Monday, October 20, 2008

More Bailout Obscenity: Rewriting the tax code

These tax measures while costing the public millions or more likely billions are hidden from view and virtually undiscussed. I wonder if either of the two presidential contenders will bother to mention this issue.

Michael Perelman: More Bailout Obscenity" if the bailout were not bad enough, the Wall Street Journalreports that the Treasury Department is, in effect, rewriting the tax codeto give away what will easily be tens of billions of dollars.On the opposite page, the paper reports that the Fannie and Freddie bailoutis likely to cost the government considerably more than expected because ofcourt suits charging, probably correctly, that management misled investors.One can safely say that more will be discovered later.Drucker, Jesse. 2008. "Obscure Tax Breaks Increase Cost of FinancialRescue." Wall Street Journal (10 October)., Aparajita. 2008. "Fannie Suit Vexes Regulator, May PayShareholders." Wall Street Journal (10 October). $700 billion financial rescue package approved by Congress to shore upbanks also carries a parallel bailout of the financial sector and otherindustries through a series of obscure tax breaks.Operating mostly under the radar screen, Congress, the Treasury Departmentand the Internal Revenue Service have been rolling back various provisionsof the tax code to help out industries and investors caught up in theturmoil.The most costly -- and most controversial -- of the moves provide billionsin extra tax relief to big banks such as Wells Fargo & Co. and Spain's BancoSantander SA. Another change gives aid to investors stung by theauction-rate securities meltdown. Still another shift relaxes tax rules tohelp big multinationals bring back cash from overseas.The total sums involved aren't clear, but the cost will easily amount totens of billions of dollars, tax experts say.The latest such move was unveiled on Tuesday, when the Treasury Departmentdeclared that the cash infusions for banks won't be considered "federalfinancial assistance." Normally, that type of funding would count as taxableincome for the recipients, and could trigger other unfavorable taxconsequences for banks receiving assistance that take part in mergers.A Treasury Department spokesman said the agency is seeking to "provideclarity and certainty regarding tax issues that have come up during marketturmoil."Tax experts say some of the changes are justified, including a number oftechnical fixes to protect taxpayers from unintended consequences related togovernment actions, such as the takeovers of Fannie Mae and Freddie Mac, orthe substantial investments in banks. Plus, the broader bailout legislationpassed by Congress earlier this month shut some other tax loopholes,including one that permitted offshore hedge-fund managers to get favorabletreatment for deferred compensation.The most controversial move so far is an obscure IRS ruling that gives banksthe unfettered ability to use the "tax losses" of banks they acquired.Typically, companies are permitted to carry over tax benefits from yearswhen they lose money to help offset taxes when they return to profitability.However, for decades, Congress has restricted the amount of those lossesthat can be used in a given year, to prevent companies from buying andselling other firms solely to benefit from the tax strategy.In a one-sentence ruling issued on Sept. 30, the Treasury Departmenteffectively lifted that restriction if the company being bought is a bankand the losses are attributable to a portfolio of loans.Sen. Charles Grassley, the ranking Republican on the Senate FinanceCommittee, has complained about the sudden loosening of the rules. "Congressshould have been informed and consulted before Treasury took such anextraordinary action that likely will add billions of dollars to thedeficit," he said.Some experts argue that the Treasury has effectively shifted fromadministering parts of the tax code to changing tax laws on its own. "Itdoesn't seem possible that they have this authority," said Robert Willens,an independent corporate tax analyst.The biggest beneficiary so far is likely to be Wells Fargo. The big SanFrancisco-based bank recently agreed to buy Wachovia Corp. of Charlotte,N.C., which has been hammered by huge losses on mortgage-related securitiesand loans. Wells Fargo has said it expects to take $74 billion inwrite-downs on the Wachovia portfolio.Under the old rules, Wells Fargo would have been limited to annual taxdeductions stemming from the Wachovia losses of roughly $930 million overthe next 20 years, or a total of $18.6 billion, estimates Mr. Willens. WellsFargo will now be able to use all $74 billion in losses. That will likelymean additional tax savings to Wells Fargo of about $19.4 billion -- or morethan the total purchase price for Wachovia's common stock, currently about$14.3 billion.A Wells Fargo spokeswoman wouldn't comment on the role of the tax change inits decision to bid for Wachovia, which bested an earlier offer by CitigroupInc. Wells Fargo's offer took place two days after Treasury's move.The new tax benefit applies to already-completed bank deals done in the pastthree years, and possibly even older ones, according to the TreasuryDepartment.Another winner from the new rule is Banco Santander, which recently agreedto buy the rest of Sovereign Bancorp. The Spanish bank will be able to takeadvantage of Sovereign's $2 billion in tax losses more quickly than underthe old regime, which would have required it to wait nearly two decades touse up the losses.Because of the Sovereign purchase, Banco Santander also will be one of themany beneficiaries of a separate break, aimed at hundreds of banks that lostmoney on preferred stock in Fannie Mae and Freddie Mac. The shift allows thebanks to count those losses as ordinary losses, rather than less-usefulcapital losses. The change is expected to cost the federal government $3billion, according to the congressional Joint Committee on Taxation.[Bailout]Many investors were caught by surprise when the auctions for auction-ratesecurites began to fail, leaving them holding notes for which there was nomarket. New York Attorney General Andrew Cuomo brokered settlements withinvestment banks and brokerage houses, in which the banks effectively agreedto cover any losses suffered by the investors.A recent ruling by the Treasury protects the investors in thosearrangements, in part by making clear that an agreement by a bank to coverthe losses isn't akin to taxable income. Another ruling protects investorswho loaned shares to Lehman Brothers Holdings Inc. from being taxed on thetransactions. Ordinarily, they are required to get the shares back within aprescribed time frame to avoid owing taxes. That rule isn't normally waived,even if the borrower of the shares goes bankrupt. But the IRS made anexception that effectively applies to transactions with Lehman, which filedfor bankruptcy protection last month.And earlier this month, the IRS relaxed the rules covering how U.S.corporations can repatriate cash parked overseas. The ruling allowscompanies to bring back money for months at a time without incurring a 35%corporate income tax they normally would owe. It is intended to make iteasier for companies to borrow money directly from their foreignsubsidiaries, instead of in the uncertain short-term lending market. It isunclear how much this will cost the government.___________________________________

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