IRS Lets Eighth Circuit Use Cash Accounting

agreed last week to let small banks in several midwestern states return to a prior accounting method for short-term loans that they said allows fairer taxation. Under the IRS ruling, banks in the eighth U.S. circuit court of appeals' district can return to or continue to use the cash accounting method for short-term loans. That method acknowledges that interest and principal are paid at the end of the loan's term. The banks had been urged for the last nine years to switch to an accrual method of accounting, in which interest was assumed to be received over the term of the loan. "The cash accounting method better matches income with expenses," said Sue Ann Nelson, an attorney with Doherty, Rumble & Butler in Minneapolis, who represented a Minnesota bank that went to court over the issue. "If they had to accrue, they would in effect be paying taxes on income they hadn't received." The small banks and their proponents had sought such a ruling since $60 million-asset Security Bank Minnesota, in Albert Lea, won a ruling in the eighth circuit court in 1993. The area covers Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota. "It's very important to banks located in the eighth circuit," Ms. Nelson said. "It will be disappointing to banks located outside the eighth circuit." The IRS will now process applications to change accounting methods for banks in the eighth circuit, as well as claims for refunds from previous related assessments. But the agency said it will still pursue the issue in other circuits. The dispute began after tax code changes in 1986 led the IRS to say that it would assume that short-term notes were paid on an accrual basis, rather than the existing cash method, affecting banks' tax planning. Banks with more than $5 million in gross annual revenues already were using the accrual method. However, banks with lower revenues, usually with less than $60 million in assets, were supposed to switch, and many did. Others protested the issue and supported Security Bank as a test case. A tax court agreed in 1992 that small banks should be able to continue to use or switch back to the cash accounting method, as did the eighth circuit court of appeals in 1993. However, the Internal Revenue Service, until last week, had refused to grant banks permission to return to the cash method on short-term loans. Charles Wheeler, national director of bank tax services for KPMG Peat Marwick, was among those protesting to the IRS. "These people fought for a test case, and you are denying them their victory," Mr. Wheeler said he told them.