The Treasury may have made some silly paper "profit" on its bailout of Citigroup (C) but the taxpayer may not get much of anything.

The Washington Post reports that as part of the bank's TARP payback agreement, it's quietly been given a $38 billion tax break by the IRS. Seriously.

The Internal Revenue Service on Friday issued an exception to long-standing tax rules for the benefit of Citigroup and a few other companies partially owned by the government. As a result, Citigroup will be allowed to retain billions of dollars worth of tax breaks that otherwise would decline in value when the government sells its stake to private investors.

While the Obama administration has said taxpayers are likely to profit from the sale of the Citigroup shares, accounting experts said the lost tax revenue could easily outstrip those profits.

So what specifically happened?

Citigroup was required to replace its federal aid with an equal amount of money from private investors, more than any other bank. The government concluded that Citigroup needed the IRS ruling because a reduction in the value of its tax breaks would have eroded its capital, forcing the company to raise more money, officials said.

Federal tax law lets companies reduce taxable income in a good year by the amount of losses in bad years. But the law limits the transfer of those benefits to new ownership as a way of preventing profitable companies from buying losers to avoid taxes. Under the law, the government's sale of its 34 percent stake in Citigroup, combined with the company's recent sales of stock to raise money, qualified as a change in ownership.

This is actually an issue that's been talked about for a while. Mike Mayo and Rolfe Winkler have been banging the drum on this, warning that the eorsion of these tax credits would eat into Citi's coming quarterly earnings, big-time.

But apparently they didn't count on the generosity of Uncle Sam once again.

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