income tax update for community banks - elliott davis · agenda •legislative update - bad debts...

Income Tax Update for Community Banks

Tuesday December 9, 2014 Beverly Seier Shareholder, Elliott Davis

© 2013 Elliott Davis, PLLC © 2013 Elliott Davis, LLC

This material was used by Elliott Davis during an oral presentation; it is not a complete record of the discussion. This presentation is for informational purposes and does not contain or convey specific advice. It should not be used or relied upon in regard to any particular situation or circumstances without first consulting the appropriate advisor. No part of the presentation may be circulated, quoted, or reproduced for distribution without prior written approval from Elliott Davis.

© 2013 Elliott Davis, PLLC © 2013 Elliott Davis, LLC 2

AGENDA

• Legislative Update - Bad Debts & OREO Carrying Costs - Tangible Property Regulations - Business Tax Extenders - State Tax Law Changes

• Information Reporting - Year End Information Reporting Checklist - Organizational Actions

• Regulatory Update - Tax Sharing Agreements - BASEL III Impact on DTAs

LEGISLATIVE UPDATE

Bad Debts

OREO Carrying Costs Tangible Property Regulations

Business Tax Extenders State Tax Law Changes

Bad Debts – LB&I Directive

• Background: - Sec. 166 permits a deduction for any debt that becomes

worthless in a taxable year - Confusion surrounding the determination of

“worthlessness” for bad debt deductions • Book treatment (GAAP & Regulatory) • Tax treatment

- IRS Exam issues - IRS Notice 2013-35 issued but more clarification was

needed


• IRS Large Business &International (LB&I) Directive Related to §166 Deductions for Eligible Debt and Eligible Debt Securities

- Issued on 10/24/2014 to IRS examiners - Applies to Bank and Bank subsidiaries - Does not apply to small banks that use the reserve

method of accounting for loan losses under §585 - Directive “is intended to provide an efficient manner of

resolving many bad debt deduction issues for Banks and Bank Subsidiaries and to more efficiently manage LB&I’s audit resources”

- Technically, only binding on LB&I field examination


• IRS Large Business &International (LB&I) Directive Related to §166 Deductions for Eligible Debt and Eligible Debt Securities

- Describes 3 situations in which examiners should not challenge a bank’s bad debt deductions depending on how the deductions are determined

- Clarifies that LB&I examiners will not challenge the inclusion of certain estimated selling costs to the extent such estimated selling costs are included in the charge-off reported in the applicable financial statement.


• Facts-and-Circumstances” Test - Examiners will not challenge a deduction if the amount is

the same as amounts reported on the bank’s financial statements for the credit-related impairment portion of its charge-off of eligible debt and debt securities

- In no event may the post-deduction tax basis of the eligible debt or eligible debt security be less than the post-deduction book basis, as increased by any portion of the book charge-off not related to credit impairment.


• “Conclusive Presumption” Rule - Used by banks that have been ordered to charge off a

debt by federal or state banking regulators - Deduction amount should match the sum of the amounts

reported on financial statements and the portion of the charge-off taken in excess of credit-related impairment pursuant to the order

- Signed Certification Statement is required


• “Conformity” method - Examiners are not to challenge a bank’s bad debt

deduction if the bank has made a proper conformity election under Regulation 1.166-2(d)(3) regardless of whether or not the express determination requirement included in Regulation 1.166-2(d)(3)(iii)(D) is satisfied.


• Implementation of LB&I Directive - Applies on an entity-by-entity basis - Applies to tax years beginning in 2010-2014 - Pending any future guidance modifying or superseding the

Directive, once the Directive is applied, it must be applied consistently from year to year going forward

- Can file amended returns or make the changes in its current taxable year – no Form 3115 / 481(a) adj required


• Certification Statement - If following Directive, Certification Statement must be provided

within 30 days of request to examiner upon examination - Must be signed by an individual who is authorized to execute

the Taxpayer’s Federal income tax return for the taxable year under audit, and must certify, under penalty of perjury that, for the taxable year under audit that certain provisions of the Directive are met

- Certification Statement Template is included in the Directive - Planning Note: Get Certification Statement signed by

authorized officer when return filed for future audit purposes


• The Taxpayer should retain the underlying accounting documentation that would permit the LB&I examiner to reconcile the Taxpayer’s Applicable Financial Statement with the amount of its bad debt deduction for Eligible Debt and Eligible Debt Securities reported on the Taxpayer’s Federal income tax return

Bad Debt Conformity Election

• Bad debt conformity election provides banks with a safe harbor for deducting worthless loans, must file a change of accounting method (form 3115)

• The tax bad debt deduction occurs in the period that a loan is determined to be a loss asset for regulatory purposes

• The election must be made by each bank in the consolidated group

• Each bank must receive an Express Determination Letter (EDL) from their primary federal regulators on an annual basis – continue to request it

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Bad Debt Conformity Election

• Advantages: - Provides audit protection against IRS for bad debt

deductions - Nonaccrual loan interest is not included as taxable

interest income (Rev Ruling 2007-32)

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Real Property Acquired through Foreclosure

• Acquisition and holding costs for OREO are NOT capitalized under IRC §263A(b)(2) and Reg. §1.263A-3(a)(1)

• If these costs were previously capitalized, taxpayer must file an Automatic Change of Accounting Method (Form 3115) with change number 195

Tangible Property Regulations

• Overview - On Sept 13, 2013, IRS and US Treasury Department

released final tangible property regulations - Impacts:

• Treatment of materials and supplies • Capitalization of amounts paid to acquire or produce

tangible property • When repairs and maintenance should be expensed vs

capitalized

- Mandatory for years beginning on or after January 1, 2014

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Tangible Property Regulations • Materials and Supplies – Reg. Sec. 1.162-3

- Incidental components obtained to maintain, repair, or improve a unit of tangible property

- Useful life of 12 months or less - Cost of $200 or less - Deductible - Impacts manufacturing type companies more than

service companies - Examples for banks: coffee for a coffee maker, toner

for a copy machine (which you are likely already expensing)

Tangible Property Regulations • De Minimis Safe Harbor – Reg. Sec. 1.263(a)-1(f)

- Allows taxpayer to follow their book minimum capitalization policy for tax purposes

- Can expense up to $5,000 per invoice or item if taxpayer:

• Has an applicable financial statement • Has a written policy in place at the beginning of the year • Treatment is same for book and tax

- Annual election attached to tax return (irrevocable)

AICPA example of a De Minimis Safe Harbor Written Capitalization Policy [Name of my company or client]

Capitalization Policy

1. Purpose This accounting policy establishes the minimum cost (capitalization amount) that shall be used to determine the capital assets that are to be recorded in [name of your business]’s annual financial statements (or books). 2. Capital Asset definition A “Capital Asset” is defined as a unit of property that: (1) has an economic useful life that extends beyond 12 months; and (2) was acquired or produced for a cost of $____ or more. Capital Assets must be capitalized and depreciated for financial statement (or bookkeeping) purposes. 3. Capitalization thresholds [Name of your business] establishes $______ as the threshold amount for minimum capitalization. Any items costing below this amount should be expensed in [name of your business]’s financial statements (or books). 4. Capitalization method and procedure All Capital Assets are recorded at historical cost as of the date acquired. Tangible assets costing below the aforementioned threshold amount are recorded as an expense for [name of your business]’s annual financial statements. Alternatively, assets with an economic useful life of 12 months or less are required to be expensed for financial statement purposes, regardless of the acquisition or production cost. 5. Recordkeeping Invoice substantiating an acquisition cost of each unit of property shall be retained for a minimum of four years.

Tangible Property Regulations • Improvements to Tangible Property – Reg. Sec.

1.263(a)-3 - Betterments must be capitalized - Restorations must be capitalized if the restoration is a

substantial part of the unit of property. If not a substantial part of the unit, they must expensed

• IRS has not defined “substantial”

- Improvements to adapt property to a new or different use must be capitalized

Tangible Property Regulations • Improvements to Tangible Property – Reg. Sec.

1.263(a)-3 (continued) - There is an annual, irrevocable Safe Harbor election

for Small Taxpayers (avg. gross receipts of $10 million or less for past 3 years)

• Election allows taxpayers to expense repairs and maintenance if less than $10,000 or 2% of the unadjusted basis of property

- Routine maintenance costs must be expensed unless taxpayer makes an annual election to capitalize (irrevocable)

• Election requires repairs and maintenance to be capitalized the same for tax as for books


• Implementation – Rev. Proc. 2014-16 - Written Capitalization Policy (asap) - De Minimis Safe Harbor Election (annual, irrevocable) - Election to Capitalize Repair & Maintenance Costs

same as books (annual, irrevocable) - Safe Harbor Election for Small Taxpayers with

Buildings (annual, irrevocable)


- Partial Disposition Election (annual, no special election form, revocable)

- Form 3115 (Automatic Change in Accounting Method) is required where applicable

• For example, if taxpayer is currently capitalizing repairs & maintenance costs and would like to expense under new regulations, they must file Form 3115


• Planning Opportunities for Banks: - Maintenance/repair items

• May potentially include parking lots, roof, renovations, signage

• Need to review invoices and work performed in relation to the entire building

- Cost Segregation Study • New branches/headquarters

Business Tax Extenders

• 50% Bonus Depreciation - Expired in 2013 – not yet extended for 2014

• Section 179 Expensing - Increased limits for 2013 were $500,000 for maximum

deduction with phase-out beginning at $2 million - Without extension, the section 179 limit would be

$25,000 with phase-out beginning at $200,000

• Qualified Leasehold Improvements - 15-Year straight-line cost recovery life expired in 2013

reverting to a 39-year recovery life

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Business Tax Extenders

• S-Corp Built-in Gains Tax - Reduced recognition period of 5-years expired in

2013 - Without extension, the recognition period would be

10-years • Will legislative action extend these business tax

incentives??

State Tax Law Changes

• North Carolina - Corporate Rate Reductions

• 6.9% in 2013 • 6% in 2014 • 5% 2015 • 4% 2016 (if state meets certain revenue targets) • 3% 2017 (if state meets certain revenue targets)

- Adjust DTAs to reflect change in tax rate which will be an additional tax expense to NC banks

- Bank change for ACH credit payments effective July 18, 2014 (Wells Fargo to Bank of America) 28


• North Carolina - Moving from NEL to NOL regime - Exempt income will no longer be a reduction in the

loss carryforward. This is not a retroactive change - Effective for years beginning on or after 1/1/2015 - May need to change your first quarter 2015 provision

calculations if generating losses with tax exempt income

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• New York - Effective in 2015, banks with NY nexus will be subject

to corporate income tax as the bank franchise tax will be repealed effective December 31, 2014


• Pennsylvania - Actively sending notices/questionnaires to banks across

the country notifying them of potential nexus - Act 52 imposed significant PA Shares Tax changes effective

1/1/2014 • Expands “doing business” criteria to out-of-state banks • Even if no PA branches/employees, may have nexus if

$100,000 or more of PA gross receipts and Bank holds a security interest, mortgage, or lien in real or personal property located in PA

- If any connections with PA, need to review activities


• South Carolina - Change in state law exempts corporate officers from

unemployment insurance coverage beginning 1/1/2015

• FAQ on SC website: - http://dew.sc.gov/corpofficers/Corporate_Officers_Exemption

_FAQ.pdf • Definition of “Corporate officers” are described in a

corporation’s bylaws or appointed by the board of directors


• South Carolina UI (con’t) - Corporations may elect UI coverage of its corporate

officers • All officers or none • If elect, must file “Election of UI Coverage Form” with DEW

- Coverage lasts a minimum of two full calendar years - Will continue if don’t terminate

• If don’t elect, the employer must notify the corporate officers in writing that they are ineligible for unemployment benefits


• South Carolina UI (con’t) - How does election of coverage of corporate officers

affect state and federal unemployment taxes? • If your corporate officers are not covered by state UI,

- Not required to pay state UI taxes on their wages - Lose Federal Unemployment Tax Act (FUTA) tax credit - Required to pay the maximum FUTA tax rate on your

corporate officers’ wages • As of January 1, 2015, 6.0 percent tax on the first $7,000 of

wages = a maximum of $420 per corporate officer per year.

• If your corporate officers are covered by state UI, - Receive FUTA tax credit against FUTA tax


• South Carolina UI (con’t) – Examples Per Officer - Elect SC UI for Corporate officers: Pay FUTA & SUTA

• FUTA: $7,000 x .006 = $42.00 per year • SUTA: $14,000 x Company SUTA Rate = $XXX.XX per year

- Don’t Elect SC UI for Corporate officers: Pay FUTA only • FUTA: $7,000 x .06 = $420.00 per year

The corporation will have to review their 2015 SC SUTA rate to determine cost/benefit.

INFORMATION REPORTING

Year End Tax Checklist

Forms 1099-A and 1099-C Organizational Actions

Year End Information Reporting Checklist

Some common forms to remember……. • Forms 1099-A/C - Cancellation of Debt • Forms 1099-INT & Forms 1099-MISC

- Gifts to Customers • 1099-INT if value > $10 for deposits less than $5,000 • 1099-INT if value > $20 for deposits of $5,000 or more

- Vendor/Director payments • Forms 3921 & 3922 – Exercise of ISOs/ESPP • Forms 8937 – Stock Basis Transactions

Forms 1099-A and 1099-C

• Generally either Form 1099-A or Form 1099-C is required for foreclosures, repossessions, etc.

- Form 1099-A • Used to report taking possession of property or property

abandonment • Can be for recourse-debt (RD) or non-recourse debt (NRD)

arrangements • Generally required when property is business property,

investment property, or real property • For Borrower, deemed sale at loan balance – NRD • For Borrower, deemed sale at FMV - RD

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• Form 1099-C - Only required when there is Cancellation of Debt

Income (COD) Present of > $600 - May file just Form 1099-C if have COD and Foreclosure

in the same year • Applies to Recourse Debt arrangements only • Debt is cancelled when an “Identifiable Event” occurs • Borrower deemed to sell property at FMV with COD Income

for the excess of debt over FMV • FMV is often questioned by the borrowers (FMV presumed to

be Bid Price)

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• Form 1099-C – Identifiable Events - A discharge in bankruptcy under Title 11 for business or investment debt - A cancellation in receivership, foreclosure or similar

court proceedings - A cancellation when statute for collecting expires - A cancellation when creditor elects foreclosure

remedies that ends the creditors rights to collect

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Forms 1099-A and 1099-C Continued

- A cancellation due to probate or similar proceedings - A cancellation under an agreement between the

creditor and debtor at less than full consideration - A discharge because of a policy of creditor to

discontinue collections

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• Form 1099-C – Identifiable Events - Expiration of the nonpayment testing period

• Basically no payments in a 36 month period ending on December 31 (MAY BE ELIMINATED)

- Creditor can rebut this occurrence if: • The creditor has engaged in significant collection

activity in the final 12 months of the testing period, OR

• Facts and circumstances that exist on January 31 following the end of the testing period

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• Loan payment in a year subsequent to issuing a Form 1099-C

- Bank should NOT amend/correct the originally filed Form 1099-C

- It is unclear how the borrower is to reverse the COD income that they reported in a prior year if they later make payment on the loan

• Charge-off does not mean debt forgiveness

Forms 1099-A and 1099-C – NEW UPDATE

• IRS has issued proposed regulations to eliminate the 36-month nonpayment rule triggering COD income reporting

- IRS agrees that information reporting (1099-C) should coincide with the actual discharge of debt. Under the 36-month rule, a debtor may believe he/she has taxable income even though the creditor has not discharged the debt and continues to try to collect it.

- Effective when Final Regulations are published

Organizational Actions

• Reporting Organizational Actions - Enacted in tandem with the 1099-B basis reporting

and transfer statement requirements - Requires issuers of stock and securities to report

actions undertaken by the issuer that affect a stockholder’s basis

- Reporting is made to the stockholders and the IRS - The goal is to provide the stockholders the needed

information to calculate the basis of the stock - This applies to any corporation of any size - So, what are the specifics and why do they matter? 45


• Reporting Organizational Actions - Any organizational action that impacts basis must be

reported - Reporting includes ID of the stock and a detailed

description of the impact of the organizational action on the stock

• Examples: - Mergers and Reorganizations - Stock Dividends - Stock Splits - Non-dividend distributions - Stock Conversion

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• Reporting Organizational Actions - Report to Stockholders by January 15th of the

following year - Report to the IRS within 45 days following the

organizational action or, if earlier, January 15th of the following year

- IRS Form 8937 has been provided to report organizational actions

- Required to report to each stockholder and the IRS – Lots of Paper if numerous stockholders

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• Reporting Organizational Actions - Regulations allow the issuers to meet both reporting

requirements by timely posting the required information on the taxpayer’s public website within 45 days of the organizational action and keeping it available for 10 years

- If you do not have a public website, you must report directly to the stockholders and the IRS

- What is the big deal if you miss the reporting requirements??? Penalties!!!!

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• Reporting Organizational Actions - Penalty is $100 for each missed report - Potential penalties are large for one organizational

action - Examples:

• 500 shareholders and the issuer misses the required reporting of an organizational action

• The penalty would be: $50,000 • No Abatement rules currently exist

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REGULATORY UPDATE

Tax Sharing Agreements BASEL III Impact on DTAs

Tax Sharing Agreement

• June 11, 2014 - Final supplemental guidance was issued by Federal regulators

- Instructs banks and their holding company to review/revise their tax allocation agreements to address tax refunds

- The goal of the guidance is to protect the depository institution

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Tax Sharing Agreement

• Agreements should accomplish the following: - Clearly acknowledge that an agency relationship

exists between the holding company and the depository institution

- Do not contain other language to suggest a contrary intent

- Require the holding company to promptly forward any payment due to the depository institution

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BASEL III Impact on DTAs

• Effective January 1, 2015

• BASEL III will impose stricter limitations on the regulatory capital calculation

• More complex than current rules

• The requirement to project the DTA that will be realized over the next 12 months is not included in the current BASAL III rules.

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• Common equity tier 1 capital deductions: - Goodwill and other intangible assets - DTAs are placed in the same category as mortgage

servicing rights and equity investments in certain financial institutions:

• Total of the DTAs, MSRs, and equity investments are limited to 15% of adjusted common equity

• No item can exceed 10% of adjusted common equity

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- DTAs from NOLs and credits will be deductions from Tier I equity. The phase–in percentages are as follows:

• 2015 – 40% • 2016 – 60% • 2017 – 80% • 2018 – 100%

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BASEL III Impact on DTA

• The deferred tax assets/liabilities will need to be segregated into the following categories: - DTAs from temporary differences

• ALLL, OREO Write-downs, etc.

- DTAs from NOLs, capital losses and tax credits - Deferred tax liabilities

• DTLs related to assets removed from Tier 1 capital are netted against those assets directly (goodwill, MSRs, net OCI – if elected).

• DTLs related to temporary differences in asset/liabilities.

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• Once the deferred tax assets and liability buckets are determined, the remaining deferred tax liabilities will be allocated among the deferred tax assets and credits

• There has been uncertainty regarding timing of the

allocation of the deferred tax liabilities. The liability allocation could occur before the calculation of the DTAs utilized from a carryback claim calculation or after, and the results may not be the same. - Must be consistent from period to period

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• The example below illustrates the impact on the DTA when DTLs are allocated after the carryback calculation:

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Given Amounts Carryback Capacity Net of C/B DTL allocated Net DTA deducted

from CET1 Gross Temporary

DTA, less DTL Reduce DTA by CB Net Temporary

DTA

Temp DTA 800 (700) 100 (60) 740 (700) 40

Credit DTA 400 - 400 (240) 160

DTL (300) - (300) -

Net Amounts 900 (700) 200 (300) 160 740 (700) 40


• The example below illustrates the impact on the DTA if the DTL allocation is done before the carryback calculation.

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Given Amounts DTL allocated

Net DTA deducted from

CET1 Gross Temporary

DTA, less DTL Reduce DTA by

CB Net Temporary

DTA

Temp DTA

800

(200)

600

(600) -

Credit DTA

400

(100)

300

DTL

(300) -

Net Amounts

900

(300)

300

600

(600) -


• There is no limitation on DTAs that can be recovered through a carryback claim, this is the same as existing rules.

• Banks with DTAs comprised of mostly NOLs will likely have a greater limitation.

• Banks that have paid income tax in the past 2 years but are now reporting losses will likely have less limitations on tier 1 capital.

• PLANNING NOTE: Determine impact of BASEL III on your bank’s capital ratios NOW

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Questions???

Beverly Seier Email: [email protected] Phone: 803.255.1214 Website: www.elliottdavis.com

Elliott Davis, LLC/PLLC is one of the largest accounting, tax and consulting services firms in the Southeast and ranks among the top 50 CPA firms in the U.S. With offices in SC, NC, GA and VA, the firm provides clients across a wide range of industries with smart, customized solutions and its people with rewarding opportunities. Founded in 1925, Elliott Davis is a member of The Leading Edge Alliance, an international professional association of independently owned accounting firms based in the U.S. and is strategically aligned with LEA Europe and LEA Asia Pacific, a worldwide network of more than 450 offices in 100 countries around the globe. For more information about Elliott Davis and its services, visit http://www.elliottdavis.com.

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