GE, Citigroup 2012 Earnings In Limbo Over Tax Fight

NEW YORK ( TheStreet)-- General Electric ( GE) and Citigroup ( C) are among companies that could see earnings decline by billions of dollars annually--starting in 2012-- if Congress chooses not to extend a loophole that lets U.S. companies avoid taxes on profits earned by overseas finance subsidiaries.

Known as the active financing exception, the provision allows companies to avoid taxes on dividend and interest income. Though Congress repealed this loophole in 1986, it was reinstated "temporarily" in 1997, and has been regularly extended since that time, according  to Wayne State University Linda Beale writing in her blog, ataxingmatter.

However, the last extension ran out at the end of 2011, notes tax consultant Robert Willens, of Robert Willens LLC.  

The last extension came Dec. 17, 2010. Prior to that, it was Oct. 3, 2008, and prior to that, Congress granted the extension in May 2006. Given the polarized state of Congress and its heated negotiations to avoid the series of drastic cuts known as the "fiscal cliff," Willens is convinced the extension--one of several "tax extenders," that remain in limbo--will have  to come in 2013, assuming Congress grants it at all.

"Unless this thing gets extended retroactively now for 2012 GE's going to be in a world of hurt because their effective tax rate is going to go up dramatically," Willens says. 

GE paid a 10.5% tax rate in 2010 and a 20% rate in 2011. The statutory--or default--corporate rate is 35%, though companies rarely pay that much. Willens believes GE's rate would go up to the high twenties without the active financing exemption.

Assuming GE added 15% to its tax rate in 2011, the company would have paid an extra $2.86 billion in taxes.

Analysts are counting on the laws being extended for GE. In a report published Wednesday, for example, based on a company presentation Monday, Bernstein Research analyst Steven Winoker predicted GE's fourth quarter tax rate would be even lower than the third quarter's 13.8% tax rate, which included a 4.4% rate for GE Capital.

A GE spokesman pointed to comments by Chairman and CEO Jeff Immelt during a presentation to investors Monday.

"The base case is that the tax laws are extended while tax reformers debate," Immelt said.

Willens says he doesn't blame Immelt for assuming the exception will eventually be extended through at least 2012. Indeed, Sen. Jeff Bingaman (D.,N.M.) writing in Politico earlier this week, noted the "tax entenders" package was passed earlier this year by the Senate Finance Committee with bipartisan support.

"We should not wait for a "grand bargain" to materialize before we finish our work on tax extenders," he wrote.

Still, in urging the swift passage of the extenders, Bingaman mentioned tuition tax credits and wind energy credits, while conveniently leaving out the benefit to the deeply unpopular financial services industry.

Even assuming the extenders eventually get passed, it will leave auditors in a tough spot if the issue still isn't resolved by the time GE and other corporations report their year-end 2012 results.

Will companies be allowed to report their results of operations as if the active financing exception had been extended even though it hasn't?

"I don't think you can make that assumption," Willens says.

While all multinational financial companies will face a similar predicament, Willens believes GE is likely to see the greatest impact. For JPMorgan Chase ( JPM), losing the active financing exception would have cost it roughly $600 million in 2011.

Among U.S. banks, Citigroup is widely understood to have the biggest international business, and Willens estimates Citigroup's earnings would have been lower by roughly $1 billion in both 2010 and 2011 without the loophole. Will Citigroup simply assume its extension for 2012 even if that hasn't happened by the time it files its 10-K?

A Citigroup spokeswoman wrote via email said the bank "won't speculate on upcoming filings."

-- Written by Dan Freed in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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