When President Trump signed the Tax Cuts & Jobs Act into law on Dec. 22, 2017, many breathed a sigh of relief, happy that the long, hard road to passing tax reform was over. The “passing” piece was indeed complete, but the “implementation” part of the new legislation is another process entirely.
Clarification on many pieces of the legislation have been sought, and as recently as May 9, the House Ways & Means
Committee was planning a “Phase II” tax reform plan that would largely be pointed towards individual provisions and families. This additional phase of tax reform legislation could make the individual tax cuts in the act permanent, rather than expiring at the end of 2025, which was required to comply with Senate budget rules. This new potential legislation may also affect education incentives and retirement savings planning. More to come on these developments.
Section 199A Deduction Clarification
The U.S. Treasury is expected to release guidance this summer for interpreting the provisions in the Tax Cuts & Jobs Act and applying the new rules. Of great importance to community bankers is the application of new Section 199A, which provides a deduction for “Qualified Business Income” (QBI) equal to 20 percent of QBI, with certain limitations. This deduction is for individual taxpayers and activities conducted within passthrough entities, such as S corporations and partnerships.
Questions have arisen from some commentators regarding whether “banking” definitely is an activity that will produce QBI and qualify for this deduction. On April 30, the ABA, ICBA and Subchapter S Bank Association sent a joint letter to
representatives at the Treasury requesting that future guidance clearly include banking as an activity that will qualify. The legislative language makes references to other Internal Revenue Code provisions indicating that Section 199A is meant to apply to banks, but still leaves many with questions. Eide Bailly tax professionals have had recent discussions with Senate staff who drafted the legislative language, and we received assurance that it was the intent of Congress to include banking as being eligible for the 20 percent deduction. It is now up to the Treasury to clarify that intent and explain how this valuable provision will be calculated on income tax returns.
It is paramount for community banks to be clear on this provision, as many banks are analyzing whether an S corporation or a C corporation tax structure would best fit their strategic direction, and this provision is a major part of that analysis. Thus, along with guidance on the mechanics of calculating the deduction, clarity is needed on what activities will produce QBI eligible for the deduction.
One more component of federal tax reform is the impact on state tax laws—will states conform to the new federal rules, or will there be a whole new set of state adjustments for taxpayers to deal with? Many states are grappling with Tax Cuts & Jobs Act provisions now. This area is on our daily watch list.
Other Provisions Impacting Community Banks
Tax Rates:The federal corporate income tax rate was changed to a flat 21 percent rate for C corporations. The maximum rate had been 35 percent, with a lowest bracket of 15 percent. This is an effective tax rate decrease for most C corporation banks, who have already had to deal with this rate change on their Dec. 31, 2017, Call Report, when their deferred tax asset or liability had to be adjusted to reflect this new corporate tax rate. C corporations should be sure to use the new 21 percent federal corporate tax rate on their tax accrual calculations during 2018.
S corporations, when computing tax distribution amounts for 2018, should take into account the new individual tax rate schedule (top marginal bracket is now 37 percent, down from 39.6 percent) and consider the new 20 percent of QBI deduction. The net investment income tax, applicable for certain passive owners of S corporations, is still in place. The Tax Cuts & Jobs Act did not change the net investment income tax rules at all.
Accounting Methods: The opportunity to defer taxable income for C corporation banks has been enhanced by the act by making available the use of the cash method of accounting for tax purposes for C corporations that have average annual gross receipts of $25 million or less for the prior three years. The prior limitation for C corporations was average gross receipts of $5 million or less for the prior three years and for every year since 1985. The new $25 million threshold will provide an opportunity for many more C corporation banks to defer taxation on accrued interest receivable until the year it is collected. Likewise, accrued interest payable and accrued expenses payable (including accrued bonuses and salaries) are not deducted until the year paid. Careful analysis will need to be done to determine whether this is a change that would benefit a C corporation bank.
It’s important to note this method change would not necessarily have an immediate impact on a bank’s income statement; the deferred income and expenses from using the cash method become components of a deferred tax asset or liability calculation.
The cash method of accounting remains available for all S corporation banks, and the change to the cash method is an automatic change for S corporation banks with average annual gross receipts of $50 million or less. This has been the case since the IRS released Revenue Procedure 2011-14 (although it is possible the IRS could change the gross receipts threshold for the automatic change in the future). For S corporation banks with average annual gross receipts in excess of $50 million, the bank can still change to the cash method, but would need advance consent from the IRS to do so.
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