Tax Victories Expected for Banks on 2 Fronts
A twofold victory may be at hand for bankers waging a battle against the Internal Revenue Service over millions of dollars in disputed tax revenues.
An IRS proposal would allow banks, instead of the agency, to decide when it is time to take a deduction on a bad loan. That shift would create some tax savings. Banks stand to benefit even more from an accounting change on loan-loss reserves that the Financial Accounting Standards Board is mulling.
"Coupled together, these changes could really help banks," said Jack Wilson, national director for financial services industry tax services for Ernst & Young in New York.
The IRS proposal, expected to be adopted by yearend, would end disputes between banks and the agency. In the past, the IRS second-guessed bankers' decisions about when a loan went bad.
For example, a bank claims a loan went bad in 1988. Under current regulation, the IRS could rule that the loan went bad in 1989. That finding means a bigger tax bill for 1988, as well as interest charges on the unpaid taxes.
"Bankers often try to convince an IRS agent who isn't familiar with the credit process that the loan is no good and we need to take a chargeoff," said Norma Lauder, senior vice president at First Chicago Corp.
Banks, of course, could dispute the IRS ruling - but seldom with much expectation of a reversal.
Under the new proposal, banks would be allowed to determine whether a loan is bad if they charge off loans in accordance with regulatory guidelines and if their primary regulator approves the way they deal with classifying problem loans. With that power, banks could pay fewer taxes.
"The bad loan numbers are so large, it could have an effect on capital," said Robert Bertgis, a senior vice president with First Union Corp., Charlotte N.C.
Not Without Problems
The IRS proposal, however, is not without some problems, according to tax experts. For example, if regulators criticize a bank for not charging off loans quickly enough, then the IRS would rescind the bank's authority for deciding when a loan is bad.
Because the IRS is trying to make sure banks do not take chargeoffs too quickly, a regulator's criticism about banks' moving too slowly should not deter banks from making their own judgments.
The IRS proposal was issued in May, and hearings followed in August. The agency is reviewing the public comments, and bankers expect the measure to take effect by yearend.
A potentially more important change in tax reporting, said Mr. Wilson, could come from the Financial Accounting Standards Board. The board is considering an accounting practice that could boost the income and capital of profitable banks.
Basically, the new method would allow profitable banks to gain tax benefits immediately from loan problems.
The accounting practice is expected to be mandatory in 1993. Some banks already use the method, which would be simplified under the accounting board's proposal.
Under current accounting methods, loan-loss reserves are tax deductible only when loans go bad. If a bank puts $100 in loan-loss reserves and the loan continues to be good for years, the tax benefits of that provision will not kick in until the loan goes bad.
Under the proposal, the $100 loan-loss reserve would be immediately tax deductible. Given a tax rate of 34%, that $100 translates into a $34 tax benefit, or a $34 boost in income and capital.
Still, banks have not won all their skirmishes with the IRS. Last week the industry lost one critical fight, and with it, an estimated $2.5 billion in annual income.
The Treasury Department said it would not change the tax code that calls for banks to pay taxes on loans that are 90 days or more delinquent. In effect, banks pay tens of millions of dollars in tax on income they do not expect to see.
And the IRS continues to tax banks' activities in capital markets, without giving them a chance to gain tax benefits from losses. A loss on a hedge, for example, is treated as a capital loss. Banks need to show a capital gain - a rare occurrence - to take that loss as a deduction.