A New Tax Battle for Big Banks: LILO Deals

Article excerpt

A federal and state crackdown on tax shelters has a handful of the nation's largest banks in hot water over yet another issue, this time a type of complex leasing deal that helped lower their taxes during the 1990s.

Five of the 25 largest banks -- AmSouth Bancorp, FleetBoston Financial Corp., BB&T Corp., KeyCorp, and Bank of New York Co. Inc. -- disclosed that they had been audited by the Internal Revenue Service and in some cases by unnamed state tax authorities over their participation in leverage leasing deals.

The banks were not specific, but those familiar with the issue say the audits concern lease-in, lease-out deals that were popular in the '90s.

LILOs can vary from one agreement to the next but typically involve large fixed assets such as power plants, subway systems, or other public facilities owned by local governments in the United States or by foreign governments. IRS officials and tax experts say tax and leasing advisers marketed the shelters to large U.S. corporate taxpayers that were seeking ways to reduce their taxes. This group would include banks, insurance companies, and utilities.

Some of the banks have disclosed that the IRS sent them "notices of proposed adjustment," which means it has disallowed the tax shelters and is seeking payment of back taxes. All five banks say they plan to fight the audit findings, though not one has filed a challenge, and that they do not expect the matter to have a material effect on their earnings.

A sixth, Regions Financial Corp. of Birmingham, Ala., said it has been audited and that it may face additional tax liability over its use of LILOs, a banking analyst said. The company declined to comment further.

Dozens of other large banks and corporations probably participated in LILOs. In all the IRS has privately identified 56 taxpayers that participated in them between the mid-'90s, when they first emerged, and 1999, when the agency started banning them.

An IRS spokesman declined to name the companies, citing a policy of not commenting on individual tax cases. Nor would he say if the IRS had settled any of the disputes, citing the agency's policy not to comment until at least 10 cases have been settled.

Paul Claytor, the senior industry adviser for the financial services industry in the IRS's large and midsize business division, said in an interview that the agency has targeted the leasing deals as part of an attack on what it considers "abusive tax shelters." It puts LILOs in a under "listed transactions," its classification for a slew of prohibited tax shelters and other tax strategies. Apart from halting the deals in 1999, it also is seeking back taxes for those contracted before then.

The agency argues that these shelters have no real economic value other than to create a tax benefit.

"It's a controversy that's rooted in the technicalities of equipment leasing and leasing rules," Mr. Claytor said. The leases in question often last 40 years or more with leases, subleases, and financing agreements between multiple parties. Structuring the transactions can require computer programs with hundreds of parameters.

"You see a lot of paper flying around and a lot of tax benefits generated out of the transaction, but the party that owned the property at the beginning of the transaction is still in full control," Mr. Claytor said. "One of the things that disturbs us is you don't see much of a change" in the situation before or after the lease transaction. …