On December 22, 2017, President Trump signed the tax reform bill, commonly known as the “Tax Cuts and Jobs Act” (the Act), the most comprehensive tax reform legislation since 1986. It will affect all businesses and individuals. The following summarizes the Act and its impact on banks. Unless otherwise noted, the changes are effective for years beginning after December 31, 2017.
Impact of the Rate Reduction
The greatest impact of the Act is the reduction of the corporate tax rate from 34% or 35% (depending on taxable income) to 21%. While banks will be able to reduce current tax provisions for future years and reduce their effective tax rates, there is a one-time adjustment to the net deferred tax asset or liability in the period of enactment, which is the fourth quarter of 2017, when the President signed the bill.
Fiscal-year taxpayers should make the one-time adjustment for the fourth quarter of 2017 as well, based on the cumulative temporary differences at December 31, 2017.
In accordance with the Financial Accounting Standards Board, Accounting Standards Codification, Topic 740, Income Taxes, all deferred tax assets and liabilities are adjusted through the income statement. This includes deferred taxes relating to certain items recognized as part of Accumulated Other Comprehensive Income (AOCI), such as deferred taxes related to available-for-sale securities, cash flow hedges and pension plans. This creates some accounting complexities, as there will be a reconciling item that will remain in AOCI until the item giving rise to the AOCI is disposed of.
Recent SEC guidance permits the reporting of reasonable estimates in the year of enactment, with subsequent refinements. The guidance also indicates that the remeasurement of a deferred tax asset does not require the filing of Form 8-K. The guidance is available at:
Calendar-year taxpayers will pay tax at a 21% rate for the tax year beginning January 1, 2018. Fiscal-year taxpayers will use a blended rate for the current tax year. The rate will be pro-rated based on the number of days before January 1, 2018 (34% or 35% rate), and the number of days after December 31, 2017 (21% rate).
Provisions that Directly Affect Bank’s Taxable Income
While some of the changes are rather detailed, here is a high-level summary of other major provisions of the Act affecting banks:
- The dividends-received-deduction is reduced from 70% to 50%.
- Bonus depreciation is increased to 100% for qualified property placed in service after September 27, 2017, and before January 1, 2023, with phase-downs over the next four years. The Act also eliminates the requirement that original use of the property commences with the taxpayer.
- The allowable Section 179 deduction is increased to $1,000,000 with an increase to the phase-out threshold to $2,500,000. The amounts would be indexed for inflation for tax years beginning after 2018.
- The thirty-nine-year depreciation period for non-residential real property is retained.
- Net operating loss carrybacks are eliminated for most taxpayers. Carryforwards are indefinite, but limited to 80% of taxable income for losses arising in taxable years beginning after December 31, 2017.
- Like-kind exchanges will be limited to exchanges of real property.
- The disallowance percentage for certain entertainment expenses will increase from 50% to 100%. There are also changes to the rules regarding providing food to employees and qualified transportation fringe benefits.
- For municipal securities, advance refunding bonds issued after December 31, 2017, will no longer be tax-exempt.
- Rehabilitation credits will be taken ratably over a five-year period beginning with the year placed in service.
- The New Markets Tax Credit is retained.
- The Code Section 162(m) annual limit on compensation deduction with respect to a covered employee of a publicly traded corporation is changed by eliminating the exceptions for commissions and performance-based compensation, and changing the definition of “covered employee.” There is a transition rule for commissions and performance-based compensation so that no changes take effect with respect to a written binding contract in effect on November 2, 2017.
- Deductibility of Federal Deposit Insurance Corporation (FDIC) assessments are phased out for institutions with total assets exceeding $10 billion.
- The Alternative Minimum Tax (AMT) is repealed for corporations, with provisions to utilize AMT credits by tax years beginning in 2022.
Other Provisions that May Indirectly Affect Your Business
In addition to changes that directly affect a bank’s taxable income, there are other provisions in the Act that may indirectly affect a bank’s business. Here is a high-level summary of some of those provisions:
- The impact of tax-exempt securities will change. With the lower corporate tax rate, the effective yield calculation will change when considering a purchase of a tax-exempt security.
- The impact of purchasing bank-owned life insurance (BOLI) will change. The pricing is based on its tax-exempt nature, which will be less valuable with a lower corporate tax rate.
- Low-income housing credit partnership investments, as well as other tax credit investments, are priced based on tax savings on its losses, so that pricing may change as well.
- For individuals, the debt limit for mortgages is reduced from $1 million to $750,000. In addition, there will no longer be a deduction for home equity indebtedness. Those changes, along with an increase in the standard deductions to $12,000 for single taxpayers and $24,000 for married taxpayers filing jointly, will mean that fewer individuals will receive a tax benefit on their interest expense. This may have an effect on the housing market and interest rates.
- There is a disallowance of net interest expense for corporations equal to 30% of an adjusted taxable income calculation. There is an exemption for taxpayers with average gross receipts of $25 million or less over the previous three years, and another exemption for real property development. This may have an impact on a bank’s commercial borrowers.
This is a very brief overview of the Act’s effect on banks.