Bank loan origination expenditures.

• Author: LaBelle, Brett E.
• Position: Taxation

The Tax Court recently held in PHC Bancorp, Inc., 110TC No. 27 (1998), that costs incurred in the process of making loans (e.g., property reports, credit reports, appraisals, recording security interests, and salaries and benefits to bank employees), were required to be capitalized and amortized over the lives of the loans. The court held the costs were related to the creation of separate and distinct assets, the benefit of which extended over the lives of the loans.

Announcement 93-60

The issue of whether financial institutions can currently deduct costs related to the creation of loans has become popular in recent years. Prior to the issuance of the original issue discount (OLD) regulations (which require financial institutions to defer de minimis loan fee (i.e., points) income over the life of loans), financial institutions would generally include loan fees in taxable income when received and deduct loan costs when paid. While the OID regulations required deferral of loan fee income, they did not address the treatment of loan origination costs.

The IRS issued Announcement 9360 on loan origination costs. However, this did not provide guidance on their proper tax treatment. Presumably, this announcement was issued in response to the flood of Forms 3115, Application For Change in Accounting Method, from taxpayers seeking permission to change their accounting methods for loan costs from a currently deductible method to a deferral method. Taxpayers were filing these forms in an attempt to ensure prospective application of anticipated IRS guidance that would mandate that loan costs be capitalized. This announcement indicated the Service was no longer accepting Form 3115.

SFAS No. 91

For financial accounting purposes, Statement of Financial Accounting Standards (SFAS) No. 91,"Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Indirect Costs of Leases" provides that direct loan origination costs, as defined in SFAS 91, must be deferred and recognized as a reduction in the loan's yield.

In PHC Bancorp, the IRS did not attempt to recompute the costs that would be capitalized for tax purposes, but simply argued that the costs the taxpayer had already identified attributable to the creation of loans in an SFAS 91 calculation should be capitalized for tax purposes.

Tax Court Opinion

In PHC Bancorp, the taxpayer contended that...