When banks originate loans, they typically charge various fees called loan origination fees. These often include points that are expressed as a percentage of the borrowed amount. Points represent prepaid interest, and the regulations generally permit points to be includable in income over the term of the loan by both accrual and cash method banks.
Banks also may charge other fees for services related to making a loan. Flat fees or specific processing fees not dependent on a percentage of the loan balance (such as $100 per loan) aren’t ordinarily counted in determining the loan’s interest rate and aren’t considered points by the IRS. Flat fees include:
- Processing fees
- Underwriting fees
- Appraisal fees
- Recording fees
- Escrow fees
The determination of when a bank includes these fee types in income depends on the bank’s accounting method. Accrual basis banks include these fees in income earlier when received or earned, and cash basis banks include them in income when received.
Opportunity to Defer Income for Cash Basis Taxpayers
Often, these fees are incorporated in the loan amount and not paid upfront at closing (during the settlement of the loan). Because of this, these fees aren’t fully paid until the loan is paid in full. This presents an opportunity to defer flat fees for cash basis banks ratably over the loan’s life. If these fees aren’t paid by the customer and received by the institution, then under the cash basis of accounting, they can and should be deferred through the loan’s life or the average life of the loan type based on historical payoff experience.
For banks on the cash basis that currently aren’t deferring flat fee income until it’s received, a change in accounting method should be considered. Depending on the institution size and method employed for reporting fee income, this could result in a significant deferral of income. Even though this deferral is temporary, if new loan originations remain constant or continue to increase as the bank grows, this essentially is a permanent deferral of income.
Being on the cash basis also presents tax savings opportunities in terms of loan payments. Banks often have the potential to structure their loans so a large portion of applicable interest income earned by the end of their tax year isn’t actually paid until the following year. Since income isn’t recorded until received with the cash method, this interest income would be deferred until the following tax year, thus deferring the related tax liability. Structuring just a few larger loans in this fashion could create another significant deferral of income over the life of the related loans.
Contact your BKD advisor to discuss the specifics of these opportunities.