On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) into law. The TCJA represents one of the most significant revisions to the Internal Revenue Code (IRC) in more than 30 years. Many provisions took effect January 1, 2018, and the TCJA will affect your bank.
In this article, we’ll touch on what we believe are the most important tax reform provisions that will affect community bankers. To keep updated on tax changes, visit BKD’s Tax Reform Resource Center.
- C Corporation Versus S Corporation
- A C corp bank will pay a flat tax of 21 percent in 2018. This provision is permanent under the TCJA. As in the past, there’s still a double tax for every dollar distributed to the bank’s shareholders in the amount of up to 23.8 percent.
- An S corp bank’s income will continue to flow through to the bank’s shareholders and will be taxed on their personal returns. The bank’s taxable earnings that are distributed to the bank’s shareholders will continue to be tax-free. The undistributed earnings will continue to increase the bank’s shareholders’ outside basis.
- In 2018, the highest individual rate is 37 percent (40.8 percent if passive). In 2026, the highest individual rate is set to go back to 39.6 percent (43.4 percent if passive) if not extended.
- In general, the bank’s shareholders will be entitled to a 20 percent pass-through deduction, which reduces the highest effective income tax rate on pass-through income to 29.6 percent (33.4 percent if passive). Please note this deduction is subject to numerous restrictions and limitations, so your bank might not receive the full benefit. This deduction is eliminated in 2026 if not extended.
- With these significant changes, a bank should evaluate its current structure to assess whether it’s still meeting its goals. When evaluating its structure, the bank should consider the exit strategy, its shareholders’ estate planning, future dividends/shareholders’ immediate cash flow needs and the bank’s capital needs.
- Other Key Bank Changes
- The TCJA provides several different ways to accelerate depreciation. Below is a recap of those options:
- For qualified fixed assets acquired and placed in service after September 27, 2017, the bank is entitled to take 100 percent bonus depreciation on both new and used additions. After 2022, this percentage starts to phase down and is ultimately eliminated after 2026.
- In 2018, the amount eligible for Section 179 (immediate tax deduction) is increased from $510,000 to $1 million. The increased amount starts to phase out when additions exceed $2.5 million. In addition to increasing the amount eligible for §179, the definition of eligible property was expanded to include certain improvements to nonresidential real property.
- Effective for 2018, a C corp bank is allowed to use the cash basis method of accounting if the average gross receipts are below $25 million. The average gross receipts test was previously $5 million. With this increase, several banks will want to evaluate making this change in accounting method in 2018. Typically, S corp banks are already using the cash basis method of accounting.
- The rules surrounding the meals and entertainment deduction have changed for expenditures incurred after December 31, 2017. Internally, the bank will need to spend additional time on capturing and categorizing information differently for tax reporting.
For more information on meals and entertainment, view this BKD Thoughtware® article and related flowchart.
- Assuming the amounts aren’t included in W-2s or 1099s, most entertainment expenditures will be nondeductible after 2017. This includes donations tied to tickets for sporting events.
- In general, most meals will still be subject to the 50 percent limitation. However, certain costs will be nondeductible starting in 2026.
- Individual Rate Change (Married Filing Joint) Table
- Other Significant Bank Shareholder Changes
- The TCJA provides several changes to itemized deductions starting in 2018:
- The combined state/local income, real estate and personal property tax deduction will be capped at $10,000. As S corp income is taxed to the shareholder, the cap would include the taxes paid on the income related to the S corp. However, since a Kansas bank is subject to the privilege tax, this is deducted at the bank level. In addition, bank shareholders are entitled to a deduction on their Kansas personal returns for the privilege taxable income. Therefore, a Kansas bank shareholder will be less affected by this revision when compared to many other shareholders that are receiving flow-through income.
- For new loans after December 15, 2017, mortgage interest paid on loans for acquisition indebtedness will be fully deductible on up to $750,000 of indebtedness. Bank shareholders also will no longer be able to deduct home equity loan interest unless the loan proceeds were used to acquire, build or substantially improve the primary residence that secures the loan (subject to the $750,000 debt limit). This will apply to the bank’s customers as well.
- There also were numerous changes to the estate and gift tax. Consider the following in future estate planning:
- For 2018, the estate tax lifetime exclusion went from $5.6 million to $11.18 million (amount to be adjusted for inflation annually). Assuming no gifts during one’s lifetime, this means a person can pass away with an estate worth less than $11.18 million without paying any estate tax. In addition, a bank shareholder can gift up to $11.18 million before death without being subject to any gift or generation-skipping tax, but this reduces the estate tax lifetime exclusion.
- Assuming this isn’t extended, the increased lifetime and gift exclusion is set to expire on December 31, 2025. To take advantage of this increased dollar amount, a bank shareholder should consider making any gifts before this provision expires.
With most of the TCJA provisions going into effect in 2018, banks should consider accelerating deductions taken on the 2017 tax return or deferring income to 2018 to take advantage of potentially permanent tax savings due to the reduction in rates. The information presented isn’t meant to be an all-inclusive listing of all changes related to the TCJA. In addition, the legislative text contained several apparent drafting errors and items that need clarity, so tax practitioners are anxiously waiting for Congress to make technical corrections and for the U.S. Department of the Treasury and the IRS to issue regulations and other guidance to assist in interpreting the law