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Everything You Need to Know About the Year-End Bank Tax Update

This article was written by: Jack Johnson, Manager, Paul Fries, Partner and Theresa Raponi, Principal.

Overview: The Fork in The Road

When visitors asked directions to Yogi Berra’s house, he would always tell them, “When you come to the fork in the road, take it.” Regional and community banks today face a similar fork in the road which impacts tax planning strategy.

For some banks, preserving cash is important in an era of deposit flight and increased regulatory scrutiny. These banks may benefit from year end tax planning to accelerate tax deductions and defer taxable income where possible, such as claiming 80% bonus depreciation, electing to defer market discount on bonds, adopting bad debt conformity, and fixing a minimum amount of year end bonus to be paid by 3/15/2024 as of 12/31/2023.

For banks with a longer-term outlook, the national debt of $33 trillion makes it likely that corporate tax rates will need to increase (in addition to spending cuts) and any tax increase would likely be effective in 2025. Banks with this perspective may want to pursue the opposite year end tax planning, accelerating income at the current 21% rate and deferring deductions to future higher tax rate years. Strategies such as electing out of bonus depreciation, electing longer tax depreciable lives, deferring partial bad debt charge offs, and considering strategic asset sales prior to 12/31/2024 may be of interest to these banks. This approach builds a larger deferred tax asset (which should be monitored for purposes of Basel 3 limitations) that would result in a permanent tax benefit if higher rates are enacted in 2025.

Which strategy best suits your bank’s needs? We would be glad to meet with you to discuss at your convenience.

M&A Outlook

With bank industry consolidation ongoing, there are many issues to consider, either for Acquiring or Target Banks. Some of these issues include the following:

+Planning to avoid a Target short period tax net operating loss carryforward to avoid bad bucket deferred tax assets (DTAs) subject to full disallowance under Basel 3.

+New IRS guidance may mitigate a former tax trap for acquired Bank Owned Life Insurance (where life insurance contracts are not more than 5% of Target Bank assets) – but careful attention to BOLI policies can avoid unintended consequences.

+Proper planning is key to minimize any non-deductible golden parachute payments.

+Analysis of transaction costs is required even if claiming the 70% safe harbor for success-based fees. Issues include whether the transaction is covered by the safe harbor and the treatment of milestone payments.

+In tax free mergers, the receipt of cash boot by Target shareholders is deemed to be a taxable repurchase by a public Target, and thus subject to the 1% excise tax on stock repurchases.

+The IRS may view any deal termination fees or breakup fees as capital gain and loss; and

+Tax insurance against acquired bank tax exposures is becoming more prevalent.

These are only a few of many considerations for both Acquiring Banks and Target Banks. We would be glad to meet with you to discuss these and other issues at your convenience.

Changing Landscape for Tax Credits

The Inflation Reduction Act created many new energy related tax credit incentives for projects constructed on or after January 29, 2023, with a 30% credit for eligible costs, provided certain requirements are met. The IRA also provides for enhanced credits where projects are located in economically or environmentally distressed areas.

The newly enacted credits can be acquired through a traditional tax equity partnership structure, but there are also transferable credits for certain clean energy projects, which do not involve a tax equity partnership investment. Additionally, certain of the new energy credits can be carried back three years.

For taxpayers considering investing in energy credits in order to file a three year carryback, keep in mind that an ordering rule provides that these ITC related credits are used first – thus, in order to reduce current year tax liability down to the 25% floor on ITC credits so as to file a three year carryback, any other unused current year tax credits of the taxpayer, such as LIHTCs, become a credit carryforward, which is a bad bucket DTA that is fully disallowed under Basel 3.

Transferable credits may only be current year generated credits, must be purchased for cash, and are not transferable a second time. These credits are purchased at a market discount in the secondary market, and the good news is that the discount is not federal taxable income. These credits can also be purchased in 2024 but applied to the 2023 return, as long as buyer and seller have not yet filed 2023 tax returns. This means that a buyer facing a federal income tax balance due of $2 million on its 2023 corporate tax liability may be able to acquire $2 million of the new transferable credits in the summer of 2024 for something less than $2 million. The transferable credit buyer still has tax risk, which makes it important to deal with experienced counterparties, and consider the need for appropriate guarantees.

Finally, the tax accounting landscape for credits arising from tax equity investments is changing as well. Since 2014, banks have been able to amortize the book investment in a qualifying LIHTC partnership on the income tax expense line of the financial statements, thus avoiding a geographic mismatch between book expense and tax benefits (ASU 2014-1). New FASB guidance (ASU 2023-02) will allow other credits from tax equity investment partnerships, subject to certain requirements, to also be amortized on the tax line. This is commonly referred to as the Proportional Amortization Method accounting or “PAM”. The requirements necessary to qualify for PAM may preclude the need for analysis of Hypothetical Liquidation Book Value (“HLBV”) accounting.

Research Credit Expenditures

To add insult to injury, Banks that did not attempt to claim research tax credits for certain technology project expenditures may still be required to capitalize internal software development and other costs over five years as enacted by the Tax Cuts and Jobs Act effective in 2022. New Notice 2023-63 provides additional guidance in this area, which may lead to the requirement to capitalize substantially more costs than what would have been treated as Qualified Research Expenditures (QRE) for purposes of the R&D Credit. While many tax advisors are hopeful that this provision will be repealed, it is worth reviewing the rules to avoid surprises on an IRS audit.

FDIC Special Assessment

The special FDIC assessment to replenish the insurance fund is expected to be finalized in Q4 2023 and payable in four installments in 2024 and 2025. This may result in a one-time GAAP expense in the fourth quarter. The FDIC has expressed the view that the special assessment is under Section 13 and not under Section 7B and is therefore deductible. As of this date, Treasury has not yet released any guidance indicating whether they concur with the FDIC.

Update: The FDIC Board voted on November 16, 2023, to exempt the first $5 Billion of uninsured deposits from the special assessment. As a practical matter, banks with less than $5B in assets will therefore not be subject to the assessment.

Disallowed Interest Expense

In today’s higher interest rate environment, the indirect interest expense disallowance for owning bank qualified municipal securities may become much more significant. There may be planning opportunities available to utilize a non-bank subsidiary, but careful attention to a taxpayer’s specific fact pattern is required.

Business Meals

The special pandemic era relief rules allowing full deduction of business meals have lapsed; therefore, for 2023 business meals are once again subject to 50% disallowance.

New York Tax Reform Regulations

A mere 9 years after the enactment of NYS Tax Reform, the Department of Revenue has issued proposed regulations, which are expected to shortly become effective. These proposed regulations, once in effect, take a number of positions which may prove to be controversial, including the treatment of FHLB and FRB dividends, the ability to follow federal mark to market rules under Section 475 for purposes of the NYS Qualifying Financial Instrument (QFI) election, and the treatment of dividends from captive REITs.

If you need further guidance or have any questions on this topic, we are here to help. Please do not hesitate to reach out to discuss your specific situation.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.