Maryland Governor William Donald Schaefer this month signed into law a longstanding tax provision allowing banks and other financial institutions to deduct the cost of buying or carrying tax-exempt state and local bonds.

Since 1968, financial institutions in Maryland have paid a state franchise tax of 7% of net earnings in lieu of the 7% state corporate tax, said Ronald Wineholt, deputy director of the Maryland department of assessments and taxation.

The franchise tax includes income from state and local bonds that are exempt from the corporate income tax.

The internal Revenue Code normally allows companies to deduct the cost of interest incurred to buy or carry taxable bonds, so Maryland has allowed a similar deduction for financial institutions, since the state is taxing banks' income from state and local bonds, Wineholt said.

The deduction is allowed to the extent such expenses are included in federal taxable income, said Wineholt. He estimated that about half the states have a similar franchise tax.

The law, which Wineholt drafted, did not arise out of any specific case, he said. The taxation department's counsel, in the course of reviewing the tax law, said a clear statutory basis was needed, and both the legislature and the governor agreed, he said.

Taxes attributable to the deduction "are in the neighborhood of $1 million a year," Wineholt said.

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