FORVIS was proud to be the Premier Sponsor of the 2023 Bank & Capital Markets Tax Institute (BTI) in Orlando, Florida. From November 8–10, hundreds of tax professionals gathered to discuss the current state of the industry. Below are topic highlights for bank tax professionals.
Tax Credits & the Inflation Reduction Act (IRA)
Tax credits were a popular topic as a result of the new provisions under the Inflation Reduction Act of 2022 (IRA). Tax credits have always been appealing for their financial benefits, as well as the social impact and sustainability provided. However, complex accounting for equity investments have deterred financial institutions from the investment into tax credits. Several new provisions have changed this.
First, the IRA allows the transferability of certain credits. In fact, it introduced the ability to purchase tax credits for cash. This is a simpler concept compared to the previous equity investments that were required. The impact of this provision is also expected to be that smaller corporations may start incorporating tax credits into planning.
Also introduced in 2023 was ASU 2023-02 issued by FASB. Heather Wallace and Greg Faucette, partners at FORVIS, discussed the Proportional Amortization Method (PAM) in relation to tax credits during the BTI event. PAM allows investors to recognize amortization on the initial cost of the tax credit investment in proportion to the anticipated total tax credits and benefits over the life of the investment as a component of income tax expense. This ASU expands the applicability of PAM to include other investments generating tax credits including new markets, historic, and energy, if certain requirements are met.
Washington, D.C. Updates
Taxpayers always appreciate a comprehensive update from Washington, D.C. Panelists discussed the Big Three during the conference and the following topics were described as having bipartisan support:
- R&D expensing
- Section 163(j) calculation modifications
- 100% bonus depreciation
Other topics such as the child tax credit and $10,000 state and local tax (SALT) cap were still being discussed at the time of the conference. The 21% corporate tax rate that was a result of the Tax Cuts and Jobs Act (TCJA) was a permanent law change. Any change to this rate would require new legislation. The Section 199A deduction for flow-throughs such as S corporation banks is scheduled to expire at the end of 2025. Although showing bipartisan support, §199A will likely follow changes in the current corporate tax rate. Speculation was that §199A would be extended on a year-by-year basis if the corporate rate remains the same.
Additional insights from D.C. can be found in the weekly “From the Hill” series from FORVIS.
State Tax Update
Pass-through entity (PTE) tax (available to S corporation banks) was discussed again this year. Additional states enacted PTE tax in 2023, with some being retroactive to 2022 as a workaround to the $10,000 SALT reduction cap created by the TCJA.
As of the article date, there are currently 36 states and one locality that enacted PTE tax. This can be a powerful tax planning tool if analyzed and implemented correctly. Numerous factors should be considered during implementation such as shareholder residencies and others. These are easily overlooked but should be considered before making an election. It should be noted that each state may have its own calculation for PTE tax and its own manner of making the election. Therefore, it’s important to understand each state’s rules where the bank may have operations.
State law changes related to certain loan interest exemptions were presented. Wisconsin and Kansas have both made recent changes. For example, Wisconsin (effective tax years after December 31, 2022) allows an exemption of interest income for commercial and agricultural loans that are $5 million dollars or less made to customers located in Wisconsin. This also applies to banks not located in Wisconsin, but those doing business in Wisconsin.
Mergers & Acquisitions (M&A)
Common drivers of M&A are ownership and management succession. When contemplating a purchase or divestiture, it’s important to include your tax advisors as they can provide insight surrounding overall structure and tax attribute planning.
For tax purposes, transactions can be structured as asset or stock deals. With an asset purchase, a buyer acquires the assets of a target. The purchase price is allocated among the acquired assets with excess consideration allocated to intangible assets. Common intangibles include core deposits and goodwill. These intangible assets generate deductible amortization for income tax purposes over 180 months. The related amortization may be quite valuable to an acquirer. Conversely, the seller recognizes gain on the sale based on the allocation of the proceeds received in excess of the tax basis of the assets relinquished.
Stock deals result in a buyer acquiring the stock of a target. The tax attributes of the target carry over to the buyer. Any resulting intangible created in the transaction is not deductible with the exception of noncompetes.
Complexities are often encountered with M&A deals. A few potential challenges include dealing with loss limitations and change in control payments. Will any change in control payments be considered excessive and not deductible under Internal Revenue Code (IRC) §280G, including the imposition of a 20% excise tax? If target is publicly traded, was IRC §162(m) considered as additional limitation of change in control payments? When a target has loss carryforwards or net unrealized built-in gains or losses, IRC §382 needs to be analyzed to determine if any limitations apply for stock transaction. Other issues to consider include information reporting, e.g., Forms W-2 and 1099-INT, payroll taxes, deductibility of transaction costs, as well as strategies surrounding a target’s bank-owned life insurance (BOLI).
Tax issues should not drive a deal. However, understanding the tax impact for both the buyer and seller can help you plan a successful transaction.
Employee Retention Credit (ERC)
Douglas W. O’Donnell, Deputy Commissioner for Services and Enforcement with the IRS, addressed the participants on November 9, 2023. He reiterated the IRS’ belief that ERC claims remain an area of focus. On July 24, 2023, the IRS published rules treating erroneous refunds of ERCs as underpayments of the relevant employment taxes. He added that underpayments would be subject to penalties, interest, and administrative collection procedures. The IRS continues to scrutinize promoters of such claims and has placed a moratorium on processing of claims through December 31, 2023.
ERC was created as a COVID-19-related benefit under the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020. Generous benefits were available for eligible businesses. Qualifications for the credits are complex, including unique benefits depending upon the size of businesses.
Two essential tests for qualification are utilized in determining eligibility. First, a gross receipts test was implemented. For 2020, if the gross receipts for any quarter were less than 50% of the gross receipts of the corresponding quarter in 2019, a business meets the test. The 50% test was changed to 80% as of January 1, 2021, through the expiration date of September 30, 2021. Gross receipts are determined utilizing tax receipts. Under current rules, taxpayers meeting the gross receipts test for these periods should see whether refund opportunities exist even though these periods have passed. A second test involved taxpayers directly impacted by a COVID-19-related government order. The IRS has issued a series of questions and answers surrounding government orders. Whether reliance made for closures are government orders or merely recommendations is believed to be a point of contention within the IRS should a refund claim be chosen for examination.
One final comment in this area is that the receipt of the refund from the IRS does not mean it agrees with the claim. The statute of limitations is generally three years. However, the statute was extended to five years in regard to ERC claims for Q3 of 2021.
Preserving Resources
Interest rates are substantially higher this year than in the past. We are observing a greater interest in deferring income and accelerating deductions. As the top federal income tax rate for corporations is 21%, a $1 million reduction of taxable income would save a corporation $210,000 in current taxes due. Assuming the bank invests this cash earning 5%, the bank incrementally earns $10,500 over the course of a year. An alternative way of thinking is that deferred tax liabilities have at least one benefit: it’s a noninterest-bearing liability.
A few strategies to consider:
- Overall method of accounting: Is the bank eligible to be on the overall cash basis method of accounting, as opposed to the overall accrual method? As an accrual basis taxpayer, accrued interest receivable is taxed when accrued. Conversely, accrued interest payable and other accruals are deducted when accrued. Should the bank be eligible, the previously taxed net amount could be deducted in the year of change in accounting method.
- TEFRA disallowance: As banks receive deposits for which they incur interest expense and often take part of the proceeds to invest in municipal securities, IRC 265(b) and 291(e) serve as penalty provisions cutting back on the interest expense deductions. With the significant increase in interest expense, these penalties have increased. We are seeing consideration given to creating municipal portfolios outside of the bank to an entity without interest expense. As with most strategies, additional risks and nontax reasons for this strategy should be navigated and considered.
- Depreciation acceleration: Determining the amount of depreciation to claim each year is fraught with decisions such as taking Section 179 or bonus depreciation. Section 179 has certain limitations that must be navigated and for 2023, bonus depreciation has been lowered from 100% to 80% of the cost of eligible property. Additionally, many states do not conform to these federal acceleration techniques. A cost segregation study for property expansions through new construction or remodeling costs is a great consideration. These engineering-based studies utilizing IRS guidelines provide the opportunity to exponentially increase depreciation deductions from an otherwise 39-year write-off.
- Market discount deferral: Bonds are often purchased on the secondary market at discounts to par value. Banks can consider deferring the accretion for tax purposes until the maturity of the underlying security.
- Prepaid expenses: For GAAP, prepaid expenses are amortized over the life of the asset. For tax purposes, certain qualifying prepaid expenses can be accelerated for immediate tax expensing.
Closing Thoughts
FORVIS works with financial institutions of all sizes to deliver assurance, tax, and consulting services within the U.S. and globally. If you have questions on any of the topics above or want to discuss impacts to your bank, please reach out to a professional at FORVIS.