Banks Lose on Stimulus Package's Tax Provisions

(MoneyWatch)  The government continues to help U.S. banks, most recently by increasing its stake in Citigroup to 36 percent, but it's been less supportive on the tax front with those same financial institutions.

Back in the fall, the Treasury Department and the IRS were being generous with banks. Remember the so-called Wells Fargo rule issued by the IRS back in late September? That notice, which came a day after Citigroup tried to purchase Wachovia at $1 a share -- but just before Wells Fargo outbid it at $7 a share -- allowed financial institutions (mostly banks and thrifts) to take advantage of built-in losses of other banks they would acquire. The main goal of this rule, an exception to the Internal Revenue Code preventing trafficking of built-in losses, was to encourage acquisitions of troubled financial institutions.

Although the rule allowed acquiring banks to save money in taxes -- about $25 billion in the case of Wells Fargo -- it was controversial because members of Congress thought the IRS exceeded its powers in unilaterally modifying the tax code. The American Recovery and Reinvestment Act nullified that notice as of the beginning of the year, but will still apply to acquisitions agreed on last year.
The stimulus act also gave a boon to companies from a tax standpoint by allowing them to defer taxes for five years on income resulting from the cancellation of debt or from a debt repurchase. Such a tax break can be an attractive alternative to any company flirting with bankruptcy. Casino company Harrah's Entertainment, for instance, was one of the first to take advantage of it. Unfortunately, that tax break doesn't apply to banks taking advantage of the Temporary Liquidity Guarantee Program, which allows banks to issue debt guaranteed by the government (PDF link). This is because the TLGP states (see page 14 in the previous link) that " an issuer cannot issue and identify debt as guaranteed by the FDIC if the proceeds are used to prepay debt that is not FDIC-guaranteed."
It's too early to see exactly how it will affect specific banks but it's safe to say that consolidation between banks and debt reduction at financial institutions both seem likely to slow.