Minimizing financial institution taxes.

• Author: Ellsworth, Richard K.

Purchasers of core deposit accounts generally pay a premium above the outstanding account balances when acquiring core deposit account portfolios. Typically, a substantial portion of this acquisition premium can be attributed to the core deposit intangible asset. Consistent with the recent Tax Court case, IT&S of Iowa, Inc.,(1) and previous decisions, amortizing this intangible asset requires a sound valuation procedure as well as statistical support for establishing a remaining useful life. By applying sophisticated valuation techniques, a financial institution can improve the prospects of successfully amortizing the core deposit intangible asset on acquisition and thus minimize the taxes associated with the transaction.

Financial institution, like all taxpayers, are constantly searching for opportunities to reduce their tax burden. One opportunity for tax reduction is the amortization of the core deposit intangible asset, which is created when a financial institution pays a premium above the outstanding account balances to acquire the core deposits of a bank or thrift institution. The acquisition premium paid above the outstanding account balances for the core deposits is considered as paid for goodwill unless the taxpayer can demonstrate the existence of an intangible asset whose value is separable from goodwill and whose life is of a limited duration. For tax purpose goodwill is not depreciable; however, an intangible asset with a limited useful life and a value distinct from goodwill is depreciable. Therefore, a financial institution seeking to minimize its tax exposure will identify any amortizable intangible assets associated with a core deposit account portfolio acquisition.

The core deposit intangible asset has historically been the most significant intangible asset that has been acquired with the purchase of core deposit accounts. Opportunities to amortize the core deposit intangible asset arise because core deposit balances represent a low cost funding source for financial institutions when compared to alternative funding sources. If a financial institution is unable to maintain substantial core deposit account balances, it will be forced to obtain financing from more expensive alternative funding sources. Obtaining the expensive financing will increase the financial institution's overall cost of funds and thereby reduce its profitability. Therefore, because the acquisition of a core deposit account population generally enables a financial institution to obtain funds at favorable interests rates, the core deposits will sell at a premium above face value since a financial institution recognizes the benefit to itself in acquiring this attractive financing source. The benefit received by the acquiring financial institution is quantified as the core deposit intangible asset. Because of the potential tax savings, many financial institutions have attempted to amortize the core deposit intangible asset. However, legal response to the core deposit intangible asset amortization issue has been inconsistent so that a brief examination of the legal history relating the amortization...