The U.S. Tax Court has handed down two decisions that could save banks with credit card operations millions of dollars.
The cases involve efforts by Barnett Banks Inc., Jacksonville, Fla., and Signet Banking Corp., Richmond, Va., to delay paying taxes on credit card membership fees.
The judges said banks could defer some of the income if the fees cover year-round services to cardholders, not just the opening of credit lines.
"You can have the cash today and pay the tax tomorrow," said Charles W. Wheeler, national director of banking and financial tax services at KPMG Peat Marwick.
The cases involve a key question in tax accounting: When to report revenue. The Internal Revenue Service wants businesses to account for revenue as soon as possible. Businesses, however, try to defer revenue into future years. The delay gives them free use of the money until the next taxable year.
Scores of credit card banks tried to take advantage of this free money during the past three decades. They would count as income - and thus pay tax on - only one-twelfth of the annual fee per month. That way they could defer, on average, half the fee income into the next taxable year.
The Internal Revenue Service began cracking down in the early 1990s, snaring Signet and Barnett. The IRS wanted to collect $4 million from Barnett for 1980 and 1981, and $3.6 million from Signet for 1982 to 1985.
The banks refused to pay, filing appeals with the tax court instead. The cases went to different judges, although both were decided on Feb. 29.
The verdict: Barnett doesn't have to pay, but Signet does.
At first blush, the rulings might seem contradictory. After all, how can the same tax dispute have two different outcomes?
The answer is in the details. One judge examined the card contracts Signet issued; the other looked at Barnett's. They wanted to know if the membership fee was paid for a continuous service or a one-time event.
U.S. Tax Court Judge John O. Colvin noted that Signet's cardholder agreement specifically states that the fee covers the establishment of the credit limit and the issuance of a card. These are one-time expense that can not be spread over an entire year, he said. That means the bank must pay the tax when it receives the fees.
U.S. Tax Court Judge Edna G. Parker, however, ruled that Barnett's fee covered year-round services. She pointed out that Barnett gave customers a rebate if they canceled their cards at midyear. Also, she said the credit card gave consumers a continuous benefit - because they didn't need to worry about carrying large amounts of cash.
Mr. Wheeler said the lesson is clear. Banks that want to defer income must spell out in their credit card contracts all of the year-round services consumers will get.
Once that's taken care of, bankers should have little trouble with Uncle Sam about the matter.