and Levin refer to as a "two-corporation LBO." Thus, EM will create a vertical chain of corporations, X Holdings I, ("Parent"), and X Holdings 11, ("Acquisition Sub").
Parent will raise debt and equity financing, approximately $25.5 billion of the former and approximately $21 billion of the latter. These funds will then be contributed to Acquisition Sub following which Acquisition Sub will be merged with and into TWTR. TWTR will be the surviving corporation in the merger and will become, as a result of the merger, a wholly owned subsidiary of Parent.
Either TWTR will assume, and become directly liable for, the acquisition indebtedness; or said indebtedness will remain a primary obligation of Parent and TWTR's earnings and cash flow will be relied upon by Parent' to service the indebtedness.

Willens told me that Musk could use the losses if Holdco, the corporation that will be the parent, can elect to be a subchapter S corporation.

In that event, the corporation's losses (from interest expense) could pass through to him. However, to be a subchapter S corporation, he would have to make sure that Holdco had only U.S. individuals as shareholders, i.e., there could be no institutional shareholders, nor could there be more 100 shareholders.

Too bad Musk worked so hard to get Saudi Prince Alwaleed Bin Talal, and a few other foreign investors, on board.

© Francine McKenna, The Digging Company LLC, 2022

Rather than words comes the thought of high windows:
The sun-comprehending glass,
And beyond it, the deep blue air, that shows
Nothing, and is nowhere, and is endless.
Philip Larkin, "High Windows" from Collected Poems.

Postscript from that 2014 Medium post about Amazon and taxes:

PwC professionals are very good at structuring personal and corporate tax avoidance, just sayin’. And, you can check, my prediction in bold was correct.

If Amazon doesn’t start showing a profit, at home and abroad, the company risks losing the ability to utilize some benefits accrued by virtue of having been such a loser. Almost $2.5 billion in operating loss carryforwards will expire in 2014. I suspect we’ll see enough profits by the end of 2014, a “just right” like Goldilocks' pudding amount, to take advantage of this one tangible benefit of being a money-losing company.
Amazon’s tax advisor is not EY. Its sophisticated tax avoidance strategy using low-tax Luxembourg cost tens of millions to design and implement, more than the minuscule amount EY collects for tax services each year. For example, Caterpillar paid $55 million to advisors including PricewaterhouseCoopers for a scheme, criticized in public hearings by Sen. Carl Levin last April, that reroutes U.S. profits to low-tax Switzerland.
Based on media reports and PwC Luxembourg’s own horn-tooting, I believe PwC structured the Amazon Luxembourg 2005 restructuring deal that’s now under scrutiny by the IRS and continues to be its primary tax minimization strategy advisor. (Amazon did not respond to my request for comment or confirmation of its relationship with PwC.)

Postscript Two:

The whole Musk distraction regarding the Twitter spambot accounts is silly and I commented on it on Twitter and was quoted about it in Business Insider. I continue to advise anyone interested in the legal and securities transaction nuances of this stuff to read Matt Levine at Bloomberg and/or Ann Lipton on Twitter and at the Law Professors Typepad site.

Here’s a blog post by Professor Stephen Bainbridge that heavily quotes both.

Is Elon Musk trying to get out of the Twitter deal? (Probably.) Will he be able to do so with impunity? (Probably not.)

Linette Lopez @lopezlinette

As @retheauditors said in my last column: "If you're buying the company based on a metric it makes up itself, like daily active users, well, then you're a complete idiot." businessinsider.com/twilight-of-te… Now enter Musk's latest letter to Twitter.

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