* Loans, regulations grant bank status - MoneyGram
* Company's claim to be a bank is "imagination" - IRS
WASHINGTON, May 27 (Reuters) - MoneyGram International Inc is fighting in U.S. Tax Court to prove it is a bank, a designation the Internal Revenue Service disputed when it blocked $900 million in tax deductions by the world's second-largest money transfer company.
In a case with implications for many financial institutions, especially those hurt by the 2008-2009 credit crisis, the MoneyGram fight centers on tax deductions only banks can claim for worthless assets, such as mortgage-backed securities (MBS).
Tax lawyers said the case is being watched closely as the definition of what constitutes a bank becomes increasingly murky.
"There is clearly precedential value to other financial institutions that may not be viewed as conventional banks," said Mark Allison, a lawyer with Caplin & Drysdale.
"Given the volume of securities and debt instruments that lost substantial value in the aftermath of the financial crisis, this will continue to be a thorny and difficult issue for taxpayers," Allison said.
A hearing seeking a decision on MoneyGram's bank-or-not-bank question is scheduled for June 6 in Washington.
MoneyGram's problems started in 2007 when U.S. home prices plummeted and the value of the company's MBS started to tank.
The company sold most of its MBS at steep losses in 2008. When reporting its taxes, MoneyGram deducted the MBS as ordinary losses, not capital losses.
Because banks must hold assets against potential loan losses, the tax code allows them to deduct certain worthless securities as ordinary losses. Ordinary investors holding such securities must book worthless securities as capital losses.
In 2012, the IRS disallowed $900 million of MoneyGram's ordinary loss deductions, the company said in regulatory filings. It filed its Tax Court challenge later that year.
The IRS and a spokeswoman for MoneyGram declined to comment.
ARE MONEY ORDERS LOANS OR MILK?
Dallas-based MoneyGram operates in more than 200 countries as the world's second-largest money-transfer business after Western Union Co.
While admitting that "bank" is not part of its name, MoneyGram is arguing its money orders establish the same "debt-creditor relationship" that banks have with account holders.
In more than 40 states, MoneyGram is regulated by the same authorities that oversee banks, the company said in court filings. These regulators require MoneyGram to hold capital reserves against potential losses.
But the IRS said MoneyGram's claim to be a bank "is entirely tax-driven (and) is nothing more than a tax planner's imagination gone awry," according to court filings.
Citing congressional testimony from company executives in 2006, the IRS argued MoneyGram has never defined itself as a bank.
Additionally, a money order is not a loan, but a sale of goods and services that is the same as "a loaf of whole-grain bread and a gallon of organic milk," the IRS said.