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Larry Summers: Stop the AIG Bonuses. Yes You Can.

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Larry Summers claims that nothing can be done about the AIG bonuses. As a former Secretary of the Treasury, he should know better.

Treasury Secretary Tim Geithner should direct the Commissioner of Internal Revenue to challenge the AIG bonuses as unreasonable compensation under the Internal Revenue Code. Finding the AIG bonuses to be unreasonable compensation would render them nondeductible for federal tax purposes, and would strengthen potential shareholder derivative suits to recapture The Great AIG Giveaway.

Section 162(a) of the Internal Revenue Code declares:

"There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including . . . a reasonable allowance for salaries or other compensation for personal services actually rendered."

In Gordy Tire Co. v. United States (155 Ct. Cl. 759, 1961), the United States Court of Claims declared that determinations of the reasonability, and thus the tax deductibility, of compensation should consider the "foresightedness and business acumen" of the individuals receiving such compensation. AIG's head honchos exhibited about as much foresightedness and business acumen as the captain of the Titanic. Larry Summers himself declared the AIG bonuses to be the "most outrageous" event of the "last 18 months."

If the AIG bonuses are determined to be unreasonable compensation, AIG would be unable to deduct such compensation for federal income tax purposes. The American taxpayers would thereby recoup some of the money they advanced to keep AIG solvent, money which wound up instead in the pockets of AIG's managers. Even if AIG does not owe any federal income tax this year, challenging the bonuses as unreasonable compensation prevents AIG from carrying the deduction forward for use as Net Operating Losses (NOLs) to offset future corporate earnings and thereby reduce AIG's future income taxes.

Determining these bonuses to be unreasonable compensation will also benefit AIG's shareholders. Corporate law allows a shareholder to bring a derivative action against the board of a corporation for recovery of excessive executive compensation. These shareholder claims will be buttressed by an IRS determination that the AIG bonuses are unreasonable.

Ordinarily, we discourage the Secretary of the Treasury (and the Economic Czar) from interfering with the day-to-day functions of the Internal Revenue Service, and the IRS has historically been loathe to examine the compensation packages given to employees of publicly traded corporations. However, these are abnormal times, and the AIG bonuses present extraordinary circumstances. AIG can respond to an IRS challenge in open court. Moreover, an IRS challenge to the reasonability of the AIG bonuses would send a strong message that such executive compensation shenanigans will not be tolerated.

Larry Summers says that the United States government is powerless to stop the unreasonable AIG executive compensation. He should know better. Mr. Summers: Yes you can.