Treasury's not-so-secret tax code change

Widely reported this week is the story of the Treasury Department´s sly tweaking of a tax rule that sweetened the deal for healthy banks buying failing ones. It´s not news (American Banker reported it October 6; the Wall Street Journal October 18), but fresh attention by the Washington Post and the Associated Press could whip up interest on Capitol Hill.

Under the change, an acquirer may deduct a target´s loan losses from its tax bill. The notice, when it came in late September, was so quietly issued and so sparsely worded that it´s hard not to figure Treasury and its Internal Revenue Service were trying to get away with something. In fact, the original purpose was to prevent acquisitions driven by tax benefits.

The Washington Post and AP articles described lawmakers´ ire over the change. (Read a letter to the Treasury Secretary Henry Paulson and IRS Commissioner Doug Shulman from Sen. Charles Schumer, D-N.Y., here). The law firm Jones Day put out a notice to clients explaining how the tax break is gravy to all the other gifts granted in the Oct. 3 bailout law. The IRA move "effectively generates additional cash benefits for the banking system over and above the Paulson Plan and TARP without the need for Congressional appropriation or review," Jones Day explains.

It´s not hard to see why lawmakers are upset. The change allowed Wells Fargo to make a much higher bid for Wachovia than its rival, Citigroup. Where Citi wanted the FDIC to assume any losses after the first $42 billion on Wachovia´s cruddy assets, Wells isn´t involving the government unless of course you count the tax benefit of roughly $20 billion the IRS change provided. Did we mention the IRS ruling came out on Sept. 30-a day after Citi´s bid and three days before Wells Fargo´s. (PNC followed suit a month later with its deal for National City. The tax break saved PNC $5.1 billion).

Mark Silverman, a partner at Steptoe & Johnson LLP, basically viewed the policy as giving banks a choice. "Now companies can decide whether they want to go the Citigroup route, with the government pitching in a lot of money, or the Wells Fargo route, where the government isn´t involved at all," he said. "I think that´s pretty sound, thoughtful policy."

Ironically among the biggest beneficiaries is Robert K. Steel, the Treasury official turned Wachovia CEO. When he got the top job in July, he bought a million shares of Wachovia stock at about $16 a share. Under Citi´s proposal, he would have gotten $1 a share for his stake. Under Wells´ deal, Mr. Steel got seven times more.

Reactions to the new media flurry will be telling. Will there be hearings on Capitol Hill? More angry letters? Or will the tax break be extended to companies that aren´t quite banks, in keeping with the newest twist the Treasury´s capital purchase program? There may already be wiggle room: This note from GrantThornton LLP points out that the purchaser doesn´t have to be a bank: "Technically," the GrantThortnon note reads, "any corporation, partnership or other taxpayer could acquire a bank and take advantage of the relaxed NOL limitations...regulators will not be limited by any definition of a purchaser in the notice that could disqualify a purchaser from relief."