BACKGROUND

In December 2020, Congress established the Emergency Capital Investment Program (“ECIP” or the “Program”) to encourage certified community development financial institutions and minority depository institutions to increase efforts to support small businesses and consumers in low- to moderate-income communities that were disproportionately impacted by the COVID-19 pandemic. 

Under ECIP, investments (the “ECIP Securities”) made by the US Department of the Treasury (“Treasury”) took the form of senior perpetual preferred stock or subordinated notes issued by participating eligible institutions. Senior perpetual preferred stock was the default security issued unless an ECIP participant could not feasibly issue preferred stock (e.g., Subchapter S Corporations or credit unions) in which case the ECIP participant was required to issue subordinated debt. 

On November 20, 2024, Treasury released its ECIP Disposition Guidelines (the “Disposition Guidelines”), which allow an ECIP participant to request that Treasury dispose of its ECIP Securities under certain circumstances at the option of an ECIP participant. In connection with the release of the Disposition Guidelines, many ECIP participants entered into a Securities Purchase Option Agreement with Treasury (the “Option Agreement”), which allows an ECIP participant to request that Treasury divest of the participant’s ECIP Securities if the ECIP participant meets certain criteria set forth in the Disposition Guidelines and the Option Agreement. 

As a result of the Disposition Guidelines and the related Option Agreements, many qualifying ECIP participants are actively preparing to exercise their option to repurchase the ECIP Securities, potentially as early as in the third quarter of 2026. ECIP participants, however, should be mindful that there may be tax consequences that were not anticipated or intended when ECIP was originally enacted by Congress. Below is a brief overview of certain tax implications that ECIP participants should be aware of, as well as potential legislative solutions that would align with Congress’s original intent and ECIP participants’ understanding of the terms of the Program.

POTENTIAL FEDERAL TAX CONSEQUENCES FOR ECIP PARTICIPANTS

Subchapter S Corporations

If an ECIP participant elects to repurchase its ECIP Securities directly from Treasury in accordance with the terms of the Disposition Guidelines and its Option Agreement, the repurchase price will be less than the initial issuance price. For those ECIP participants taxed under Subchapter S of the Internal Revenue Code of 1986 (the “Code”), each referred to as an “S Corporation,” the ECIP investment was issued in the form of subordinated debt. Under Section 108 of the Code, the repurchase of such subordinated debt for a price less than the outstanding principal amount of the indebtedness will result in “gross income” due to the cancellation of indebtedness, which may result in the ECIP participant paying a substantial amount in federal income taxes. Conversely, if an ECIP participant is not an S Corporation, which we refer to as a “C Corporation,” its outstanding ECIP Securities are in the form of perpetual preferred stock. As such, the repurchase of the perpetual preferred stock under the Option Agreement will not result in the same “gross income” due to the cancellation of indebtedness. Thus, S Corporations whose ECIP Securities are in the form of subordinated debt are at a tax disadvantage when it comes to a repurchase under the Option Agreement.

Further, we are aware that some S Corporation ECIP participants have made the strategic decision to revoke their S Corporation election and then request that Treasury exchange their ECIP subordinated debt for perpetual preferred stock. Such ECIP participants, however, should be aware that the mere exchange or substitution of subordinated debt issued to Treasury for an equivalent amount of perpetual preferred stock (even on near identical terms) may still result in the realization of “gross income” due to the cancellation of indebtedness under Section 108(e)(8) of the Code to the extent that the “fair market value” of the perpetual preferred stock issued to Treasury in exchange for the outstanding subordinated debt is less than the outstanding principal amount of such subordinated debt. 

Accordingly, despite the subordinated debt and perpetual preferred stock being nearly identical investments, ECIP participants whose ECIP Securities are in the form of subordinated debt could potentially be required to recognize “gross income” due to the cancellation of indebtedness as a result of either (i) exercising their right to repurchase their ECIP investment under the Option Agreement or (ii) exchanging or substituting their ECIP subordinated debt for perpetual preferred stock. 

C Corporations

Furthermore, C Corporations whose ECIP Securities are in the form of perpetual preferred stock are not necessarily immune from potential tax exposure. As described above, pursuant to the Option Agreement and the Disposition Guidelines, an ECIP participant (or a purchaser designated by an ECIP participant) may repurchase the ECIP Securities from the Treasury. The value that an ECIP participant (or a purchaser designated thereby, including a mission aligned nonprofit affiliate) receives from Treasury in such repurchase may be viewed by the Internal Revenue Service as a taxable grant by the federal government. That is, the spread between the repurchase price and the outstanding principal of the ECIP Securities at the time of the repurchase, regardless of whether the ECIP Securities are in the form of subordinated debt or perpetual preferred stock, could be treated as gross income to a taxpayer (i.e., the ECIP participant). 

KEY TAKEAWAYS AND PROPOSED LEGISLATIVE REMEDY

The purpose of ECIP was to encourage certain eligible financial institutions to support small businesses and consumers in their communities that were disproportionately impacted by the COVID-19 pandemic. At no point in the creation or implementation of ECIP did Congress or Treasury anticipate or intend to generate tax revenue. Further, ECIP participants did not expect to incur tax liability resulting from their participation in a program designed to make a positive impact on their community.

Congress can resolve this issue by amending the Code to explicitly exclude from the meaning of “gross income” any cancellation of indebtedness income or other gains resulting from an ECIP participant’s exchange, substitution, or repurchase of its ECIP Securities from Treasury. Illustrative language in the form of a potential addition of new Section 139M of the Code, 26 U.S.C. § 139M, is presented below.

Spearheaded by the Louisiana Bankers Association, our firm has worked with numerous state banking associations, community bank advocacy groups, and ECIP participants to hold discussions with Speaker of the House of Representatives, Mike Johnson, and other members of Congress to introduce this legislative amendment. Hunton is coordinating with these organizations to continue lobbying efforts to keep the needed fix at the forefront of Congress’s legislative agenda. Please contact our firm and your state banking association to help contribute to the success of these efforts. ECIP participants also are encouraged to consult with tax and legal advisors, and to advocate for their local Representatives and Senators to adopt a legislative fix to eliminate unintended tax consequences under ECIP.

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PROPOSED AMENDMENT

 26 U.S. Code § 139M - Certain amounts received under the Emergency Capital Investment Program

1. General rule.
   Gross income shall not include—
   
   (1) any capital investment received by an eligible institution under the Emergency Capital Investment Program established under section 4703a of title 12, United States Code;
   
   (2) the discharge of any indebtedness issued by a debtor corporation to the U.S. Department of the Treasury pursuant to the Emergency Capital Investment Program established under section 4703a of title 12, United States Code, that is satisfied by the repurchase of such indebtedness or the transfer, substitution or exchange of such indebtedness for stock of the debtor corporation; or
   
   (3) gain from any repurchase of any preferred stock or other financial instruments issued by an eligible institution to the U.S. Department of the Treasury under the Emergency Capital Investment Program established under section 4703a of title 12, United States Code and pursuant to applicable rules, regulations and policies promulgated by the U.S. Department of the Treasury in accordance with the authority granted under section 4703a of title 12, United States Code.
2. Definitions.
   For purposes of this section, the terms “capital investment” and “eligible institution” have the respective meanings given to such terms by section 4703a of title 12, United States Code.