PNC and loan origination costs.

• Author: Purcell, Thomas J., III
• Position: Decision of U.S. 3d Circuit in PNC Bancorp Inc.

On hearing about a "landmark" decision, practitioners expecting a dramatic development might have been disappointed to learn instead of a decision involving loan origination costs. Despite the mundane nature of the issue, the decision of the Third Circuit in PNC Bancorp Inc., 5/19/00, does indeed have the potential to be a "landmark." If not reversed, this decision could represent an important turning point in the long-running controversy between taxpayers and the Service over item capitalization.

The Issue

PNC involved the proper treatment of loan origination costs. This term is shorthand for several different categories of costs that a bank incurs in connection with granting loans. These costs cover payments to third parties for credit reports, property reports and appraisals, and recording of security interests, as well as the salaries of bank employees involved in making loans. While banks traditionally deducted such expenses in the year incurred, two developments moved the Service to pursue capitalization of such costs.

SFAS No. 91 and INDOPCO

The first development, in time if not importance, occurred in 1986, when the Financial Accounting Standards Board (FASB) adopted Statement of Financial Accounting Standards (SFAS) No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating and Acquiring Loans and Initial Direct Costs of Leases," effective for fiscal years beginning after Dec. 15, 1987. Briefly stated, SFAS No. 91 required banks to defer loan origination costs over the loans' expected lives. However (as the Third Circuit observed), the original focus of SFAS No. 91 was not on the banks' costs, but on its fees; the FASB was concerned that banks, as a result of charging high upfront fees, were overstating income in the initial years. Accordingly, SFAS No. 91 required banks to defer fees over the lives of the loans. It was at the urging of the banking industry that the FASB sanctioned the deferral of the associated costs. The industry argued that deferral of fees without deferral of the associated costs would distort the picture. Beginning in 1988, PNC deferred, for financial accounting and reporting purposes, the costs described in SFAS No. 91, while continuing to deduct them for tax purposes. The resulting difference between book and tax treatment was duly reported on PNC's Schedule M-1.

The second development occurred in 1992 when the Supreme Court handed down its decision in INDOPCO, Inc., 503 US 79 (1992)...