eTrade 2010 Annual Report Download - page 155

Debt Exchange
For the year ended December 31, 2009, the effective tax rate on the Debt Exchange of 20% was below the
Company’s statutory federal tax rate of 35%. This was primarily due to certain components of the loss on the
Debt Exchange not being deductible for tax purposes, which are summarized in the following table (dollars in
thousands):
Year Ended December 31, 2009
Amount of Loss Tax Rate Tax Benefit
Deductible portion of the loss on the Debt Exchange $722,952 35% $253,033
Non-deductible portion of the loss on the Debt Exchange 245,302 — —
Prior period interest expense on the 12
1
⁄ 2 % Notes not deductible
as a result of the Debt Exchange N/A N/A (57,687)
Total $968,254 20% $195,346
Tax Ownership Change
During the third quarter of 2009, the Company exchanged $1.7 billion principal amount of its interest-
bearing debt for an equal principal amount of non-interest-bearing convertible debentures. Subsequent to the
Debt Exchange, $592.3 million and $720.9 million debentures were converted into 57.2 million and 69.7 million
shares of common stock during the third and fourth quarters of 2009, respectively. As a result of these
conversions, the Company believes it experienced a tax ownership change during the third quarter of 2009.
As of the date of the ownership change, the Company had federal NOLs available to carryforward of
approximately $1.4 billion. Section 382 imposes restrictions on the use of a corporation’s NOLs, certain
recognized built-in losses and other carryovers after an “ownership change” occurs. Section 382 rules governing
when a change in ownership occurs are complex and subject to interpretation; however, an ownership change
generally occurs when there has been a cumulative change in the stock ownership of a corporation by certain
“5% shareholders” of more than 50 percentage points over a rolling three-year period.
Section 382 imposes an annual limitation on the amount of post-ownership change taxable income a
corporation may offset with pre-ownership change NOLs. In general, the annual limitation is determined by
multiplying the value of the corporation’s stock immediately before the ownership change (subject to certain
adjustments) by the applicable long-term tax-exempt rate. Any unused portion of the annual limitation is
available for use in future years until such NOLs are scheduled to expire (in general, the Company’s NOLs may
be carried forward 20 years). In addition, the limitation may, under certain circumstances, be increased or
decreased by built-in gains or losses, respectively, which may be present with respect to assets held at the time of
the ownership change that are recognized in the five-year period (one-year for loans) after the ownership change.
The use of NOLs arising after the date of an ownership change would not be affected unless a corporation
experienced an additional ownership change in a future period.
The Company believes the tax ownership change will extend the period of time it will take to fully utilize its
pre-ownership change NOLs, but will not limit the total amount of pre-ownership change NOLs it can utilize.
The Company’s updated estimate is that it will be subject to an overall annual limitation on the use of its
pre-ownership change NOLs of approximately $194 million. The Company’s overall pre-ownership change
NOLs, which were approximately $1.4 billion, have a statutory carryforward period of 20 years (the majority of
which expire in 17 years). As a result, the Company believes it will be able to fully utilize these NOLs in future
periods.
The Company’s ability to utilize the pre-ownership change NOLs is dependent on its ability to generate
sufficient taxable income over the duration of the carryforward periods and will not be impacted by its ability or
inability to generate taxable income in an individual year.
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