Letter to Secretary Henry Paulson, Department of the Treasury and Doug Shulman, IRS Commissioner

Letter

Letter to Secretary Henry Paulson, Department of the Treasury and Doug Shulman, IRS Commissioner

SCHUMER SEEKS ANSWERS FROM IRS, TREASURY ON TAX CODE CHANGE THAT SUBSIDIZES BANK ACQUISITIONS

Rule Change Allows Banks Pursuing Acquisitions To Write-Off Acquired Losses - IRS Notice Was Issued Without Congressional Action or Consultation

Senator Questions Necessity, Cost of Change After Passage of $700B Rescue Plan and Rollout of Capital Injections; Says Rule May Incentivize Banks To Pursue Takeovers That Are Unnecessary for Financial Market Stability

U.S. Senator Charles E. Schumer (D-NY) demanded an explanation from the Bush administration Thursday for a controversial tax rule change that allows financial institutions to write off built-in losses stemming from takeovers of other banks to offset future income. The new tax change, which Treasury approved without any notification to or action by Congress on September 30th, paved the way for Wells Fargo's acquisition of Wachovia earlier this month, and has since provided significant tax savings to at least two other banks pursuing takeovers.

In a letter sent today to Treasury Secretary Hank Paulson and IRS Commissioner Shulman, Schumer questioned the need for the tax change after the implementation of the Treasury's capital injection program and expressed concern that the change will 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 last month. Schumer also questions whether the tax change creates 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 to future tax deductions to shelter their earnings.

"I am 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," Schumer wrote. "I also fear 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."

Since the tax change was made, three banks stand to reap billions of dollars in savings through takeovers of smaller banks. Besides Wells Fargo, which prevailed over Citigroup in a contentious battle to acquire Wachovia earlier this month and stands to save $19.4 billion as a result of the tax change, PNC Financial is estimated to save more than $5.1 billion in its takeover of Cleveland-based National City, according to a published report Thursday. Wells Fargo and PNC Financial have already benefited from $25 billion and $7.7 billion, respectively, in capital injections from the government.

A copy of the letter to Paulson and Shulman appears below.

October 30, 2008

Secretary Henry Paulson
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

Commissioner Doug Shulman
IRS Commissioner Office
1111 Constitution Avenue NW
Washington, D.C. 20224

Dear Gentlemen:

I write out of concern that the September 30th notice by the IRS (2008-83, the "Notice") to alter Section 382 of the tax code for banks could add to the overall cost of the federal government's financial rescue program and cause unnecessary consolidation in the financial services industry.

As you know, Internal Revenue Code Section 382 was enacted by Congress to prevent tax-motivated acquisitions of loss corporations. On September 30th, the Notice effectively removed the limit on how much taxable income a purchasing bank, thrift, industrial loan company, and trust company could deduct post-acquisition without consulting Congress.

I understand and appreciate that the Notice was made in an effort 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 possess a portfolio of loans that have deteriorated in value. Yet I am 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. I also fear 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.

Since the Notice was issued, at least three banks stand to gain sizeable tax benefits from mergers and acquisitions. The new ruling will allow Wells Fargo to save $19.4 billion in taxes from their acquisition of Wachovia, according to published reports. Wells Fargo will also be benefiting from a capital injection by the Treasury of $25 billion from the recapitalization program. The estimated tax savings for PNC Financial under this tax change, who recently acquired National City Corporation, could total $5.1 billion according to recent reports. PNC stands to receive $7.7 billion in capital injections from the Treasury, which helped make this acquisition possible. Banco Santander SA, which is acquiring the remaining assets of Sovereign Bancorp, is also reported to benefit from billions of dollars in tax write-offs from its merger.

Given that the Notice does not have an expiration date, leaving its future uncertain, I am concerned that this change in the law may lead to takeovers motivated solely by the opportunity to take advantage of tax savings. Law firm Jones Day has estimated that the industry could save up to $140 billion in taxes just on bad housing loans. In light of these concerns, I respectfully ask that you respond to the following questions as soon as possible:

1. What was Treasury and IRS's rationale for making this change? Why was there no consultation with Congress?

2. The Section 382 change was made prior to the Treasury's rollout of its capital infusion program. Does the Treasury still think the change to Section 382 is necessary as part of its financial rescue efforts? Does the Treasury believe that the above acquisitions would not have taken place were it not for the change to tax law?

3. What analysis, if any, has the Treasury done to ensure that this change will not create an incentive for consolidation beyond what is necessary for stability in the financial sector? Is there a concern that this may motivate takeovers in the financial industry solely for tax savings?

4. What are your plans for reviewing the outcome of this change to the tax law and assess its cost-effectiveness?

5. As one of the main goals in designing the financial rescue program is allowing taxpayers to share in the upside as the financial industry recovers, is it not against taxpayers' interests to allow these tax deductions to be carried forward, since it reduces the taxable profits of the banks making the purchases and reduces taxpayers' potential upside?

I look forward to your response on this matter.

Sincerely,

Charles E. Schumer

United States Senator

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