Interstate May Bring Tax Consequences for Stay-at-Home Banks, Too

As if dealing with nationwide interstate banking and branching weren't taxing enough for community bankers, many also face uncertainties over how they will be taxed.

"Traditionally, because of the restrictions on interstate banking, most states taxed the banks in-state and didn't pay much attention to the out- of-state banks," said Charles Wheeler, national director of bank tax services, KPMG Peat Marwick, Washington.

But now, as states begin to consider reconfiguring their tax laws to respond to the altered state and national banking environment, even community banks that maintain the status quo must monitor any changes to state laws.

Community banks "need to have a good grasp of how they're being taxed in the states where they're doing business," said Mary Jane Egr, national coordinator of state and local taxes with Grant Thornton in Chicago. "The community banks need to be involved because the big banks are going to drive the process to a large extent. They need to make sure they're not going to end up bearing the majority of the burden."

Historically, states have taxed in-state banks based primarily on physical property and payroll, Ms. Egr said. Before interstate branching, banks had to have a separately chartered subsidiary in every state in which they operated, and were taxed accordingly.

With the need for separate subsidiaries eliminated in the new interstate branching environment, however, states must formulate new taxation criteria for both in-state and out-of-state banks operating across their borders.

Many tax law changes will have "little effect" on some community banks directly, said James Engel, national director of state and local taxes for the banking practice of KPMG Peat Marwick in Boston.

However, "if they're near a border, and they're more likely to branch across state lines, the tax schemes of the various states becomes more important to them," he said.

Also, many banks near state lines have a small number of customers in a neighboring state, but no physical presence there.

"It would surprise you how many instances of that there are," said Henry Ruempler, national director of bank tax services in the Washington office of Ernst & Young.

Tax experts concur that the best solution would be a uniform method of bank taxation in all states.

"If everybody has the same tax system, then it's a fairer system," Ms. Egr said.

Already, several states, including Minnesota, Indiana, Tennessee, and West Virginia, have adopted tax regulations developed by the Multistate Tax Commission, which tax the "economic presence" of banks that have more than a certain amount of business there.

If more states seeking additional bank tax revenue adopt such measures, community banks could find themselves paying new taxes, Mr. Ruempler said.

"I think the most significant thing is that they may find themselves subject to tax in a state other than their home state that they hadn't been subject to before," said Mr. Ruempler.

Also, even if the new taxes aren't burdensome, the changes to the laws might force employees to spend more time on documentation. So small banks must determine if doing business across state lines is worth the cost and effort, observers said.

"Right now, we don't have a state that's got a model ... rule that would attempt to reach a middle ground," he said. "It's in the states' interest to have a good hard look at this."

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