Banks should carefully consider tax strategies for the end of 2013 and beyond.
What Banks Need to Know About Taxes for 2013 and Beyond
by Amanda Garnett
The end of 2013 brings a number of tax issues for community banks to consider. Tax rates have increased for top earning shareholders, government stimulus provisions are set to expire, and new regulations are on the horizon. Tax planning discussions with your institution’s tax advisors should be at the top of your year-end to-do list.
Corporate structure: S versus C
Many community banks elect S corporation status to mitigate double taxation on earnings. However, with the permanent higher personal income tax rates, many banks are considering whether S corporation status still makes sense for their institution.
S corporation shareholders pay taxes associated with the corporation on their personal income tax return. The maximum tax bracket for individuals increased to 39.6 percent beginning in 2013, and some shareholders may also be subject to a phase-out of itemized deductions and personal exemptions, further increasing their tax liability. In addition, passive S corporation shareholders may be subject to a new 3.8 percent net investment income tax (NIIT) on top of their ordinary income tax rates.
In contrast, C corporations pay a maximum federal income tax rate of 34 percent. If no dividends are paid by the corporation, shareholders pay no additional tax. If dividends are paid, the maximum rate on those dividends is 20 percent, plus the possibility of the additional 3.8 percent NIIT.
Though the maximum tax rate facing individuals is now higher than the corporate tax rate, remaining an S corporation or electing to become one continues to be a sound tax strategy in many cases. Of course, there are other factors to consider. Discussing the advantages and disadvantages of your corporate status with your advisors before year end will help ensure that it is still in the best interests of your institution.
Expiring stimulus provisions
The American Taxpayer Relief Act of 2012 (ATRA), passed by Congress on January 1, 2013, extended a number of stimulus provisions that have been very popular with community banks. They are now set to expire on December 31, 2013, unless Congress takes action.
Section 179
Section 179 of the Internal Revenue Code allows businesses to expense some or all of their qualified fixed asset purchases in the year of purchase rather than depreciating them over the standard tax life. Eligible property for this deduction includes new and used furniture and fixtures, computer and peripheral equipment, and certain software and vehicles. The $500,000 maximum expense limitation remains for 2013, but is scheduled to return to $25,000 in 2014.
Bonus depreciation
Automatic 50 percent bonus depreciation continues to be available on certain fixed asset purchases. It is allowed only on new property with a tax life of 20 years or less, including office equipment, computer equipment, certain software, and qualified leasehold improvements. Bonus depreciation is scheduled to be eliminated after December 31, 2013.
For banks considering purchasing fixed assets in the near future, it could be advantageous to do so before these provisions expire. To be eligible for the accelerated deduction, items need to be purchased and placed in service by year end.
In addition, banks that have recently built new branches or significantly remodeled should discuss ways to accelerate deductions. Fixed asset cost segregation studies can often be performed to accelerate tax deductions on buildings and provide significant tax savings.
Final regulations on repairs and maintenance
The IRS has issued final regulations on when expenditures related to tangible property must be capitalized and when they can be deducted as repairs. Under these rules, which take effect in 2014, taxpayers must capitalize amounts paid to acquire or improve fixed assets unless:
- The expenses are for materials or supplies
- The expenses qualify under the de minimis safe harbor rules
Since many fixed assets purchased by banks are relatively small dollar items (such as computers and office equipment), the new de minimis safe harbor election could simplify recordkeeping and result in tax savings.
The de minimus rule allows corporations with applicable financial statements, including audits, call reports, and Federal Reserve filings, to deduct up to $5,000 per item for smaller fixed asset purchases. However, there must be a written capitalization policy in place by the start of the tax year. In addition, items expensed for tax purposes must be immediately expensed for book purposes.
The rules also require repairs to property and equipment to be capitalized if the repair increases the physical size of the property, increases productivity, or substantially improves its condition.
Tax treatment of OREO expenses
Historically, the IRS considered other real estate owned (OREO) to be inventory for tax purposes, and expenses to maintain the property (i.e., property taxes, electricity, lawn mowing, etc.) had to be capitalized. Those expenses could not be deducted until the property was sold. This treatment has applied to all OREO unless the property was income producing, such as rental property. As a result, many community banks have had significant deferred tax deductions associated with their OREO properties that were unavailable until the properties were sold.
After significant challenges by banks and bank advocates, the IRS intends to reverse its position on the treatment of OREO expenses. However, it has not released final guidance on how prior and current year OREO expenses should be deducted to date. This issue may not be resolved before the end of 2013.
There’s still time to talk
Although 2013 is coming to a close with much less tax uncertainty than 2012, thorough and timely tax planning remains critical for community banks, bank holding companies, and their shareholders. Early discussions with your tax advisors will help ensure a smooth tax return process and offer thoughtful consideration of all the opportunities for your institution.
Amanda Garnett, Manager, Financial Institutions
amanda.garnett@CLAconnect.com or 309-495-8842