Tax professionals and community bankers gained insights at this year’s Community Bank Tax Workshop. Here are a few of our main takeaways from the tax workshop, which was held as part of the Bank & Capital Markets Tax Institute from November 8–10, 2023, in Orlando, Florida.
Current Tax Legislative Focus
Section 174 Costs
For tax years beginning after December 31, 2021, taxpayers are required to capitalize specified research or experimental expenditures and instead amortize such costs over a period of five years (for domestic research) or 15 years (for foreign research). Previously, these costs were allowed to be expensed as they were paid or incurred.
Section 163(j) provides a limitation for certain taxpayers on the deduction for net business interest expense. Prior to 2022, the deduction for interest expense was limited to 30% of EBITDA (earnings before interest, taxes, depreciation, and amortization). For 2022 and after, the interest expense limitation is calculated using 30% of EBIT (earnings before interest and taxes), thus providing a stricter limitation for taxpayers on the deduction for interest expense.
100% Bonus Depreciation
From 2017 to 2022, bonus depreciation has been available to expense 100% of the cost of an asset when it is placed in service for tax purposes. Starting in 2023, only 80% of the cost may be immediately expensed, and this percentage further decreases 20% each year until the end of 2026 when it is no longer available.
An extension of the more favorable treatment of these three items was included in the Build It In America Act introduced in June 2023, but it has been noted the bill will not have Democratic support without an expansion of the Child Tax Credit. Current estimates from the Joint Committee on Taxation show the extension of these items through 2025 costing a net $47.38 billion from 2023–2033.
Sunsetting Tax Provisions
These temporary provisions were put into place as part of the Tax Cuts and Jobs Act of 2017 (TCJA) but are currently set to expire at the end of 2025.
All the individual and trust/estate tax brackets were lowered as part of the TCJA. Upon expiration, the rate structure will revert to higher pre-TCJA levels and the top rate for individuals, trusts, and estates will rise to 39.6%.
Section 199A – Qualified Business Income Deduction
Currently, 20% of a taxpayer’s qualified business income from a pass-through entity is allowed as a deduction. Absent an extension, this would be a major change for S corporation banks as the top effective tax rate would go from 29.6% to 39.6% for trust and individual shareholders. Including the 3.8% net investment income tax, this would push the top tax rate to 43.4% for passive investors.
Gift & Estate Tax Exemption
The gift and estate tax exemption was increased as part of the TCJA. It is currently set at $25.84 million for joint filers, or $12.92 million for single filers in 2023. In 2026, the exemption amounts are set to be cut in half—around $13 million for married filers and $6.5 million for single filers.
Current estimates show the cost to extend these provisions, including income tax rates, Section 199A deduction coupled with the standard deduction, expansion of the Child Tax Credit, and alternative minimum tax exemption, for the next 10 years to be $2.064 trillion. The cost to extend the higher gift and estate tax exemption for the same time period is $102 billion.
Tax Planning in a Period of Rising Interest Rates
Looking beyond tax legislation, other tax planning considerations in a period of rising interest rates include:
- Deferral of bond market discount accretion
- Realization of any bond losses as ordinary losses
- Limit the TEFRA interest expense disallowance on tax-exempt bonds through reducing non-bank qualified bond portfolio or formation of a separate investment subsidiary
- Review availability and applicability of any state pass-through entity tax deductions
- Utilize accelerated depreciation methods and consider the applicability of any cost segregation studies
- Consider adoption of a bank bad debt conformity election to defer taxation of nonaccrual loan interest
- Ensure bonus accruals meet the appropriate definitions for deduction in the year of accrual
- Deduct short-term prepaid assets
There are many factors to consider given the current economic and legislative environments relative to community banking. As the year-end approaches, reach out to a professional at FORVIS to discuss planning for these and other potential tax considerations.