VOLUME 37

GLOBAL ECONOMY POISED FOR FASTER GROWTH IN 2018 SWEEPING CHANGES TO THE TAX LAW TAKE EFFECT

5 ISSUES FINANCIAL INSTITUTIONS NEED TO BE THINKING ABOUT NOW

ECONOMYTHE REAL

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ABOUT THE AUTHORS

Our thought leaders are professionals with years of experience in their fields who strive to help you and your business succeed. Thought leaders who have contributed content to this issue include:

Joe Brusuelas, Chief Economist, RSM US LLP

Charlie Ratner, Senior Director, Washington National Tax, RSM US LLP

Kyle Brown, Manager, RSM US LLP

Ramon Camacho, Principal, Washington National Tax, RSM US LLP

Rob Alinsky, Senior Associate, Washington National Tax, RSM US LLP

John Behringer, Partner, RSM US LLP

Nicholas Hahn, Director, RSM US LLP

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This publication represents the views of the author(s), and does not necessarily represent the views of RSM. This publication does not constitute professional advice.

Global economy poised for faster growth in 2018 4

Sweeping changes to the tax law take effect 8

5 issues financial institutions need to be thinking about now 12

TABLE OF CONTENTS

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International economic growth in 2018 will increase by 4 percent with the potential for a much faster appreciation due to a likely increase in demand for finished goods by the United States and broad-based strength across other developed and emerging markets. With most developed economies, and a good number of emerging economies, operating well below their long-run growth levels and capacity to produce, there is potential for acceleration well before global central banks take steps to cool growth rates.

The International Monetary Fund recently indicated that 75 percent of the global economy, measured by the gross domestic product (GDP) at purchasing power parity, is sharing in the acceleration in economic activity with the United States, Europe, Japan and China leading the way. Meanwhile, global industrial production is robust and export volumes are now accelerating.

Late cycle fiscal expansion in the United States figures to stoke global demand for commodities and finished goods, which should provide a growth buffer as emerging markets adjust to modest increases in rates and the U.S. dollar.

While growth will continue to moderate in China, growth in India is going to be one of the major economic narratives in 2018. The consensus forecast is that India will grow by 6.7 percent, and economic activity in China will expand by 6.5 percent. Coupled with growth in the European Union (EU) likely to expand at a 2 percent pace, and with the United

States likely to see better than 3 percent growth in the next year, 2018 is shaping up as the best year for global economic growth in more than a decade.

Risks to the outlook: The major risks to the global economic outlook this year will revolve around policy uncertainty in the developed world, growing trade tensions between the United States and its major trading partners, a tightening of financial conditions and the potential reversal of capital flows linked to central bank policy.

Policy uncertainty around the ongoing negotiations between the U.K. and the EU over Brexit will be one of the two major global economic risk narratives this year, with the other being the attempt by the U.S. political authority to withdraw from or weaken both the North American Free Trade Agreement (NAFTA) and the World Trade Organization. Potential disruptions to the North American and global supply chains would result in damage to value chains and pricing, causing global productivity to slow.

With the U.S. central bank likely to hike its policy rate by 75 basis points in 2018 with risk of another 25 basis points still on the table, and the European Central Bank (ECB) likely to begin its long journey toward policy normalization, which will end its negative interest rate policy and large-scale asset purchases. Given the direction of rates in the developing economies and risk of a quicker than expected policy normalization in the United States, there is a risk that capital flows may move toward the developed economies out of emerging markets and developing economies.

GLOBAL ECONOMY POISED FOR FASTER GROWTH IN 2018

Synchronized growth across much of world for first time in a decade

By Joe Brusuelas, Chief Economist, RSM US LLP

MIDDLE MARKET INSIGHT:The global middle market community should see one of the best years of the expansion. The Trump tax cut should spur consumer demand by US consumers that should help mop up excess supply globally, and a widening of the US trade deficit should boost the fortunes of middle market firms across the globe.

MIDDLE MARKET INSIGHT:The UK middle market will face a challenging 2018. Middle market businesses will likely need to look to push forward on innovation to improve their own revenues, profits and growth.

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Central banks and financial conditions: 2018 will see the U.S. central bank modestly quicken its pace of normalization due to an economy growing well above trend. In our estimation, the Fed will raise rates by 100 basis points this year, versus the three rate increases the central bank has forecasted.

In Europe, the ECB will, by the end of the year, conclude its quantitative easing and negative interest rate policies, which will certainly lead to modestly higher rates along European maturity spectrums. While the Bank of Japan will retain its extreme accommodative policies, the two major central banks make the case that, despite modest policy tightening, large balance sheets will continue to suppress long-term rates, push risk-taking out along the curve supporting equity prices and tight credit spreads, which should be supportive of strong financial conditions. Just before the end of 2017, financial conditions in the United States stood at 2.254 standard deviations above neutral, while those in Europe and Asia, excluding Japan, were roughly neutral. In our estimation, the central banks of China, Brazil, Mexico and Canada will be closely monitoring the pace of policy in the United States, and that will likely dictate the direction of capital flows this year.

Eurozone: Growth continued to firm across the Eurozone last year, which grew by 2.6 percent through the end of the third quarter of 2017 and is expected to grow at a 2.1 percent rate in

2018. Strong business investment and export growth imply a self-sustaining expansion amid signals by the ECB of the first move toward policy normalization in late 2018. Growth in Germany is expected to be 2.2 percent, France should expand by 1.8 percent, Italy 1.4 percent and Spain at a 2.5 percent pace. The major risks to the Eurozone outlook are the exit by the U.K., the difficulties forming a government in Germany and the Italian election in spring 2018.

United States: The growth outlook in the United States remains strong, with the increase in overall economic activity likely to expand by 3.1 percent in 2018 and 2.9 percent in 2019. Solid household consumption and fixed business investment, which both were already the major drivers of the above trend growth that middle market firms will be bolstered by the fiscal boost agreed upon by the U.S. Congress at the end of 2017. Given the changing growth dynamics, we expect the U.S. dollar to appreciate against a trade weighted basket of currencies, the 10-year yield to test 3 percent before the end of the year, the trade deficit to widen and the U.S. annual operating fiscal deficits to arrive near $900 billion in 2018 and $1 trillion by the end of 2019. This reinforces our call for four rate hikes by the U.S. Federal Reserve this year, versus the three hikes signaled by the central bank.

United Kingdom: The lagged economic impact of the 2016 Brexit referendum is beginning to bite the British economy. Rising prices on the back of sterling depreciation and much slower pace of consumption imply growth will limp ahead at a 1.4 percent pace. Inflation likely peaked at 3.1 percent in the final quarter of 2017. While the Bank of England (BOE) will have to send a letter to Parliament on missing its long-term inflation target, the outlook is far more tilted toward a

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U.S. North America Eurozone Germany China India EmergingEconomies

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Source: RSM US, Bloomberg

Global growth: faster expansion with upside risk in 2018

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GLOBAL ECONOMY, cont. period of mild disinflation in 2018 and in the out years as the economy adjusts to a post-EU reality. The BOE will not be in the business of hiking rates anytime soon.

Both household consumption and fixed business investment are likely to grow by an anemic 1 percent this year with risk of a slower pace of expansion. In particular, policy uncertainty around the pace and direction of UK/EU negotiations is likely to damp capital expenditures. If the Brexit negotiations appear headed toward an unruly exit starting in March 2019, risks to foreign direct investment flows, of which the UK economy is dependent, will rise. Given the differentials in growth rates and likely central bank policy between the UK EU and United States risk of further currency deprecation is skewed to the downside for the British pound.

Canada: We expect the Canadian economy to expand at a healthy 2.4 percent in 2018 boosted by demand from the United States, which should stoke exports of goods, services and oil

this year. While there are risks around household debt levels and the pace of consumer spending, we expect that growth will be driven primarily by a combination of household spending, government spending and fixed business investment, which all should expand near a 2.2 percent pace this year. We anticipate a modest increase in the policy rate by the Bank of Canada to 1.75 percent by the end of 2018 from the current 1 percent level, and deprecation of the looney against the greenback, which should result in an improvement in the terms of trade. The USD/CAD exchange rate should fall to 1.22 by the end of the year. The major risk to the Canadian economic outlook is the potential withdrawal of the United States from NAFTA.

Mexico: Growth in Mexico, along with its North America trade partners, will likely surprise to the upside this year due to the fiscal boost to consumer demand in the United States. We expect growth to be near 2.5 percent, above the current 2.2 percent consensus, driven by strong exports, private consumption and rising oil prices. While growth in 2017 was lackluster, much of it had to do with the impact of the twin natural disasters—earthquakes and hurricanes—that negatively impacted the economy. With inflation climbing higher, investors should anticipate further rate hikes out of the Bank of Mexico that will be focusing closely on the pace of monetary policy in the United States and direction of NAFTA modernization discussions in the early portion of 2018. Should Trump pull out of NAFTA, Mexico would bear the largest burden of adjustment and pose significant risks to the domestic economic outlook.

China: We expect China’s growth to continue to slow to a 6.5 percent pace this year. In our estimation given China’s economic transition, this is a positive development, and it is only natural

that an emerging market moving toward a more mature phase would see its overall growth rate moderate over time to more sustainable levels and pace. The major driver of growth will continue to be the consumer sector as the fixed investment and industrial production growth moderates in alignment with the longer-term transformation of the economy to one organized around domestic consumption.

The major risk to the economic outlook is debt in the nonfinancial business sector and in the prefects and cities that will tend to act as a net drag on overall investment. In addition, the housing market appears to have tentatively stabilized, with prices still elevated in the major cities. The debt overhang from the long expansion and growing trade tensions between China and the United States underscores the domestic risk. The recent hike by the Chinese central bank is indicative of how sensitive the monetary authority is to rising rates in the United States and capital outflows this year. This will be one of the major global economic narratives this year.

Japan: While growth remains somewhat soft in Japan, the economy has put together its strongest rate of expansion in over 16 years. The Japanese economy will likely expand by a 1.5 percent

pace driven by above 3 percent increases in exports, fixed business investment and industrial production. Yen depreciation, which improved the terms of trade, and a strong global economy are the major economic narrative in Japan at the moment. Inflation continues to be muted due to sluggish wage growth, and the Abe government appears determined to push through economic reforms that over the long term will put a firm foundation underneath the aging economy.

MIDDLE MARKET INSIGHT:While the Mexican middle market is well positioned to prosper in 2018, if the Trump administration withdraws from NAFTA, businesses in the manufacturing, agricultural and apparel ecosystems will bear the disproportionate burden of adjustment in the near term as the economy contracts in 2019 and 2020.

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Australia: The Australian economy figures to be one of the primary beneficiaries of the synchronized improvement in global growth this year. The economy will likely expand at a 2.8 percent pace driven by a strong increase of 6.7 percent in exports and solid household, government and fixed business spending. The Royal Bank of Australia kept its cash rate at 1.5 percent at its December meeting, citing soft expectations of labor market and wage growth, which signaled the likelihood of only one 25 basis point rate hike this year and sustained low inflation. Given the rebound in commodity prices, the Aussie will likely appreciate against the USD this year, which will improve overall purchasing power by domestic consumers. This will somewhat mitigate the risks around slow wage growth and elevated levels of household debt that damped household spending in 2017. The levels of household debt remain the major medium-term risk to the economic outlook.

Brazil: We anticipate a strong rebound in growth around 2.5 percent in 2018 driven by strong increases in gross fixed investment and household spending. Real exports should continue to support

growth due to overall improvement in global commodity demand. Given that the economy is currently recovering from the deepest recession on record, growth trends imply sustainment of the recovery. Despite an increase in inflation to 2.8 percent through November 2017, the central bank will likely continue to reduce its policy rate which stood at 7 percent at its December 2017 meeting. Left alone, the Brazilian economy will continue to recover at a modest pace. However, the political uncertainty linked risks around the Brazilian political sector will continue to hang over fixed business investment this year.

Argentina: Growth in Argentina will likely accelerate to 3.2 percent this year as the lagged impact of recent reforms begin to take hold. Growth will be fueled by robust expansion in private consumption and fixed capital investment. Improvements in demand for commodities should stoke growth in mining after a two-year industry recession, while the construction industry should remain hot throughout 2018, albeit at a slightly modest pace from the 25.3 percent increase on a year-ago basis through October. The primary risk to the economic outlook remains the inflation rate which stood at 23.2 percent at the end of the September 2017 and is likely to slow to near 17 percent next year. Given that the peso will likely depreciate against the USD amidst a central bank reluctant to hike rates, risks around the outlook remain linked to rising inflation.

India: Overall economic activity should expand by 6.7 percent driven by exports, industrial production and gross fixed investment. Through the end of September 2017, fixed investment increased by 5.8 percent, industrial production advanced at a 5.5 percent pace, while private consumption remained strong despite inflation above the 4 percent target of the Reserve Bank of India. The globally synchronized

expansion notably stoked demand in the mining and quarrying sector which was up 5.5 percent heading into the final three months of the year. We expect that sector to observe robust growth in the year ahead. We expect the RBI to hold the policy rate near its current 6 percent.

Dollar exchange rates: We expect a gradual tightening of policy rates by the world’s central banks, led by the United States. While the consensus expects modest dollar depreciation this year, we have an outlier expectation that the greenback will appreciate against a trade weighted basket of currencies as the Fed quickens the pace of its policy normalization campaign on the back of a much stronger growth in the United States over the next two years. The 5 percent decline in the value of the greenback in 2017 in our estimation makes it ripe for appreciation in 2018.

Global energy markets: Oil prices continue to rebound from the 2016 nadir, and we look for them to rise above $60 per barrel on a sustained basis in 2018. Given the strong probability of above-trend growth in the United States, India, the EU and Japan, it is difficult to make the case for lower energy prices. Moreover, with Brazil, Russia and other emerging markets looking toward improvement after years of stagnation, there is a higher risk of rising oil prices this year. Efforts by OPEC to curb production and the global economic recovery that is in train, both support higher prices this year. Natural gas prices near $2.88 per MMBTU and low inventories and a cold winter should send prices higher this year.

Commodity prices: Global organic demand for commodities is accelerating. The Bloomberg Commodities Index is up 2.58 percent since June 2017, while prices paid index in the US ISM Manufacturing survey and the United Nations Food Price index, both imply strong growth in demand and nascent pricing power going forward. The front month contract for copper is up 25.64 percent from a year ago, while costs of aluminum, corrugated metal and hot rolled steel all surged into the final days of 2017, and will likely put upward pressure on finished good prices to kick off the new year.

Global financial conditions remain conducive to growth

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Bloomberg Financial Conditions Plus = 2.254

Bloomberg EU Financial Conditions Index = -0.055

Bloomberg Asia Financial Conditions Index Excluding Japan = 0.259

Source: RSM US, Bloomberg

Z-score of zero indicates neutral

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On Dec. 22, 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act (the Act). The summary below addresses the major business, international and individual tax provisions contained in the Act.

Business provisions

All provisions are effective for tax years beginning after Dec. 31, 2017, unless otherwise noted.

• Corporate tax rate – Rates are reduced from a top rate of 35 percent to 21 percent.

• Corporate alternative minimum tax (AMT) – The corporate AMT is repealed.

• Pass-through businesses – Pass-through businesses are allowed a deduction tantamount to excluding 20 percent of the business income of many pass-through entities and sole proprietors. For owners otherwise subject to the top 37 percent individual tax rate, the effective tax rate on qualified income will be reduced to 29.6 percent.

- Pass-through owners whose taxable income exceeds $315,000 for a joint return (or lower amounts for single filers) are subject to restrictions on the deduction in situations where the business did not have a specified level of wage payments or a specified amount of tangible, depreciable assets used in the business. In addition, restrictions on the deduction apply to

certain service businesses and other businesses described in the new law.

- Trusts and estates are eligible for the 20 percent deduction.

- A new restriction limits an owner’s ability to deduct active business losses against nonbusiness income.

• Carried interests – The Act creates a new three-year holding period that must be satisfied to enjoy long-term capital gains rates with respect to certain carried interests in certain investment or real estate funds.

• Capital expensing – The legislation provides for immediate expensing (i.e., 100 percent bonus depreciation) for certain qualified assets acquired and placed in service after Sept. 27, 2017. The 100 percent bonus depreciation benefit will begin to phase out in 2023. The Act also increased the expensing allowance under section 179 to $1 million, also subject to a phase-out.

• Business interest – The deduction for net business interest of corporations and many pass-through businesses is limited under a formula. Generally speaking, deductions cannot exceed 30 percent of EBITDA (earnings before interest, taxes, depreciation and amortization) for the next four years. After that period,

SWEEPING CHANGES TO THE TAX LAW TAKE EFFECTBy Charlie Ratner, Senior Director, Washington National Tax, RSM US LLP Kyle Brown, Manager, RSM US LLP Ramon Camacho, Principal, Washington National Tax, RSM US LLP Rob Alinsky, Senior Associate, Washington National Tax, RSM US LLP

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interest deductions may not exceed 30 percent of EBIT (earnings before interest and taxes). Disallowed interest deductions can generally be carried forward indefinitely, but may be subject to certain limitations applicable to partnerships. Certain taxpayers are exempt from these rules, including taxpayers with average gross receipts of $25 million or less for the three years immediately preceding the effective date of this provision, as well as taxpayers involved in certain real estate activities.

• Net operating losses (NOLs) – The Act limits the NOL deduction to 80 percent of taxable income. Carrybacks are generally eliminated, but unused losses can be carried forward indefinitely.

• Domestic manufacturing deduction – The section 199 domestic production deduction is repealed.

• Research credits and expenses – The legislation retains the research and development credit and requires capitalization and amortization of research and experimental expenses over a five-year period. The capitalization provisions apply to amounts paid or incurred in tax years beginning after Dec. 31, 2021.

• Overall methods of accounting – The Act increases the gross receipts threshold above which C corporations and partnerships with C corporation partners must generally use the accrual method of accounting from $5 million to $25 million.

• Like-kind exchanges – Like-kind exchanges under section 1031 are limited to real property that is not held primarily for sale. Personal property no longer qualifies for tax-deferred treatment.

INDIVIDUAL PROVISIONS

Unless otherwise noted, these provisions apply as of Jan. 1, 2018, and expire (sunset) at the end of 2025.

Income tax

• Tax brackets – The law provides for seven individual tax brackets–10, 12, 22, 24, 32, 35 and 37 percent. The top individual rate of 37 percent will apply for individuals earning $500,000 and above and joint filers earning at least $600,000.

• Individual AMT – The individual AMT is retained, albeit with a higher exemption ($70,300 for individuals and $109,400 for married taxpayers filing jointly) and a higher phase-out threshold ($500,000 for individuals and $1 million for married taxpayers filing jointly.)

• Standard deduction and personal exemptions – The standard deduction is doubled to $12,000 for individuals and $24,000 for married couples, and the additional deduction for the elderly and the blind is retained. The deduction for personal exemptions is repealed.

• Home mortgage interest deduction – The deduction for home mortgage interest will be limited to interest on $750,000 of acquisition indebtedness incurred on newly purchased principal and second residences after Dec. 15, 2017, and a deduction for interest on any home equity loans will not be allowed, regardless of when the loan was obtained.

• State tax deduction – A deduction of up to $10,000 for state and local property, income or sales tax is allowed. However, the Act precludes taxpayers from pre-paying 2018 state and local income taxes in 2017 in order to get the deduction before the $10,000 cap is imposed after 2017.

• Alimony – Alimony paid pursuant to divorce after Dec. 31, 2018, will not be deductible (or includible in the income of the recipient). Modifications to existing agreements will be impacted.

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• Medical expenses – Medical expenses exceeding 7.5 percent of adjusted gross income (AGI) will be deductible for 2017 and 2018, and the AMT preference for medical expense deductions is eliminated for 2017 and 2018.

• AGI limitations – The 3 percent of AGI limitation on deductions is suspended, and a reduction for miscellaneous deductions that exceed 2 percent of AGI is eliminated (including investment management fees, tax preparation fees and unreimbursed business expenses).

• Charitable contributions – The deduction for charitable contributions is preserved, with an increase in the AGI limitation for cash contributions to public charities and certain private foundations from 50 percent to 60 percent.

• 529 plans – Up to $10,000 of 529 savings plans can be used per student for public, private and religious elementary and secondary schools.

• Individual Retirement Accounts (IRAs) – A conversion of a traditional IRA to a Roth IRA cannot be recharacterized as a contribution to a traditional IRA. This does not prevent conversion of a traditional IRA into a Roth IRA, only the reversal of such a conversion is barred.

Estate, gift and generation-skipping transfer (GST) tax

• The estate, gift and generation-skipping transfer (GST) tax exemptions are doubled to approximately $11 million, effective January 2018.

• The estate, gift and GST rates remain the same as existing law.

Key provisions of current law that were undisturbed by the bill

• Income tax - The 3.8 percent tax on investment income

under section 1411 and the 0.9 percent Medicare tax on compensation

- Tax rates on capital gains and qualified dividends

- Exclusion of gain on sale of a residence

- Ability to identify the securities that an investor is deemed to sell (i.e., the Senate’s proposal for a ‘first-in, first out’ method is not included in the Act)

- Pre-tax contribution limits (including catch-ups) for 401(k) plans

- Ability for beneficiaries to ‘stretch’ IRA withdrawals out over their lifetimes

• Estate, gift and GST tax - The gift tax and the rate of tax imposed for

estate, gift and GST tax

- Step-up in basis for inherited assets (other than items of income in respect of decedent)

- Current design flexibility of grantor retained annuity trusts (GRATs) and rules for ‘defective’ grantor trusts

INTERNATIONAL TAX PROVISIONS

All provisions are effective for tax years beginning after Dec. 31, 2017, unless otherwise noted.

• Establishment of a territorial tax system – The Act establishes a ‘territorial’ system of taxation, for the first time in U.S. history, under which U.S. corporations (not individuals) may deduct dividends received from a ‘specified’ foreign corporation held for one year.

• Mandatory taxation of deferred foreign earnings at a reduced rate – U.S. corporations and certain individuals who own at least 10 percent of the voting shares of a foreign corporation must take into current income, for 2017, their pro rata share of the untaxed earnings of the corporation. This income is subject to tax at either a 15.5 or 8 percent rate depending on whether such earnings are attributable to cash or tangible assets of the foreign corporation. Dividends paid in 2017 to U.S. shareholders subject to these rules will not be taxed as regular dividends but will be taxed at these rates. Taxpayers may elect to defer payment of the actual additional taxes resulting from this mandatory inclusion over an eight-year period. However, because the first payment will

TAX LAW, cont.

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be due on the date when the taxpayer’s final tax payment for 2017 is otherwise due, taxpayers should be prepared to pay an additional amount with their 2017 extension.

• Retention of rules requiring inclusion of income upon investment in U.S. property by a controlled foreign corporation (CFC) – In a surprising change, the final bill deletes the proposal to repeal the current law rule that results in the taxation of offshore earnings corresponding to an investment in U.S. property made by a CFC. The conferees likely retained this provision in order to raise revenue.

• Special tax rates for offshore intangible income – While the Act sets the overall domestic corporate tax rate at 21 percent, it also provides special tax rates for foreign intangible income earned directly or indirectly through a CFC. In particular, the Act imposes a 13.125 percent effective tax rate for intangible income earned directly, and a 10.5 percent rate for intangible income earned through a foreign corporation.

• No extension of ‘look-through’ rules for certain CFCs – The final legislation does not extend an expiring rule that characterizes income received from a controlled foreign corporation by reference to the underlying income of the CFC. With the expiration of that rule, taxpayers will likely have more subpart F income that will be generally subject to the normal domestic corporate tax rate of 21 percent and will not enjoy any offsetting dividends received deductions or similar benefits. A wide variety of taxpayers currently relies on this rule, and such taxpayers may wish to consider restructuring options.

• Base erosion and anti-abuse tax (BEAT) – To prevent the erosion of the U.S. corporate tax base, the Act imposes a 10 percent tax (5 percent for 2018) on U.S. corporations that make excessive tax-deductible payments to related foreign persons. This complex tax operates somewhat like an AMT and will require considerable analysis. The rules apply only to corporate taxpayers with

average annual gross receipt of at least $500 million, and only if they have a ‘base erosion percentage’ of 3 percent or higher. Companies with significant tax-deductible payments to related persons, such as those with global supply chains, should carefully assess the impact of this provision.

• Definition of intangibles – The final bill contains rules that ensure that goodwill, going concern value and workforce in place will be taxed if transferred to a foreign corporation.

• Fair market value method of apportioning interest expense for purposes of determining foreign tax credits – Current law allows taxpayers to elect the fair market value method of apportioning interest expense, which may benefit taxpayers who have significant intangible assets with high value but a low tax basis. The Act disallows the use of this method, forcing taxpayers to apportion based on a tax basis. This change may limit the ability of certain taxpayers to claim a foreign tax credit.

As a result of tax reform, there may be planning opportunities available or other changes that will be necessary to comply with the new law that fall outside the scope of normal tax return preparation. Please consult your regular tax advisor for guidance.

Related Tax Alerts

Congress passes sweeping changes to the tax law

The Tax Cuts and Jobs Act (the Act): Corporate tax considerations

Federal tax reform and the states: Conformity is key

Tax reform: international planning considerations

Payroll reactions to the Tax Cuts and Jobs Act

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5 ISSUES FINANCIAL INSTITUTIONS NEED TO BE THINKING ABOUT NOWBy John Behringer, Partner, RSM US LLP and Nicholas Hahn, Director, RSM US LLP

There are a number of significant issues and emerging trends affecting U.S. middle market companies and the U.S. economy in general, both of which are crucial to the health and vibrancy of the financial institutions sector. Given this environment, it is imperative for financial institutions to be thinking about the following five issues in evaluating their strategic plans:

1. The need to adopt the current expected credit loss (CECL) guidance which reflects fundamental changes to accounting for credit losses and related financial reporting.

2. Congress and regulatory agencies in Washington and in states across the country are focusing on tax reform and regulatory reforms.

3. Technology and data are creating opportunities to drive profitability.

4. A tighter job market is challenging the ability of institutions to identify and hire qualified employees, particularly in technical areas such as compliance and information technology.

5. Changes in consumer preferences are forcing banks to evaluate the products and services they offer and the related delivery channels.

Following are a few of the changes that have taken place or are on the verge of being implemented, and what actions financial institutions should be considering to address them.

1. Regulatory changes

The challenge for financial institutions is staying on top of a number of regulatory and accounting changes, including:

• Home Mortgage Disclosure Act (HDMA) data collection: Additional HMDA data fields are required for reporting. A new rule requires 48 new or modified data points and will allow regulators to determine if unfair lending practices could be occurring through the use of data analytics. The American Bankers Association noted that “The new HMDA rules are inherently complex and very expensive to implement.”

• CECL: With acquisition activity gaining traction in the banking industry, it is important for institutions that plan to grow via acquisition to consider how adoption of the CECL model will affect accounting for loans, securities and other affected instruments at the target institution.

• Revenue recognition: The new standard is complex and represents a fundamental and significant change in accounting. It may be more challenging than many companies and institutions realize.

Several major changes have taken place or are on the verge of being implemented that financial institutions should be prepared to address.

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2. Tax reform

In a challenging low-rate environment, banks are entering new markets and offering niche products in their efforts to generate loan growth. In the rush to market, many institutions have not considered what impact the loans being originated may have on nexus which may result in state and local tax liabilities outside of their physical footprint. To date, certain states have not rigorously enforced compliance; however, as a number of cash-strapped states, counties and local governments across the country are facing significant revenue shortfalls, banks may now be on the radar. With more aggressive enforcement and collection activities by state and local governments to generate revenue, banks should actively evaluate and manage their nexus risk.

Finally, institutions that have made a subchapter S election should also monitor the outcome of individual tax reform in combination with corporate tax reform to determine if the subchapter S election remains the most tax-efficient model for operations.

3. Technology and data

Financial technology, or fintech, is used in banking and financial services to deliver an array of products and services ranging from credit scoring to digital currency, and online lending to asset management. Fintech captures the same consumer data that community banks have access to—in fact, with the consumer’s permission, these

entities scrape the data from consumer’s bank accounts to drive credit decisions—but fintech companies typically are more effective in their ability to leverage the data and capitalize on it.

Large banks are harnessing this data as well, but smaller banks may not have the resources to make the effort profitable. The data may be residing on multiple systems or it may be inaccurate or out of date. But the ability to efficiently capture and leverage data will fundamentally change how banks go to market and drive profitability. Banks that want to capitalize on the consumer data they already have will need to make a strategic decision to either ignore the data, imitate the fintech companies or partner with them.

Regulators are also leveraging data and, as a result, increasing reporting requirements for institutions as a way to conduct efficient, on-going monitoring. This is also fundamentally changing the way regulatory exams are conducted both for safety and soundness and compliance. Institutions that invest in their ability to leverage data for risk management purposes will see not only better regulatory outcomes but also improved profitability.

Cybersecurity remains an immediate and broad-based threat—and bank regulatory scrutiny in this area has ramped up accordingly. Banks need to have an effective data security plan in place to deal with the threats that come with gathering so much information.

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4. Labor and workforce

Maintaining a skilled workforce is a challenge across industries. Banks are struggling to fill core functions where decisions are traditionally made by a person and not by artificial intelligence or automation. But changing demographics, and the demand for higher wages and a clear career path, have made it challenging to identify, attract and retain candidates in key roles across institutions. It has become particularly difficult to find qualified and well-trained credit analysts and compliance officers in such a tight labor market. Further, given most community and regional banks’ focus on commercial real estate lending, the projected shortage of qualified appraisers presents a significant challenge to the industry as a whole. Ultimately, this lack of qualified workers may constrain growth, service and innovation if not addressed from a strategic perspective.

Banks in smaller markets in particular face difficulty in attracting and retaining talent, but they can partially or completely outsource many responsibilities, such as those in information technology, asset liability management and regulatory compliance. A thoughtful approach to outsourcing can assist in maintaining core activities while allowing internal resources to focus on strategic activities.

5. Changing consumer preferences

As customers move towards non-branch, digital channels, acquiring new customers—and increasing wallet share of existing customers—should be top areas of strategic focus throughout 2018.

Customer expectations and needs are changing: Millennials prefer to go online for their banking transactions. While the importance of branches as the center of customer activity has diminished overall, they are hubs of activity in certain markets. Boomers are shifting from wealth accumulation to maintaining and preserving, and are migrating to warmer states. As a group they prefer a mix of in-person and digital interaction, particularly those that split time between cold and warm weather climates depending on the season. In an effort to retain these customers, many banks are not only modernizing branches into sleek, welcoming locations with a number of amenities but providing a sense of security in educating this demographic on the ability to leverage digital channels in a secure manner.

Banks need to find the balance between the digital and the personal, and be agile enough to respond to these changing preferences and customer demographics.

5 ISSUES FOR FINANCIAL INSTITUTIONS, cont.

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