On Tuesday, the Senate appointed seven Democrats and five Republicans from the Banking and Agriculture Committees to the conference committee on H.R. 4173, the Wall Street Reform Act, which will negotiate a compromise between the House and Senate versions of the bill. The seven Senate Democrat conferees are Sens. Chris Dodd (D-CT), Tim Johnson (D-SD), Jack Reed (D-RI), Charles Schumer (D-NY), Blanche Lincoln (D-AR), Patrick Leahy (D-VT), and Tom Harkin (D-IA). The five Senate Republican conferees are Sens. Richard Shelby (R-AL), Mike Crapo (R-ID), Bob Corker (R-TN), Judd Gregg (R-NH), and Saxby Chambliss (R-GA).

Also on Tuesday, House Majority Leader Steny Hoyer (D-MD) said the House would not appoint conferees until the week of June 7-11, after the Memorial Day congressional recess. Speculation is that the House’s delay is intended to prevent House Republicans from offering politically painful motions ‘to instruct conferees’ on the floor prior to the appointments. House Financial Services Committee Chair Barney Frank (D-MA) also circulated a memo saying he would pick himself and Reps. Paul Kanjorski (D-PA), Luis Gutierrez (D-IL), Maxine Waters (D-CA), Mel Watt (D-NC), Gregory Meeks (D-NY), Dennis Moore (D-KS) and Rep. Carolyn Maloney (D-NY) as the Democratic representatives from the House to the financial reform conference committee. In the memo, Frank also laid out this proposed timeline, which could include coverage of open meetings on C-SPAN: Tuesday, June 8th: conferees appointed … Wednesday, June 9th: first open meeting of the conference, organizational matters and opening statements only. Tuesday, June 15th, Wednesday, June 16th, Thursday, June 17th: conference meets on substantive issues. Tuesday, June 22nd, Wednesday, June 23rd: conference meets on substantive issues. Thursday, June 24th: conference concludes with formal signing ceremony; conference report filed shortly thereafter. Monday, June 28th: Rules Committee meets to grant rule. Tuesday, June 29th: House passes conference report which gives the Senate three days to pass it before the beginning of the July 4th recess.

On Wednesday, Michael Barr, Assistant Treasury Secretary for Financial Institutions and Diana Farrell, Deputy Director of the National Economic Council, held a joint press conference about the Administration’s position on the financial regulatory reform bill. Both Barr and Farrell repeatedly deflected questions on the derivatives’ desk spinoff provision, authored by Sen. Blanche Lincoln (D-AR), which has drawn fierce opposition from business groups, Republicans and some Democrats. Lincoln, chairwoman of the Senate Agriculture Committee, faces a tough fight in the conference committee to persuade the House and Senate to maintain the provision. Along with the administration, Frank and Dodd have also not indicated they will support the provision in the conference.

7th Circuit Reverses Tax Court in Vainisi –

Subchapter S and Q Sub Banks Following Notice 97-5 with Respect to Expenses Relating to Tax Exempt Income
Should Consider Filing Refund Claims

On March 17, 2010, the U.S. Court of Appeals, Seventh Circuit, reversed the U.S. Tax Court’s decision in Vainisi v. Commissioner, 132 T.C. No. 1 (2009), which held that a sub-S corporation that is a bank (or in this case a bank holding company that owned a bank that had made a qualified S subsidiary or “Q-sub” election) is required, under the provisions of Section 291 of the Internal Revenue Code of 1986, as amended, (the “Code”), to increase the amount of its taxable income by 20-percent of the amount of the bank’s interest expense that is considered attributable to certain qualified tax exempt-obligations that are owned by the sub-S bank, despite the plain language of Code Section 1363(b)(4), which provides that “section 291 shall apply if the S corporation (or any predecessor) was a C corporation for any of the 3 immediately preceding taxable years.” The bank in the Vainisi case had been a Q-sub for longer than 3 years.

Senate Financial Regulatory Reform Bill

On Thursday, Senate Banking Committee Chairman Chris Dodd (D-CT) announced he was ending negotiations with Senate Banking Committee Republicans Bob Corker (R-TN) and Richard Shelby (R-AL) and moving forward with releasing his draft bill the week of March 15 with a likely markup in the Committee the week of March 22. Corker responded by announcing that he was disappointed that Dodd had ended negotiations but that he would continue to work towards a bipartisan bill.

The move by Dodd to abandon bipartisan negotiations was caused by the increasing pressure from Committee Democrats and House Financial Services Committee Chairman Barney Frank (D-MA) to move a bill with stronger consumer protections than what Republicans would agree to during the bipartisan negotiations. A sign of the increasing pressure on Dodd by fellow Democrats was seen on Thursday when Sens. Jeff Merkley (D-OR) and Carl Levin (D-MI) announced they would be introducing legislation that would expand the proposed Volcker Rule to limit propriety trading and other risk-taking activities to include nonbank financial institutions. Dodd has till this point been resistant to including the Volker provisions in the legislation.

While the compromise between Dodd and Corker to house the new consumer protection agency in the Federal Reserve seems to have remained intact, Dodd has now acknowledged that the biggest outstanding issues remain how to regulate over-the counter “OTC” derivatives and how to finance the new “resolution” authority. Senate Majority Leader Harry Reid (D-NV) said Thursday that the Senate would pass the financial reform bill before its Memorial Day recess, which is scheduled to begin May 31.

Senate Passes Tax Bill

On Wednesday, the Senate passed the American Workers, State and Business Relief Act which extends unemployment insurance benefits and eligibility for the 65 percent COBRA health care tax credit during Dec. 31, 2010. The legislation retroactively extends tax cuts for middle-class families and businesses that expired at the end of 2009. The bill also provides relief for pension plans by allowing companies to amortize their obligations over a longer time period and prevents a reduction in the federal poverty level from taking effect through 2010. The scheduled reduction is caused by a decrease in the average cost of goods resulting from the economic downturn. It allows families to continue to qualify for programs such as stamps, Medicaid and home-heating assistance. Likewise, the legislation allows individuals living below the poverty level to continue to disregard refundable tax credits and refunds as part of their income for 12 months after receipt.

The bill also extends tax cuts for research and development, allows restaurant owners and retail stores to depreciate improvements over 15 years rather than 39.5 years, extends tax credits for small businesses that continue to pay employees who have been called to active duty in the military, extends tax credits biodiesel and renewable energy, extends tax credits for teachers who buy classroom supplies, creates tax credits for home energy efficiency improvements, and allows taxpayers to continue to deduct state sales tax on their federal tax returns.

The bill also extends the increased federal assistance for state Medicaid programs, made available through the American Recovery and Reinvestment Act, for six months. In addition, the legislation continues funding for loan programs for small businesses, extending funding to reduce or eliminate fees under the Small Business Administration’s 7(a) loan guarantee program and the 504 loan program through the end of this year. In addition, the legislation reverses a scheduled 21 percent payment cut for doctors who provide services through Medicare and Tricare. The legislation also extends several other Medicare protections, including the exceptions process for Medicare beneficiaries who exceed their cap on therapy services and provisions affecting doctors and other health care providers who serve rural communities.

The Senate passed the bill by a 62-36 margin, but getting a final bill to President Obama’s desk might prove more difficult. New Ways and Means Chairman Sander Levin (D-MI) said Tuesday he “wouldn’t be surprised” if the House forced a conference committee on the extenders bill to iron out the significant revenue issues.

The current versions of the economic stimulus tax bills under consideration by the Senate Finance and the House Ways and Means Committees contain two (2) provisions that are likely to be of particular interest to and will directly impact most, if not all, of our bank and other financial institution clients.  The provisions are (i) changes in the rules allowing for the carryback of a net operating loss (“NOL”) of up to five (5) years instead of the current carryback period of only two (2) years, and (ii) a repeal (with limited transitional protection) of the relief provided in Notice 2008-83 issued by the Internal Revenue Service (“IRS”) in the fall of 2008 that exempted certain losses on loans and foreclosure property incurred by banks from the NOL limitation rules applicable to built-in losses.

Increase in the Net Operating Carryback Period

The provisions of the Senate Finance and the House Ways and Means Committees’ bills increasing the NOL carryback period to two (2) to five (5) years are essentially identical.  The increased carryback period only applies to NOLs arising in 2008 and 2009.  In addition, the 90% limitation (or the 10% haircut  required) on the use of NOL carrybacks when computing a corporation’s alternative minimum tax is suspended.  For those banks or other financial institutions with NOLs in 2008 and 2009, the bill will provide three (3) additional years (i.e., 2003, 2004, and 2005) from which they can obtain a refund of federal income taxes paid.

One of the consequences of the TARP Capital program is that some banks will use some of the capital infusion to acquire other banks.  We believe that the “winners” in the TARP race will also attract additional private capital as investors decide who the long-term survivors are.  The Internal Revenue Service recently released two notices intended to provide relief to banks and other financial institutions that are looking to raise capital from the tax rules limiting the use of losses after there has been an ownership change in the stock of a corporation.  We believe that once it is widely understood by banks it will add momentum to the merger activity.

Generally, a corporation that has a taxable loss (i.e., tax deductions in excess of taxable income and gains) for federal income tax purposes during a taxable year generally may carry that loss back to each of the two (2) preceding years (to recoup federal income taxes paid in those years) and then forward to each of the following twenty (20) taxable years.  There are special rules, however, that limit the use of a tax loss (commonly referred to as a net operating loss or “NOL”) carryforward that arose prior to the time when the corporation underwent an ownership change with respect to its stock.