Tax Updates: Relief & Reform

Transcription

1 Current Tax Issues November 13 Moderator: Jeffrey Spiegel, Principal, Spiegel Accountancy Corp. Speakers: Kalen Richey, CPA, Mortgage Banking Practice & Tax Manager, Richey May Seth Sprague, CMB, Executive Vice President, Phoenix Capital, Inc. Tax Updates: Relief & Reform Presented by Kalen K. Richey Mortgage Banking Practice Leader Richey May & Co. 1

2 Tax Updates: Relief and Reform What relief is available for disaster affected areas? What does proposed tax legislation include? What is left out of the proposed legislation? Will reform lead to tax simplification? What impact could reform have? Disaster Relief Qualified (tax free) disaster relief payments Grants from employers for medical, temp housing, & transportation Personal, family, living or funeral expenses Repairs to rehabilitate a personal residence or repair or replace its contents Cannot be reimbursed by insurance or otherwise. Must be reasonable and necessary. 2

3 Disaster Relief Postponement of Time to Comply or Pay Individuals with principal residence in disaster area Entities whose principal place of business in disaster area Records located in disaster area Disaster Relief Casualty Loss Deduction (Individual) Itemized deduction - all casualty, disaster, and theft losses deductible if >10% AGI Standard deduction - add to deductions for casualty, disaster, and theft losses Additional 2% AGI floor applies to employee property Casualty Loss Deduction (Business) Loss = Adj. basis of property salvage value insurance reimb. Loss Decrease in FMV Single, identifiable property MSRs not included in this definition of property 3

4 Disaster Relief Case Study Mortgage Servicing Rights GNMA portfolio Underlying property located in disaster area Borrower unable or unwilling to pay Forbearance period lapses No flood insurance Lender possesses property through foreclosure (or deed) Result: MSR value hit, lender estimates rehab costs and books liability, no tax deduction until cash paid Tax Reform Sept. 27 Unified Framework for Fixing our Broken Tax Code Tax reduction for middle-class Tax reduction for businesses especially small businesses Simple filing End incentives to ship jobs, capital, & tax revenue overseas Broaden tax base by closing special interest tax breaks and loopholes Oct Budget Resolution passed by Senate Nov. 2 House of Representatives draft 429 page bill 4

5 Tax Reform Current Law 7 rates from 10% % Std. Deduction $6,350/$12,700 Exemptions $4,050 Multitude of itemized deductions Alternative Minimum Tax Estate Tax / GST Tax Individuals (1040s) House Bill (Nov. 2) 4 rates 12%, 25%, 35% & 39.6% Std. Deduction $12,000/$24,000 No Exemptions (CTC increases) Mortgage Int., Real property taxes and Charitables only itemized deductions No Alternative Minimum Tax double the excl & after No Estate or GST Tax Tax Reform Businesses (1120, 1120S, 1065, Sch. C) Current System Corporate rate 35% Corporate interest expense fully deductible Flow-through entities with income taxed to owners Complicated rules for capital expenditures (fixed assets) House Bill (Nov. 2) Corporate rate 20% Corporate interest expense will be partially limited Flow-through entities taxed at 25% Immediate expensing of capital expenditures 5

6 Tax Reform What was left out of the framework / house bill? Income levels for new tax brackets Details about a higher, 4 th tax bracket Net Investment Income Tax (Obamacare tax) Differentiation between Ordinary Income and Capital Gains Tax Reform Will reform really be able to accomplish simplification? Perception is reality, right? Less brackets = Less complexity Complexity of tax code and regs does not exist within tax brackets Better question: will reform ever be simple enough to get accomplished? Budget must be passed House could pass legislation using reconciliation Senate must pass after House 6

7 Tax Reform What are the potential impacts of reform stemming from framework or current house proposal? C-corporation entity type competing for best vehicle even for small business The biggest corporations bringing piles of cash back to the US Some middle-class paying more in taxes Mortgage interest deduction no longer appealing to consumers Charitable organizations will receive less financial support from middle and lower classes More compliance headaches with state adoption or lack thereof Thank you 7

8 Seth Sprague, CMB Executive Vice President Phoenix Capital, Inc. Tax Law Changes Changes to the Individual and/or Corporate tax rates can result in material changes to the MSR market For BASEL III purposes ( C corps), MSRs are measured net of the deferred tax liability For originated MSRs, there is no tax basis if the servicing fee retained is at / below safe harbor levels For pass thru entities, the retaining the MSRs defers the income taxes until the cash is received (actual revenues less actual expenses) or if the MSR is sold Sample Segue Slide 8

9 BASEL III In late August 2017, the Fed, OCC and FDIC issued a proposed notice of rulemaking that would pause the full BASEL III in anticipation of another rule change (issued in late September) to simply the capital treatment of MSRs MSRs are measured net of the deferred tax liability Proposed delay is only for banks using the non advanced approach Under $250 billion in assets Total balance sheet foreign exposures under $10 billion Delays change to risk weighting (held at current levels) If over 10% limit, incremental capital charge is frozen at 80% BASEL III On September 27th, the federal banking agencies issued a proposal to simplify some of the capital rules for banks with less than $250 billion of assets. The proposal has a 60 day comment period. MSRs are measured net of the deferred tax liability The current proposed 10% limit for MSRs is increased to 25% MSRs are removed from the aggregate 15% limitation test with deferred tax assets (DTAs) and minority interests Minimum MSR risk weighting is 250% 9

10 BASEL III Sample (With DTL) Fully BASEL Implementation No Changes Sept 29th Proposal Sept 29th Proposal Corporate Tax Change to 20% Current BASEL III (Fully Current BASEL III (Fully Implemented) LOCOM Implemented) Fair Value (25% Limit and 250% RWA) LOCOM (25% Limit and 250% RWA) FV (25% Limit and 250% RWA) LOCOM (25% Limit and 250% RWA) FV Fair Market Value 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 30,000,000 Book Value (For LOCOM 90% of FV) 27,000,000 30,000,000 27,000,000 30,000,000 27,000,000 30,000,000 DTL (if applicable) (9,450,000) (10,500,000) (9,450,000) (10,500,000) (5,400,000) (6,000,000) MSR Asset net of DTL (if Applicable) 17,550,000 19,500,000 17,550,000 19,500,000 21,600,000 24,000,000 Tier 1 Common Equity MSR BASEL Threshold 10,000,000 10,000,000 25,000,000 25,000,000 25,000,000 25,000,000 MSRs above BASEL Threshold 7,550,000 9,500,000 BASEL III Implementation Factor 100% 100% 100% 100% 100% 100% BASEL III Capital above BASEL Threshold 7,550,000 9,500,000 Non dollar for dollar Capital Required 3,890,000 4,100,000 5,400,000 6,000,000 5,400,000 6,000,000 Total Capital Required 11,440,000 13,600,000 5,400,000 6,000,000 5,400,000 6,000,000 Actual Risk Weighting 530% 567% 250% 250% 250% 250% Minimum Risk Weighting 250% 250% 250% 250% 250% 250% Percentage of Capital Required Actual 42.4% 45.3% 20.0% 20.0% 20.0% 20.0% Additional MSR (Before dollar for dollar) (7,550,000) (9,500,000) 7,450,000 5,500,000 3,400,000 1,000,000 BASEL III Sample (No DTL) Fully BASEL Implementation No Changes Sept 29th Proposal Current BASEL III (Fully Current BASEL III (Fully Implemented) LOCOM Implemented) Fair Value (25% Limit and 250% RWA) LOCOM (25% Limit and 250% RWA) FV Fair Market Value 30,000,000 30,000,000 30,000,000 30,000,000 Book Value (For LOCOM 90% of FV) 27,000,000 30,000,000 27,000,000 30,000,000 DTL (if applicable) MSR Asset net of DTL (if Applicable) 27,000,000 30,000,000 27,000,000 30,000,000 Tier 1 Common Equity MSR BASEL Threshold 10,000,000 10,000,000 25,000,000 25,000,000 MSRs above BASEL Threshold 17,000,000 20,000,000 2,000,000 5,000,000 BASEL III Implementation Factor 100% 100% 100% 100% BASEL III Capital above BASEL Threshold 17,000,000 20,000,000 2,000,000 5,000,000 Non dollar for dollar Capital Required 2,000,000 2,000,000 5,000,000 5,000,000 Total Capital Required 19,000,000 22,000,000 7,000,000 10,000,000 Actual Risk Weighting 880% 917% 324% 417% Minimum Risk Weighting 250% 250% 250% 250% Percentage of Capital Required Actual 70.4% 73.3% 20.0% 20.0% Additional MSR (Before dollar for dollar) (17,000,000) (20,000,000) (2,000,000) (5,000,000) 10

11 BASEL III With a permanent BASEL III change Could increase demand for MSRs in both the bulk and flow market Bank buyers who are currently on the sidelines could become buyers again Increase liquidity for smaller deals Impact on the potential volume of deals (sellers) as some bank (who has BASEL III concerns) may elect to retain servicing Change in corporate tax rate without a change in BASEL III limits is a worst case scenario for C corporations C Corporations Example Wells Fargo SunTrust US Bank Total Residential MSR $12.8 Billion $1.6 Billion $2.6 Billion Portfolio Tier 1 Common Equity $151 Billion $17 Billion $34 Billion ( T1CE ) MSR as % of T1CE 8.5% 9.4% 7.6% 35% Tax Rate (All OMSRs) 20% Tax Rate (All OMSRs) 5.5% 6.2% 4.9% 6.8% 7.5% 6.1% Based on June 30 th Qs, does not include Commercial MSRs 11

12 C Corporation Example (Continued) Total Residential MSR Portfolio Tier 1 Common Equity ( T1CE ) Wells Fargo SunTrust US Bank $16 Billion $2.0 Billion $3.25 Billion $151 Billion $17 Billion $34 Billion MSR as % of T1CE 10.6% 11.8% 9.6% 35% Tax Rate (All OMSRs) 20% Tax Rate (All OMSRs) 6.8% 7.6% 6.2% 8.5% 9.4% 7.6% Assumes rates are up and values increase 25% Pass Thru Entity Example Sell MSRs Immediately Sell MSRs Immediately Total Unpaid Balance $1 Billion $1 Billion SRP Value 100 bps 125 bps Pre Tax MSR Cash Proceeds Net Cash with 39% Tax Rate Net Cash with 20% Tax Rate $10 million $12.5 million $6.1 million $7.6 million $8.0 million $10 million 12

13 Capital Gain Treatment (MSRs) For pass thru entities, the retaining the MSRs defers the income taxes until the cash is received or the MSR is sold. The difference between the individual tax rate and the capital gains tax rates can change the desire to retain servicing Some MSR sellers have gotten capital gain treatment on a portion of the MSR bulk sale proceeds if: Servicing is retained more than 12 months Normalizing the capital gains and individual tax rate can reduce the incentive for some non banks to retain servicing Impact to the MSR supply in the market could impact prices Thank you 13

14 Tax Reform Effect on Mergers & Acquisitions Presented by Jeffrey Spiegel, Principal Presentation Concepts: Review Of Deal Structure Review of Taxation for Business Combinations Tax Reform How it Might Affect Acquisitions 14

15 Common Approach to Deal Structuring Identify Target Entity Prepare High Level Valuation of Target In mortgage banking, focus on DCF and Comparable Transaction Methods Determine structure Asset or stock purchase Buyers typically want Asset purchase structure, unless Buyer is a new entrant or desires Agency approvals and state licenses Sellers typically want Stock purchase because of more favorable tax treatment Deal Terms Purchase select Assets (MLHS, MSR, Pipeline, Fixed Assets, Warehouse Lines, Brand, etc.) Franchise Premium how much if any? Franchise Premium if applicable How much upfront? How much deferred into an Earn Out? Earn Outs see next slide Earn- Outs What are Earn Outs? Deferred deal consideration based on certain factors such as earnings and/or production Why Earn Outs? Mortgage banking is volatile protects buyers from unexpected events Can provide seller with additional upside Aligns interests of buyers and sellers Keeps selling principals engaged and focused during earn out period Time frame typically 1 to 3 years 15

16 Common Earn Out Structures Based on future production The good news - straightforward calculation However, no incentive to optimize profits Buyer and seller interests not fully aligned Based on future earnings Seller receives portion based on pre-determined formula Possible priority return to buyer Caps and floors possible Conceptually more appealing and more common than production-only based earn outs Downside Accounting and scorekeeping issues (e.g. Gain on Sale, Overhead Allocations, Shared Services, etc.) Compensation to seller shareholders Deductible by Buyer and Ordinary Income to Seller Taxation of Business Combinations Stock Acquisition For the seller: Taxable event to the shareholders who must recognize capital gain or loss on sale of stock Assuming a gain, one level tax for the shareholder If held > one year, the LTCG will likely be at 20% plus the new 3.8% NIIT. This is the best tax scenario sellers could have in a taxable sale. Clean, simple transaction for seller: The entity goes away with all tax history and seller does not need to deal with distributing assets, dissolving, and other legal administration 16

17 Taxation of Business Combinations Stock Acquisition For the buyer: We get the entity exactly as it exists. Retain approvals such as HUD, FNMA, GNMA, state licensing. Liabilities and tax positions remain (need for due diligence efforts). We have a cost basis in the acquired stock for what we just paid. Target s inside attributes remain unchanged. There is no step up or step down in target s assets. We get target s net operating losses subject to limitation under Section 382 Election to Treat Stock Sale as Deemed Sale of Assets Consider a Section 338(h)(10) or 336(e) election We need a qualified stock purchase generally the purchase (by our newly formed acquisition C corporation) of at least 80% of the vote and value of: A C corporation subsidiary of a C corporation parent (we need a C corporation seller). An S corporation (we don t need a C corporation seller). Reality threshold: We ll never consider a Section 338(h)(10) election unless we have a premium deal. That means we re looking for a step-up in the tax basis of target s assets. Bigger future deductions inside target depreciation of PPE, amortization of intangibles and goodwill, etc. Also means target will have inside gain on the deemed sale of its assets 17

18 Straight Asset Acquisition For the seller: If the target is a C corporation, then it looks just like the Section 338(h)(10) and Section 336(e) discussion. Double tax if C Corp, expect resistance and/or request for compensation. If the target is an S corporation, also looks just like the Section 338(h)(10) election. If S corporation or LLC, no double tax, but could be sellerdisadvantageous tax rate arbitrage and some incremental state taxes. More legal administration: asset retitlements, transfer taxes, consents, etc. mentioned above. Seller has to deal with its entity structure after the sale. Straight Asset Acquisition For the buyer: Target entity stays behind and we form new structure however, we might prefer it to look Adoption of new methods, new elections, new tax period, etc. whatever we want. Most liabilities and tax positions stay behind -recall trimmed diligence efforts, focus on non-income taxes that can attach to the assets acquired. NOLs and other attributes do not come to us as buyer; no Section 382 considerations. We get a new purchased basis in the assets equal to what we paid (i.e., we ll either have a step-up or step-down compared to historic tax basis). Price paid for assets (cash plus any new debt) plus assumption of target liabilities and debt = the total amount allocated to target s assets. Fresh start tax-basis balance sheet 18

19 Tax Reform Current System Proposed Corporate Rate 35% Corporate Rate 20% S Corp and LLC Flow Through at Flow through entity 25% Individual Rate 39.6% Capital Gain Rate 23.8% Capital Gain Rate 23.8% Sale of Stock Capital Gain Rates, no difference Sale of Assets C Corp rate drops for 35% to 20%, double taxed at 23.8%. S Corp and LLC rate drops from 39.6% to 25% for ordinary portion of assets sold, 23.8% for capital gain portion. 19