SHOCK: Treasury Made Controversial Tax Policy Change Under Bailout Cover

[DavidS]

The financial world was fixated on Capitol Hill as Congress battled over the Bush administration's request for a $700 billion bailout of the banking industry. In the midst of this late-September drama, the Treasury Department issued a five-sentence notice that attracted almost no public attention.

But corporate tax lawyers quickly realized the enormous implications of the document: Administration officials had just given American banks a windfall of as much as $140 billion.

The sweeping change to two decades of tax policy escaped the notice of lawmakers for several days, as they remained consumed with the controversial bailout bill. When they found out, some legislators were furious. Some congressional staff members have privately concluded that the notice was illegal. But they have worried that saying so publicly could unravel several recent bank mergers made possible by the change and send the economy into an even deeper tailspin.

"Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no," said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. "They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks."

The story of the obscure provision underscores what critics in Congress, academia and the legal profession warn are the dangers of the broad authority being exercised by Treasury Secretary Henry M. Paulson Jr. in addressing the financial crisis. Lawmakers are now looking at whether the new notice was introduced to benefit specific banks, as well as whether it inappropriately accelerated bank takeovers.

The change to Section 382 of the tax code -- a provision that limited a kind of tax shelter arising in corporate mergers -- came after a two-decade effort by conservative economists and Republican administration officials to eliminate or overhaul the law, which is so little-known that even influential tax experts sometimes draw a blank at its mention. Until the financial meltdown, its opponents thought it would be nearly impossible to revamp the section because this would look like a corporate giveaway, according to lobbyists.

Andrew C. DeSouza, a Treasury spokesman, said the administration had the legal authority to issue the notice as part of its power to interpret the tax code and provide legal guidance to companies. He described the Sept. 30 notice, which allows some banks to keep more money by lowering their taxes, as a way to help financial institutions during a time of economic crisis. "This is part of our overall effort to provide relief," he said.

The Treasury itself did not estimate how much the tax change would cost, DeSouza said.

Link here.

 

[Turboswede]

I wouldn’t worry about this too much, Obama’s team is thinking about eliminating the Net Operating Loss (NOL) carry forwards altogether (or severely limiting them) in an effort to broaden the tax base instead of raising marginal corporate rates. It basically provides a one year tax break for financial institutions that acquire other financially strapped financial institutions.

So if Bank A acquires bank B and bank B has a negative net worth due to substantial losses and a big hit to market capitalization, Bank A can use more of Bank B’s losses to offset tax liability.

Normally it wouldn’t be an issue because Bank B would just go under in that situation and the FDIC would be forced to cover deposits. Here the government is giving solvent banks an incentive to take over banks that are insolvent in hopes of preventing an FDIC bailout of deposits. It makes sense given this year’s financial climate and, as I said, I think Obama is going to get rid of the NOL provisions next year anyway.