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Tax Break Negates U.S. Profit from Citi's TARP Repayment

The U.S. government is forfeiting billions of dollars in tax revenue collections from Citigroup Inc. (NYSE: C) that could be worth more than the profit reaped from the bank's repayment of bailout funds.

The U.S. Treasury's Internal Revenue Service (IRS) on Friday made an exception to longtime tax rules that will enable Citi to avoid taxes on its next $38 billion in profits – the value of the bank's past losses at the end of the third quarter, The Washington Post reported.

"The government is consciously forfeiting future tax revenues. It's another form of assistance, maybe not as obvious as direct assistance but certainly another form," Robert Willens, an expert on tax accounting who runs a firm of the same name told The Post .   "I've been doing taxes for almost 40 years, and I've never seen anything like this, where the IRS and Treasury acted unilaterally on so many fronts."

The loss of tax revenue for the United States – which is seeing its deficit rise to record levels – could easily outstrip taxpayers' net income from Citi's TARP repayment, according to The Post , which cited accounting experts. Citi's payback of money borrowed under TARP could net U.S. taxpayers $13 billion to $14 billion, a Treasury official told Reuters on Monday. The Treasury expects to have its entire stake in Citi sold within 12 months.

Normally, federal tax law allows companies to reduce taxable income in a good year by the amount of losses in bad years. However, the law prohibits the transfer of such a benefit to new ownership so profitable companies won't buy losers to avoid taxes. The U.S. government's sale of its 34% stake in Citigroup as well as the company's recent stock sale to repay funds under the Troubled Asset Relief Program (TARP) qualifies as a change of ownership.

The official Treasury line is that the ruling benefits taxpayers because it made Citi's shares more valuable and without it, the company would have been unable to repay TARP at this time.

“The rule was designed to stop corporate raiders from using loss corporations to evade taxes, and was never intended to address the unprecedented situation where the government owned shares in banks," Treasury spokeswoman Nayyera Haq told The Post. "And it was certainly not written to prevent the government from selling its shares for a profit."

A Democratic aide to the Senate Finance Committee, which oversees tax policy, said the Obama administration could legally issue the new exception, but Republicans have their eyebrows raised, particularly at the notion the ruling helps Citi's share price.

“You're manipulating tax rules so that the market value of the stock is higher than it would be under current law," a Republican aide told The Post, speaking on the condition of anonymity. "It inflates the returns that they're showing from TARP and that looks good for them."

The IRS' ruling “dispelled” fears that Citi would lose the tax breaks when the Treasury begins selling its stake, tax expert Willens said this week in a note to clients.

But there's still lingering concerns about the health of Citigroup and other financial firms that have repaid TARP, as a jobless recovery and continued economic weakness are contributing to a rising number of credit defaults.

"They are rolling the dice big time," Christopher Whalen, a financial analyst with Institutional Risk Analytics told The Post . "My fear is that the banks will definitely have to raise a lot more capital next year. The question is from whom and on what terms."

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