The Next Examiner You See May Be from the IRS: Chances of Receiving a Routine Tax Audit Have Increased for Community Banks. on the Bright Side, Opportunities for Saving on Taxes May Be Perking Up, Too. (2002 Tax Update)

Reducing, deferring, or otherwise legally avoiding burdensome taxes keep many businesses busy, and community banks are no exception. In fact, more than most, community bankers remain keenly aware of the relationship between taxes and competitiveness -- after all, credit unions' aggressive growth is directly attributable to outdated tax laws. It's vitally important that bankers stay informed of the latest tax developments in order to retain valuable customers; increase liquidity and funding; and provide the greatest shareholder return. I'll review several pending issues of interest along these lines, but will open with a chilling one: more Internal Revenue Service audits of community banks are coming. IRS: friend or foe? The Internal Revenue Service has undergone significant changes since enactment of the IRS Restructuring and Reform Act of 1998. One of the most striking is a new effort at providing customer service and helpful taxpayer guidance. This massive bureaucracy has also been reorganized into four operating divisions. Banks now come under the oversight of the new Large and Midsize Business (LMSB) Division. Previously, IRS operated through various district offices, oftentimes without any clear purpose. These shifts have implications for banks. For instance, recent reports have confirmed that IRS tax audits of community banks are on the rise. This has not been because of perceived abuses. Instead, the reason should sound familiar. Just as the bank regulatory agencies frequently break in newer examiners in community banks, IRS has been realigning examination resources in an effort to train agents who are unfamiliar with the banking industry, and once again, community banks prove a good training ground. The agents have the discretion to review a variety of tax return positions, including the sufficiency of deductions taken for nonperforming loans (i.e., loan chargeoffs); whether interest nonaccrual was appropriate for a particular loan or loans; and cost-capitalization issues. Other items may be reviewed by an IRS examiner, including, but not limited to, employee or executive benefit documents and certain third-party information. An audit specialist may also become involved to look at or request information on specialty matters, including items such as tax shelters, leasing arrangements, or bank-owned life insurance. While a community bank's risk of being audited still remains relatively low, being informed of developments may save time, frustration, and money. For example, it is useful to know that the IRS Chief Counsel's Office recently announced a change in its litigating position regarding capitalization of intangibles. Many tax practitioners view this announcement as a major victory for business taxpayers. For the banking industry, this announcement is welcome relief and is a major first step in resolving a longstanding dispute involving the tax treatment of loan origination costs, which are incurred by community banks virtually every business day. Further guidance is forthcoming from the IRS. IRS plans to publish proposed rules in 2002 where capitalization would not be required for employee compensation (other than bonuses or commissions), fixed overhead, or de minimus costs related to the acquisition, creation, or enhancement of intangible assets or benefits. The IRS expects de minimus amounts to be those costs that do not exceed $5,000 per transaction. Clearly, many other costs that are potentially subject to IRS audit would benefit from this announcement. (IRS Chief Counsel Notice (CC-2002-021) was issued soon after the release of Advance Notice of Proposed Rulemaking (REG-125638-01), which outlined the capitalization rules that Treasury Department and IRS intend to publish in 2002.) The other face of tax costs There's more to the tax burden than taxes themselves. …