IRS Takes on Fannie Mae Over Big Tax Writeoff

The Internal Revenue Service is battling the Federal National Mortgage Assn.--a former federal agency that still enjoys preferential treatment from the government--over a $666-million tax writeoff the association took for what the IRS says was an $875 expenditure.

In one of the largest U.S. Tax Court cases ever tried, the IRS says the mortgage association, known as Fannie Mae, owes $320 million in taxes as a result of a series of improper mortgage-loan exchanges and refinancing agreements. Another $200 million is owed separately, the IRS says, by savings and loans that participated in the deals with Fannie Mae. The Fannie Mae case is expected to set a precedent for those cases too, the IRS said.

“When all was said and done, Fannie Mae spent $875 . . . and the Treasury was out approximately half a billion dollars,” IRS trial attorney Kendall C. Jones said during opening arguments in the trial, which began in U.S. Tax Court on Monday.

Altogether, as much as $1 billion in taxes may be at stake when other similar transactions are added to the Fannie Mae tax writeoffs, IRS officials said. If many S&Ls; have to pay significant amounts of back taxes, it could put a heavy strain on the ailing industry, experts say.

The IRS filed a deficiency notice for the contested taxes in April 1986; Fannie Mae paid some $200 million and then filed suit against the IRS to recover the money and an additional amount that it said it was owed as a refund.

The deals, carried out by Fannie Mae in the early 1980s, were made possible by regulators at the Federal Home Loan Bank Board, which changed its rules so that the transactions would not be recorded as losses for accounting purposes, even though they were generating large tax losses. As a result of the ruling by the bank board, Fannie Mae and the S&Ls; posted profits when they might otherwise have had losses.

The IRS is seeking to prove that tax breaks were the only motivation for the deals. Fannie Mae officials do not deny that they entered into the swap arrangements with tax benefits in mind, but they say there were legitimate business reasons as well.