Year-end tax planning is imperative to the strength of your financial institution. As we approach the end of 2022, take time to prepare and organize your financials, assure accurate reporting and plan strategically for the year(s) ahead.
Tax Legislation Affecting Year-End Planning
The sweeping tax law changes expected with the Build Back Better Act in early 2021 generally did not materialize into tax law. This means tax rates and provisions from the Tax Cuts & Jobs Act (TCJA) of 2017 have largely remained in effect, with a few exceptions.
However, there is still uncertainty because 2022’s mid-term elections may change the current federal tax environment. This means calendar year-end tax planning for 2022 is still very important for community banks.
Year-End Tax Planning Opportunities
With tax rate increases for 2023 not currently expected, there are a number of tax planning strategies to consider.
Strategies for deferring income and accelerating deductions for the 2022 tax year
- Review the bank’s loan watch list and classified loans to determine if any additional charge-offs may be appropriate.
- Write down “other real estate” or “other personal property” repossessed during the year to fair market value. Keep in mind, the initial write-down may be deductible as a loan charge-off by booking it to the bank’s loan loss reserve account. Subsequent write-downs are non-deductible for tax purposes until the property is eventually sold.
- For cash basis banks, consider payment of accrued liabilities and paying certain short-term prepaid expenses that qualify for accelerated deduction before year-end.
- In 2022, accrual basis banks may also prepay and deduct some prepaid expenses. Taxes, insurance and warranty contracts may qualify for this deduction.
- Generally, an accrual basis bank may deduct accrued bonuses if payment is made within the first 2 ½ months following the end of the tax year. However, there may be limitations if the bonus plan allows the bank to retain any accrued bonus amounts forfeited by employees.
- Contributions to the bank’s qualified retirement plan are tax deductible if paid prior to the tax return’s due date (March 15, 2023, for banks with a calendar year-end), which is a special rule for retirement plan contributions.
- Review meals and entertainment accounts to assure meals purchased at a restaurant during the year are separate from other meals. Meals paid and incurred at a restaurant during 2022 are 100% deductible (otherwise 50% deductible), but this provision ends on December 31, 2022. TCJA disallowed a deduction for entertainment expenses.
- With significant differences in state tax rates, ensure state identification of loans, deposits and loan interest income is properly updated in bank records before year end. This is necessary for state apportionment calculations and to be certain that all state tax filing requirements are being satisfied. If a state tax balance due is projected, payment of that balance due prior to December 31, 2022, may provide cash basis taxpayers a 2022 federal tax deduction. A review of the bank's available-for-sale security investment portfolio is important to identify securities with unrealized losses. Sales may be considered to recognize ordinary losses before year-end. Of course, the sale of securities affects the bank’s financial statement as well, so sufficient analysis needs to be performed.
Year-end fixed asset considerations
- Review the bank’s tax depreciation schedule for assets that are no longer in service and have been disposed. The bank may be allowed a loss on disposal if tax basis remains in these assets.
- Review the dollar expensing threshold included in the bank’s fixed asset capitalization policy to determine if that amount still makes sense for the bank.
- Review the bank’s repairs and maintenance expense accounts and current year fixed asset additions to ensure compliance with the bank’s capitalization policy.
- If equipment or furniture (new or used) is needed, placing them in service during 2022 may yield tax savings.
- The Section 179 expensing threshold for qualified furniture, equipment and other assets is $1,080,000 per entity in 2022. Phase-outs begin if the total assets placed is service exceeds $2,700,000.
- If not fully expensed under the Section 179 provisions, 100% bonus depreciation on qualified assets is available for 2022. The allowable bonus depreciation deduction decreases to 80% of the cost of qualified property in 2023, to 60% in 2024, 40% in 2025, 20% in 2026 and fully expires in 2027.
- Cost segregation studies may provide significant current-year (2022) tax deductions on buildings that have been in service for several years. A cost segregation study may identify current year tax benefits available by accelerating depreciation deductions on purchased or constructed bank buildings.
Speak to an Eide Bailly tax advisor about possible clean energy tax incentives such as 179D, provided by the Inflation Reduction Act, which may benefit your bank or holding company. Our in-house Energy Incentives team includes professional engineers and energy modelers who are able to generate and certify the deductions after the necessary due diligence and review.
Specific Planning Considerations for S Corporation Banks and Holding Companies
Here are some tax planning strategies for S corporation banks and holding companies. Consider these action items when looking for ways to defer income and accelerate deductions.
- Year-end tax planning is a good time to perform relevant S corporation due diligence functions. It is important to ensure that the corporation and shareholders still meet all S corporation eligibility requirements. Carefully consider eligibility if shares were transferred during the year (especially to a trust) or new shareholders were added. S corporation banks must comply with IRS requirements and the Federal Reserve Bank rules.
- The 20%, Qualified Business Income Deduction (QBI, Internal Revenue Code 199A) is set to expire on December 31, 2025. If QBI expires, the effective federal tax rate of the shareholder group may increase without the deduction. Consider an analysis to compare current and future tax benefits and disadvantages of an S corporation to a C corporation. It is also important to consider the bank’s goals for growth and shareholder distribution strategies when analyzing entity structures.
- If the bank is in a state with a “Passthrough Entity Tax Election” (PTE) available, this election may benefit shareholders by providing a net tax benefit. Many states have made PTE elections available for 2021 and earlier years. PTE is a complex topic. Careful analysis of the bank’s specific tax situation is necessary to ascertain whether this election makes sense for the bank in 2022.
- Consider working with the bank’s shareholder group to update and maintain individual stock basis records, if that is not already a routine part of the S corporation’s year-end tax reporting process. Shareholders must report S corporation basis on their personal income tax returns.
- If the holding company meets the definition of a small bank holding company, it may be a good idea to project the debt-to-equity ratio for the 2022 year-end. Pursuant to the Federal Reserve Bank’s “Small Bank Holding Company Policy,” if the holding company’s debt-to-equity ratio exceeds 100%, shareholder distributions, including tax distributions, are not permissible under the Federal Reserve policy.
Currently, the Federal Reserve Bank includes a holding company’s entire equity accounts in this calculation, including Accumulated Comprehensive Income. This may have a substantial impact on the bank’s year-end debt-to-equity ratio, particularly for small bank holding companies with debt on their balance sheet.
Partner with a Trusted Tax Advisor for Year-End Tax Planning
To finish the year strong, financial institutions should focus on accurate reporting and proactive preparation and planning. Consult with a tax advisor for guidance on deferring income and accelerating deductions for the 2022 tax year, as well as benefiting from available business credits and incentives.
Year-end tax planning is vital to your bank’s overall financial strength. Our tax advisors will help you with your year-end and long-term tax planning strategies.