Loan Origination: Getting Tax and Financial Accounting to Mesh

SFAS No. 91 creates conflict with tax accounting.

We have seen that, with respect to many items of income and expense, tax accounting differs, diametrically, from financial accounting. This divergence, of course, is not surprising in light of the fact that the fundamental goals of each system also diverge.

Financial accounting has as its underpinning the doctrine of conservatism such that, wherever possible, net income is understated through the mechanism of accelerating expenses and deferring income. The fundamental objective of the tax accounting system, as we are all aware, is revenue collection such that the system strives to enhance net (or taxable) income and, to this end, income items are accelerated while expenses, wherever possible, are deferred. With each system, however, ”matching” (of revenues with the expenses incurred to produce such revenues) is also advertised as a central tenet. But frequently, this particular objective is sacrificed on the alter of the larger objectives — conservatism and revenue enhancement.

SFAS No. 91 requires, among other things, that loan origination costs be capitalized and amortized — as a yield adjustment — over the life of the associated loan. It also requires that the capitalization and amortization of loan commitment fees is a prime source of divergence between tax and financial accounting.

In PNC Bancorp v. Commissioner, for instance, a bank was required, in accordance with SFAS No. 91, to defer its costs incurred in connection with the origination of loans. The IRS seized upon this treatment of such costs and attempted to impose similar treatment for purposes of tax accounting. The court, ultimately, rejected this attempt to achieve accounting parity and ruled that these costs could be treated as ”period” costs for tax accounting purposes. In the process, the court rejected the IRS’s attempt to subject these costs to the capitalization results supposedly dictated by the Supreme Court’s decision in the Indopco case.

That case stands, broadly, for the proposition that expenses must be capitalized if they provide benefits that extend beyond the year in which such expenses are incurred. This principle, the court felt, was inapposite here because these expenses were incurred “for the needs of current income production.” The Indopco doctrine did not apply, in the court’s judgment, because, here, the loan marketing activities “lie at the very core” of the bank’s recurring and routine day to day business.

Although the result in PNC Bancorp favored the taxpayer, the divergence between tax accounting and financial accounting, recently produced by the decision in American Express Co. v. United States, cut the other way. There, Amex issued charge cards with respect to which it received ”annual payment fees.” SFAS No. 91 required these fees to be capitalized and amortized into income as such fee was ”earned” through the passage of time. It sought similar deferral treatment for tax accounting purposes under the auspices of Rev. Proc. 71-21 which, in limited circumstances, permits the deferral of advance payments. However, no deferral is permitted for income that does not represent payment for services and the IRS had held, in GCM 39434, that credit card fees were loan commitment fees for a property right — the right to use money — rather than for services. In short, the extension of credit (with respect to which the fee was received) was not a form of service.

Ultimately, the court upheld the Service’s determination on the theory that “deference” is due the IRS’s interpretation of its own Revenue Procedure because, in this case at least, that interpretation was reasonable. Accordingly, Amex is required to include the fees when they are received (despite the possibility that such fees may have to be refunded) and, as a result, its tax and financial accounting, with respect to this item, will not mesh.

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