Compromise Tax Reform Legislation Falls Hard on Financial Institutions; Banks, Thrifts Could Pay $10 Billion in New Taxes in Next 5 Years

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Compromise Tax Reform Legislation Falls Hard on Financial Institutions

Banks, Thrifts Could Pay $10 Billion in New Taxes in Next 5 Years

While the tax reform bill hammered out by House and Senate conferees over the weekend aims to lift the burden on average Americans, the legislation will weigh heavily on the nation's banks and thrifts.

Despite lower rates, financial institutions will pay more than $10 billion in new taxes over the next five years as Congress ends what has been a summer of dissatisfaction for the industry.

If the sweeping legislation is approved intact by Congress and signed by President Reagan, which is expected in September, virtually every department in a bank or thrift will be forced to adapt. Among the changes:

Lending divisions will no longer enjoy a tax buffer against potential losses. For banks with more than $500 million in assets, and less than 75% of capital in problem loans, there will no longer be a deductible reserve. What's more, the present tax reserve of 0.6% of loans must be paid out as income over five years, a collective drain on the industry of $3.3 billion. Thrifts face a similar problem: Only 8% of annual income can be placed in tax deductible reserve. Banks lending to developing countries will be prevented from juggling taxes to offset American obligations, beginning in 1999.

Deposit gathering will likely be impaired by limits on individual retirement accounts. These had been a stable source of funds for many banks and thrifts. Now, only those not covered by a private pension, or making less than $25,000 a year ($40,000 a year for married couples), can make a tax-deferred contribution of up to $2,000 a year to an IRA. The inside build-up in all IRAs, however, remains tax-deferred.

Investment strategies must be revamped. Banks will lose a deduction for the interest paid on debt to buy tax-exempt bonds, except for a municipality's issues that are limited to $10 million a year. This provision affects investments after Aug. 7, 1986.

Also, a strict minimum tax will mean banks may pay as much as a 10% tax on municipal bond holdings. Leasing divisions, where banks reaped lucrative tax credits through investments in equipment, will be restructured since many tax benefits will be stripped.

For thrifts and others that invested directly in speculative real estate projects, tax reform will erase many tax benefits. Real estate investment trusts may remain attractive investments since their tax-free status is retained. Some projects may fail, forcing thrifts to foreclose.

Related industries served by bankers will also be transformed. Real estate developers must confront a new depreciation schedule. The current 19-year, accelerated framework that helped spark a development boom has been lengthened to an average of 30 years, without accelerated writedowns. …