It’s been just over a year since the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA). Now is a good time to review the impact of some of the new law’s provisions on banks, as many of the changes are effective for the first time in 2018.
Banks will soon be preparing their quarterly financial statements and tax returns, and the data generated in that process can pay additional dividends when it's used to analyze current tax plans and manage future tax obligations.
Here are a few of the provisions banks should consider.
Opportunity zones. This provision in the law incentivizes investment in low-income census tracts designated by states. It allows for the deferral and, in some cases, exclusion of capital gains that are reinvested into the opportunity zone. With many banks already putting money back into their neighborhoods to meet Community Reinvestment Act requirements, the law gives an additional tax advantage to these investments if structured properly.
To qualify for deferral, capital gains must be invested into a Qualified Opportunity Fund (QOF) within 180 days. The fund then acquires qualified property located in an opportunity zone, either directly or through an investment in a partnership or corporation that holds the qualified property. Property can include real estate or operating businesses. Capital gains tax can be deferred until April 2027 for investments held through Dec. 31, 2026. In addition, 10 or 15 percent of the original capital gain can be excluded from tax if the investment is held for five or seven years, respectively. If the QOF investment is held for at least 10 years, capital gains tax is eliminated on any appreciation in the QOF investment occurring after the initial investment.
Expanded eligibility of cash method of accounting for tax purposes.
The cash method of accounting can now be used for income tax purposes by most businesses with average gross receipts of $25 million or less. This could be relevant for some community banks, and it often results in the deferral of income into later years.
Modification of deductibility for annual compensation in excess of $1 million. The TCJA made changes to the $1 million annual compensation limitation for certain companies that was in effect under the previous tax rules. The rule now applies to the covered employees of a company whose stock or debt is publicly traded or registered with the SEC. It also repealed the exception for performance-based compensation so that these amounts now count toward the calculation of the $1 million limit applicable to covered employees. TCJA also expanded the definition of a “covered employee” to include the CFO and any individual who would be a covered employee at any time during the current year, as well as anyone who was a covered employee in any prior year.
The cash method of accounting can now be used for income tax purposes by most businesses with average gross receipts of $25 million or less.
Parking benefits are no longer deductible. Employers can no longer deduct the cost of “qualified transportation fringe benefits” provided to employees, including transit passes and parking. This deduction prohibition covers amounts contributed to transaction flexible spending accounts by employers or employees, employer reimbursements of certain employee transportation expenses, and any costs associated with employee parking at leased or owned locations. The value of these benefits are still tax-free to employees.
Corporate AMT repeal, credit refundability, and sequestration. The good news is that the TCJA ended the corporate alternative minimum tax (AMT) for tax years beginning after Dec. 31, 2017. Credits carried forward can be used to offset the regular tax liability in full, with 50 percent of the excess refunded to the taxpayer. Any amount not used by 2021 will be fully refunded in that year.
There’s a slight catch, though. Federal budget sequestration rules apply to cash refunds of AMT credits (i.e., only the amounts refunded under the 50 and 100 percent rules above), meaning that the refunds will be reduced each year by a percentage that the Office of Management and Budget calculates. For refunds processed in the federal fiscal year ending Sept. 30, 2019, refunds will be reduced by 6.2 percent.
Changes to deductibility of meals and entertainment. The TCJA made several changes in this area, such as:
- Employers can now deduct only 50 percent of the cost of meals provided on the employer’s premises for the convenience of the employer. After 2025, these meals will not be deductible at all. Pre-TCJA, these costs were 100-percent deductible.
- Costs for business-related entertainment are no longer deductible at all. Food and drinks purchased separately at an entertainment event are still 50-percent deductible.
Banks may want to set up individual general ledger accounts to track 50, 100 and 0 percent-deductible expenses separately rather than attempting to sort the amounts at the end of the year.
Year of inclusion. TCJA changed the timing of inclusion for gross income items by stating that the “all events test” would be met no later than when an item is recognized as revenue for financial statement purposes. Essentially, gross income cannot be recognized for income tax purposes any later than when it’s recognized in financial statements. The law carved out an exception for mortgage servicing rights. Also, original issue discount will be affected but only in tax years beginning after Dec. 31, 2018.
Although the TCJA ended the corporate alternative minimum tax for tax years beginning after Dec. 31, 2017, there is a catch.
FDIC premium deduction phase-out. The FDIC premium deduction for banks with total consolidated assets between $10 billion and $50 billion is being phased out under the TCJA, and the deduction for banks with assets of $50 billion or more is being eliminated. Banks with less than $10 billion in assets may continue to fully deduct FDIC premiums, which means that most community banks won’t be affected.
Accelerated depreciation. The act made some business-friendly changes to depreciation rules, including:
- Bonus depreciation for property placed in service after Sept. 27, 2017 and before Jan. 1, 2023. During that time period, the bonus depreciation allowance is 100 percent. The bonus percentage decreases to 80 percent in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026. It goes away after Dec. 31, 2026.
- Bonus depreciation can be claimed on used property placed in service during the period. Previously, only new property qualified for bonus depreciation.
- The TCJA raised the limit on Section 179 deductions for assets placed in service during the year to $1 million.
These changes make cost segregation studies even more attractive, as they can accelerate some depreciation deductions into the bonus depreciation period.
Executives should work closely with their tax advisors to make sure they understand all of the changes that could affect their bank’s federal and state tax liabilities.
For more information on any of the provisions discussed in this article or any other changes that might affect your bank, please contact us today.