Relief efforts and further guidance continue to be released in the wake of the COVID-19 pandemic. But how do these relief provisions actually impact community banks?
A lot of activity has occurred in a relatively short amount of time, so in many cases banks lack important guidance from the IRS, SBA and others needed to determine the effect on the industry. However, a key area of focus for many community banks will be tax legislation and related regulatory relief provided for banks relative to capital ratios.
There’s much to consider when it comes to COVID-19’s impact on organizations. We’ve compiled resources to help.
Banks can benefit from several business provisions contained in the CARES Act.
Net Operating Losses
The CARES Act allows net operating losses (NOLs) generated in 2018, 2019 and 2020 to be carried back five years. The availability of a five-year carryback period for NOLs can potentially boost a bank’s Tier One capital ratio. Deferred tax assets attributable to NOLs are not included in Tier One capital under current regulatory guidelines.
A NOL carryback effectively monetizes the NOL (to the extent tax refunds are generated from prior tax years) and allows a bank to reclassify the carryback refund from its deferred tax asset account to a current income tax receivable account on the balance sheet. This reduces the subtraction from capital on the bank’s Call Report relative to deferred tax assets attributable to NOL carryforwards. In addition, carrying back NOLs to 2013-2017 (where effective tax rates were generally higher) may provide permanent tax savings that reduce tax expense and increase earnings.
We broke down various components of the CARES Act.
Alternative Minimum Tax
Similarly, the CARES Act accelerates the refund of Alternative Minimum Tax (AMT) credits to the 2019 corporate income tax return (or to 2018 at a taxpayer’s election). Deferred tax assets attributable to credit carryforwards are also not included in Tier One capital. So, reclassifying an AMT credit to a current income tax receivable account on the bank’s balance will likewise provide an increase to Tier One capital.
For banks that lease their facilities, the CARES Act also fixed a glitch from the 2017 tax reform law that made certain leasehold improvements no longer eligible for 100% bonus depreciation beginning on January 1, 2018. The CARES Act retroactively allows leasehold improvement expenditures to be treated as eligible for 100% bonus depreciation. While these types of expenditures had been eligible for the Section 179 expense deduction, some S corporation banks with shareholders not able to utilize a Section 179 deduction were not able to realize the accelerated tax benefit for leasehold improvements. This correction provides welcome relief; taxpayers that placed in service qualifying leasehold improvements during 2018 or 2019 can now claim bonus depreciation on the property.
Employee Retention Credit
A provision of the CARES Act that, on the surface, seemingly provides relief to community banks is the Employee Retention Credit (ERC). This refundable credit of up to $5,000 per employee rewards eligible employers that retain their employees through the COVID-19 crisis. The credit is based on 50% of qualifying wages paid to employees from March 13, 2020, through December 31, 2020, for up to $10,000 of qualifying wages for all payroll quarters combined. This valuable tax credit is generally available for employers that do not participate in a forgivable loan program with the Small Business Administration’s Paycheck Protection Program (PPP), and that:
Many banks will provide payment deferrals to assist their loan customers over the coming weeks; however, it is in question whether the deferral volume would result in a 50% reduction in quarterly receipts in the case of banks on the cash basis for tax purposes. In addition, most states did not order closure, either partial or in full, of banks. Many banks have voluntarily closed their lobbies and maintained drive-through operations and mobile banking applications, but this was a decision made by each individual bank rather than ordered by a state government. Thus, depending on each bank’s circumstances and interpretation of the requirement to “partially suspend” operations, many community banks may not qualify for the ERC. Hopefully, future IRS guidance will clarify this issue for banks and other taxpayers in similar situations.
Learn more about the provisions of the employee retention credit.
Payroll Tax Deferral
Another provision in the CARES Act that could aid community banks is the deferral of payments of the employer portion of Social Security taxes on employee wages incurred from March 27, 2020, through December 31, 2020. The deferred taxes can be paid over the two following tax years, with half of the amount required to be paid by December 31, 2021, and the other half by December 31, 2022. Although this deferral can provide added liquidity, the payroll tax liability still needs to be accrued as a payable on the bank’s balance sheet, so earnings will not be directly affected by the deferral. Since currently most banks’ cost of funds is minimal, deferring the payment of payroll taxes provides very little indirect effect on a bank’s financial position. However, if the cost of funds should rise over the next two years, the deferral could provide increased benefit for banks. A final note—the payroll tax deferral is not available to taxpayers that have PPP debt forgiven.
Bank regulators have also provided banks temporary relief in dealing with the COVID-19 pandemic. Due to the uncertainty of future economic conditions and the extent of resulting losses, regulators took steps to help banks continue their lending operations. Since credit losses combined with increased loan demand could potentially put pressure on a bank’s capital ratios, relaxed capital requirements have been put into place.
An interim rule effectively permits S corporation banks to pay tax distributions to their shareholders even if they fall into the Basel III capital “buffer zone.” Normally, distributions to shareholders were prohibited without prior approval of applicable bank regulators.
In addition, the CARES Act reduces the Community Bank Leverage Ratio (CBLR) to 8% from the previous minimum of 9%. Regulators have since issued two interim rules that will modify the CBLR framework in these two ways:
Under the interim final rules, the CBLR will be 8% beginning in the second quarter of 2020 and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The interim final rules also maintain a two-quarter grace period for a qualifying community banking organization whose leverage ratio falls no more than 1% below the applicable CBLR.
There’s much to consider when it comes to the impact of COVID-19 on community banks. We’ve addressed common questions we’ve received.
Stay up to date on information affecting your bank
Guidance continues to be released and regulations continue to be updated. It’s important to stay in the know on information related to your financial institution and how these relief provisions may help you as you navigate this uncertain time.
Stay up to date on the latest information and resources related to the organizational impacts of COVID-19.