investingfromtheright

I am retired and take educated guesses on all things financial.

January 26, 2010

January 27, 2010: Big Banks' New Money Pit

If you thought the recent tax juggernaut against Big Banks was huge, how about this?

According to a New York Times article, e-mailed to me in part:

The IRS is set to claim that "equity swaps" are in effect tax avoidance tactics leading to tax evasion schemes.

The feds are scrutinizing financial derivatives they claim Wall Street banks have been using to avoid collecting scores of billions of dollars in withholding taxes on stock dividends. These equity swaps mimic ordinary shares and give investors such as hedge funds the benefits of stock ownership without actually owning the shares. Big Banks also benefit from the swaps because, under federal tax rules, the banks may avoid paying a 30 percent tax that is normally present on stock trades.

The IRS is closely examining whether banks are using the swaps to mask who really owns the shares underlying the instruments, thereby clouding the reporting and collection of dividend withholding taxes.

IRS field auditors have been given marching orders on how to aggressively pursue these type of equity transactions. In part,the IRS directive states that audit guidelines reflect suspicion that ALL cross-border equity swaps are tax avoidance transactions, even though IRS regulations had previously treated these transactions favorably.

Tax lawyers regard the IRS pursuit at this time as significant because it concerns a vast, unregulated market and could lead to hundreds of billions of dollars in tax disputes between the IRS and Wall Street banks.

Four types of swaps are in for an IRS cleansing: cross in-cross out, cross in-interbroker dealer out, cross in-foreign affiliate out, and synthetic equity transactions.

The assault on Big Banks continues. Is it not of humor, then, that the more publicized Financial Crisis Responsibility Fee is now affectionately called the F_C_ _R Fee by some clever potential victims in the world of Big Banks?

I believe that investing in the common stock of Big Banks, even such stalwarts as J.P. Morgan (JPM) and Goldman Sachs (GS) at this time is a mistake. However, the preferreds, especially trust preferred securities from Big Banks,should remain a hefty and safe dividend play in this troubled investment sector.

Thanks to a tax attorney who provided the inspiration for this article.

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