The recently enacted tax reform legislation – informally called the Tax Cuts and Jobs Act – contains substantial changes to the taxation of businesses. Some of the Act’s changes will affect accruals of income tax expense for financial statement (Call Report) purposes and require changes to tax accrual worksheets used by many banks.
Tax Rate Change
Most calendar year banks that file tax returns as regular corporations have already made appropriate adjustments to their deferred tax assets and liabilities as of year-end 2017 to reflect the lower corporate tax rate of 21 percent under the Act. This lower rate also needs to be used for accruing income taxes on current year earnings. The 21 percent rate is a “flat” tax that will apply regardless of a regular corporation’s taxable income; the graduated rate schedule imposing a maximum 35 percent rate is eliminated. This should simplify the Federal income tax calculation on bank tax accrual worksheets.
For banks using a fiscal year-end in 2018 other than December 31, the new 21 percent rate is “blended” with the rates in place prior to January 1, 2018. For example, a bank subject to the 35 percent tax rate on 2017 income with a June 30, 2018, year-end would use a blended federal income tax rate for its fiscal year of 28.06 percent (based on the number of days before and after the effective date of the tax rate change). The tax rate calculation, in this case, would be [(35% x 184/365) + (21% x 181/365)].
In addition to the tax rate change, other changes made by the Act can affect the accrual of federal income taxes.
For these, and – potentially – other deductions limited by the Act, banks should modify their tax accrual worksheets to provide add-backs increasing taxable income if appropriate.
S Corporation Banks
While S corporations are not generally subject to corporate level income taxes, Act provisions will affect the calculation of taxable income allocated to shareholders and other income tax related computations. For example, most S corporation banks make special dividend distributions to shareholders that reflect the anticipated income tax expense shareholders will incur on their respective shares of the bank’s taxable income. The lower individual tax rates and limitations on deductions, such as the state income taxes, may warrant changes to the calculations supporting these distributions.
The Act includes many provisions, including lower tax rates and limitations on certain deductions, affecting the taxation of banks and their shareholders that may require changes to accounting procedures and internal worksheets used for estimating income tax expense. The changes needed can vary depending on each bank’s facts and circumstances. In addition, many states have yet to determine the impact of the federal changes to their income tax laws; so state income tax accrual worksheets should be reviewed, as well.