Tax Reform Implications for Banks January 9, Charles J. Frago, CPA Daniel F. Morrill, CPA Michael J. Rowe, CPA

Transcription

1 Tax Reform Implications for Banks January 9, 2018 Charles J. Frago, CPA Daniel F. Morrill, CPA Michael J. Rowe, CPA MEMBER OF ALLINIAL GLOBAL, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS 2018 Wolf & Company, P.C.

2 Before we get started Today s presentation slides can be downloaded at The session will last about 1 hour, and we will be taking questions throughout the webinar the presentation. Our audience will be muted during the session. Please send your questions in using the Questions Box located on the webinar s control panel.

3 About Wolf & Company, P.C. Established in 1911 Offer Audit, Tax, and Risk Management services to over 250 financial institutions Offices located in: Boston, Massachusetts Springfield, Massachusetts Albany, New York Livingston, NJ Over 250 professionals As a leading regional firm founded in 1911, we provide our clients with specialized industry expertise and responsive service. 3

4 Financial Institution Expertise Over 85 Risk Management Professionals: IT Assurance Services Group Internal Audit Services Group Regulatory Compliance Services Group WolfPAC Solutions Group Provide services to over 250 financial institutions: Approximately 90 FIs with assets > $1B Approximately 25 publicly traded FIs Constant regulatory review of our deliverables Provide Risk Management Services in 27 states and 2 U.S. territories 4

5 Introduction Charles J. Frago, CPA Principal Daniel F. Morrill, CPA Member of the Firm Michael J. Rowe, CPA Principal 5

6 Agenda Overview Federal Tax Rate Change Accounting for Income Tax Considerations Other Provisions Affecting Banks Provisions Indirectly Affecting Banks 6

7 Overview Tax reform bill, commonly known as the Tax Cuts and Jobs Act ( TCJA ) was signed into law by President Trump on December 22, 2017 Most significant tax legislation since 1986 First change in corporate tax rates since 1986 Most provisions are effective for taxable years beginning after December 31,

8 Maximum tax rates Pre-TCJA TCJA C Corporation Rates C corporations Up to 35% 21% C Corporations and their owners * 50.47% 39.8% Taxpayers Other than C Corporations and Their Owners Most Business Income 39.6% 37% Tax Favored Business Income (QBI) 39.6% 29.6% * These rates reflect income taxes imposed on the taxable income of corporations under section 1; the taxable income of individuals under section 11; and the net investment income of individuals under section

9 Reduction in C Corporation tax rate PRE-TCJA C Corporation subject to graduated tax rates as follows: 15% for taxable income of $0 - $50,000; 25% for taxable income of $50,001 - $75,000; 34% for taxable income of $75,001 - $10,000,000; and 35% for taxable income over $10,000,000 TCJA for tax years beginning after December 31, 2017, the corporate tax rate is a flat 21% rate Note that a blended tax rate will apply to fiscal year corporations for their fiscal year that includes January 1, 2018 (e.g., a Taxpayer with June 30, 2018 tax year end and taxable income of $10,000,000 will have a blended statutory rate of 28.06%, assuming a 35% rate before tax reform) Look to accelerate as many deductions into FY 2018 and defer as much income to next period (common provisions compensation accruals, charitable contributions) 9

10 Impact of reduction of C Corporation tax rate Banks with a traditionally higher effective tax rate(etr) will benefit from the reduced statutory tax rate. Somewhat lowers impact of tax planning as starting off with a much lower effective tax rate. Tax Credits Tax advantage investments BOLI Tax Exempt Obligations Dividends Received Deduction 10

11 Accounting for Tax Rate Change ASC The effect of a change in tax laws or rates shall be recognized at the date of enactment. ASC Deferred tax liabilities and assets shall be adjusted for the effect of a change in tax laws or rates. A change in tax laws or rates may also require a reevaluation of a valuation allowance for deferred tax assets. ASC When deferred tax accounts are adjusted as required by paragraph for the effect of a change in tax laws or rates, the effect shall be included in income from continuing operations for the period that includes the enactment date. 11

12 Accounting for Tax Rate Change SEC Guidance, SAB 18, provides guidance when not enough information is available to complete accounting for the tax rate change before issuance of financial statements. Three scenarios, may need to use all three in 2017 financial statements. 1. Measurement is complete a) Reflect in the financial statements 2. Measurement can be reasonably estimated a) Report provisional amounts, adjust during measurement period 3. Measurement cannot be reasonably estimated a) Continue to apply ASC 740 based on tax laws in effect prior to enactment Measurement period should not be more than a year from enactment date. 12

13 Accounting for Tax Rate Change Accounting consequences For items recognized in AOCI (AFS securities, pension plans, CF hedges), the adjustment to the DTA/DTL is recorded through tax expense. This creates a dangling debit/credit in AOCI Day 2 considerations 13

14 Accounting for Tax Rate Change Facts: $1,000,000 unrealized gain on AFS investment with an amortized cost of $10,000,000 on enactment date Current rate - 41% New rate - 27% Entry to record unrealized gain at current rates immediately prior to enactment Dr. Investment $ 1,000,000 Cr. Deferred Tax Liability $ 410,000 Cr. AOCI $ 590,000 Calculation and entry to record the change in tax rate on date of enactment New Deferred Tax Liability $ 270,000 (27% * $1,000,000) Old Deferred Tax Liability $ 410,000 (41% * $1,000,000) Decrease $ 140,000 Dr. Deferred Tax Liability $ 140,000 Cr. Current tax expense $ 140,000 Results in a "dangling" DTL sitting in AOCI Unrealized gain 1,000,000 Deferred Tax Liability (270,000) Unrealized gain, net of tax 730,000 Unrealized gain, net of tax in AOCI $ 590,000 Dangling DTL in AOCI $ 140,000 14

15 Accounting for Tax Rate Change Day 2 Accounting for dangling amount in AOCI No GAAP guidance Common methodologies have developed Item by item approach Aggregate portfolio approach Underlying premise is that the amount in AOCI is relieved once item(s) giving rise to AOCI cease to exist FASB meeting on January 10 th to discuss 15

16 Accounting for Tax Rate Change Disclosure considerations for 2017 SAB 118 Qualitative disclosure of incomplete items (income tax effects and deferred amounts) Items reported at provisional amounts Reason why accounting is not complete Additional information needed to complete accounting Tax rate reconciliation Schedule of significant components of income tax expense Required - Adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates or a change in the tax status of the entity Schedule of accumulated other comprehensive income Policy for Day 2 accounting 16

17 Net operating losses Net operating losses arising in tax years ending after December 31, 2017 may be carried forward indefinitely, but may not be carried back Fiscal year 2018 taxpayers will NOT be able to carry back their losses to recover taxes paid in prior periods Indefinite carryforward period may ease impact of section 382 limitations, etc. For losses arising in tax years beginning after December 31, 2017, the amount of an NOL that a taxpayer could use to offset taxable income is limited to 80% of taxable income Rule ensures that virtually all taxpayers will pay tax at some level; similar but more restrictive than prior 90% limitation for AMT NOLs (2% effective rate for AMT vs. 4.2% effective rate under TCJA) No limitation applied to losses incurred in tax years beginning before December 31, 2017 requires separate tracking of NOLs 17

18 Tax Credits Rehabilitation credits will be taken ratably over a fiveyear period beginning with the year placed in service. The New Markets Tax Credit is retained. 18

19 Repeal corporate AMT and availability of existing AMT credits For tax years beginning after December 31, 2017, the corporate alternative minimum tax is repealed Taxpayers may continue to use carry forward AMT credits to offset regular tax liability and all credits will be utilized / refunded by 2022 For tax years beginning after 2017 and before 2021, taxpayers are able to claim a refund of 50% of the excess of the minimum tax credit for the tax year over the amount of the credit allowable for the year against its regular tax liability Any remaining AMT credit will be refunded for any tax years beginning in 2021 Impact Eliminates some of the complexity inherent in federal tax law Due to 80% of taxable income limit on NOL utilization going forward, some level of AMT concept remains in the code 19

20 Expansion of bonus depreciation provisions Extends the additional first year depreciation deduction through 2026 (2027 for longer production period property and certain aircraft) 100% bonus depreciation with respect to qualified property acquired and placed in service after September 27, 2017 and before January 1, Phase down for subsequent years: 80% bonus depreciation for qualified property placed in service before January 1, %, before January 1, 2025; 40% before January 1, 2026; 20% before January 1, 2027 Qualified property includes property if it is the taxpayer s first use of such property (provided that such used property is not acquired from a related party or in a carryover basis transaction) M&A impact increased incentive for asset purchases due to immediate expensing of PP&E Prior law - only on new assets. Excludes any property used in a trade or business with floor plan financing indebtedness rules under section 163(j) 20

21 Expansion of section 179 expensing A taxpayer may, subject to limitations, elect under section 179 to deduct (or expense) the cost of qualifying property rather than to recover such costs through depreciation deductions Increases the expensing limitation under section 179 from $510,000 to $1m with the phase-out increasing from $2,030,000 to $2.5m for tax years beginning after 2017 The provision reduces the $1m amount (but not below zero) by the amount by which the cost of the qualifying property placed in service during the tax year exceeds $2.5m Modifies definition of qualified real property to: Eliminate references to qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property, replacing such references with a reference to qualified improvement property; and At the election of the taxpayer, qualified property may include the following improvements to nonresidential real property placed in service after the date the property was first placed in service: Roofs Heating, ventilation, and air-conditioning property Fire protection and alarm systems Security systems 21

22 Dividends received deduction Pre-TCJA corporations are allowed a deduction with respect to dividends received from other taxable domestic corporations The amount of the deduction is generally equal to 70% of the dividend received In the case of any dividend received from a 20% owned corporation, the amount of the deduction is equal to 80% of the dividend received TCJA for tax years beginning after December 31, 2017, the dividends received deduction is as follows: The 70% DRD to 50% The 80% DRD to 65% Impact Due to reduction in corporate tax rate, the net tax paid on dividends received by corporations remains essentially unchanged 22

23 Expansion of interest expense limitation For tax years beginning after December 31, 2017, net interest expense for every business (regardless of form) is now limited to 30% of adjusted taxable income (exception for floor plan financing* interest) Interest expense disallowance to be determined at the tax filer level (e.g., for a partnership, the limitation would be determined at the partnership level, not at the partner level) No grandfathering clause for existing indebtedness No debt-to-equity safe harbor as previously provided in former section 163(j) provisions Small business exception taxpayers with average annual gross receipts of $25 million or less for the 3-year period ending with the prior tax year are exempt from limitation Applies to all taxpayers, regardless of their form and regardless of whether interest is paid to related or unrelated parties (foreign or domestic) * Floor plan financing financing for the acquisition of motor vehicles, boats, or farm machinery for sale or lease and secured by such inventory is exempt 23

24 Miscellaneous provisions For municipal securities, advance refunding bonds issued after December 31, 2017, will no longer be tax-exempt. The Code Section 162(m) annual limit on compensation deduction is changed by eliminating the exceptions for commissions and performance-based compensation, and changing the definition of covered employee. There is a transition rule for commissions and performance-based compensation so that no changes take effect with respect to a written binding contract in effect on November 2, Deductibility of Federal Deposit Insurance Corporation (FDIC) assessments are phased out for institutions with total assets exceeding $10 billion 24

25 Meals & Entertainment expenses Pre-TCJA Section 274 disallows an otherwise available deduction for expenses relating to entertainment, amusement, or recreation activities and facilities unless the item is directly related to or associated with business Expense not disallowed if there was a substantial and bona fide business discussion right before or after the entertainment, amusement, or recreation The disallowance is subject to a number of exceptions, including: Food and beverages for employees furnished on the business premises; Expenses treated as compensation Reimbursed expense Nondiscriminatory recreation for employees Business meetings for employees, stockholders, agent, or directors Business league meetings Entertainment sold to customers 25

26 Meals & Entertainment expenses Pre-TCJA If an entertainment expense is exempt from disallowance by virtue of one of the exceptions or because the expense was directly related to or associated with business, section 274(n) generally permits deduction of only 50% of the expense An entertainment or meal expense is exempt from the 50% disallowance under one of a number of exception, including if the expense is: Treated as compensation, Reimbursed, or The cost of the meal is excludable from the employee s income under section 132(e)(2) Section 132(e)(2) excludes the value of a meal provided at an employeroperated eating facility if the facility is on or near the employer s business premises and its revenue at least equals its direct operating costs 26

27 Meals & Entertainment expenses TCJA Amended to disallow entertainment expenses even if directly related to or associated with business As a result, for expenses paid or incurred after December 31, 2017, business entertainment is now entirely nondeductible unless eligible for one of the exceptions, which have NOT been modified 100% of entertainment expenses are nondeductible Significantly affect business deductions to the extent those deductions include a leisure element All forms of business entertainment, including golf outings, fishing, sailing, sporting events, theater, and resort events are likely nondeductible going forward even if substantial and bona fide business discussions were associated with the activity Meals provided at employer-provided eating facilities no longer exempted from 50% disallowance 27

28 Nondeductible penalties and fines Pre-TCJA no deduction is allowed for fines or penalties paid to a government for the violation of any law TCJA for amounts paid or incurred on or after the enactment date, no deduction is allowed for an otherwise deductible amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or specified nongovernmental entity in relation to: The violation of any law; or The investigation or inquiry by such government or entity into the potential violation of any law Exception payments that taxpayer establishes are either restitution (including remediation of property) or amounts required to come into compliance with any law that was violated or involved in the investigation Need to be identified in court order or settlement agreement as restitution, remediation, or required to come into compliance Transition rule provisions don t apply to amounts paid or incurred under any binding order or agreement entered into before the date of enactment If court order required, must be obtained before the enactment date 28

29 Employee achievement awards Pre-TCJA an employer may deduct a certain amount of the costs associated with providing an employee achievement award that is tangible personal property TCJA adds a definition of tangible personal property that provides that tangible personal property does not include: cash, cash equivalents, gift cards, gift coupons or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items pre-approved by the employer), or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items. Employers that provide other items of tangible personal property remain eligible for deduction 29

30 Amounts paid for sexual harassment subject to nondisclosure agreement Effective for amounts paid or incurred after the enactment date, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement 30

31 Cash method of accounting Pre-TCJA The following taxpayers were required to use the accrual method of accounting as their overall method for tax purposes (partial list): C-corporations with average annual gross receipts (prior 3 years) > $5M Tax shelters Exceptions: Certain taxpayers with average annual gross receipts of more than $1M, but no more than $10M, can use the cash method Small businesses with average annual gross receipts of $1M or less can use the cash method even if they would otherwise be required to use the accrual method due to the presence of inventories 31

32 Cash method of accounting TCJA For tax years beginning after December 31, 2017, the cash method may be used by taxpayers (other than tax shelters) that satisfy a $25 million gross receipts test, regardless of whether they purchase, production, or sale of merchandise is an income-producing factor $25 million gross receipts test taxpayers with annual average gross receipts that do not exceed $25 million (indexed for inflation for tax years beginning after December 31, 2018) for the three prior tax years are allowed to use the cash method No impact on Taxpayers previously allowed to use cash method with no restriction, provided cash method clearly reflects income: Qualified personal service corporations Partnerships without C Corporation partners S Corporations Change from accrual to cash is accounting method change covered under section

33 Limitation on like-kind exchange treatment Pre-TCJA provided that no gain or loss was recognized to the extent that property, which included a wide range of property from real estate to tangible personal property, held for productive use in the taxpayer s trade or business, or property held for investment purposes, was exchanged for property of a like-kind that also is held for productive use in a trade or business, or for investment purposes TCJA generally effective for transfers after December 31, 2017, the deferral of gain on like-kind exchanges is modified to allow for like-kind exchanges ONLY with respect to real property that is not held primarily for sale Transition rule if taxpayer has either disposed of the relinquished property, or acquired the replacement property on or before December 31, 2017, then the like-kind exchange rules should still apply 33

34 Indirect Provisions For individuals, the debt limit for mortgages is reduced from $1 million to $750,000. In addition, there will no longer be a deduction for home equity indebtedness. Those changes, along with an increase in the standard deductions to $12,000 for single taxpayers and $24,000 for married taxpayers filing jointly, will mean that fewer individuals will receive a tax benefit on their interest expense. This may have an effect on the housing market and interest rates. 34

35 Indirect Prov- cont d State and local income and property taxes limited to $10,000 Cannot prepay 2018 state income taxes Property taxes must be assessed to prepay Individual rates- some decreases Double standard deduction to $24,000 Eliminates deduction for personal exemptions 35

36 Bank Tax Reform: Q & A Charles J. Frago, CPA Principal cfrago@wolfandco.com P: Daniel F. Morrill, CPA Member of the Firm dmorrill@wolfandco.com P: Michael J. Rowe, CPA Principal mrowe@wolfandco.com P: