The Mother of All Tax Breaks

The Washington Post is reporting that the Internal Revenue Service granted an exemption late last week allowing Citigroup, the nation's third largest bank, to preserve a $38 billion tax benefit that Citibank would have forfeited if it repaid the money it had borrowed via the Troubled Asset Relief Program (TARP) back to the US Treasury. The decision essentially waives a longstanding rule that disqualified certain tax breaks if a significant ownership stake changed hands in an effort to discourage outside investors from buying tax benefits.

The Internal Revenue Service on Friday issued an exception to long-standing tax rules for the benefit of Citigroup and a few other companies partially owned by the government. As a result, Citigroup will be allowed to retain billions of dollars worth of tax breaks that otherwise would decline in value when the government sells its stake to private investors.

While the Obama administration has said taxpayers are likely to profit from the sale of the Citigroup shares, accounting experts said the lost tax revenue could easily outstrip those profits.

The IRS, an arm of the Treasury Department, has changed a number of rules during the financial crisis to reduce the tax burden on financial firms. The rule changed Friday also was altered last fall by the Bush administration to encourage mergers, letting Wells Fargo cut billions of dollars from its tax bill by buying the ailing Wachovia.

"The government is consciously forfeiting future tax revenues. It's another form of assistance, maybe not as obvious as direct assistance but certainly another form," said Robert Willens, an expert on tax accounting who runs a firm of the same name. "I've been doing taxes for almost 40 years, and I've never seen anything like this, where the IRS and Treasury acted unilaterally on so many fronts."

It's effectively a subsidy though perhaps unavoidable in order to unwind the Treasury Department's one-third ownership of Citigroup. The US Treasury Department plans to begin selling its shares that it received as part of the TARP loan along with the Citibank's planned $17 billion follow-on stock offering. Such an ownership change would have required a forfeiture of these tax breaks. While the value of US Treasury held shares are likely to appreciate, only 34 percent of that benefit accrues to the government. The rest will benefit Citibank shareholders. Still no matter which way you slice it, it is a $38 billion dollar hit to the Treasury Department.

Edward Harrison of Credit Writedowns defines the issue:

At issue is accounting for loss carry-forwards. Basically, it works like this: if a company loses money in one year, the company can then offset its profit during a fixed number of subsequent years with that prior loss to reduce its tax bill. For instance, if Megacorp loses $100 million in year 0, but makes $200 million in Year 1, it can pay Year 1 taxes as if it had only made $100 million. This tax treatment is designed to level the playing field for cyclical companies that operate at a loss for part of the business cycle.

The problem, however, is that this can be used by predators in mergers. The predator company can swoop in and buy a company in a deal that makes no sense except to gain a tax benefit from the huge net operating losses (NOLs) it inherits from its prey. In order to prevent tax-motivated acquisitions of loss-making companies, the IRS limits how much of the NOLs a company can use post-merger. In Canada, unclaimed NOLs expire immediately when change of control occurs.

During the credit crisis, the Bush Administration relaxed these rules. Initially Treasury Secretary Hank Paulson benefitted Fannie Mae and Freddie Mac under IRS Issue Notice 2008-76 (pdf.) when they were taken into conservatorship. (See Yves Smith's post here.) Treasury then rewrote tax law to include banks under IRS Issue Notice 2008-83 (pdf.). For example, Wells Fargo was exempted from a change of control NOL loss when it acquired Wachovia. I assume the same was true in all the bank mergers after Lehman failed. The rationale for the exemption was that tax law needed to make accommodation as it was only designed to prevent the kind of predatory acquisition I mentioned earlier.

But the law is the law and it applies to everyone.  Exemptions under this law are a huge hidden freebie.

Furthermore as the New York Times notes the "ruling raises questions about whether federal officials moved too quickly to allow Citigroup to begin untangling itself from the government, given its fragile health. " Additionally given the political climate, the deal is likely to draw sharp criticism even as if the sweeping changes to two decades of tax policy were initially and quietly effected under Hank Paulson and the Bush Treasury Department. The decision will provide ammunition to those who argue that Obama is just like Bush.

Tags: CitiBank, Internal Revenue Service, Obama Administration, TARP, US Tax Policy (all tags)

Comments

26 Comments

Re: The Mother of All Tax Breaks

It's stories like these, combined with the convenient absence of the heads of the top three banks from the WH conference (it can be and is being interpreted as a polite 'fuck you') that fuel conspiracies theories that are being forwarded by Matt Taibbi and others. The way Citi has received sweetheart deals like this is just shameful. It would have saved the tax payer a lot of money if the government had just temporarily taken over Citi than keep this faltering bank on a permanent lifeline. Shameful!!

by tarheel74 2009-12-16 03:14AM | 0 recs
Re: The Mother of All Tax Breaks

I think this guy had it 100% right.

Once again, we're getting a whole lot of outrage based upon not very much understanding. The important information is all buried at the bottom of the article.

This is the sequence of events:

1) Citigroup loses $38 billion. Under normal circumstances, they could use this loss as a tax carryforward and deduct it against future earnings. This is routine, and is exactly what is intended under the tax code.

2) The US government stepped in and bought 34% of the company to prevent it from going bankrupt. This provided much needed capital.

3) The US government wants to get its money back now that the crisis is over. In order to do so, it wants someone else to provide replacement capital so that it's money is no longer needed.

4) For some good reasons, the government does not want investors to buy a company just to pick up its outstanding carryforwards. Therefore, if a company changes hands, the acquiring company is not allowed to use any existing carryforwards for its own purposes. However, those carryforwards remain on the balance sheet of the company that was acquired, and can be used against its own future profits.

5) If the government sells its 34% stake in Citigroup, that technically counts as a change of ownership for tax code purposes. Because of some quirks, this particular ownership change would eliminate Citigroup's carryforward altogether, because it would be considered to have purchased itself.

6) That makes no logical sense. It doesn't meet the purposes for why the tax rule is in place. The nature of the transaction does not meet the spirit of what was meant by a change in ownership. It's a stupid result. There isn't any reason that the carryforward ought to disappear.

7) The administration is bending the rules with this ruling, but staying well within their spirit. Carryforwards aren't supposed to just disappear; they are supposed to still be available to the company that suffered the losses. All that this ruling does is to declare that Citigroup is, in fact, Citigroup, that it lost $38 billion in the recent past, and that it is entitled to deduct its own losses against its own future profits if it has any during the 20 years after those losses, just like any other company.

The comparison to the Bush administration's ruling to allow Wells Fargo to deduct Wachovia's losses from its own profits is a complete red herring. In that case, you really did have one company buy another company. That's exactly the scenario that the rule in the tax code was meant to prevent. Hank Paulson flagrantly broke both thew spirit and the letter of the law in allowing that deduction.

That's not what is going on here. As is often the case, things get weird when the government is involved in the ownership of a private company. The treasury isn't creating a giant loophole for its cronies. It is making a ruling that may or may not break the letter of the tax code (I haven't looked at the ruling or the specific regulation in enough detail to be sure, and I'm definitely not trusting the Post to be able to provide a correct answer), but that leads to a result that is consistent with what is supposed to happen.

This is not like the Wachovia/Wells Fargo deal, where the Treasury Department allowed one company to use another company's carryforward deduction as a sort of lobbyist-won perk.  This is a pretty simple, if unprecedented, situation.  Citi legitimately lost $38 billion and they're being allowed to use that loss as an offset on their taxes, just like any other company.  It's not a sweetheart deal.

There's just no good reason why they should lose the tax deduction just because the government temporarily took an equity share.  The tax laws weren't written with that goal in mind.

by Steve M 2009-12-16 04:05AM | 0 recs
I agree completely

and the stories are being written to imply that Citi was just forgiven $38 billion in taxes, which is completely misleading and false.

by John DE 2009-12-16 04:26AM | 0 recs
Yes, but sex sells

by ND22 2009-12-16 04:42AM | 0 recs
Re: Yes, but sex sells

Did you say sex?

I thought this was some boring story about $38 billion.

by the mollusk 2009-12-16 06:40AM | 0 recs
Re: The Mother of All Tax Breaks

Agreed. When I first saw the headline I was about to flip out.

But the story isn't as bad as it first seemed (not that I'm particularly happy with it though)

by jeopardy 2009-12-16 06:14AM | 0 recs
Re: The Mother of All Tax Breaks

Agreed. It is sad when you get misled by liberal bloggers and Huff Po (which front paged this for a long time.) There are plenty of things to be mad about, but this simply isn't one. I am way more skeptical of stuff I read on liberal sites now. I don't think there is intentional misinformation, but there is a lot of inaccurate stuff making the rounds.

by Lolis 2009-12-16 07:10AM | 0 recs
Re: The Mother of All Tax Breaks

I do think there is intentional misinformation. These guys should know better.

by vecky 2009-12-16 07:29AM | 0 recs
Re: The Mother of All Tax Breaks

It's like anything else, you're looking for an outrage to sell to people.  I don't begrudge them any of it, but I read with a skeptical eye.

by the mollusk 2009-12-16 07:37AM | 0 recs
Re: The Mother of All Tax Breaks

They've gone capitalist...

by vecky 2009-12-16 07:44AM | 0 recs
Re: The Mother of All Tax Breaks

you mean they didn't start out as capitalists?

by the mollusk 2009-12-16 08:03AM | 0 recs
Like I said, sex sells

by ND22 2009-12-16 08:25AM | 0 recs
Re: The Mother of All Tax Breaks

You should read the link Charles posted. It is a very good analysis of this 38 billion gift, and yes it is a gift of tax-payer money.

by tarheel74 2009-12-16 08:20AM | 0 recs
Re: The Mother of All Tax Breaks

I hardly think Citibank buying itself back from the government qualifies as a "change of ownership" that would subject it to the tax.

Just because you want to tax it for something else doesn't mean there is merit to this argument.

by vecky 2009-12-16 08:46AM | 0 recs
Re: The Mother of All Tax Breaks

Of course you don't! Big surprise!!

by tarheel74 2009-12-16 08:54AM | 0 recs
Re: The Mother of All Tax Breaks

Your argument is missing an argument.  Why should Citi not be entitled to deduct its operating losses in subsequent years, just like every other company gets to?

by Steve M 2009-12-16 09:17AM | 0 recs
Re: The Mother of All Tax Breaks

Because the government own 34% of Citi, a controlling interest that it was forced to buy to save their sorry asses. If Citi was to write off the taxes as past losses, it must first have enough taxable income (which is doubtful), or keep accruing back taxes. Plus when the government sells its controlling share, Citi has to write this down, or as Edward Harrison writes:

"A sale of that stake by the government should reduce the $38 billion in deferred tax assets that Citigroup has on its balance sheet, meaning they should have to write this down immediately. But, apparently they are being gifted taxpayer money as Secretary Geithner and the IRS have exempted Citi."

In effect, it is another bail-out.

by tarheel74 2009-12-16 09:39AM | 0 recs
Re: The Mother of All Tax Breaks

WTF... you didn't understand a word of what was said.

by vecky 2009-12-16 09:59AM | 0 recs
Re: The Mother of All Tax Breaks

The entire purpose of the rule against transfer of carryforwards is that we don't want one company to buy another merely to take advantage of the acquired company's tax writedowns.  If Gimbel's buys Macy's, Macy's can still take advantage of its outstanding tax writedowns (I think they're good for 20 years), but Gimbel's is not allowed to combine the two companies and take Macy's writedowns for themselves.  

There is no reason on God's green earth why a company should be prohibited from writing off its own operating losses, which is exactly what Citi proposes to do here.  It's just the unique circumstances of the bailout that make it appear like there's been a change in control, when in reality the Citi that will exist after the government sells back its equity share is the exact same Citi that took the $38B loss in the first place.

Again, this is completely different from the Wells Fargo/Wachovia transaction that Paulson arranged special treatment for.  110% different.  This is simply a company carrying forward its own operating losses.

by Steve M 2009-12-16 10:10AM | 0 recs
Re: The Mother of All Tax Breaks

Citi is buying the controlling share, in effect according to law, causing a transfer of ownership. So something has to give, either they still let the tax payer own the majority stake, or pay taxes for buying the majority stake. We did not buy the stake for the heck of it, we bought it because they were weak and failing. So either Citi is strong now and pay the taxes it owes, or it is weak and carries on as it is. Anything else, as in this case, is special treatment. This administration is not doing any better than the last one when it comes to showing special consideration to preferred banks.

by tarheel74 2009-12-16 10:17AM | 0 recs
Re: The Mother of All Tax Breaks

So the alternative is that they don't repay the TARP, and use the write-off over the next few years until it is gone, and only then pay back the TARP. How exactly is that a better situation?

By the way, your statement about "pay taxes for buying the majority stake" is incorrect. There is no discussion in any of this that Citi should or would have to pay taxes for buying back the majority stake. The issue is when buying back the majority stake if that should be treated as one that wipes out the existing tax credits or not. Although I understand the emotional argument that they should be punished and lose the tax credit, logically I see that it shouldn't work that way.

by fsm 2009-12-16 10:41AM | 0 recs
Re: The Mother of All Tax Breaks

They are buying themselves.  There is no reason they should lose the tax carryforward as a result of buying themselves.  The purpose of the rule is to prevent one company from purchasing another company's carryforward, not to preclude companies from taking advantage of their own carryforward.

Citi is not being excused from paying their taxes, they're merely being given the same right to offset their operating losses as every other company enjoys.  Again - Wells/Wachovia was an example of special treatment, this is not.

by Steve M 2009-12-16 10:44AM | 0 recs
Re: The Mother of All Tax Breaks
Can you believe that Obama is such a MILKTOAST namby pamby President. Come on Barack don't you even have a pair.
Two days ago these FATCAT BANKERS failed to even come to the White House and by rejecting your invitation they ran all over you and the Presidency. A strong President with some brass ones would have told those guys--"Since you  aren't here because of the weather and flying conditions --- AS PRESIDENT I AM SENDING YOU MY AIRPLANES---THEY FLY IN ALL WEATHER. At that point he should have dispatched a platoon of Marines in Full BATTLEGEAR to go and get these OVERPAIND INSOLENT BANKING CEO PRICKS. The Marines could have landed ontop of the Banks where these CEO's were holed up in their executive suites. Obama should have had them  enter those fine woodpaneled CEO/EXECUTIVE offices by knocking down the doors just like in Iraq. Then the Marines would get these jerks by the neck and throw them in one of our $100 million "all weather flying helios" and fly them straight to the White House in handcuffs for all the press to see. Instead Obama has them on a freaking conference call like a WOOSE
I cannot believe what a weak President he is--Congress, the Bankers, etc. all run all over him and he only sez "CAN I HAVE ANOTHER SWAT ON BY BUTT---PLEASE KIND SIRS!!!!"
Until Obama starts acting like a real Harry Truman / Ike / LBJ / Reagan / even Bush, he will continue to get NO WHERE WITH THESE GUYS.
by hddun2008 2009-12-16 12:13PM | 0 recs
Re: The Mother of All Tax Breaks

I don't even know if this is a real comment or a parody but it is probably the most awe-inspiring comment of the day.

by Steve M 2009-12-16 12:15PM | 0 recs
Re: The Mother of All Tax Breaks
It's been just one year of Obama not doing anything substantive---I'm already bored out of my mind with his "not ready for prime-time Presidency".
My message is to Dr. Howard Dean:  Please get ready to run in 2012 primaries--WE NEED YOU BADLY....
by hddun2008 2009-12-16 12:39PM | 0 recs
That's what MyDD has come to

when you can't tell snark from a real comment

by ND22 2009-12-16 04:04PM | 0 recs

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