The Current State of Financial Institution Taxation
Writing about anything right now regarding taxation requires a large timestamp. So let’s make sure we timestamp this as the beginning of September 2020 as the tax world could change a lot between now and next week or even a day from now! As we face a different world in 2020 the tax landscape is no different than the rest of life. We are dealing with new rules, new normals, and a large cloud of uncertainty. This article tries to point out some noticeable tax law changes and other considerations for banks in light of the current economic environment. Some of this material originates from the CARES Act. Although this article does not attempt to delve into the CARES act in depth, readers can refer to our CARES act guide for more information.
Disallowed parking expenses is a topic that brings about no joy or smiles to people. We last received guidance with Notice 2018-99 back in December 2018. Since then we have been relying on that notice to calculate and apply the parking expense rules. Many banks have found that their headquarters and/or operations center often are subject to a disallowance, whereas many branches do not because of an exception for lots used more than 50% by the general public.
In June 2020 proposed regulations on the topic finally were issued. The proposed regulations largely adopted the rules of Notice 2018-99, but with some notable differences. The regulations introduced a safe harbor for the newly defined term “mixed parking expenses.” This consists of expenditures for things such as rent, taxes, utilities, etc., that are applicable to the parking lot and a related building, where it is difficult (or impossible) to ascertain which costs relate to the building vs. the parking lot. The safe harbor allows an allocation of 5% of these costs to the parking lot. While this can greatly simplify the calculation, the safe harbor is by no means mandatory. Careful consideration should still be given to other reasonable allocation methods that could result in a smaller disallowance.
Other differences include adding two new methods to calculating the disallowance. The general rule still exists which basically says any reasonable method may be used. Also still existing is the primary use methodology whereas you go through the calculation based on parking spot counts and the overall usage of the parking lot. The two new methods are the qualified parking methodology and the cost-per-space methodology. The latter still requires a lot of the work that comes with the primary use method but may provide some relief if you have a large number of reserved parking spots. With this method you determine what the cost per parking space is for the lot and multiply by the number of employee spots used during peak demand. The former is calculated by multiplying total number of spaces used during peak demand by employees (or just the total number of employees) by the Section 132(f) monthly limitation ($270 for 2020) for each month. While this method may be simple to use, it may result in a higher disallowance amount.
Other new rules exist that introduce some safe harbors for reserved parking spots and new definitions. This article is not intended to go into depth of the new parking regulation, but please reach out to your BNN advisor, who can apply the new rules to your specific fact pattern.
Debt & Loan Considerations:
With the ever changing economic landscape many financial institutions have had to re-work some loan terms. Often this involves a small deferral of payments or perhaps a waiver of certain fees or interest. However these troubled debt restructurings (TDRs) might need to be considered for a potential tax impact. These rules are certainly not new but have not had a light shone on them since back in 2008/2009 when it was more prevalent. Given the potential for TDRs again we thought a quick reminder and overview would be appropriate before calendar year-end.
The tax laws surrounding TDRs are complex and often difficult to apply broadly to all loans. Where tax differences come into play is when these loan restructurings rise the level of “significant” in the eyes of the Internal Revenue Service. For tax purposes, when the restructuring is significant the loan is considered to have been sold and a gain (or loss) on the loan should be recognized. This likely would generate a temporary difference and become part of the institution’s deferred tax asset (or liability). The primary things to consider when trying to determine if the loan is significant are:
- Was there an alteration to the legal rights of the borrower?
- Is the loan economically different?
Other considerations/guidance include:
- In general, forbearances of 2 years or less are not considered significant.
- Modification is significant if the debt’s yield changes by the greater of 25 basis points or 5% of the unmodified debt’s yield (fees should be kept in mind when determining a change in yield if the fee is treated as interest).
- Significant modification may exist if timing of payments creates a material deferral. A safe harbor is available for the lesser of 5 years or 50% of the original term.
The largest thing to take away from TDRs rules is that if you encounter a restructuring that you think may be significant you may want to revisit the tax rules and discuss it with your advisors.
Another player in the debt and loan considerations is deferred interest. Absent a bad debt conformity election, nonaccrual interest remains taxable unless deemed uncollectible. It is possible that some loans may be deferring interest income for GAAP and not be on nonaccrual due to COVID-19 and Cares Act considerations. Interest may still be taxable on these loans, similar to nonaccrual loans, and a timing difference will exist between book and tax.
Lastly, consider bad debt expense. It is possible that we may see some larger GAAP loan loss provisions during 2020. For the most part, what is deductible is net charge offs (or in the case of banks with less than $500,000,000 in total assets, use of the experience or reserve method). Lenders should remain aware of the criteria that impacts the timing of their tax deductibility related to these losses.
State Tax Considerations:
The concept of nexus is getting more attention in today’s remote working environment. It is possible that some employees are working from home in a bordering state in which you do not currently file a return. On a state by state basis, you will need to determine whether a filing obligation has been created in new states because of remote working. There also may be payroll tax considerations in these scenarios. A number of states have created new rules to temporarily help ease the remote working implications but you need to be aware that new filing requirements may exist.
Future Tax Rate Considerations:
Lastly, financial institutions should be keeping a close eye on the upcoming elections. The results could impact future corporate tax rates. Most questions pertain to what will occur if the corporate tax rates go up. In short it would be the opposite of what occurred with the reductions that accompanied the passage of TCJA. Corporations will be motivated to defer deductions and accelerate income into the lower tax rate years. You may look a number of things including depreciation, prepaid expenses, deferred revenue contracts, and compensation. As tax advisors, it will go our against every fiber in our bodies to recommend paying more taxes for that short window, but when you look at the entire picture over a number of years it will help save taxes, rather than increase them.
In these times no one knows for sure what new tax laws may be signed into law, what might happen to tax rates, or just what will happen tomorrow. Financial institutions during these times should be nimble, be able to act quickly in these scenarios, and stay proactive.
For more information or a discussion on how this may impact your bank, please contact Adam Aucoin or your BNN tax advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.