BAC-WT - Bank of America Warrants

[Uccmal]

Agrred with above.  BAC is at or around its high this year so we may see the opposite effect of tax loss selling.

 

Institutions will tax loss sell other stuff to buy the banks.  You wouldn't want to have to explain to the investment committee at the next meeting why you have no BAC.

 

And Sanjeev's weight gain program to speed up his skiing will help, of course.  And mini's are crawling up above the high thigh again.  And the Bills are going to win the super bowl.  And the Leafs the Cup.

[Parsad]

And the Leafs the Cup.

 

Now you're pushing it!  The Leafs...the Cup? 

 

Well maybe if they shorten the season to six games and they come out gangbusters like last year!  ;D  Cheers!

[onyx1]

I'd read the prospectus, it has a section on the tax implications. I would be careful in a taxable account with the warrants because an adjustment for strike or share number might be classified as a taxable event even though you're not exercising them.

 

 

I asked my accountant (he works at a CPA firm with 1300 employees) to get to the bottom of our question on how taxes would be applied to holders of BAC warrants in a US taxable account.  My hopes for a clear and simple answer were quickly dashed!  The problem, as explained by their resident expert, is the language in the prospectus, here:

 

http://www.sec.gov/Archives/edgar/data/70858/000119312510044940/d424b7.htm#tx70043_71

 

“Adjustments to the Number of Shares of Our Common Stock Underlying the Warrants and/or the Exercise Price of the Warrants

To the extent any adjustment to, or failure to adjust, the number of shares of our common stock underlying the warrants and/or the exercise price of the warrants results in an increase in the proportionate interest of a holder in our assets or our earnings and profits, such holder will be treated as having received a distribution of property. Such a distribution will be taxable to holders as a dividend, return of capital or capital gain in accordance with the rules discussed under “U.S. Federal Income Tax Considerations—Taxation of Common Stock, Preferred Stock, and Depositary Shares— Consequences to U.S. Holders—Distributions on Common Stock, Preferred Stock, and Depositary Shares”  beginning on pages 73.”  (page S-35)

 

 

He said that the definition of “proportionate interest” is unclear and that only BAC is in a position to measure it at the time of a dividend declaration.  The good news is that we should know a lot more (and maybe all we need to know) at the time of next dividend increase. 

 

In the meantime, his opinion is that there is no escaping the taxman.  A reduction of the warrant strike price and an increase in the number of shares per warrant from a regular dividend are likely to be taxed at the current dividend tax rates.  The holder of the warrant will feel the effect of the phantom income (cash tax liability without cash income) but the payment of this tax will increase the cost basis of the holder so that smaller capital gains will be recognized in the future if the warrant is sold at a gain (or a greater capital loss will be recognized in the future if sold at a loss).  Of course, if dividend rates are higher than cap gains rates, there is no way around the inefficiency.

 

He offered to continue to research for more information, and I will forward results if he makes any progress.

[ERICOPOLY]

Thanks onyx1,

 

Unfortunately it sounds to be designed exactly as I would have designed it, and indeed as I mentioned above.

 

From ERICOPOLY's fictional dictionary:

"proportional interest" :  the number of shares the warrant converts to (your proportional interest in the common stock)

 

Thus, if your warrant converts to 1.5 shares and there is a 60 cent dividend declared on the common, then you need to pay dividend tax on 90 cents.

[nkp007]

Thanks onyx1,

 

Unfortunately it sounds to be designed exactly as I would have designed it, and indeed as I mentioned above.

 

From ERICOPOLY's fictional dictionary:

"proportional interest" :  the number of shares the warrant converts to (your proportional interest in the common stock)

 

Thus, if your warrant converts to 1.5 shares and there is a 60 cent dividend declared on the common, then you need to pay dividend tax on 90 cents.

 

Well that sucks.

[ERICOPOLY]

Yes, it sucks.

 

However, it is non-recourse leverage.  You could instead leverage up a taxable margin account with common stock but it puts you in the same taxation boat.  Somebody above compared the warrant's leverage to be the equivalent of going 150% long on the common.  Scary to be that leveraged in the common without buying puts... and right there it really starts getting expensive.

[Cardboard]

Thanks Onyx1,

 

You and your accountant are likely correct and I believe that the best course of action is to wait for BAC to issue a filing or instructions to holders of the warrants on how to account for these.

 

If this taxation issue really becomes a large one, it will simply mean that we are making a ton of money on the warrants. Also, the way things are going and unless we hit a major recession soon, I will likely be out of these things by late 2014 or as BAC approaches $25 a share. By then, other opportunities with a higher indicated rate of return will likely have emerged. So this "problem" may only be a 2013 fiscal year thing.

 

Cardboard

[Uccmal]

Thanks Onyx,

 

Like Cardboard, my sense is that the warrants will rally once the dividend is increased, and I may be exiting fairly quickly, and switch to common.  We shall see.

 

In theory, at least, they may rally alot, initially, to account for future cash flows ( dividends). 

 

Am I right that no bank with warrants has increased its dividend beyond the adjustment yet?

 

 

[JRH]

Am I right that no bank with warrants has increased its dividend beyond the adjustment yet?

 

Not sure about banks, but Hartford (HIG) has.

[ERICOPOLY]

There might also be some selling of winners this year to book long term capital gains rates at 15% and without any Obamacare taxes.

 

 

[meiroy]

Thanks onyx1,

 

Unfortunately it sounds to be designed exactly as I would have designed it, and indeed as I mentioned above.

 

From ERICOPOLY's fictional dictionary:

"proportional interest" :  the number of shares the warrant converts to (your proportional interest in the common stock)

 

Thus, if your warrant converts to 1.5 shares and there is a 60 cent dividend declared on the common, then you need to pay dividend tax on 90 cents.

 

I don't really understand this. How can a dividend tax be applied when no cash was distributed? For example, non US residents are not required to pay capital gain tax in the states but are withheld dividend tax. So how is that going to work for them with no dividend actually paid?

[ERICOPOLY]

Thanks onyx1,

 

Unfortunately it sounds to be designed exactly as I would have designed it, and indeed as I mentioned above.

 

From ERICOPOLY's fictional dictionary:

"proportional interest" :  the number of shares the warrant converts to (your proportional interest in the common stock)

 

Thus, if your warrant converts to 1.5 shares and there is a 60 cent dividend declared on the common, then you need to pay dividend tax on 90 cents.

 

I don't really understand this. How can a dividend tax be applied when no cash was distributed? For example, non US residents are not required to pay capital gain tax in the states but are withheld dividend tax. So how is that going to work for them with no dividend actually paid?

 

I mentioned earlier that there is already a similar precedent in US tax law.

 

TIPS adjust every year with the CPI.  An upward revision to the CPI increases the principle value -- it's only an inflation adjustment, and it is non-cash in nature.  However, it is taxed as regular income during the year that the adjustment is made.  Personally, I think the worst part of it is that by design it's an inflation adjustment and thus not any "real" gain, but it's taxed as regular income anyhow.

 

EDIT:  So I guess see how that issue is handled in the TIPS example.  Perhaps you'll get lucky and not owe any tax on the adjustment?

[meiroy]

Thanks onyx1,

 

Unfortunately it sounds to be designed exactly as I would have designed it, and indeed as I mentioned above.

 

From ERICOPOLY's fictional dictionary:

"proportional interest" :  the number of shares the warrant converts to (your proportional interest in the common stock)

 

Thus, if your warrant converts to 1.5 shares and there is a 60 cent dividend declared on the common, then you need to pay dividend tax on 90 cents.

 

I don't really understand this. How can a dividend tax be applied when no cash was distributed? For example, non US residents are not required to pay capital gain tax in the states but are withheld dividend tax. So how is that going to work for them with no dividend actually paid?

 

I mentioned earlier that there is already a similar precedent in US tax law.

 

TIPS adjust every year with the CPI.  An upward revision to the CPI increases the principle value -- it's only an inflation adjustment, and it is non-cash in nature.  However, it is taxed as regular income during the year that the adjustment is made.  Personally, I think the worst part of it is that by design it's an inflation adjustment and thus not any "real" gain, but it's taxed as regular income anyhow.

 

Well, someone who does not pay taxes in the states wouldn't have to pay that "regular income" tax as well, right? So that's the same with the comment about the dividend.

 

And another question about "an increase in the proportionate interest".  If, for example, the common price is now at the current strike price and there is a large regular dividend which reduces the strike price there is actually no increase in the proportionate interest from this aspect of the dividend amount as it was already at the strike price and it's not like it went from 0 share to 1 share.  Thanks for having the patience to reply, Ericopoly.

[ERICOPOLY]

Thanks onyx1,

 

Unfortunately it sounds to be designed exactly as I would have designed it, and indeed as I mentioned above.

 

From ERICOPOLY's fictional dictionary:

"proportional interest" :  the number of shares the warrant converts to (your proportional interest in the common stock)

 

Thus, if your warrant converts to 1.5 shares and there is a 60 cent dividend declared on the common, then you need to pay dividend tax on 90 cents.

 

I don't really understand this. How can a dividend tax be applied when no cash was distributed? For example, non US residents are not required to pay capital gain tax in the states but are withheld dividend tax. So how is that going to work for them with no dividend actually paid?

 

I mentioned earlier that there is already a similar precedent in US tax law.

 

TIPS adjust every year with the CPI.  An upward revision to the CPI increases the principle value -- it's only an inflation adjustment, and it is non-cash in nature.  However, it is taxed as regular income during the year that the adjustment is made.  Personally, I think the worst part of it is that by design it's an inflation adjustment and thus not any "real" gain, but it's taxed as regular income anyhow.

 

Well, someone who does not pay taxes in the states wouldn't have to pay that "regular income" tax as well, right? So that's the same with the comment about the dividend.

 

And another question about "an increase in the proportionate interest".  If, for example, the common price is now at the current strike price and there is a large regular dividend which reduces the strike price there is actually no increase in the proportionate interest from this aspect of the dividend amount as it was already at the strike price and it's not like it went from 0 share to 1 share.  Thanks for having the patience to reply, Ericopoly.

 

I don't know what to say with regards to the foreigners who own these things.  I have no experience paying taxes as a non-resident of the US.  I guess I was only addressing the US taxpayers who are griping that taxes will be due despite there being no cash dividend paid out.

 

I don't really understand your question about the proportionate interest.  I suppose I can just repeat my understanding of how this thing should work, but it still wouldn't be an opinion from a tax professional.  But I can't help myself so I'm going to repeat my understanding of how this should work:

 

First quarterly dividend :

Step 1: Taxable dividend income is calculated by the declared dividend (less 1 cent) multiplied by 1 (the share conversion adjustment).

Step 2:  Warrant convertibility now adjusts to 1.x shares (to simulate the dividend being reinvested into more shares of the common)

Step 3:  the taxable amount from Step 1 is added to the cost basis of the warrant.

Step 4:  warrant strike reduced by the amount of the declared dividend (less one cent)

 

Second quarterly dividend:

Step 1: Taxable dividend income is calculated by the declared dividend (less 1 cent) multiplied by 1.x (the share conversion adjustment).

Step 2:  Warrant convertibility now adjusts to 1.y shares (to simulate the dividend being reinvested into more shares of the common)

Step 3:  the taxable amount from Step 1 is added to the cost basis of the warrant.

Step 4:  warrant strike reduced by the amount of the declared dividend (less one cent)

 

etc.. etc... etc...

 

I don't believe Step 2 in it's own right ever triggers any tax, just like the act of buying more common with your dividend shouldn't be taxable.  But when the next quarterly dividend is paid, you have a greater number of underlying shares per warrant so you'll have to pay a dividend tax on the dividends that each of those shares receives.

 

So for example after several years if the convertibility of the warrant is to 1.5 underlying shares and a $1.01 dividend is paid, there would be $1.50 of taxable dividend and the warrant strike would decrease by $1.  Let's say the stock is trading at $10 at the time the dividend is paid -- the convertibility of the warrant should be increased by roughly an additional 0.15 shares ($1.50 worth of dividends when paid at a $10 stock price can be reinvested into 0.15 shares) so it should now be roughly 1.65 underlying shares that the warrant converts to.  And the cost basis of the warrant should increase by $1.50.

 

EDIT:  I fixed some math in that last paragraph and also corrected the error I had made in Step 4

[ERICOPOLY]

Ironically I might finally qualify for a mortgage because I'll have tons of dividend income.

 

Even though it's not income!  Thus ending my long struggle with those underwriters.

 

Ha, ha, ha, ha.

[vpagano]

Am I right that no bank with warrants has increased its dividend beyond the adjustment yet?

 

Not sure about banks, but Hartford (HIG) has.

 

Zions threshold is only $.01 and after passing the stress tests I would think they bump their dividend well over that.

[MrB]

Am I right that no bank with warrants has increased its dividend beyond the adjustment yet?

 

Not sure about banks, but Hartford (HIG) has.

 

Zions threshold is only $.01 and after passing the stress tests I would think they bump their dividend well over that.

 

First Financial might have.

[compoundinglife]

Am I right that no bank with warrants has increased its dividend beyond the adjustment yet?

 

Not sure about banks, but Hartford (HIG) has.

 

Zions threshold is only $.01 and after passing the stress tests I would think they bump their dividend well over that.

 

First Financial might have.

 

They did: http://www.snl.com/Cache/13642719.pdf?O=3&IID=100255&OSID=9&FID=13642719

[Green King]

anyone know if the US taxes apply to TFSA ?

[StubbleJumper]

anyone know if the US taxes apply to TFSA ?

 

 

Not sure how they would apply.  Usually it's the withholding tax on a dividend that applies...but there's nothing to withhold for a warrant.

[kevin4u2]

anyone know if the US taxes apply to TFSA ?

 

 

Not sure how they would apply.  Usually it's the withholding tax on a dividend that applies...but there's nothing to withhold for a warrant.

 

Yes the withholding tax applies to US dividends within a TSFA.  Put the US dividend payers in a RRSP instead, no withholding tax.

[StubbleJumper]

anyone know if the US taxes apply to TFSA ?

 

 

Not sure how they would apply.  Usually it's the withholding tax on a dividend that applies...but there's nothing to withhold for a warrant.

 

Yes the withholding tax applies to US dividends within a TSFA.  Put the US dividend payers in a RRSP instead, no withholding tax.

 

 

Agreed, the US divvy payers belong in the RRSP. 

 

The question, however, was about the warrants.  Since the warrants do not have any cash distributions, there's nothing to withhold as far as I can see.

[Uccmal]

anyone know if the US taxes apply to TFSA ?

 

 

Not sure how they would apply.  Usually it's the withholding tax on a dividend that applies...but there's nothing to withhold for a warrant.

 

Yes the withholding tax applies to US dividends within a TSFA.  Put the US dividend payers in a RRSP instead, no withholding tax.

 

 

Agreed, the US divvy payers belong in the RRSP. 

 

The question, however, was about the warrants.  Since the warrants do not have any cash distributions, there's nothing to withhold as far as I can see.

 

I think that is correct.  You get all the benefits and none of the punishment, except if you sell at a loss. As in an RSP there is no tax loss claim available.  I am pretty conservative with my tax sheltered accounts to avoid permanent losses.  To the other thread, that is where most of my FFH is held now.

 

Now in my TFSA I hold AIG, BAC, and WFC, common and/or warrants.  I am actually so confident that these position will gain and not lose over the long term.  I'll just eat the 15% withhold tax on any dividends.  It is dwarfed by the capital gains I expect.

 

I wish the TFSA was around 25 years ago.  Adding up 5000 per yr. of contribution room would have been awesome. 

 

 

[kevin4u2]

 

I think that is correct.  You get all the benefits and none of the punishment, except if you sell at a loss. As in an RSP there is no tax loss claim available.  I am pretty conservative with my tax sheltered accounts to avoid permanent losses.  To the other thread, that is where most of my FFH is held now.

 

Now in my TFSA I hold AIG, BAC, and WFC, common and/or warrants.  I am actually so confident that these position will gain and not lose over the long term.  I'll just eat the 15% withhold tax on any dividends.  It is dwarfed by the capital gains I expect.

 

I wish the TFSA was around 25 years ago.  Adding up 5000 per yr. of contribution room would have been awesome.

 

Why wouldn't you put the US common shares (that pay a dividend) in a RRSP and the FFH in the TFSA?  Your giving away money.  Only US non-dividend and Canadian companies belong in a TSFA because of the dividend tax treatment.  I have my TFSA's stuffed with BAC warrants only.  I used to have some of my WFC commons in there but as soon as I discovered the tax treatment they were very quickly moved the RRSP. 

 

Swap the FFH out and the US common shares into the RRSP. 

 

Your allowed one free transfer out of TFSA per year and year end is a good time to do it.  I recommend wait till near the end of the trading year where you can transfer them out after the markets are closed and you can choose the high or the low of the day.  Naturally you want to choose the high price of the day coming out and the low price going into the TFSA.

[warrior]

Also , if I’m  not mistaken , one cannot have investment in USD $ within your TFSA only CAD$. So, exchange risk applies