Financial Services – Year-End Planning & Other Considerations
Methods to Accelerate Deductions
Cash Method of Accounting for Tax Purposes
The Tax Cuts and Jobs Act (TCJA) provided the opportunity for more financial institutions to be eligible to use the cash method of accounting when it increased the gross receipts threshold, beginning in 2018, to $25 million for C corporations ($26 million for 2019 and 2020). For financial institutions that are S corporations, the gross receipts threshold is $50 million.
Under the cash method, income is generally taxed when cash is received and expenses are generally deducted when cash is paid. Since financial institutions are typically in a “net receivable” position, there’s potential for a significant tax deduction in the year of change. Qualifying taxpayers can make the election to change to the cash method by filing an automatic accounting method change (Form 3115) with the IRS. Financial institutions filing as an S corp that have gross receipts in excess of $50 million may still have the option to make the election by filing a nonautomatic accounting method change with the IRS and paying a user fee.
Therefore, if your institution hasn’t yet converted to the cash method of accounting for tax purposes, you might consider making this election for 2020. Current cash basis taxpayers should consider reducing accounts payable balances before year-end, e.g., real estate taxes, etc., to increase the current-year deduction.
Cost Segregation Studies & Qualified Improvement Property
The TCJA and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) also provided another approach to accelerating tax deductions by taking advantage of the increased 100 percent bonus depreciation available for qualified assets.
Taxpayers constructing and/or purchasing real estate should consider a cost segregation study to assist in analyzing a building’s components to identify whether certain components would qualify for more favorable recovery periods that are eligible for bonus depreciation. Learn more about cost segregation studies here.
The CARES Act fixed the “retail glitch” that was created by the TCJA whereby qualified improvement property (QIP) would be assigned a 15-year recovery period, thus being eligible for bonus depreciation. You can learn more about QIP and the “retail glitch” fix in this BKD Thoughtware® article. It’s possible your institution has assets that fall under this asset category and, therefore, additional depreciation deductions available.
Taxpayers should analyze 2020 assets to determine if such assets are eligible to be treated as QIP or, in the case of a new building, consider performing a cost segregation study to take advantage of bonus depreciation for eligible components. Also, if you haven’t already examined 2018 and 2019 assets to determine if such assets are eligible to be treated as QIP, it would be beneficial to do so to determine whether your institution needs to file amended tax returns or a Form 3115 to deduct eligible bonus depreciation not previously taken.
Additional Ways to Accelerate Deductions
For financial institutions, one additional method to accelerate deductions is to analyze substandard loans at year-end to determine if additional charge offs are necessary. Since a financial institution’s bad debt deduction is based on net charge offs, either for the current year or based on a six-year average, additional charge offs can increase the current-year deduction.
Methods to Defer Income
In addition to accelerating deductions, certain strategies are available to financial institutions for deferral of income. These strategies include changes in the method of accounting for discount accretion, mortgage servicing rights, and loan origination fees.
Since each of these income deferral strategies is specific to each institution, you should determine which strategies might be beneficial and reach out to your advisor for more details.
Net Operating Losses
As a result of the strategies mentioned above, merger and acquisition activity, or perhaps just a year with a decline in earnings, a taxpayer may generate a net operating loss (NOL). Although the TCJA eliminated the NOL carryback provisions and limited the annual NOL deduction to 80 percent of taxable income, the CARES Act changed the NOL regulations by allowing NOLs generated in 2018, 2019, and 2020 to be carried back five years and temporarily removed the 80 percent limitation for tax years ending prior to 2021. Carrying back NOLs to years prior to 2018 creates an advantage of offsetting taxable income at higher tax rates (pre-TCJA), and the income tax benefit received from carrying back NOLs to such years can be recorded currently as an offset to tax expense, creating an immediate benefit.
Please consult your BKD Trusted Advisor™ or complete the Contact Us form below to discuss your institution’s specific tax situation and year-end goals to determine if your organization can apply any of these strategies in 2020.