The Internal Revenue Service (IRS) will not appeal the U.S. Tax Court's ruling in PSB Holdings, Inc. v. Commissioner. Last November, the court decisively ruled in favor of PSB Holdings, Inc., the parent company of Peoples State Bank in Wausau, on the so-called TEFRA disallowance issue. The IRS had until March 11th to appeal the ruling.

The Wisconsin Bankers Association (WBA) and Community Bankers of Wisconsin (CBW) established a joint fund to pay for the litigation on behalf of the scores of Wisconsin banks potentially impacted by the IRS' interpretation of the TEFRA disallowance rules.

Godfrey & Kahn, S.C. attorneys Debra Koenig and Sarah McNally, who successfully litigated the case for PSB Holdings, Inc., learned today that the IRS will likely be refunding any tax, interest and penalties paid in connection with the bank audits on this issue, assuming an affected bank timely filed a refund claim and did not waive its right to file a refund claim in federal court. It may take several months for the refund(s) to be processed, and banks should work with their tax advisors if any questions arise.

According to these same IRS sources, the IRS will be issuing a new regulation that, on a prospective basis, will attempt to change the law to provide that the TEFRA calculation will now have to include tax-exempt obligations held by bank subsidiaries.

Any bank that computed its TEFRA interest disallowance by including any of the tax-exempt obligations of its investment subsidiary with those of the bank should consider filing an amended return to receive a tax refund on this issue for all open years. Since the statute of limitations for calendar year 2004 returns may run as early as March 15, 2008, any affected banks should contact their tax advisors on this issue immediately.

For 2007 returns, a bank should not include any of the tax-exempt obligations of the investment subsidiary with those of the bank in computing the bank's interest disallowance.

This is a huge victory for Wisconsin banks, and we would like to again thank Peoples State Bank of Wausau for being the trailblazer on this issue.

As an aside, these developments do not affect S corporation banks. The TEFRA issue for those banks is still pending with the U.S. Tax Court.