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Tax Exemption Options for Loan Accounts

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Not Tax Exempt - This option is used for standard loans. With Not Tax Exempt loans, a bank can use the interest expenses (carrying costs) on the funds that they raise as a write off.

Non-Bank Qualified or Bank Qualified - Select one of these options if the loan is tax-exempt. Your bank needs to determine if a loan is Bank Qualified or Non-Bank Qualified. 

Bank Qualified and Non-Bank Qualified loans have different 'Interest Disallowance Factors' assigned them at the Regional level in PrecisionLender (Administration) which reflects an IRS regulation regarding the percentage of the interest expenses (carrying costs) that are disallowed from being written off. 

Fully Tax Exempt - This option is a holdover from before the Non- Bank-Qualified and Bank-Qualified options were available. PrecisionLender recommends disabling this option at the Product level.

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On an opportunity that is marked Tax Exempt, if you click into the Initial Rate field you'll see the Effective Yield, which is calculated as Interest Income / Average Assets.

 

For more information on how to add/remove tax exempt options from a specific product, visit this article: Setting Up Commercial Loan Products

 

The Math Behind the Scenes:

The tax equivalent yield (TE) of municipal obligations for taxpayers paying regular tax is stated in the formula

TaxEquivalentYield.png

Where:

MUNI: The municipal yield is the yield to maturity on the tax-exempt obligation under consideration.

MD: The market discount component of the yield on the municipal bond. This is calculated by subtracting the coupon rate on the obligation from the total yield of the municipal bond under consideration. Market discount only exists when the bond is not offered at a premium or at par. If there is no market discount, the “MD” component of the formula is disregarded (when MD = 0, MD has no impact on the formula).

CF: A bank’s cost of funds, expressed as a percentage of total assets. This approximates the ratio of interest expense to average total assets (part of the formula required under the Code). This ratio “allocates” a bank’s interest expense to the portion of the indebtedness used to purchase or to carry tax-exempt obligations. The cost of funds is not a precise measure, but does provide a good estimate of the required ratio and is easily accessible for most banks.

IDF: The interest expense disallowance factor, i.e., the percentage of a bank’s total interest expense disallowed as a deduction because it is deemed to be allocable to the purchase price or carrying cost of tax-exempt obligations. Bonds acquired before 1983 will have an IDF of 0 percent; qualified tax-exempt obligations purchased after August 7, 1986 and those investments acquired after 1982 and before August 8, 1986 have an IDF of 20 percent; and nonqualified tax-exempt obligations issued after August 7, 1986 have a disallowance factor of 100%.

TR: The marginal federal tax rate to which the bank is subject.

STR: The marginal state tax rate to which the bank is subject.

TE: The Tax-Equivalent Yield

 

 

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