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2016 Tax Planning Strategies and Considerations

October 21, 2016

With the presidential election just around the corner, the nation is abuzz on the candidates’ tax policy proposals, among various other issues. That said, as we head into the “home stretch” of the 2016 year, it is doubtful that Congress will pass any major changes to the existing tax code, providing some certainty for short-term tax planning strategies this year, which is unusual lately. Unlike the past few years, there are no major expiring tax provisions waiting in limbo for Congress to act on extender legislation in 2016. 

PATH Act Impact
Last December, Congress passed the PATH Act, which provided the following tax provisions, all still in place and pertinent for 2016 year-end tax planning:

Important extenders granted permanent extension

  • Federal Section 179 expensing set at $500,000, with a $2 million phase out limitation. Software is eligible for this expensing. Also, heating and air conditioning units are now eligible for Section 179 expensing going forward.
  • S corporation recognition period is five years (rather than 10 years) for the built-in gains tax.
  • Individuals age 70 ½ or older may exclude from gross income qualified charitable distributions from an IRA.
  • Research and development tax credit made permanent.

Important temporary extensions

  • Bonus depreciation extended through 2019. Taxpayers can depreciate 50 percent of the cost of qualified new assets acquired and placed in service during 2016 and 2017. The 50 percent bonus depreciation will be reduced to 40 percent in 2018, and 30 percent in 2019, with the provision expiring for the 2020 tax year.
  • Work Opportunity Tax Credit (WOTC) extended through 2019, along with modifications for employers who hire long-term unemployed individuals.
  • Qualified Zone Academy Bond (QZAB) extended through 2016.

Year-End Planning Opportunities
There are several tax planning opportunities to minimize a bank’s 2016 taxable income. Here are a few planning points to consider during your year-end bank tax planning process:  

  • Review the bank’s loan watch list and classified loans to determine if any additional charge-offs would be appropriate. In addition, if not already done, the bank should consider making a “bad debt conformity election” for bad debts under IRS regulations. This election provides for book and tax conformity when loans are charged off. Similarly, the bank can consider complying with the October 2014 IRS directive on bad debts, which provides similar audit protection in the area of bad debts.      
  • For “other real estate” or “other personal property” repossessed during the year, make sure the property has been written down to fair market value. Keep in mind, the initial write-down should be booked to the loan loss reserve and is deductible as a loan charge-off. Subsequent write-downs to the property due to the decrease in value are non-deductible for tax purposes until the property is eventually sold.
  • For cash basis banks, consider payment of accrued liabilities and paying certain short-term prepaid expenses that are qualified for accelerated deduction before year-end.
  • Generally, an accrual basis bank is allowed a current deduction for accrued bonuses if they are paid within the first 2 ½ months of the following tax year. However, there are tax deduction limitations if the bonus plan allows the bank to retain any amounts forfeited by employees.
  • With significant differences in state rates of taxation, make sure state identification of loans, deposits and loan interest income is properly identified in bank records for apportionment calculations to the appropriate states, and be certain that all state tax filing requirements are being satisfied.
  • Review your bank’s tax depreciation schedule for assets that are no longer in service and may have been disposed by the bank. If any tax basis remains, it can be deducted as a loss on disposal.
  • If considering a year-end automobile purchase, determine whether a trade or outright sale of the auto provides the best tax result. Many luxury autos, due to depreciation limitations, have high tax bases in comparison to their trade values. Thus, a sale of the vehicle could generate a deductible loss, while a trade would defer that loss until the next vehicle was ultimately sold.
  • Prior to year-end, review the dollar expensing threshold included in the bank’s capitalization policy and determine if that amount still makes sense for your bank. In addition, review your repairs and maintenance expense accounts and your current-year fixed asset additions to ensure all items are in compliance with the bank’s capitalization policy.
  • A review of the bank’s available-for-sale security investment portfolio should be made, and securities with unrealized losses should be considered for a sale in order to recognize the ordinary loss before year-end.         

Other Items to Consider for the 2016 Tax Year
Mortgage Servicing Rights
For banks that sell mortgages and retain mortgage servicing rights, an asset reflecting the value of those mortgage servicing rights may or may not be reflected on the bank’s balance sheet, dependent upon the materiality of the asset. Regardless of whether the asset is booked or not, the bank needs to consider the tax implications of retaining these mortgage servicing rights.

According to current tax rules (IRC Section 1286 and Revenue Ruling 91-46), banks are to “peel away” some tax basis from the mortgage loans being sold (and realized a current year taxable gain), and assign that tax basis to the mortgage servicing rights, based on the relative fair market values of the loans and retained servicing rights. That tax basis “peeled away” from the loans being sold and assigned to the mortgage servicing rights is then amortized and deducted from taxable income over the life of those rights. This can be quite burdensome from a record-keeping standpoint, not to mention that it accelerates taxable income since the loans being sold will be at a gain for income tax purposes.

There is a method to avoid this result—Revenue Procedure 91-50 provides a safe harbor election that a bank can make to avoid the burdensome record-keeping and accelerated taxation. In order to effectively make this election, a bank’s mortgage servicing rights compensation on 1-4 unit residential mortgages sold must meet the safe harbor fee levels in Revenue Procedure 91-50, as set forth below:

  • Conventional, fixed-rate mortgage – 0.25 percent
  • Mortgage < 1 year old, guaranteed/insured by Federal Housing Association, Veterans Administration or Farmers Home Administration – 0.44 percent
  • Any other 1-4 unit residential mortgage – 0.375 percent
  • If original balance of mortgage was < $50,000, - 0.44 percent

If the mortgage servicing fee does not exceed the above amounts, then the Revenue Procedure 91-50 safe harbor election can be made and the accelerated taxable income can be avoided. Also, if a bank does book a mortgage servicing asset for GAAP purposes, it realized a large amount of book earning related to booking that asset. If the safe harbor election can be made, those GAAP earnings will be currently nontaxable (nor will subsequent GAAP amortization be tax deductible).

S Corporation Due Diligence
For S corporation banks and holding companies, year-end tax planning is a good time to perform some due diligence functions to ensure that all S corporation eligibility requirements are still being met by the corporation and its shareholders. If shares were transferred during the year or new shareholders were added, it is important to make sure compliance with S corporation requirements is still in place, particularly if shares were transferred into trusts during the year. Care must be taken to ensure that IRS requirements, as well as Federal Reserve Bank rules, are being complied with.

Look Long-Term
The above items are only a few things to consider during your bank’s year-end tax planning process. Taking into account the current political environment and the uncertainty of future tax reform, it is important for banks to not only factor in tax planning for the current year, but to also analyze the possibilities and plan long-term, i.e., comparing C corporation versus S corporation structures, considering whether someday banks could be converted to LLCs and tax partnerships, etc.