Former CUs Turn To Innovative Methods To Reduce Taxes

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In converting from tax-exempt status, several former credit unions are using some innovative methods to reduce their tax liabilities.

Rainier Pacific Financial Group is among those that have developed a new method to minimize the federal tax bite. As part of its initial public stock offering last November, the bank holding company established by the converted credit union once known as Rainier Pacific CU created a not-for-profit charitable foundation and endowed it with $6.3 million, including $5 million in stock and $1.3 million in cash, that will be used to invest in eligible projects surrounding its Fife, Wash., community base.

While the creation of tax-exempt foundations like these is not unprecedented, Rainier Pacific is believed to be the first converted credit union to go this route. "It's not rare, but it's not commonplace, either," said Richard Garabedian, a Washington lawyer who specializes in the conversion of mutual savings banks and has converted 10 credit unions to MSB. The purposes of such foundations are two-fold, he said. "You get a tax benefit, but you also put money back into the community."

IRS Gives Approval

The IRS, said Garabedian, has approved the tax-exempt status for such foundations in the past but under strict conditions. "There are rules about how much you can deduct when you do charitable contributions," said Garabedian, adding that federal thrift regulators also have requirements on charitable giving through foundations.

Among the conditions imposed by the IRS is that the foundation will be required to distribute a minimum of 5% of the average fair market value of its net investment assets annually.

There are other ways former credit unions have been able to reduce their federal taxes after converting. One way is to realize deferred losses on loans. Under IRS rules, a financial institution may carryback net operating losses to the two preceding taxable years and forward to the succeeding 20 years.

This allows credit unions converting to taxable entities, like mutual savings banks, to claim loan losses accrued during the two years prior to conversion as tax deductions, according to Garabedian.

Michigan CU Plans To Pursue Option

Hans Ganz, president and CEO of Pacific First Bank, said his bank was allowed to book a net deferred tax asset after converting from a credit union, Pacific Trust FCU, in 2000. The company's annual report filed with the SEC shows that amount to be $456,000.

In the latest credit union-to-bank conversion, officials at Lake Michigan CU, in Grand Rapids, Mich., said after the credit union converts to a taxable mutual savings bank structure they expect to use depreciation charges the credit union has accrued through its taxable auto leasing subsidiary to offset some of its new tax liability.

The discussion of the tax impact Rainier Pacific provides in its annual report filed with the SEC gives a fuller illustration of how it successfully reduced its taxes after converting from credit union.

How The Entity Is Structured

The bank said for 2001, the year it converted from a credit union, it was able to declare a net deferred tax credit of $2.2 million, due to its conversion from a nontaxable entity to a taxable entity. The major components of the related deferred tax assets were: $1 million for the allowance for loan losses not expensed for tax purposes but expensed for book purposes, $723,000 related to accumulated depreciation due to differences in book and tax depreciation lives, $551,000 related to the gain on the sale of the administration office deferred for book purposes but not for tax, and $188,000 for vacation, sick and bonuses deducted for book purposes but not for tax. The significant deferred tax liability included $311,000 to record the difference in the tax and book basis for FHLB stock resulting from stock dividends recognized for book purposes but not for tax.

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