On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017 (TCJA). The TCJA itself is more than 500 hundred pages, and we will likely see at least that many more pages of guidance from the IRS in the coming months and years. Many would argue the TCJA is anything but simplification. Nevertheless federal income tax laws likely won’t change significantly again for several years.
Below are significant sections of the TCJA that affect the banking industry. Here you can find a more comprehensive listing of provisions. Note that most of these changes are effective for years beginning after 2017 and before 2026.
Corporate tax rate reduced
As well publicized, the major tax attribute from the TCJA resulted from the reduction in corporate tax rates to a flat 21 percent starting in 2018. This dramatically decreases the future tax of the many banks still operating as C corporations. However, C corporation earnings continue to be subject to double taxation when distributed to their owners. Along with the general tax rate reduction, the corporate alternative minimum tax (AMT) was completely repealed which eliminates the detrimental effect that large amounts of tax exempt interest possessed on a bank’s overall federal corporate tax. For those banks that previously paid AMT and have AMT credits carrying forward, the TCJA allows for the full utilization of these credits against tax from 2018 through 2021.
Cash accounting method expanded
The availability of the cash accounting method has been expanded to all taxpayers with three year average gross receipts of no more than $25 million. Using the cash method can enable taxpayers to more easily align their tax liability with cash generated from their businesses along with the deferral of the tax.
Individual income tax brackets rates reduced
For Subchapter S banks, there was also some welcome news. The number of individual income tax brackets is still seven but the rate for all brackets, other than the 10 percent bracket, has been reduced. The top individual tax bracket is down 2.6 percent to 37 percent and is applicable to taxable incomes in excess of $599,999 for married filing joint taxpayers. Prior to TCJA the top comparable tax bracket applied to incomes in excess of about $470,000.
Section 199A deduction now available
In addition to the above tax rate changes, the TCJA puts a new deduction in place for sole proprietors, S corporation shareholders and partners referred to as the Section 199A or pass-through deduction. The Section 199A deduction is intended to compensate businesses operating in an entity type other than a C corporation for the tax rate cut C corporations received. The calculation of this deduction can be complex and is beyond the scope of this article. It is generally 20 percent of the lesser of qualified income or taxable income but may be subject to limits based on wages and qualified property of the qualified trade or business. It’s important to note that one of the limits is taxable income rather than adjusted gross income. With this pass-through deduction most business owners will save more lifetime tax dollars by operating in S corporation form.
Besides the above tax rate changes and new pass-through deduction, the TCJA contains various other beneficial and harmful items to banks and their customers.
Bonus depreciation increased
On the good side of the ledger, Section 168(k) depreciation – more commonly referred to as bonus depreciation – has been increased from 50 percent to 100 percent for qualified fixed assets available for service after Sept. 27, 2017, and before 2022. Note that you must not have committed to the purchase prior to Sept. 27 to qualify for 100 percent bonus. As an added benefit, both new and used assets now qualify for this accelerated deduction. This removes tax considerations from the business decision on whether to buy used or new assets. The depreciable treatment of qualified building improvements is still up in the air as the Congressional conference report indicates they would now qualify for a 15-year depreciable period but the final tax bill was written without that language which leaves them with a 39-year depreciable period.
Section 179 eligible items expanded
The TCJA also expanded the definition of items eligible for expensing under Section 179 to include expenditures for new roofs, HVAC, fire protection and security systems on existing buildings. The Section 179 expensing limit was also increased to $1 million starting with 2017 tax years.
Business loss changes
As for less favorable items, net operating losses incurred in years beginning after 2017 may not be carried back freeing up cash flow to businesses in need. In exchange the carry forward period has been increased from 20 years to indefinitely. Furthermore, net operating losses arising in years after 2017 may only offset up to 80 percent of taxable income as they are carried forward.
Net operating losses are not the only type of loss whose present value has been reduced with the TCJA. There’s a new hurdle to fully deduct current year business losses for individual with pass-through losses. Trade or business losses exceeding $500,000 for married filing joint taxpayers and $250,000 for single taxpayers will be disallowed starting with 2018. This provision applies at the shareholder or partner level. Taxpayers with large salaries, investment or other types of income may still be forced to pay income tax even though their share of business losses exceeds their non-wage and non-business income. The excess will be carried forward to the next tax year and treated as a net operating loss subject to the restrictions discussed above. It serves in part to limit the current value of losses generated from large depreciation and other deductions.
Business interest expense now limited
In exchange for 100 percent bonus depreciation, business interest expense may now be subject to limits if your average gross receipts exceed $25 million. The limit is initially set to 30 percent of taxable income before interest expense, depreciation, amortization and depletion. Most businesses won’t have an issue with this limit but may after 2021 since the limit for years beginning in 2022 is modified to 30 percent of taxable income before interest expense only. For banks, this provision will not be of concern because it only applies to taxpayers with a net interest expense position. The concern for banks is related to the impact on their customers’ borrowings due to the potential disallowance of the interest being paid on loans.
Personal interest expense
On the personal side of interest deductibility, the TCJA reduced the maximum mortgage interest deduction to interest on the first $750,000 of acquisition debt. In addition, they suspended the deductibility of interest paid on home equity loans (HELOC) from 2018 until 2026.