To keep pace with its neighbors in Rhode Island and Massachusetts, Connecticut has enacted a law that lets banks avoid paying state taxes on mortgage income.
The law, which is to take effect Jan. 1, lets state-chartered banks and thrifts put mortgages into passive investment subsidiaries. Revenues from the subsidiaries are exempt from state tax.
The size of the tax cut will vary by institution, said Lindsey R. Pinkham, senior vice president of the Connecticut Bankers Association. At least 15 banks have told the association they are establishing passive investment units to take advantage of the law, and Mr. Pinkham said he expects more.
"There is a good appetite out there for this," said John S. Carusone, president of Bank Analysis Center, a Hartford, Conn., consulting firm. "It's an effective way to shelter some income and improve a bank's competitiveness."
Similar laws are on the books in Rhode Island and Massachusetts. Connecticut bankers warned that, without the change, some of them would have moved mortgage operations out of state.
Establishing the subsidiaries will come at a price, however. First Federal Savings and Loan Association, a $992 million-asset thrift in East Hartford, said last week that it would take a $500,000 charge this quarter to qualify for the tax break.
The expense came courtesy of accounting rules that require a thrift to write off credits on its mortgage loan-loss reserves that it could have applied to future state tax bills. Those credits are now moot because the new subsidiary's profits will not be taxed.
Still, James D. Shelton, First Federal's president and chief executive officer, said the thrift will earn back that writeoff in 1999. He said he expects the move to cut the company's combined federal and state tax rate on pretax income from 39.61% to 34%, saving $1 million over the next two years.
"It's a great opportunity, but you have to swallow some medicine to take advantage of it," Mr. Shelton said. "We decided to take the charge now in order to start earning the tax break as soon as possible."
