Recent developments are shining light on the sometimes confusing practice of settling the cash for tax payments and refunds between members of a consolidated banking group. Here’s what you should know.

The “Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure,” issued in 1998 by the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Fed), the Federal Deposit Insurance Corp. (FDIC), and the Office of Thrift Supervision (OTS), embodies the regulatory directive that depository institutions filing consolidated tax returns with their parent holding company and other affiliated entities should make tax payments and receive tax refunds in the same amounts and timing as if the institution filed separate returns with only its own subsidiaries (in other words, at the call report level).

To illustrate, suppose that in year one, Bank X would have had a $5,000 tax liability had it filed its own federal tax return. Its holding company, Parent Y, had a tax loss (as holding companies typically do), which reduced the actual consolidated return liability to $4,200. Parent Y would have collected $5,000 of tax payment from Bank X and submitted $4,200 to the IRS, pocketing the $800 difference as payment for the use of Parent Y’s loss. Now suppose that in year two Bank X had a tax loss large enough that, if it had filed its own returns, it would have carried the loss back to year one and received a refund of the entire $5,000. In reality, Parent Y carries the consolidated loss back and receives a refund for the $4,200 year one consolidated tax. Not only must Parent Y pay the entire $4,200 to Bank X, but it also owes Bank X another $800.

This scenario played out multiple times during the recent economic crisis, causing considerable angst to cash-strapped holding companies. In extreme cases, failing banks’ assets were seized by the FDIC, and the holding companies, left with little but debt, filed bankruptcy. Some holding companies also filed bankruptcy in order to facilitate the sale of their distressed banks before FDIC seizure. These situations often involved carrybacks of tax losses and outstanding refunds to be received from tax authorities. Legal battles arose over whether each refund, when received, was due immediately to the bank or whether it belonged to the parent’s bankruptcy estate, leaving the bank as just one more unsecured creditor. Since 1993, at least 11 court cases have decided this issue, some in favor of the bank, but many determining the bank was just another creditor, despite the fact that the regulatory policy statement clearly says that a parent receives a consolidated tax refund as agent on behalf of the group members.

In response to this chain of events, the Fed, OCC, and FDIC in December 2013 proposed an addendum to the policy statement to clarify that an agency relationship (rather than a debtor-creditor relationship) exists between a holding company and its subsidiary banks. The proposed addendum would require bank holding companies to review their consolidated tax-sharing agreements and add clear language on the agency issue. Comments were due by Jan. 21, 2014. No final version has yet been issued.

So if your bank is financially healthy and you don’t anticipate a bankruptcy filing, what does this have to do with you? In addition to anticipating a likely upcoming review and revision of your tax-sharing agreement, now would be a good time to review existing practices for settling taxes among entities. A common problem is failure to true up cash payments between entities when returns are actually filed. Take the earlier example of Bank X (with its $5,000 liability) and Parent Y (with an $800 benefit), and throw in another Parent Y-owned entity, Subsidiary Z, with a $2,000 liability, making the net amount due to the IRS $6,200. Now suppose that throughout the year the following estimated payments were made: $5,800 from Bank X to Parent Y, $1,700 from Subsidiary Z to Parent Y, and $6,600 from Parent Y to the IRS. When the return is filed, the $400 overpayment to the IRS is carried forward to apply to year two. At the same time, Parent Y should refund $800 to Bank X, collect $300 from Subsidiary Z, and treat the $400 IRS overpayment as applied to its own account. Common errors are not collecting the $300 from Subsidiary Z or not paying $800 to Bank X but instead just crediting the $400 IRS overpayment to Bank X. If this happens over multiple years, with many different entities and amounts, settlements can become very inaccurate, leaving one to wonder who owes whom.

Don’t wait for the next financial crisis to get your tax settlement house in order. Review practices now to make sure your banks are protected.