Tax Change for Banks Challenged

Lawmakers Question Cost of Move to Push Acquisitions of Ailing Institutions

Key lawmakers said yesterday they were pressing the Treasury Department to explain why it changed tax regulations last week to encourage bank mergers in a way that could cost the government billions in lost revenue.

Treasury made the change without consulting the Senate Finance Committee, which oversees federal tax law. Committee leaders now are questioning whether Treasury had the authority to make the change, and whether it was a good use of tax money.

The ranking Republican, Sen. Charles E. Grassley (R-Iowa), said in a statement that he was concerned by the change, which he said he first read about in the newspaper.

"Congress should have been informed and consulted before Treasury took such an extraordinary action that likely will add billions of dollars to the deficit," Grassley said. "I'm looking further into it, and if this is indicative of Treasury's mindset, I'm concerned about what may be next."

The committee chairman, Sen. Max Baucus (D-Mont.), spoke with Treasury this week about the change, according to aides.

The change is intended to encourage mergers between healthy and ailing banks by allowing healthy banks to shelter profits from taxation based on losses at the companies they acquire.

Companies are allowed to shelter profits from taxation based on their own past losses. When a profitable company buys a company with losses, however, the government historically has limited the profitable company's ability to shelter its income based on the acquired company's losses. The new tax regulation specifically removes the limits on the income that banks can shelter. The provision applies solely to banks.

New York law firm Jones Day estimates the change could cost the government up to $140 billion in lost revenue.

The Treasury Department has defended its right to make the change, but the decision has aroused controversy in part because of its timing, which immediately benefited Wells Fargo in its battle with Citigroup for control of Wachovia.

Wells Fargo estimated that Wachovia's loan portfolio includes unacknowledged losses of about $74 billion. Under the old tax regulations, Wells Fargo could have used those losses to shelter up to $1 billion of its own income from taxes each year for the next 20 years. Under the new rules, Wells Fargo could shelter its next $74 billion in profits.

The potential tax savings for Wells Fargo could be around $25 billion, based on the standard corporate tax rate.

Citigroup made its initial bid before the regulation was changed. Yesterday it ended the bid. Citigroup has not made a quarterly profit since last fall, so its ability to benefit would have been limited.

Citigroup has pressed for a congressional review of the timing of the Treasury announcement, and has raised questions about the motivation for the changes, according to people familiar with the matter.

But a Treasury spokesman, Andrew DeSouza, said the change was not intended to benefit any particular company, and that Treasury did not consult with any bank before making the change.

"This notice was not meant to help any particular taxpayer or transaction, and was not in response to an outside request," DeSouza said.

The change was made the day after the House initially rejected the administration's $700 billion rescue plan. In response, the government announced a series of measures designed to buttress the banking industry, including a proposed increase in government insurance on bank deposits and a relaxation of accounting rules requiring banks to acknowledge the market value of their investments.