House Stimulus Bill Would Repeal IRS Ruling 2008-83 Favoring Bank Acquisitions; Exclude TARP Recipients from 5-Year Loss Carryback

The economic stimulus bill unveiled by the House today would prospectively repeal IRS Notice 2008-83 that interprets Section 382 of the Internal Revenue Code to allow banks and other financial institutions pursuing acquisitions to write-off acquired losses stemming from takeovers of other banks to offset future income. Section 382 was enacted by Congress to prevent tax-motivated acquisitions of loss corporations. On September 30, 2008, Notice 2008-83 effectively removed the limit on how much taxable income a purchasing bank, thrift, industrial loan company, and trust company could deduct post-acquisition. The Notice was designed to help the struggling banking sector recover by allowing acquiring banks the ability to deduct the built-in tax losses of any banks they acquire that possesses a portfolio of loans that have deteriorated in value.

The bill would also exclude companies receiving TARP benefits, and Fannie Mae, Freddie Mac, from a 5-year carryback of net operating losses for companies.

Notice 2008-83 came under intense criticism by many in Congress and is now very likely to be repealed in any version of economic stimulus legislation presented for President Obama’s signature. For example, in a letter to Treasury and the IRS, Senator Charles Schumer demanded to know why the IRS issued a notice allowing financial institutions pursuing acquisitions to write-off acquired losses stemming from takeovers of other banks to offset future income.

He questioned the need for the tax change after the implementation of the Treasury’s capital injection program and expressed concern that the change would result in tens of billions of lost tax dollars for the federal government, which has already committed $700 billion in resources to many of these same financial institutions under the rescue plan approved by Congress.

Senator Schumer also questioned whether the tax change created an unnecessary incentive for acquisition-minded banks to pursue takeovers that provide no benefit to the stability of the larger financial system, but simply represent an opportunity for firms seeking future tax deductions to shelter their earnings. Since the Notice was issued, he continued, at least three banks stand to gain sizeable tax benefits from acquisitions. For example, the new ruling will allow Wells Fargo to save $19.4 billion in taxes from their acquisition of Wachovia, according to published reports.

The senator and others were concerned that the Notice, which was never debated by Congress, could end up costing taxpayers tens of billions of more dollars on top of the hundreds of billions of dollars already approved by Congress in the financial rescue plan. He also feared that the Notice could have the unintended consequence of motivating more financial firms wanting future tax deductions to shelter their earnings to buy competitors, leading to more consolidation in the financial industry than would be necessary to restore stability in the financial sector.

Given that the Notice does not have an expiration date, leaving its future uncertain, he is concerned that this change in federal tax law may lead to takeovers motivated solely by the opportunity to take advantage of tax savings.

Senator Schumer and others more broadly questioned the rationale for making this change and why was there no consultation with Congress. The Section 382 change was made prior to the Treasury’s rollout of its capital infusion program; and there was a question whether Treasury still thought the change to Section 382 was necessary as part of its financial rescue efforts. Another fear was that this change could create an incentive for consolidation beyond what is necessary for stability in the financial sector.

Even more broadly, the prospective repeal of Notice 2008-83 reveals Congress’ belief that allowing the Notice to stand would thwart a main goal of the financial rescue program to permit taxpayers to share in the upside as the financial industry recovers. The repeals signals congressional belief that it would be against taxpayer interests to allow these tax deductions to be carried forward, since it would reduce the taxable profits of the banks making the purchases and reduces taxpayers’ potential.