Magazine article American Banker

IRS Probe of Tax Refunds Could Hurt Banks' Capital

Magazine article American Banker

IRS Probe of Tax Refunds Could Hurt Banks' Capital

Article excerpt

Byline: Rachel Witkowski

The Internal Revenue Service is scrutinizing at least a handful of banks that sought large tax refunds for charging off bad loans last year.

The inquiries, if they turn into full-blown audits, could have significant implications for community and regional banks. If the IRS denies a refund, the bank would lose the ability to count it as much-needed capital.

"It could wipe out $1 million to $2 million in capital" for a community bank, said Bill Massey, a shareholder and CPA at Saltmarsh, Cleaveland & Gund in Pensacola, Fla.

After writing off soured loans and taking a net loss, many banks sought refunds on their 2009 tax returns, a technique known as loss carry-backs. Some banks are facing audits because by law, refunds that exceed $2 million trigger an IRS examination of any business.

While that trigger has been on the books for years, many banks posted the worst chargeoffs and net losses in their history last year, so the IRS is conducting more audits and paying close attention to charged-off loans.

The situation is a Catch-22 for banks whose regulators demanded they write off more nonperforming credits. Massey pointed to a recent case where the IRS challenged a loan that a bank charged off because it was still trying to foreclose on the collateral. If the bank hadn't charged off the loan "they could get criticized by their regulators," he said.

Only 25% to 30% of U.S. banks may seek refunds inexcess of $2 million, Massey said. Yet accountants whose clients include banks worry that the IRS could also look at institutions that claimed smaller refunds. And once an audit begins, its scope could widen.

"Whenever a company's tax liability goes way down, it is not surprising that there's an audit ... and the administration said they were going to be more aggressive in the corporate tax world," said Kip Weissman, a partner at the law firmLuse Gorman Pomerenk & Schick. "The bad thing is when they're going in for one thing and they find something else."

The IRS would not comment for this story.

Federal lawrequires certain refunds in excess of $2 million that result from carry-backs from credit losses be approved by the Joint Committee on Taxation. An IRS auditor could scrutinize these returns even more thoroughly than in a general audit because the agency must report its findings to the committee to secure refund approval, said Bob McCahill, a director in the New York office of McGladrey, an accounting firm. …

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