Pub. 2 2012-2013 Issue 4

10 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S Q DISALLOWANCE RULES – continued In PSB Holdings, Inc. v. Commissioner of Internal Revenue , the U.S. Tax Court determined how this formula is to be applied to a corporation filing a consolidated return. PSB Holdings, Inc. was a bank holding company that owned Peoples State Bank (Peoples). Peoples formed a nonbank subsidiary, PSB Invest- ments, Inc. (Investments), by transferring cash, taxable securities, tax-exempt securities and loan participations as paid-in-capital. Investments’ activities were limited to holding and managing these assets. It was not a financial institution, as defined. In- vestments purchased securities from cash flow it received from interest, sales and maturities; it had no debt and, therefore, no interest expense. The court held the tax-exempt securities held by Peoples’ wholly owned subsidiary, Investments, were not to be taken into account when applying the statutory formula for calculation of interest expense disallowance for Peoples. Had the tax-exempt securities held by Investments been held directly by Peoples, interest expense would have been allocated to those securities; at least a portion would have become a permanent, nondeduct- ible expense. Based on this holding, financial institutions can use valid separate entities to decrease the amount of interest expense disal- lowance that would result in applying the statutory formula to a single entity. Given the potentially significant and permanent tax savings, financial institutions with tax-exempt debt instruments should evaluate the benefits of creating an investment subsidiary. For more information, contact your accounting advisor. Q John Wright is a director with BKD. Contact the author at jlwright@bkd.com. Given the potentially significant and permanent tax savings, financial institutions with tax-exempt debt instruments should evaluate the benefits of creating an investment subsidiary.