New NOL rules may hurt some profitable banks.

• Author: Ziegelbauer, John
• Position: Net operating loss

The Taxpayer Relief Act of 1997 (TRA '97) reduced the net operating loss (NOL) carryback period to two years and increased the NOL carryforward period to 20 years. Even in the midst of the current economic expansion, this change in the NOL carryback period is already causing some problems for banks getting ready to prepare their 1997 financial statements. The reduced carryback period may even result in a charge to the earnings and capital of profitable banks, because of the possible need to establish a financial statement deferred tax asset valuation allowance.

New NOL Carryback and Carryforward Periods

Under prior law, an NOL could be carried back three years and forward 15 years. These new carryback and carryforward periods are effective for NOLs generated in tax years beginning after Aug. 5, 1997.

The new NOL carryback period is especially rough on banks because regulators impose limitations more stringent than those contained in Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), for purposes of determining the amount of deferred tax assets that a bank can include as Tier I capital.

SFAS 109: Accounting for Deferred Tax Assets

The Financial Accounting Standards Board (FASB) issued SFAS 109 in February 1992. Under the standard, a bank reports deferred tax assets arising from tax carryforwards and deductible temporary differences (i.e., future deductions or income taxed but not booked).

Tax carryforwards are deductions or credits that a bank cannot use for current tax purposes, but may carry forward to reduce taxable income or taxes payable in a future period. Temporary differences arise when a bank records transactions in one period on the bank's books and recognizes them in another period (or periods) on its income tax return.

A bank may only realize deferred tax assets arising from deductible temporary differences by:

* Recovering taxes paid in prior years;

* Offsetting taxable temporary differences; or

* Earning sufficient future taxable income.

SFAS 109 allows a bank to record deferred tax assets that are dependent on future taxable income. The bank must, however, also establish a reserve to adjust the recorded asset to the amount that will more likely than not be realized.

Regulatory Treatment of Deferred Tax Assets

The banking agencies adopted the provisions of SFAS 109 for reporting in quarterly Consolidated Reports of Condition and Income beginning Jan. 1, 1993. The regulatory policy...