Since the Tax Cuts and Jobs Act of 2017 (TCJA) was implemented, several guidelines have been issued in order to clarify specific rules — many of which have a significant impact on financial institutions. And just as we were digesting and putting these changes into practice, the CARES Act was passed and brought with it a whole new set of changes and opportunities.
Below, we highlight six tax reform and CARES Act items to keep in mind, identify proposed tax changes, and emphasize areas financial institutions should consider as they prepare their annual tax filings. We also highlight tax-planning activities to consider moving forward.
Net operating losses and AMT credits
The TCJA eliminated the two-year carryback of net operating losses that allowed taxpayers to recoup tax paid in prior years. These losses could now only be carried forward indefinitely. The CARES Act then put in a 5-year carryback period for net operating losses generated in 2018, 2019, and 2020. Generally, a carryback claim can be filed on Form 1139 within one year, but the CARES Act has provided an extended 18-month period for Form 1139 to be utilized.
Under the TCJA, AMT for corporations was repealed. AMT credits that were generated in previous years are treated as refundable. For tax years beginning in 2018, 2019 and 2020, to the extent that AMT credit carryovers exceed regular tax liability, 50% of such excess AMT credit carryovers will be refundable. Any remaining credits will be fully refundable in 2021. The CARES Act provided a provision that accelerates the refunds of these credits even further. You should not have to wait until 2021 to get the full amount of these back — there are mechanisms to claim the refundable amount in 2018 or 2019.
Actions to consider
If the bank has a net operating loss in 2018 or 2019 and you have taxable income in that 5-year carryback period, consider carrying that loss back to a previous tax year that had taxable income. This allows for the potential to carry the loss back to a year where the tax rate was higher than it would potentially be if it were carried forward. This could turn a timing difference between when you utilize the net operating loss to a permanent difference due to a potential rate arbitrage.
The same action should be considered if you have AMT credits that are refundable. Filing Form 1139 can result in you getting cash sooner.
Payroll tax deferral
The CARES Act allows for a deferral of payroll taxes — specifically, the 6.2% employer share of the FICA tax. This deferral extends until December 31, 2021, with 50% of the tax due and the remainder due December 31, 2022.
Actions to consider
Financial institutions should consider deferring their payroll taxes to allow for the use of cash. Hopefully, you’ll receive a return on investment of that cash that would have otherwise been remitted for payroll tax purposes today.
Revenue recognition and 451(b)
The TCJA amended Section 451 to change the timing of the recognition of income for accrual method taxpayers. The amendment basically states that if something is recognized in book income on an applicable financial statement, it also needs to be picked up in taxable income at that time. Fortunately for financial institutions, the proposed rule excludes mortgage servicing rights. While this has been around since the TCJA was passed, taxpayers are especially aware of it now for two reasons.
The first reason is due to the IRS releasing proposed regulations in September of 2019 to help clarify the rules provided for in the TCJA. The second reason relates to the potential impact that 451(b) could play related to any changes implemented under the new book revenue recognition standards. As bank accounting teams are working with their auditors to document and understand the impact of the new revenue recognition standard, remember that 451(b) could play a role in the tax treatment of that change.
Actions to consider
Keep the impact of 451(b) top-of-mind when analyzing any potential changes that may result in the way revenue is recognized for book purposes. If a change occurs in a way where the tax treatment is also changing, then the institution may need to consider making an accounting method change. Work with your tax advisor to determine whether the change would be a non-automatic or an automatic method change.
Accelerated depreciation
Bonus depreciation is an incentive included in the TCJA that allows for 100% depreciation of eligible asset purchases (e.g., computer equipment) in the first year for purchases occurring after September 17, 2017. Currently, 100% bonus depreciation is slated to remain in effect until the end of 2022. Beginning in 2023, it’s scheduled to drop 20% each year for four years, fully expiring at the end of 2026. While financial institutions are currently eligible for significant favorable benefits, keep in mind that the benefit is creating a deferred tax liability that will reverse.
Section 179 is also applicable to purchases of this nature. The Section 179 expensing limitation is $1.02 million for 2019 and $1.04 million for 2020. Section 179 deductions for 2019 are eligible for asset purchases up to $2.5 million in total, and that limit increases to $2.59 million for 2020. In excess of $2.5 million for 2019 or $2.59 million, the deduction is reduced on a dollar-per-dollar basis. Section 179 expenses must be taken out before you calculate bonus depreciation.
The CARES Act corrected an oversight in the 2017 TCJA related to Qualified Improvement Property (QIP) that prevented improvements to non-residential property from qualifying for accelerated depreciation. Under the CARES Act, the QIP depreciable life is reduced from 39 years to 15 years, allowing QIP to qualify for 100% bonus depreciation. This change is retroactive back to assets placed in service after December 31, 2017.
Actions to consider
When weighing Section 179 and bonus depreciation options by electing either accelerated depreciation method, you are eligible to deduct 100% of your eligible asset cost in the year of purchase. But, financial institutions should consider their relevant state tax implications. They could see a potentially state tax-favorable result by taking Section 179 over bonus depreciation because, while many states require you to add back the bonus, fewer do the same for Section 179 expenses.
Institutions should analyze any assets that would qualify as QIP placed in service in 2018 or 2019 to determine the appropriate steps to claim that accelerated depreciation deduction if the organization desires to take advantage of that.
On an ongoing basis, analyze whether it makes sense to use bonus depreciation, considering your income and whether there are any net operating losses that might cause you to want to elect out. From a cash perspective, you’ll also want to be mindful of when the bonus depreciation rule starts to phase out — the deferred tax liability mentioned above that has been built up will likely start to reverse and thus become a cash tax event to the IRS.
Non-deductible parking
In December 2018, the IRS issued guidance related to non-deductible parking expenses in Notice 2018-99. The Notice details how banks need to calculate the qualified transportation fringes (QTFs) no longer eligible for deduction. Initially, it was expected that this change would primarily apply to institutions located in large cities. The reality, however, suggests that all banks should consider their parking situation, both at the head office and branch level.
Actions to consider
Work with your tax advisors to understand the implications of the new rules. You’ll also need to consider your current parking situation and explore whether signage should be changed in ways that would help minimize tax impacts.
Entertainment expenses
The TCJA made significant changes to eligible meals and entertainment expenses. Under the changes, which took effect in 2018, eligible meal-related expense deductions are limited to 50%, while general entertainment expenses are no longer deductible.
Actions to consider
Monitor your expenses and consider opportunities to minimize the entertainment component of your spending. You’ll also need to focus on breaking out events or activities, keeping records and details as to different components in order to maximize the 50% deduction for meals.
Reminders for tax credits and opportunity zones
- Tax credits: With everything else that’s happening, don’t overlook the value of tax credits. For example, we see financial institutions investing in low-income housing credits and new markets tax credits. These credits have wide-ranging benefits: offsetting taxes and flowing through losses, which reduces tax liabilities and can provide Community Reinvestment Act credits.
- Opportunity zones: Created under the TCJA, opportunity zones provide a great opportunity to defer capital gains, so they shouldn’t be overlooked. If a bank has generated a capital gain, they should speak to their tax advisor about how they might be able to use opportunity zones to avoid tax on the gain while also earning a good return.
Prepare yourself
Tax reform, the CARES Act, and required adjustments or action items needed to take advantage of or comply with new rules can be complicated. Work closely with your tax advisors to make sure you understand how changes are evolving and what impact they might have on your federal and state tax liabilities.
Want more information on any of the issues highlighted in this article or on any other tax matters? Contact your local Plante Moran tax advisor.
