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The Impact of the Tax Cuts and Jobs Act on Financial Institutions

Tax Cuts and Jobs Act (H.R.1)

On December 22, 2017, President Trump signed the Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 commonly referred to as, the Tax Cuts and Jobs Act of 2017 (“TCJA”). The TCJA represents the most significant overhaul of America's tax system in decades. The TJCA will not only cause corporate taxpayers to evaluate the impact on year-end financial and regulatory reporting, but will have a great effect on financial institutions across the country.

The impact of tax reform on financial statements

The TJCA reduces the corporate tax rate to 21 percent, effective for taxable years beginning after December 31, 2017. Filing entities subject to the provisions of Accounting Standards Codification 740 Income Taxes (ASC 740) record their deferred tax assets and liabilities at the rate which deferred taxes are expected to reverse. As a result, a reduction in the corporate tax rate will require deferred tax balances to be remeasured at the newly enacted tax rate whether these deferred tax assets are carried directly on the balance sheet or recorded net of tax in other accumulated other comprehensive income (“AOCI”)

ASC 740, in its historic form, requires the impact of this re-measurement to run through continuing operations on the income statement as tax expense. This is true for items that are included in AOCI although the deferred tax items in AOCI were not created through the income statement. This is generally referred to as ASC 740’s prohibition on backwards tracing. Applying ASC 740’sprohibition on backwards tracing requires the deferred tax effect of a change in tax law or rates be recognized as a component of income tax expense or benefit from continuing operations in the reporting period that includes the enactment date whether the deferred tax was created through continuing operations.

In simplified terms, the ASC 740 treatment ends up reclassing impacts of AOCI to retained earnings. This treatment has two impacts that are considered detrimental to the financial services industry. First, this treatment results in something called “stranded effects”. Stranded effects are defined as balances sitting in AOCI that are no longer representative of the actual underlying items. Secondly, the movement in these items can impact regulatory capital.

As the bill was enacted before December 31, 2017, calendar year companies will remeasure their deferred tax balances within their December 31, 2017 financial statements. For companies with year ends before December 22, 2017, the enactment falls outside of the period subject to the financial statements. As such, if those companies have not yet issued their financial statements they will need to consider if the new tax law represents a reportable subsequent event.

FASB’s reaction to tax reform and the financial reporting of comprehensive income

In response to the enactment of the TCJA and the above noted potential negative impacts, members of the financial services industry submitted unsolicited letters to the FASB expressing their concerns. While the long-term impact of the corporate rate reduction will be beneficial to the financial services industry beginning in 2018, generally the short-term impact of financial reporting for the rate re-measurement was projected to be immediately detrimental to current operations.

On February 14, FASB issued ASU 2018-2, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, allowing companies the option to reclassify the stranded effects remaining within AOCI to retained earnings which will simplify the future accounting for those companies that chose to adopt. Additionally, the reclassification adjustment, if recorded, would immediately address capital concerns raised by members for those tax adjustments typically recorded through the statement of shareholder’s equity. This change is effective for all entities with fiscal years beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted, including adoption in any interim period for which financial statements have not yet been issued. Financial statement disclosures in accordance with the ASU will be required.

Other impactful provisions of the TJCA are as follows:

AMT Planning

Alternative minimum tax (AMT) is a second tax system that affected certain corporate and non-corporate taxpayers. This system was designed to reduce a taxpayer’s ability to avoid tax all together with the creative use of specific deductions and preference items. For corporate taxpayers, AMT will be repealed for tax years beginning after December 31, 2017, which may provide institutions with non-taxable income streams an overall effective tax rate less than the 21% statutory rate.

Many entities have AMT tax credits for AMT taxes paid while the AMT was in effect. For tax years beginning after 2017 and before 2022 the AMT credit carryforward will be refundable and may offset regular tax liability up to 50 percent of the remaining AMT credit after regular tax has been reduced to $0. Any remaining AMT credits will be fully refundable in 2021.

Net operating losses

Historically, net operating losses could be carried back two years and carried forward twenty. For net operating losses arising in tax years ending after December 31, 2017, the two-year carryback is repealed but may be carried forward indefinitely. Net operating loss carryforwards may only be used to offset 80 percent of future taxable income. Institutions may need to evaluate the impact to regulatory capital calculations and be prepared to make estimated tax payments on reportable taxable income.

Reporting meals and entertainment expenses

The TCJA provides additional limitations on the deductibility of business meals and entertainment expenses. Under the TCJA, entertainment expenses paid or incurred after December 31, 2017 are generally 100 percent non-deductible unless the expenses are related to recreation, social, or similar activities primarily for the benefit of the taxpayer’s employees, other than highly compensated employees.

The TCJA also limits business meals provided for the convenience of the employer. Amounts paid or incurred after December 31, 2017 for business meals are now only 50 percent deductible. Barring further action by Congress, business meals provided for the convenience of the employer will be considered fully non-deductible for tax years beginning after December 31, 2025. We encourage management to review internal policies, expense reporting procedures, and general ledger management to ensure the provisions of the new law are accounted for appropriately.

Capital improvements

For property placed in service in tax years beginning after December 31, 2017, the maximum amount a taxpayer may expense under Code Section 179 is increased to $1 million, and the phase-out threshold amount is increased to $2.5 million.

A 100 percent first-year deduction is available for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. First year-bonus depreciation phases down in tax years after 2023 and is currently expected to sunset after 2026.

Credit for employer-paid leave

Tucked into the new law is a provision that offers companies a tax credit if lower-wage workers are provided paid family and medical leave. To be eligible for the credit, an employer must have a written policy in place that provides at least two weeks of family and medical leave at a rate that is at least 50 percent of an employee’s normal pay rate. The amount of credit is based on a percentage of wages that are paid to qualifying employees, for tax years beginning after December 31, 2017 and before December 31, 2019, equal to 12.5 percent of the paid family and medical leave wages if the rate of payment is 50 percent of the employee’s normal wage. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the payment rate exceeds 50 percent.

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