By Allan Sloan
Tuesday, June 2, 2009
You don't often get to use "Time Warner" and "hot stock" in the same sentence, given the company's horrible investment performance over the years.
But Time Warner's pending deal to unburden itself of AOL by dumping the ailing firm onto its shareholders is one of those times, thanks to an insight I got from tax guru Bob Willens of Robert Willens LLC. Willens, who lives and breathes (and probably dreams about) the tax code, says that Time Warner's plan to distribute AOL stock to its shareholders in a tax-free transaction is benefiting from a little-noticed change last year in the rules governing "hot stocks."
In this case, "hot stock" doesn't mean shares with a rapidly rising price; it means shares that can trigger a tax liability.
The "hot stock" here would be Google's 5 percent stake in AOL. Time Warner sold those shares to Google in 2005, and plans to buy them back by the end of this year, then distribute them (along with the other 95 percent of AOL) to Time Warner shareholders in a tax-free deal.
Without last year's change, Willens says, the Google stake in AOL would have been a "hot stock" to both Time Warner and its shareholders because Time Warner would have been distributing the stock to its holders within five years after buying it from Google.
How much in tax savings are we talking about? Call it $200 million or so. The exact amount depends on the market value of AOL stock when Time Warner distributes it. Should AOL be valued at $5.5 billion, the value that Google placed on AOL in February, the "hot stock" rule change would save Time Warner and its shareholders from having to report $275 million each in taxable income. (I'm assuming that Time Warner's cost of AOL for tax purposes is close to zero.) At federal, state and local tax rates totaling 40 percent, Time Warner and its shareholders each save about $110 million.
Willens says the "hot stock" rule was changed last December when the Treasury tweaked the appropriate regulations. A Time Warner spokesman said the company played no role in the change. Spokesmen for the Treasury and Google declined to comment.
Under the previous rules, there would have been a "hot stock" liability because Google decided to invoke its right under the AOL stock-purchase agreement to sell back its AOL stake to Time Warner. The price is currently being negotiated.
I suspect that taxes play a big role in Google's decision to sell. If Google, which paid $1 billion for its AOL stake, sells the stake for the $274 million at which it's now carried on its books, it gets a $726 million tax loss. That would reduce its income-tax bill by about $290 million.
Time Warner and its shareholders avoid taxes, perfectly legally, and Google gets to save some taxes, also perfectly legally. All other taxpayers, in effect, pick up the tab for those savings.
'Twas ever thus, when it comes to big-time dealmaking. And 'twill always be thus.
(Full disclosure: many of my Fortune colleagues have stakes in the stock price of Time Warner, our employer. I joined Fortune in 2007 and have a minor, indirect stake in Time Warner's stock price.)
With reporting by Alyssa Abkowitz. Allan Sloan is Fortune magazine's senior editor at large. His e-mail address is firstname.lastname@example.org.